Canadian Small Cap

Performance Review and Suncor

2010-03-02T08:18:00.000-08:00

Sorry for being quiet for so long. We got a new baby .... life took over but now I am back.

In 2009, I discussed 5 companies. If one had built an equally weighted portfolio of these companies on the days following my posts, one would have seen a return of approximately 87% (not including dividend: both Richelieu and Bird pay a dividend) as of today. The best return was from Neo Materials (+259%) and the worst from Richelieu hardware (+23%). I am happy with these numbers.

These days, I am looking into Suncor. The stock has been under pressure lately with two fires at its facilities. Following its acquisition of Petro Canada, Suncor has been slowly improving its balance sheet by selling some non-core assets. My guess is that one day, investors will wake up and realize that the fires were anomalies and that the balance sheet has been improved and the stock price will go back. I know this is not small cap but I thought I would mention it.

Note: This is not a recommendation. Do your own research. I am evil.

Neo Material Technologies vs. Pala Investments

2009-02-18T12:04:00.000-08:00

I discussed Neo Material in a previous post in which I mentioned how Pala Investments was making a bid for about 20% of the shares outstanding of Neo at $1.40/share. Neo's Board responded by amending its poison pill to stop what it sees as an opportunistic offer that undervalues Neo massively. Pala press released that it disagrees with the "knee-jerk" reaction of the Board and that shareholders should be allowed to decide for themselves with regard to accepting or rejecting the offer at $1.40. If the offer is accepted, Pala would own about 40% of Neo.

I think it is worth asking if your interests as a small shareholder are necessarily aligned with that of a large shareholder such as Pala Investments. If you think that $1.40 is solid value for the company, then the answer is obvious. On the other hand, if you think that $1.40 is a large discount to the true value of the company, should you welcome Pala and look forward to having more of the shares owned by a "strong long-term investor"? Here is a little story.

In May 2008, JMI Equity and The Carlyle Group offered to buy all of the shares outstanding of Gemcom Software International. Pala Investments was a large shareholder of Gemcom (owning about 20% of the shares). Pretty simple takeover offer; well, there is one more twist in this story. In July 2008, we learned that the offer was increased but that Pala Investments was now part of the buying group, partnering with JMI Equity and The Carlyle Group to buy Gemcom. The bid was successful and Gemcom is now a private company.

I do not know if Gemcom shareholders got solid value for their company. I do not know if Pala helped shareholders get a better price for the company. What I know is that Pala can buy companies and take them private and as such, Pala is not necessarily aligned with the interest of small shareholders.

If you were a shareholder of Neo Material, would you want to see Pala Investments own 40% of your company? Do you agree with the Board of Neo Material Technologies? Let me know.

CSC

Note: Once again, do your own due diligence.

Update: Ruggedcom a Smart Grid Company

2009-02-12T14:25:00.000-08:00

Ruggedcom (ticker: RCM in Toronto) was the first company I discussed on this blog. The company reported its third quarter financial results last night and had a conference call this morning. Overall, the results were impressive.

Revenues were up 53.4%.
Consensus was expecting earnings per share of $.21 and the company reported $.033.
Gross margin was up strongly to 65.7% due to improved product costs, favorable sales mix and foreign exchange.
The company generated cash once again. The cash on the balance sheet declined slightly but it was a foreign exchange effect.

A few things to consider. In the past few weeks, this company has been hyped on television or in newspapers by a number of "experts". Hype can be a problem, especially for companies with volatile quarterly results. One weak quarter and all the "fast" money would want to exit at the same time. It is a problem but it can also create a buying opportunity. One last tidbit, I would not be surprised if one day Cisco buys Ruggedcom. Keep this one on you radar screen.

"Attractive": Neo Material Technologies

2009-02-10T06:38:00.000-08:00

In keeping with my philosophy of investing only in "good" companies with strong balance sheet and solid free cash flow generation, I came up with Neo Material Technologies (ticker: NEM in Toronto, market cap of $149 million @ $1.22/share). Their website is here. Neo is a producer of high-quality rare earth and magnetic powders that are essential in the manufacture of many high-tech products.

The company is an intermediary between the mining company and the manufacturers. It buys rare earths mineral concentrates in China and separates the individual elements, which are then sold. Some of the processes used by Neo are protected by patents (expiring in 2014) and as such, the company enjoys a very high market share in some of its markets. For example, the company sells 80% of the "neo powders" sold worldwide. Neo powder is used to make very strong magnets. Neo's products are essential to the manufacture of various high tech products including: micro motors, computers, optical lenses, mobile phones, display panels and electronic chips. Some of Neo's clients include: Daido, Epson, Panasonic, Hitachi, BASF, Philips, Samsung, Canon, and 3M. Not bad for a small company.

Why invest in rare earths? Rare earths are part of the Minor Metals group, which got its name from the fact that these metals were initially considered of minor industrial importance as compared to Major Metals (iron, lead, copper, etc.). I believe that we have entered a new age: the Age of the Minor Metals. We went through the Stone Age, the Bronze Age, the Iron Age and now we are in the Age of the Minor Metals. Minor metals are essential to our high tech world. While the quantity of minor metals produced will be dwarfed by the quantity of copper, zinc, .... produced , the importance of minor metals should not be underestimated. No minor metals = no iPhone and no flat screen TV.

I believe that, while the cyclical forces currently affecting the global economy will hurt Neo, the secular trend is for continued growth. As such, the current environment could enable us to get a good company at a great price.

At the end of the last reported quarter, Neo had a net cash position of about $32 million (that's $0.27 per share on a fully diluted basis) and the company was generating cash from its operations. In the last 4 quarters, the company reported earnings of $0.30/share and as such, it is trading at 3x to 4x trailing EPS, depending on how you adjust for the net cash. This does not look very expensive but earnings will likely be lower going forward due to the recession. So in the short term, Neo's financial results should be less than inspiring, however, this represents an opportunity for investors with a longer term view.

One of the risks with Neo is that the company relies on Chinese mining companies for its concentrates. China dominates the world's production of rare earths and therefore, it is not surprising that Neo uses Chinese suppliers. As Chinese internal demand for rare earths increases, it is possible that the Chinese government will erect export barriers, making more difficult for Neo to supply its clients. It is something to watch.

Of note, Pala Investments, owner of about 20% of Neo's share outstanding, has announced its intention to bid for up to 23 million Neo shares (representing about 20% of shares outstanding) at $1.40. For the flippers out there, you can buy Neo today at $1.22 and sell your shares to Pala Investments for $1.40 for a quick 15% profit. Sounds good but there is a risk. Neo has a poison pill provision, which states that 50% of the independent shares must be tendered in order for the proposed bid to proceed. Pala has asked Neo's Board of Directors to waive this provision to allow the bid to proceed. I have not insight on what the Board will do but if it waives the provision, the shares should climb quickly to near $1.40 while if the provision is not waived, the stock could go down to where it was before the bid, which is below $1.10.

Pala, a long term investor in Neo, sees value in the company and is, in my view, being opportunistic. As a long term investor, I also see value in Neo and I think that 2009 should offer a very attractive entry point.

CSC

Note: Do your own due dilligence. I am Evil.

Profiting from Infrastructure Spending: Bird Construction

2009-01-27T05:48:00.000-08:00

With governments everywhere announcing more stimulus money aimed at infrastructure spending, a few companies should be able to benefit from this trend. Bird Construction Income Fund (BDT.un in Toronto) is one of them.

Bird is one of Canada's largest general contracting construction companies with a 20-year history of uninterrupted positive earnings, a positive net cash position of $100 million (unrestricted cash), a backlog worth over $1 billion and a distribution yield of 7.6%. This long profitable history comes from very strong risk management protocols that have enabled the company to avoid "bad" contracts.

Bird is exposed to the commercial market (malls, big box stores, ...), the industrial market (oil sands, petrochemicals, waste water, ...) and the institutional market (schools, hospitals, ...). The mix of revenues between these markets can change dramatically from one year to the next depending of the type of contracts being executed. Of note is that a few of the oil sands related contracts in their backlog have recently been delayed due to the weakness in oil prices. With current economic conditions, I do not expect the industrial and commercial markets to be the main drivers for this company but I think that the institutional market should benefit from the increase in infrastructure spending. Of particular interest is the fact that Bird has had some success in winning Public-Private-Partnerships (P3) contracts such as the Surrey Outpatient Hospital and the Alberta School Alternative Procurement project.

For the 9 months ended Sept 2008, cash available for distribution was $44 million while the amount distributed to shareholders was only $15.3 million. Interestingly, Bird pays some taxes even though it is an income trust. Once the company has to switch back to a corporation in 2011, it will start paying taxes at the full rate. The fact that it is currently paying some taxes will make for a smoother transition. From various comments by management, I do not think that we should expect much in terms of distribution increases. Management also stated that they would likely convert to a high dividend paying corporation once the income fund structure is no more.

Looking at the balance sheet, you will notice that the company has a $74 million "debt". This is a non-recourse debt for the Brampton Youth Facility project that will be extinguished by a balloon payment from the government of Ontario upon completion of the project in mid-2009. I did not include it in my net cash calculation.

At current price ($19), EV/EBITDA is at around 2x for 2008, while this is a low number, let's not forget that 2008 was a very good year. A study of similar companies shows that the trough EV/EBITDA multiple is around 2.5x and from that point of view, Bird looks like solid value. Personally, I am waiting for the company to report their fourth quarter results to hear what management has to say about the effects that project delays (mostly oil sands) will have on their financial results going forward.

NOTE: This is not a recommendation. Do your own due diligence since you should not rely on me because I am Evil.

Richelieu Hardware: Great Company in a Tough Environment

2009-01-23T13:54:00.000-08:00

Richelieu (Ticker: RCH in Toronto) is Canada's leading distributor, importer and manufacturer of specialty hardware and complementary products - and also ranks among the top players in its specialty in North America. After looking at this website, you are probably wondering why we should consider investing in a company that is obvously exposed to the housing market. Great companies can use difficult markets as a spring board to future growth. I think that Richelieu could be one of those great companies.

Richelieu just reported its fiscal year 2008 results that were solid in light of the economic conditions. During a difficult 2008, the company managed to pay down its debt (now debt free), bought back $20 million worth of its shares representing 5% of shares outstanding, paid over $7 million in dividend (payout ratio of about 20%) and made two acquisitions. Not bad for a company that sells to the "housing market".

During its latest quarter, Richelieu saw its Canadian sales (>80% of revenues) increase by 3.5% while sales in the United States decreased by 9.35%. While I fully expect that Canadian sales could prove more difficult in 2009, Richelieu seems to be able to offset declines by making solid acquisitions and gaining market share. So Richelieu ended up making $.046 for the quarter, which was more than last year and better than expectations.

The consensus earnings for both 2009 and 2010 is $1.52. Due to the difficult end market, expectations of growth have been removed from the market. With the stock trading at $17.95, we get a P/E multiple of about 12x and a dividend yield of 1.8%. Operations generated over $40 million in cash flow in 2008 while the company only paid out about $7 million in dividends. Even if 2009 were to be more difficult than 2008, the dividend appears safe.

With its debt free balance sheet, the company should continue to make acquisitions. Hopefully, some of their competitors will get into financial trouble during the downturn, enabling Richelieu to acquire them cheaply.

At this point, I feel that 2009 could be the low point of the cycle for Richelieu and the year could provide a solid entry point into the stock. Richelieu is definitely a company that I am watching very closely.

NOTE: This is not a recommendation. I may or may not own the stock mentioned. You should do your own due diligence since I am Evil.

The Aftermath of Financial Crises

2009-01-21T06:44:00.000-08:00

Every day, we hear about a new prediction on the length and severity of the current recession. I believe that, while history does not repeat itself, it can be a very useful guide. I have found this paper called "The Aftermath of Financial Crises" that presents a historical analysis of other banking crises in advanced economies since World War II. It is an easy read and is well worth the time it takes to review it. Overall, it appears that we are still in the early innings of the crisis. Here is one of the graphs in the report.

Fertilizing your Portfolio: Migao Corporation

2009-01-18T11:17:00.000-08:00

If you want to invest in the fertilizing business in Canada, you have a few large cap choices: Potash Corp. (POT-t, market cap: $26.7 billion) or Agrium In.c (AGU-t, market cap: $6.3 billion). You may not know that you also have small cap fertilizer companies that are investable: Hanfeng Evergreen (HF-t, market cap: $338 million) and Migao Corp. (MGO-t, market cap: $231 million). I am particularly interested in Migao because it is a specialty fertilizer company that sells to Chinese tobacco and fruit/vegetable growers. These are high value crops that can absorb high fertilizer prices, as we saw in 2008.

Migao's two main products are Potassium Nitrate (NOP: current capacity of 80,000 t) and Potassium Sulphate (SOP: current capacity 180,000 t). For more details, please see their website at http://www.migaocorp.com/.

In recognition of the quality of its fertilizers, the company has secured a five-year contract with Yunnan Tobacco (a large Chinese Tobacco producer) for the NOP. What is interesting is that Yunnan is increasing its tobacco acreage to deal with the growth in China and to increase its exports. This should be positive for Migao's growth plans. Also, Migao has recently signed a joint venture with Chili-based SQM, the world's largest producer of NOP. The Companies are developing a 40,000 tonne plant (NOP) in China in the form of a 50/50 joint venture.

In terms of growth, in addition to its joint venture with SQM, Migao is working on two 40,000 tonne SOP plants (Shanghai and Zunyi), on a 120,000 tonne Sulfuric Acid plant (sulfuric acid is an input necessary to make its fertilizers) and a new blending facility.

The new blending facility is the most interesting development in my view. The tobacco industry asked Migao to build it. Basically, the blending facility takes the specialty fertilizer from Migao and blends it with more generic fertilizers to meet the needs of specific tobacco growers. Each facility costs about $4.5 million to build and the company stated that it can recover that cost from the first year profit of the facility (payback of less than a year). Also, Migao said that they could end up building 4 to 6 of these facilities, all for the tobacco industry. To put this in perspective, for the last 12 months, the company EBITDA was around $33 million, so these new blending facilities could create significant growth for the company. On the other hand, we have no seen any financial results from the blending facilities so there is risk in these forecasts.

The company has had solid revenue and earnings growth, however, part of that growth came from Migao's policy of targeting 20%-24% gross margin range. When input prices increase, such as in the last few years, the company sees increased absolute revenues and gross profits. If, for example, potassium (KCL) prices were to decrease, Migao would likely see more muted growth for a while.

Last quarter, Migao had about $17 million in cash, $14 million in debt and $78 million in raw inventory on its balance sheet. The company stated that it can achieve its growth plans by using its cash flow from operations and cash on hand: it does not need more financing. I like that the founder still owns about 18 million shares (40% of the company). Of note, Migao's revenues, costs and profits are in Chinese Renminbi that are translated in Canadian dollars for reporting purposes. So, if you feel that the value of the Renminbi will change dramatically versus the Canadian dollar, you must consider this in your due diligence.

For the fiscal year ending September 2009, the consensus EPS estimate is around $1.10 (last year, its earnings were $0.63, with the last quarter of the year at $0.31). With the shares trading at $5.49, you have a 5x price to earnings ratio. Under a similar valuation approach, Agrium trades at 5.9x and Potash trades at 7.4x.

Migao seems to have quality products and solid growth prospects while trading at a low multiples. Even if potassium prices were to decreased substantially, thus affecting the company's absolute earnings, the company would still be profitable and growing with a solid balance sheet. I think it is worth considering.

NOTE: This post is not a recommendation, do your own due diligence. I may or may not own this stock so please keep this in mind.

Riding the Wave - Ruggedcom Inc. (Ticker: RCM in Toronto)

2009-01-16T12:02:00.000-08:00

Have you heard of The American Recovery and Reinvestment Act of 2009? In the next few weeks, the U.S. Congress will consider this Act, which could have very positive effects on a few small cap companies with exposure to the U.S. market. One of them is Ruggedcom. The focus of the Act is to modernize the U.S. infrastructure, including creating a smart grid. Ruggedcom has designed products and technologies that are the communications backbone of the smart grid and the company has been successfully selling to electric utilities for past few years. I could go on and on about the various products offered by Ruggedcom but I think the best way to educate yourself is to visit their website (http://www.ruggedcom.com/).

Ruggedcom has been riding a wave of investment in rugged communications. Last quarter, its revenue was up 54% year-over-year and 13% quarter-over-quarter, with most of the growth coming from sales to electric utilities. The other segments (Transportation, Industrial and Military) have also shown some limited growth.

(Click picture to enlarge)

Profitability has also exhibited strong growth but with some volatility. This volatility in earnings could potentially provide an entry point into the stock if the company were to report a "bad" quarter.

(Click picture to enlarge)

In addition to the fact the Ruggedcom is in a good industry to benefit from infrastructure investments, I also like the company because it does not need financing. Ruggedcom has over US$45 million (that's US$3.60 per share) on its balance sheet with no debt and it is generating cash. So the company has staying power.

For the fiscal year ending in March 2009, the consensus estimate is around US$.82. The shares are trading at around $14.50 putting the P/E multiple at 17.6x or 13.3 (x-cash). While this is not cheap considering current markets, I think that this is a good company that is well positioned to take advantage of infrastructure spending.

NOTE: This post is not intended as a recommendation but it is aimed at generating a discussion about the company. I may or may not own shares in the company mentioned. Do your own due diligence. Do not solely focus on the potential profit but make sure you understand the risk of any investment.