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


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.


Short: CarMax

Current Price: $44.89 (1/21/2016) Market Capitalization: $8.81 Billion
Enterprise Value: $19.37 Billion TTM EV/EBITDA: 17.43
Price Target: $15 (~66% downside) Time Frame: 6 – 24 months

Note: The enterprise value figure includes $9.34 Billion of non-recourse loans. The real debt attributable to CarMax is circa $1.2 Billion

Real Time price: KMX 63,97 -0,85 -1,31%

CarMax (NYSE:KMX) is the largest used car retailer in the United States. CarMax market offering entails 1-10 year old used cars. CarMax operates under two segments:

  1. CarMax Sales Operations (CSO): sells used vehicles, purchases used vehicles from customers and other sources, sells related products and services, and arranges financing options for customers, all for fixed, no-haggle prices.
  2. CarMax Auto Finance (CAF) provides financing solely to customers of CarMax. Basically, it acts as the middle man between the bank and the borrower and collects the spread between what the bank charges it and what it charges the borrower. While CarMax holds these loans on their balance sheet, the loans are non-recourse with regards to CAF.
CarMax Price Chart
(Chart 1) CarMax 5-Year Price Chart

The stock has declined over the past few months due to slowing sales and declining same-store sales. The sharp decline on the Chart 1 in late 2015 and early 2016 can be attributed to the massive sell-off  global markets have experienced as a result of the high-yield bonds associated with low oil prices as well as the fears of a slowing Chinese economy.

Investors are not fully pricing the imminent headwinds CarMax faces, and I believe the stock price is going to trend lower.

Catalysts for a lower stock price

The auto industry is cyclical; once the economy turns, so will CarMax’s business. The signs of this end-cycle is becoming more apparent by the quarter:

Rising loan delinquency rates and dropping recovery rates

Delinquent loans, according to CarMax, those are 31 days past due. Delinquency rate is the dollar amount of delinquent loans as a percentage of total loans. Although CarMax originates and services these loans, they are not responsible for delinquent borrowers. The cars are repossessed and sold, the lender gets whatever is recovered; that is the recovery rate.

Delinquency and Recovery Rates

CarMax faces deflationary headwinds as a result of the strong dollar and the record auto sales. Recovery rates have fallen from 58% to 49% in just 1.75 years. A 49% recovery rate means that when the car is repossessed and sold, the lender only gets 49% of what the customer owes. A dropping recovery rate makes the industry less attractive to lenders. Delinquency rates have risen from 2.5% to 3.2%; more borrowers are defaulting. As we await Q4 numbers, my guess is that the trend will continue. 2015 Auto sales, although debt driven, came in at 17.5 million highest since the peak of the dot-com bubble of 2000. This bodes poorly for CarMax since the 2015 cars and the close third 2014 16.5 million cars will eventually turn into used cars, aiding the deflationary pricing pressures and tumbling recovery rates.

Piling Inventories

Inventory turnover has been falling. This highlights the coming margin compression as management is yet to get rid of the excess inventory it has compiled over the past 2 years.

inventory turnover
CarMax Inventory Turnover

Rising Rates and Decreasing supply of Auto Loans

CarMax’s business is wholly dependent on external financing. So as more of these loans default, more lenders will slowly pull away from the market, starting with the subprime borrowers. This will both push up auto loan interest rates and also decrease the size of CarMax’s potential target market. It is also important to note that this is with ZIRP  in place.

Short Strategy

January 2017 $25 puts sit at $0.75, and the 2018 $30 puts sit at $3.

I purchased January 2017 puts yesterday at market open, but the stock is up about 6% since then. So, the puts that I bought for a dollar, are now worth $0.75. The long portfolio is up as well, so it has offset this. Also, these puts make up just 1% of my portfolio and I will be doubling down in the event that the January 2017 falls to $0.50 or if the January 2018 falls below $2.50, then I will add that instead. The numbers to watch out for in the March earnings report are the Inventory turns, delinquency and recovery rates. If those go south, and the stock still goes up after the report, then I’ll be doubling down regardless of price.