Update

Hi Guys,

I’ve been a bit sick and also really busy lately, so I haven’t posted anything in about 3 weeks. So I want to update, there will be no ‘Official’ May Performance Report, but I’ll summarize the updates on each position on here as of today’s date (5/5/2016) – Happy Cinco De Mayo btw – Regular monthly performance reports will commence in June. The portfolio rose 0.49% vs 0.39% for the S&P 500. The portfolio is still about 50% invested, it’s difficult to find bargains in this market – most of the ‘cheap’ cyclical stocks are stuffed with overvalued inventories that still need to be written down, so I don’t want to buy something just because it looks cheap. I’ll update for the other indexes later on the homepage, but I believe it underperformed all other indexes except the S&P.

Flanagan Enterprises (BDL)

I want to start with BDL since I purchased this stock mid last month but didn’t have time to post about it. This is going to be a very brief summary of what I would have written. I purchased this at $21.2, the stock trades at about $18/sh so i’m about 15% underwater now.

In a nutshell, the company owns and operates restaurants and liquor stores in the Florida area. The company still generates mid to high single digit comparable store sale numbers and is growing at 10% and yet it trades at about 11x earnings.

The company partners up with other investors on the restaurants and the way the partnerships work is that the company pays the investors with the cash flows and collects no management fees beyond the money required for regular operations. Once the investors receive their invested money back in full, then the cash flow each restaurant generates is split in half between the company and the investors. So, the company is basically guaranteed to increase the bottom-line in the future. This won’t happen quickly, but if you were to model this out, the company should at least trade somewhere around 15-20x earnings. So I believe there’s at least 50% upside from these prices. S&P’s P/E ratio is about 24x, so the current P/E is less than 1/2 of S&P’s.

While the company carries about $10 million in debt, it also owns about $20 million of land and property in florida, so there is sufficient equity to conservatively eliminate the debt from any valuation calculations.

Please note that BDI and BDL are different. BDI is Black Diamond Group Ltd, BDL is Flanagan’s Enterprises.

Other Positions

Before doing this, I want to send my thoughts and prayers to the people of Fort McMurray. As some of you may have heard by now, there is a massive wildfire in the Canadian city of Fort McMurray. The city has been evacuated – though no casualties have been reported, people have lost their homes and belongings.

Canadian Trail

(Longs)

The Canadian stocks have basically offset each other over the past few days. Gamehost down 17% because of the Fort McMurray fire (more below) and Black Diamond up 28% today because it has excess capacity for temporary housing in the Oil Sands around that area.

Gamehost Inc.

Gamehost was my largest position just a few days ago. One of Gamehost’s Casinos – Boomtown Casino –  is located in the city of Fort McMurray. With the wildfire causing a complete evacuation of the city, the effect on earnings becomes obvious. Less activity at the Casino – if it even survives -and thus, less earnings for gamehost. I called the company two days ago to get more information before posting about this, but they were swamped with thousands of investors attempting to ask the same question I was – Is the building insured?

Per the company’s filing on Sedar yesterday:

The Company’s Boomtown Casino in Fort McMurray, Alberta is fully insured including property and business interruption coverage. All Gamehost properties and operations are fully insured by a leading multinational property and casualty insurance company. Management has initiated an insurance claim in anticipation of losses at our Boomtown Casino and is currently in discussions with the insurer regarding due process.

I had a 37% equity in the position wiped down to about 16%. I’m going to add more when I trim Black Diamond. I want this position and Black Diamond Group (See Below) to make up 25% of the portfolio. Any more positions on Canadian stocks will be hedged with futures or put options shorting the CAD to reduce currency exposure.

Black Diamond Group Ltd

BDI reported earnings yesterday and shot up 28% today – I don’t believe it was because investors liked the earnings, but because of the fire in Fort McMurray since BDI provides temporary housing. Total equity in this position is +19% and it’s now my largest position after the Gamehost decline.

The company reported:

  • 47% q/q decline in revenues and Q1 EPS of -0.06.
  • Total debt q/q down 20%

As I mentioned in the original thesis, the dividend was cut down to pay down debt and the company will still be cashflow positive even though earnings will turn negative. So that’s precisely what we’re seeing. While the company reported a loss of $2.4 million, it actually took in about $10 million of cash for the quarter. This is because of the discrepancy between the CapEx and Depreciation I mentioned in the original thesis.

The company has historically sold its used fleet for above book prices, but since the industry is depressed. Assuming a conservative 20% haircut on book value, the company will still trade below the new book value – this means we’re basically getting the company for free! The positive FCF and debt repayment should continue while we wait for the industry to recover.

The fire in Fort McMurray is providing support to the price, so as of 5/5, it makes up about 13% of my portfolio after the +28%. Once the stock surpasses book value, I’ll trim it down to 10% of the portfolio.

United States’ Trail

Pacific Health Care Organization

No new news on PFHO, but it has been fairly volatile. The illiquid nature of the stock leads to large swings in price. I’d buy more, but the bid/ask spread irks me. Price target remains the same at about $14/sh

Pier 1 Imports

Pier reported earnings and guided to higher margins as I anticipated in the original post. One mistake I made however, was ignoring the competitors. Piers inventories were so far in line that I thought their competitors would be irrelevant, but they are not. Virtually every cyclical company is stuffed with overvalued inventories that will have to be sold off. The company did guide to higher margins and is first in line for the industry recovery, so I’m holding on for now.

Trip Advisor (Short)

Reported earnings earlier this week. Revenues declined but investors are still not paying attention to the more important declining metrics – Trip’s Revenue per hotel shopper and Expedia’s Revenue per hotel night.

The company has investors convinced that their ‘successful expansion’ in China will fuel growth will 2017 while 2016 ‘will remain muted’. The same China where iPhone sales just fell (-25%) off a cliff?  They have been deceived into pricing a company with declining revenues at 45x earnings. The company will have to fight an uphill battle with growth since the price of the service is in a deflationary spiral.

CarMax (Short)

CarMax’s inventories remain elevated. One mistake I made on this one was buying short-term (1 year, January 2017) puts. I regret that and will get rid of all 2017 put options on the portfolio next time we have another volatility stint.

Recovery rates y/y fell from 54.2% to 51.2%. Inventories fell relative to sales, which is actually good. Past due accounts and LTV ratio trickled up a bit. The U.S. economy continues to slow and I believe we will likely see easy credit slow, which is bad for CarMax.

LuluLemon (Short)

Lulu reports earnings later this month. I’m going to address the company after that happens. I’m still yet to add my January 18′ put, but if the stock sees $65 again, I’ll add January 18′ put options.

Mind CTI Ltd

Reported earnings this week as well. Revenues fell 19%. This was expected. As I mentioned, the company’s sales has historically risen over the long-term but have wildly fluctuated, which is why it trades at 5x its Enterprise Value. Its 10% yearly dividend is basically a unicorn in today’s market.

 

Update $LULU $KMX $BDI

I increased my stake in Black Diamond Group (BDI) by 11%. Crude oil has been shooting up, and BDI has not moved. I’m still looking to add the 2018 LULU puts, but the stock has been falling, so I’m holding back until we see some price support. I don’t want to buy it only to see the puts decline the following week. Carmax reported earnings, and I want to refrain from making any comments until they file the 10-K.

 

Black Diamond Group Ltd.: Beaten down Crude Oil Service Provider With Substantial Upside

Note: Purchasing is possible in U.S. Dollars (USD) on OTC Markets, or on the Toronto Stock Exchange (TSE) in Canadian Dollars (CAD). For liquidity purposes, I will be buying in Canadian dollars on the TSE. So, all figures listed are in Canadian Dollars, unless otherwise noted. Current USD price is $3.52, and CAD price $4.58 (3/18/2016).

Real Time price: BDI 2,68 +0,17 +6,77%

Purchase Price: $4.60 (3/18/2016) Market Capitalization: $188 Million
Price Target: $13.80 (200% Upside) Enterprise Value: $345 Million
TTM EV/EBITDA: 4.10 Time Frame: 24 Months

Black Diamond Group Ltd: (TSE:BDI) rents and sells modular workforce accommodation and space rental solutions to customers in Canada, the United States and Australia. In addition to providing turnkey lodging and other support services related to remote workforce accommodation and space rentals, the company also provides specialized field rentals to the oil and gas industries of Canada and the US. The company is headquartered in Calgary, Alberta, Canada, and operates under 4 segments:

  1. Structures Provides modular structures designed for remote site accommodation and space rentals. The remote site accommodations, when assembled together, form large dormitories, kitchen/dining facilities and recreation complexes. Space rental modular structures provide high quality, cost-effective modular space solutions to a diverse customer base in Canada and the United States. The space rentals fleet includes office units, storage units, office complexes, training facilities, lavatories and custom manufactured structures.

    Structure BDI Created for Mount Milligan Project in British Columbia
    Structure Black Diamond Group (BDI) created for Mount Milligan Project in British Columbia.
  2. Logistics – Operates remote lodging facilities for itself and other third parties. The primary revenue sources consist of turnkey lodging services for camps operated by Black Diamond, remote facility management and supply chain solutions. The majority of the business activity within this segment occurs in western Canada.
  3. Energy Services Provides accommodations fleets for drill camps, geologist/engineer quarters and staff quarters. Energy Services also provides a complement of surface rental assets that would typically support a drilling or completions operation such as solid and liquids containment, rig matting, and support equipment. The primary revenue sources consist of rental revenue for this equipment, and non-rental revenue consisting primarily of catering, transportation and servicing of equipment revenues.
  4. International and Corporate – Provides modular structures for remote workforce housing and modular workspace solutions and provides associated services in Australia and other areas outside of North America. The primary revenue sources consist of rental revenue for this equipment, and non-rental revenue consisting primarily of catering, transportation and installation revenues. Corporate includes the costs of head office administration, interest costs, taxes, other corporate costs and residual assets and liabilities.
5-Year Chart – YCharts
Black Diamond Group Ltd. (BDI) 5-Year Price Chart

WHAT HAPPENED?

The stock peaked in may 2014 at $35.70 and trades at $4.58 or 87% lower. This was driven by two factors:

1. China’s Real Estate Bubble & Iron Ore

Iron Ore 20-Year
Iron Ore 20-Year Price Chart (Source: Index Mundi)

Iron Ore comprises 26% of Australia’s exports. Iron Ore is used to make steel, which is used in real estate construction around the world. The Iron Ore price run-up from 2005 – 2011 was driven by the Chinese Real Estate bubble which also occurred during the same period. China produces just over 40% of the world’s Iron Ore supply, but consumes more than that. By default, the second largest producer, Australia, is the world’s largest exporter.  Since China consumes more than it produces and it is the worlds largest producer, it consumes 64% of the world’s Iron Ore exports. China is Australia’s largest trading partner for this very reason. Three Chinese cities, Shanghai, Shenzhen, and Beijing have Property Price – to Income ratios of over 30, Beijing’s property prices rose 800% from 2003 to 2011! To put this into perspective, New York and San Francisco’s red-hot bubble real estate market have ratios of 14 and 22. It puts Vancouver and Toronto’s bubble to shame.

In 2010/2011 Chinese authorities became weary of a real estate bubble required any family purchasing a second home to put down 60%. This, along with the number growing unoccupied real estate in China brought Iron Ore demand to a halt. Most producers, expecting stable demand, had no plans to curb production. This led to the oversupply, and thus, the falling Iron Ore prices. The market is still in a deleveraging phase that will likely need a few more years to stabilize.

BDI’s International and Corporate segment provides services in the resource rich states – Queensland and Western Australia – of Australia. It was hit by the falling commodity prices when demand for its workspace and work force housing services fell along with the commodities.

2. U.S. Shale Oil Bubble

Crude Oil 20-Year
WTI Crude Oil Spot Price (Source: Index Mundi)

In 2009, energy companies began using improved drilling techniques to extract oil from shale rocks. This process is costly, but was justified because of high Crude Oil prices. U.S. based oil production slowly gained market share at the expense of other Oil producing countries. This led to a supply/demand imbalance, hence the level of crude oil prices today.

BDI provides services to the Oil and Gas sector primarily in Canada, but also in the United States. Depressed Crude Oil prices led E&P companies to curl CapEx spending which hurts BDI.

RISK

Debt

The company carries $159 million of debt today, but paid $37.4 million towards the debt load last year. The CapEx and dividend cut should propel the debt reduction. The company also holds hard assets with a book value of $547 million. The company has historically been able to fetch above book for its used assets. So, the workforce accommodation fleet assets ($339 million BV) can be liquidated if it does come to that – I don’t believe it will.

WHY BUY NOW?

Low CapEx

Like Gamehost Inc., maintenance CapEx ranges from about 1-2% of the Asset values. This means that the company is able to curl those expenditures at will. CapEx spending over the past few years have been more on growth than maintenance.

The company is vertically integrated, meaning that the segments depend on each other. For example, the logistics segment provides catering, waste management, security services etc. to the structures and Energy Services segment. So as CapEx gets cut for the Structures, the Logistics segment automatically slows the necessity to spend. This is beneficial as the company has the foresight to curb expenses for all other segments automatically. CapEx has dropped from $120 million in 2014 to $50 million in 2015 to an expected $10 million in 2016. The company depreciates ~$55 million a year, but won’t need to purchase anymore equipment or structures until the coast clears. So while net income may turn red, cash flow will remain green.

Dividend

The company recently cut its dividend and will be paying, even after the cut, a robust 6% forward dividend yield at these prices. The cut is necessary at this time due to the depressed oil prices and the necessity to divert the cash flows to its debt load.

Crude Oil Recovery

Although U.S. production is falling, inventories are still rising. We need to thread cautiously. I do believe, however, that we will see a bottom by this time next year (hopefully).

Iron Ore Recovery

This will likely come after the crude recovery since the deleveraging phase is so much larger. A significant risk to this is China’s slowing economy. But As the world works off the excess inventory, we should hopefully see a bottom within a few years or so.

VALUATION

Asset utilization peaked in 2012 because of the Iron Ore slowdown. Assuming that the company resumes back to peak revenue levels with 15% profit margins as it was before the slump, we’d be paying approximately 3.25x peak earnings. This is a company that recorded revenues of $5 million in 2006 and then $386 million in 2014, or a CAGR of 72% – It’s one of those hyper growth stocks that kept reinvesting profits. The growth will likely resume and even run higher once crude oil stabilizes because of the increased capacity before and during the oil slow down. I believe a 200% run from these levels is reasonable.

Conclusion

I bought this on Friday (3/18/16) for CAD $4.60 and it’s my largest position at 11% of the portfolio. This is not for the faint-hearted as it’s likely going to be volatile. As some of you know, unlike most hedge fund managers and virtually all of academia, I do not equate volatility or beta to risk. My belief is that risk comes from whatever distorts the future cash flows of a company and not the volatility of its stock price or stock prices in general. The depressed price of Crude Oil is a clear risk, but will likely subside as the market corrects itself. U.S. Crude Inventories are still rising, so this might take at least few months before we see a real bottom. My next trigger buy will be at $4.00, and then $3.50. I’ll increase my position by 25% each time the stock price drops below the trigger levels.