Wednesday, 25 November 2015

Update to Real Time Asset Allocation Experiment, November 25, 2015

November 25th update:

As November draws to a close, I likely won't be adding any units of the various equity index funds I hold at TD.  Thus far, the monthly close on SPY will not be meaningfully lower than the previous month's close.  The month is flat vs. October 31.

The updated table below encompasses initiation date through current holdings of the index fund portion of my retirement accounts.  I may end up adding to the bond index holdings as the monthly price change in the Canadian long bond index through current vs. previous month has been around -3/4 of 1%.  If I do $100 across all of the accounts, I will end up with an $800 allocation on November 30.

DatePrice SPY (input)PX SPYPrice Bonds TD E-series (input)PX BondsCumulative unitsM2MP/L Per unitCumulative costValue Index (input)Value Bonds (input)P/L unitsCpd. annualized return

Bought 50 United Guardian, $19.08 - update

I will do a more detailed post on the company over the next few days.

Suffice to say, in brief, the company is a specialty chemical company which appears to have a wide moat product, Lubrajel, used in various end market products, namely; cosmetics, personal care, pharmaceuticals, medical lubricants, healthcare and industrial products.

Lubrajel comprised approximately 86% of revenue in 2014.  The company sort of reminds me of WD40 in this way.  The company's pharmaceutical product, Renacidin, comprised approximately 8.6% of revenue in 2014.

The company has no debt, and has about $3 per share of net cash (just cash + securities less total liabilities).

The CEO owns 30% of the shares and the company pays a variable dividend, currently $.82, so good for a 4.3% yield.

The company trades at just under 16x ttm eps of $1.22 (but ttm are inclusive of a spike in sales due to Yuan devaluation impact).  If I apply a 15 x multiple to eps of $1.22 plus net cash of $3, I get $21.30 per share, about 10% above current.

Important update.  It's likely that forward eps will not be $1.22.  In their Q3 2015 report the company warned of softness for the final quarter as a result of sales to China. As the company has earned .91 for the 9 months ended September 30, 2015, I'm going to assume at least $.91 in eps for fiscal 2015. The company earned $.09 per share in Q4 2014.  Assuming no growth, we get $1 in eps for 2015 if the compamy earns $.09 in Q4 2015. 

Here are the last 5 quarters:

There are some key risks here which need to be addressed:

  • Significant dependency on one product (Lubrajel) and economic dependency on marketing partners to distribute the products
  • Tiny microcap with tiny float, will thus affect liquidity
  • Variable dividend policy as noted above
  • Significant proportion of sales to Asia

I believe that the investment thesis here is a function of possible future cash flows from sales of the company's Renacidin 30ml product (currently under FDA review).

Will chime in on further analysis over the next few days.

Tuesday, 24 November 2015

Corus Entertainment Inc., Danger Will Robinson (For equity anyway)

I often check the high yield offerings at TD, and it seems they've had an inventory in Corus' 4.25% bonds, due Feb 11, 2020 for a while.

Here's a snapshot of the inventory as at today's close:

These yield 5.53% (at TD's offer), and are rated BBH by DBRS and BB+ by S&P.

For $.9525, you can get yourself a YTM of about 250 bps over comparable risk free GIC's maturing in 4 years.  My question, is it enough?  4 years is a long time, and as we all know in market land, anything can happen.

Here's the chart over the last year:

Pretty dismal.  If equity is down 50% this year alone, I'm wondering why the bonds are still priced at 95% of par.  I'd hazard a layman's guess that there is more uncertainty regarding the sustainability of the monthly dividend than there is over the bondholders being made whole in 2020, hence equity gets the short end of the stick.  Given the pounding the stock has taken thus far in 2015, I wonder if a dividend cut is already priced in (I'm in no way, shape or form advocating purchasing the stock).

As part of the company's loan agreement/s, Corus is subject to certain restrictive covenants. From reading their statement of interest coverage compliance for the fourth quarter ended August 31, 2015, it appeared that the company was in compliance.

Here's a snapshot of the balance sheet as at Augst 31, 2015:

And here's the note disclosure on the long term debt from the same quarterly report:

A cursory look at the composition of the debt shows about 50% of the total debt are bank loans, while the remainder are Senior Unsecured Guaranteed Notes, which incidentally, are the bonds TD has on offer.

Further, I note that the banking syndicate hold as collateral, a first ranking charge on all of the assets, so the TD bonds rank secondary to the banking syndicate.  If there was an adverse credit event, the banking syndicate will get first kick at the can, and the unsecured bondholders will get whatever is left.

Out of curiosity then, I wondered what Corus' assets would be worth in a liquidation.  I recast the balance sheet as follows:

First Attempt:

AssetsAs reportedAdjustmentReproduction cost
Income tax recoverable12100%12
Prepaid expenses1425%3
Total current228177
Tax credits receivable26100%26
Program & film rights316100%316
Film investments370%0
Broadcast licenses957100%957
Deferred tax assets410%0
Total LT2,4041,313
Total assets2,6321,489
Total Liab's1,412100%1,412
Deferred tax -252100%-252
Total Liab's (Adjusted)1,1601,160
Excess / (deficiency)330

In the event of a liquidation, I've made the following simplifying assumptions (take one):

  • The assets will need to be adjusted to reflect likely liquidation value.  A/R is probably 75% to 85% collectable 
  • Taxes refundable are likely 100% collectable, I've made a simplifying assumption that tax credits receivable might be SR&ED or government broadcast credits
  • Prepaids are 25% collectible (deposits portion only)
  • PPE is probably specialized equipment and likely won't fetch much in a liquidation
  • Goodwill is written off
  • Intangibles are written off
  • Film investments are written off
  • Broadcast licenses and Program & film rights have value.  The key here is what these licenses & film rights would fetch in a liquidation.  If both categories are legally seperable and saleable, they well could be worth 100 cents on the dollar
  • I've adjusted deferred tax liabilities out of total liabilities, these are probably related to timing differences on tax depreciation taken

In the above case, there seems to be enough of an excess after the syndicate of banks is made whole to cover the unsecured bonds.

What if the Broadcast licenses and Program & film rights are only 50% recoverable in a liquidation, instead of 100% recoverable?

After all, in Canada recently, the CRTC changed the rules regarding pick and pay channels.  As Corus produces content which was bundled by the cable co's in the past, the ruling may very well directly impact Corus if there is insufficient viewer demand for their specialty content. 

So in a pick and pay world, do the broadcast licenses and program & film rights have the same value they had under the previous regime?

Second Attempt:

AssetsAs reportedAdjustmentReproduction cost
Income tax recoverable12100%12
Prepaid expenses1425%3
Total current228177
Tax credits receivable26100%26
Program & film rights31650%158
Film investments370%0
Broadcast licenses95750%478
Deferred tax assets410%0
Total LT2,404676
Total assets2,632853
Total Liab's1,412100%1,412
Deferred tax -252100%-252
Total Liab's (Adjusted)1,1601,160
Excess / (deficiency)-307

Under the above scenario, there are insufficient proceeds to cover the unsecured bonds.  In this case, there are $.73 of assets to cover the adjusted liabilities (in theory), but remember, the unsecured bondholders rank second to the banking syndicate.  The banks will want 100 cents on the dollar (in theory), so after they're made whole and are repaid their $409M, there will be $444M left over to cover the unsecured bondholders and any other creditors. Out of a total of $750M of remaining liabilities, there is 444M in theoretical cash left over, or $.60 on the $1.

Concluding Thoughts

The above is purely hypothetical, but I do find it interesting that the unsecured bonds are priced at 95% of par.  It's entirely possible that none of the above will ever come to fruition, but for me, I'll stay away from the bonds as I don't believe they provide anywhere near a sufficient margin of safety in the event of the unthinkable.

Monday, 23 November 2015

Bought Gamestop, 30 shares @ $34.73

They missed earnings expectations and were down significantly this morning.

The short thesis seems to be that Gamestop will eventually go the way of Radioshack, and thus far, this hasn't happened (doesn't mean it won't happen).

DGI's will be interested to know that Gamestop has become more shareholder friendly over the last four years and pays a $1.38 dividend, good for a 3.45% yield, up from $.80 initially in fiscal 2013. The company has also been returning capital by way of buybacks since 2010.  Over the last five years, the company has returned $1.7B to shareholders by way of buybacks.  On a current market cap of $3.75B, it's encouraging to note that the company has retired almost 1/3 of the float since 2010.

I happen to think the company is cheap, but not without risk obviously.  The prevailing sentiment seems to be that bricks and mortar retail vendors of hardware and software are going to go the way of the dodo, and maybe this sentiment is correct.  But, until Amazon can deliver game consoles by drone to every household in the universe, I'm of the humble opinion that Gamestop will continue to have a place in the universe selling all things gaming related.

Gamestop seems to have grown free cash flow at a 17% CAGR since 2002, however, this initial observation might be optimistic in that this period likely encompasses aggressive expansion of the store base, and certainly, store expansion going forward isn't likely to be anywhere near as rapid as it has been over the last 14 years. For my purposes, I modeled future cash flows at zero growth going forward and still came up with a interesting result.

I modeled free cash flow based on the average free cash flow over the last 10 years, or $407M (TTM FCF was $550M so I believe I'm being conservative), and I came up with the following result:

Sum of DFC'sRe =
G = 8%9%10%12%15%Average, growth, blended Re
Average, Re, blended growth67.8457.4949.8539.2929.64

The company maintained its guidance for fiscal 2016 at between $3.66 and $3.86 per share, so about 9.3x expected 2016 earnings at the low end.

If Gamestop somehow gets down below $29, I will likely revisit the analysis.  I'll probably add another 30 shares if it gets down to $25.

Sunday, 22 November 2015

Mediagrif Interactive Technologies

Mediagrif showed up on my 52 week low list a couple of times this week.  It's an interesting sounding company, and my first thought on doing some preliminary research was that it appeared cheap relative to other more established B2B and B2C e-commerce businesses, but when something seems cheap, there's usually a good reason.

The CEO, Claude Roy, owns over 20% of the shares and, after taking over in 2008, seems to have grown the business via acquisition while at the same time curtailing spend via cost reduction.

The company trades at just over 15x ttm earnings and 14.3x fwd 2016 earnings.

The company also pays a modest dividend of $.40 per share, good for a 2.5% yield.

I'm having trouble finding comparable stand alone companies with a small enough market cap equivalent to Mediagrif.  In the US, there's NIC Inc., which provides ecommerce services to the US government.  From the sounds of it, the company could be compared to all of Alibaba, ebay, Ariba, NIC, Monster Worldwide, and to a lesser extent, Torstar (Workopolis).

While most of the above companies trade at premium multiples (ignoring Torstar and Ariba which is now owned by SAP), I suspect that Mediagrif's low multiple is a reflection of low growth.

Over the last 10 years, the company has grown sales from $50M to $70M currently, good for around 3.5% CAGR.  Since Mr. Roy took over in 2008, sales have grown at 5% CAGR.

EBIT and FCF have grown similarly, 3.1% and 4.9% CAGR respectively since 2006, but 5.6% and 9.7% respectively CAGR since Mr. Roy took over.

If I can summarize the company's offerings succinctly, I'd say Mediagrif offers a hodgepodge of e-commerce platforms.  Here's their profile:

And from the AIF:

Also in the AIF, a description of some recent events including:

  • The loss of a significant contract between the company and the Public Works and Government Services Canada for the use of the company's MERX platform to manage tenders
  • The acquisition of Jobboom Inc., from Quebecor for $56.8M
  • The acquisition of Reseau Contact Inc. from Quebecor for $7.4M 

I'm most interested in the Jobboom acquisition as the Public Works contract is ancient history.  The company paid $56.8M for Jobboom in June 2013, which was accretive to revenues and earnings in the year ended March 31, 2014.  From the 2014 annual report, it appears that Jobboom contributed $7.7M in revenues and $1.1M in profit from the date of acquisition.  On a pro-forma basis, had the acquisitions taken place on April 1, 2013, it sounds as if Jobboom would have contributed another $2 - $3M in revenue, and another $500-$600K in profit (assuming profit means net income after tax).

So, for somewhere between $10M - $11M in revenue, and $1.6M - $1.7M in profit, the company paid $57M, equivalent to 5.2x - 5.6x revenue, and 33x -35x profit (assuming profit means net income after tax).

Seems steep.  How has the overall business grown since Jobboom was acquired?  Revenues in 2013 were $60.7M (inclusive of Public Works), and revenues in 2014 inclusive of Jobboom's and Resau's contributions of $7.7M & $1M respectively were $65.4M, so I'm guessing that Public Works' contribution was around $4M ($65.4 - $7.7 - $1 - $60.7).

Normalizing for Public Works and full year contributions from both Jobboom and Resau, I'm guessing that the growth in Jobboom's and Resau's business since acquisition in 2013 is somewhere around ($71.3 - ($65.4 - $4) = $9.9M vs. $9.7 - $10.7M in Jobboom alone, so, no growth, and more likely negative growth.  From the company's recent MD&A, for the six months ended Sep 30, 2015, Jobboom along with other sites experienced decreases in revenue of $2.1M.

All of the above begs the question, with limited to no growth, why did management pay such a hefty price? And, if the acquisition was a poorly timed (or poorly valued) acquisition, what can management do about it now?  Heck, close to 30% of the goodwill on the company's balance sheet seems to be attributable to the Jobboom acquisition.

I suppose this is one of the reasons as to why the company seems cheap at first glance.

Management has emphasized its growth strategy going forward, and it seems to be acquisitive (let's hope that future acquisitions are wiser than Jobboom).   In the absence of any transformational acquisitions though, I'd hazard a guess that the company will continue to trade at a discount.

Here are my estimates in terms of valuation:

First, my Two Stage DCF Matrix:

Sum of DFC'sRe =
G = 8%9%10%12%15%Average, growth, blended Re
Average, Re, blended growth24.6820.8518.0214.1110.53

I'd be interested in the company only at G (0,0) - G(2,1), &  Re = 12%  - 15%  given it's low growth profile.

Next, my EPV analysis:

Cost of capital rates:EPVAdj for Debt & Excess CashAdj EPVO/S sharesEPV / shareBVPS / shareExcess EPVCurrent pricePrice / EPVPrem/Discount vs EPV
Stress test15%158.90-18.20140.7015.2759.217.91.1716.241.7676.31%
LT equity return; 2014 - 192810.50%227.01-18.20208.8115.27513.677.91.7316.241.1918.80%
Upper bound10%238.35-18.20220.1515.27514.417.91.8216.241.1312.68%
Combined NI & Div growth5.98%398.50-18.20380.3015.27524.907.93.1516.240.65-34.77%
Per GF4.17%571.58-18.20553.3815.27536.237.94.5916.240.45-55.17%