CarMax fell post earnings; the puts didn’t move much. The spread did thin, however. I’m going to wait for the next volatility period to get rid of them. I also added some more PFHO yesterday at $8.00 to rebalance it at about 5% of the portfolio.
Pacific Health Care Organization reported earnings on Thursday and fell 26% on Friday. One thing I missed in my earnings forecast was the operating leverage; this happened because I did not use a financial model. Nonetheless, the company still worth a premium above today’s prices. I tried to place a limit order for Friday around $6.80, and my broker did not execute the order and the stock subsequently rallied. At today’s prices, it trades at a slight premium to book. Provided the company does not lose another major customer, it is still worth at least 30-40% above today’s prices on a zero-growth valuation basis. I’m going to be on the lookout to pick up more shares today if we see another drop.
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.
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.
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 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’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.
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.
Lululemon reported earnings last week. Things to note:
- Revenues rose 15%, net income increased 11%
- Comparable store sales increase 5% and 10% on a ‘constant dollar’ basis
Funny thing is the management of retail companies love the ‘constant dollar’ comparisons when the ball falls in their park. I’m yet to see one report inventory increases on a ‘constant dollar’ basis. Cash from Operating Activities fell 6% because inventories rose a staggering 37% y/y. Gross margins decreased from 50.86% to 48.4%. Management says that:
We are in fact seeing inventory levels rebalance with sales now that we are deep into Q1, so we remain confident that our inventories will be well aligned with forward sales at the end of the quarter. (Source: Q1 Transcripts)
Gross Margins are not going to stay stable while inventories move in line with sales. The problem Lululemon faces is secular. They are getting undercut by competitors selling the same apparels for lower prices. Although LULU is forced to cut prices, they are attempting to keep that to a minimum for brand image purposes. One of two things will happen:
- Gross Margins fall
- Inventories Rise
Since management says that inventories are in-line with sales, we should expect a decline in gross margins; and voila:
We anticipate gross margin to be approximately 47%. The factors driving this are continued improvements in product margins as we benefit from lower airfreight usage and improved initial merchandise margins. (Source: Q1 Transcripts)
They guided gross margins down to 47% from 51.4% last year! The only way to keep gross margins stable is to pile inventories. The only way to push down inventories is for gross margins to fall. The stock rose 10% after earnings. I’m going to add January 2018 puts to the portfolio. These puts will make up 1%. This means that Lululemon puts will now make up 1.5% of the portfolio. Hopefully, the markets do not open with too much volatility.
Pacific Health Care Organization
PFHO also reported earnings last week. Things to note:
- Revenues fell 13.1% y/y
- Net Income fell 14%
More importantly, as I mentioned in the original post, the costs are very variable because costs for the segments that those two clients were concentrated in are outsourced. The company shed the costs under that by 38% and was able to keep net margins in-line with sales.
A look at the updated balance sheet above shows a cash balance of $3.8 million, Acct receivable of $1.04 million. If we take the rest of the current assets at face value and then assume that the rest of the assets (long-term) are worth nothing, then the hypothetical book value comes out to $5.222 – $0.385 = $4.835
The liquidation value comes out to $4.835(Book value) – 8.24 Million (Market Cap) = -$3.41 Million
Now, since Part of the AmTrust revenues were shed in Q4, shedding the total 2015 net income in half is conservative since we’ll be double counting part of the removal of AmTrust. 2015 Net Income of $1.677 million/2 = $838,500.
The company now trades at $3.41 million/$838,500 = 4.06x earnings. Now, I don’t want to speculate on what revenues will be next quarter; I’ll leave it to the real analysts to do that. I no longer use financial models, but you do not need Excel to tell you that this thing is a steal, even at $10/share.
I’m moving the price target from $11.76 to $14/sh.This still makes up just over 5% of the portfolio. Let’s hope for a stellar Q1!
|Purchase Price: $7.85 (2/15/2016)||Market Capitalization: $6.23 million|
|Price Target: $11.76||Enterprise Value: $2.95 million|
|Upside: 50%||TTM EV/EBITDA: 0.96|
Pacific Healthcare Organization Inc (OTCMKTS:PFHO) is a specialty workers’ compensation managed care company providing a range of services for self-administered employers, insurers, third-party administrators, municipalities and others. The Company Operates under 5 segments:
- Medex – Administers Health Care Organizations and Medical Provider Networks. Helps clients save money by giving them more control over the Insurance claims process, reducing the cost of fraudulent claims and disability awards in the process.
- Industrial Resolutions Coalition, Inc (IRC) – Creates legal agreements for the implementation and administration of Workers’ Compensation Carve-Outs for California employers with collective bargaining units
- Medex Medical Management, Inc. (MMM) – Manages Nurse case management services
- Medex Managed Care (MMC) – Offers automated medical bill and utilization review services that can cut the overhead costs of the clients and increase payer savings.
- Medex Legal Support (MLS) – Offers lien representation services
The company lost its second largest client, Companion Property & Casualty Insurance Co., in the second quarter of 2015, after it was acquired by Enstar group in August 2014.
On November 2015, they reported that their largest client, AmTrust North America (34% of FY 2015 first 9 months revenue), provided a 60 day notice to cease all services. This means that revenues and profitability will be affected as early as Q4 of 2015 (they report in next month, March 2016). This will also be reflected in its 2016 financials, hence the 0.96 EV/EBITDA ratio.
Why buy now?
Less Exposure to Large Clients
Having lost its two largest clients, the company is now less exposed to concentrated clientele risks. As of December 31st, 2015, according to the 10-K:
During 2014, AmTrust North America, Companion Property & Casualty Insurance Co. (“Companion”) and Prime Health Services, Inc. accounted for approximately 19%, 13% and 13%, respectively, of our total sales. During 2013, AmTrust North America and Companion accounted for approximately 14% and 13%, respectively, of our total sales.
The only one of those three companies left is Prime Health Services, Inc., which by my estimates, should account for approximately 20% of 2016’s revenues. It’s also likely, though, that one of the existing clients will become a ‘large’ client as a result of the smaller base.
For its Utilization Review and Medical Bill Review sub-segments, the company outsources employment and is able to feasibly cut those cuts. To put this into perspective, after Companion Property & Casualty Insurance was acquired, Pacific Health Care lost it as a client in Q2, and subsequently shed $393,000 of outsource service fees in Q3. AmTrust North America is concentrated in those two sub-segments. The company should be able to shed the costs associated with that client. CapEx is also minimal as the company provides services and does not manufacture anything.
No-Growth Liquidation Valuation
The company carries a solid balance sheet. High cash balance and no debt. The company also generated $1.8 million in FCF in 2014. FY 2016 cash flows will be lower as a result of the loss of AmTrust and Companion (both of these were included in FY 2014 and partially 2015 financials). I’m going to tackle the valuation from a liquidation perspective. We’ll start with the balance sheet (Note: I’ve hidden some cells for presentation purposes):
The actual case represents the numbers on the balance sheet as of Q3. The base case assumes that account receivable takes a 4% (in line with historical bad debts) haircut, all other current assets, -25%, PP&E, -66%. The bear case assumes that accounts receivable takes a 50% haircut, all other current assets + PP&E, -75%. We arrive at Liquidation Value (LV) of -$1.71 million (base) and -$2.62 million (bear).
From a profitability perspective, the company generated $6.7 million in revenues with net income of $2.4 million in the first 9 months of FY 2015. Companion and AmTrust were responsible for $2.61 million or 39% of revenues. Now if we take the FY 2014 revenues of $9.46 million and shed 50%, rather than 39% (for conservative purposes), we arrive at $4.73 million. Profit margin for FY 2016 was 21%, but we are going to use a conservative 15% to arrive at net income of $709,500. If we also assume that net income approximates cash flows, then the company would trade at an LV/FCF ratio of 2.42 for the base case and 3.7 for the bear case. I’ll have a better idea of what these numbers will be when the dust settles after Q1 2016 in may. I do believe, however, that my assumptions above are reasonable. The company could also be taken private as the CEO owns just under 60% of the shares outstanding. He also purchased more shares after the November drop. One of the directors also bought some shares earlier last month and now owns 7% of the company.
This one’s very illiquid, so I’m going to be buying it in small sizes over the course of this week to avoid a price spike. This will make up 5% of the portfolio.