Monthly Performance Review - February 2017

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Includes: ADES, AEY, BSHI, MMTRS, MSN, PARF, SPKE, TA, TRT, TRUP, WTLC
by: Jan Svenda

Summary

I believe in transparency when doing equity research, therefore every month I publish performance of every ticker that I wrote an article on alongside the initial thesis.

Through this I want to build a strong habit of looking back at my own reasoning. The review will be heavily skewed to stocks where my thesis is not working out.

February saw several successful additions, but I remain to be slightly wrong on several stocks.

Dear Followers/Readers,

First of all, I would like to thank you for your continued interest in my work and I hope you are getting value out of my research!

In order to increase the latter, in August, I introduced a monthly review of all of the tickers that I am actively covering alongside my initial thoughts about the stocks. I think this can be beneficial for the following reasons:

  • Learning exercise – I will primarily focus on stocks where my initial thesis was wrong. I will try to understand why, how to prevent this from happening in the future, and what should one do about this fact.

  • Increased frequency of thesis updates – This will be beneficial for people that are following specific tickers and might be interested in the latest developments that are not necessarily asking for a full-blown update.

  • Creating a database – It is always fun, to look back and either laugh about failures or cheer about winners.

I am doing so through the following simple table, which I publish at the end of each month.

Notes: The price at the origin is the opening price on the date of the first publication and the current price is the closing price on last trading day of the month. The original thesis that is labeled Neutral (Long) is a thesis where I have a positive view on the stock, but for whatever reason I do not believe it the right time to buy. The same goes for Neutral (Short). I do not judge neutral ratings unless the share price movement is significant and I missed an opportunity to be on the right side of the trade. This is slightly subjective. Feel free to address any neutral rating that you believe I got wrong.

I also add two indices that can be used to ‘benchmark’ the performance of the covered stocks. I chose Russell 2000 due to its small-cap bias and Russell 3000 in order to track the overall market.

During the reviews, I will not be talking about every stock, but rather ones that I started to cover in the past month, the ones I am wrong about, or that are undergoing significant developments.

February Highlights:

This energy service company is my first active short idea on my SA profile. I believe that the company is overvalued due to the inherent issues in its business model, which results in significant customer churn. This churn then needs to be plugged by acquisitions, which further strains the already leveraged balance sheet. The corporate governance also adds to the issue due to the company’s structure that is unfavorable to public shareholders. Lastly, the company is facing significant regulatory risk as NY’s energy regulator is now contemplating revoking SPKE’s license.

All this then shows that the company should not be trading at a premium to book value and rich EV/EBITDA multiples.

The initiating article can be seen here.

The next short is based on the thesis that the stock price got ahead of itself due to managerial expectations. This pet insurance company is trading at 10x book value while being unprofitable and operating in a market that is still evolving. While the company might be able to achieve its growth rates that might justify such valuation, I believe that this is not around the corner (likely at least 2 years away) and that the future growth is uncertain.

The management is touting its business model as different from the rest of the market, but this might not be the case. Containing acquisition costs will also be challenging. Therefore should the company miss one or two quarters in the next two years, the price to book value ratio should normalize.

The initiating article can be seen here.

I am coupling these two stocks due to their similarity. Both of these are trading below NCAV with additional value present in real estate. This undervaluation does not make sense especially when both companies have incredibly stable operations (BSHI - construction gloves, PARF - candied fruit). The only difference between them is that BSHI can generate slightly more cash.

Due to this, I believe both are good long-term picks, the only issue might be the catalyst, as both managements are tight groups that might not sell the business in order to realize the value the most efficient way possible.

The initiating articles can be seen here [BSHI] and here [PARF].

This is a curious business shell that is wildly undervalued due to its cash on the balance sheet and NOLs. The issue is though that the future value depends on what the management will do with the entity but due to the NOLs. A position might be interesting as this slightly limits the corporate actions. The management is experienced in dealing with this kind of entity, and therefore they should be able to create value, but the question whether public shareholders will be able to fully participate remains.

The performance so far is nice, but that is partly due to the low volume which might push up the prices significantly. That being said, the company is still trading at one-third of the liquid NCAV value (around $6 million). This also ignores the $20 million of NOLs.

The initiating article can be seen here.

This is an interesting dividend opportunity as MMTRS have seen a stable performance of its songs for which it receives royalties. There are several Christmas classics in the portfolio which are likely to continue to perform well, which could ensure a return of invested capital in around 11 years, implying 9.1% yield per annum. MMTRS could also benefit from legal issues that it previously had with EMI (distributor of royalties to the trust).

On the other hand, the key question here is the share price risk because the price can alter the yield significantly. This is impossible to forecast, but given the past and the current implied yield, I believe investors are being compensated for this risk.

The initiating article can be seen here.

  • Emerson Radio (MSN)

The stock continues to grow and the recent earnings release did not showcase any new issues and did show that the company is repurchasing shares. Therefore statistical position continues to be warranted, but the corporate governance also continues to be the long-term issue.

  • Advanced Emissions Solutions (ADES)

As mentioned couple of times before, since the company did not point to any new tax equity investors, I believe that the run-up is over-exaggerated. We will see what will the results look like, but I am not sure whether the cash flow will look different enough to warrant the increased valuation.

  • ADDvantage Technologies (AEY)

This continues to be a buy despite the fact that the Telco segment continued to pressure the operations. The main reason being that the new acquisition is likely to offset some of that loss in the upcoming quarters. The Cable segment also seemed to rebound, which could support the still strong cash flow.

I wrote a quick update on the Q4 results, which can be accessed here.

  • Trio-Tech (TRT)

This stock had a nice run-up this month due to fairly positive earnings results, but I still believe that due to the uncertainty regarding capital allocation and management incentives, the long thesis is not clear enough.

This month, I also wrote about Aramco’s (Private:ARMCO) IPO, which I believe Saudi Arabia is yet to take seriously due to the possibility that it will not allow a thorough audit of oil reserves, which is the key question regarding the company's fundamentals.

This month, I will also discontinue covering TravelCenters of America (TA) which is the first stock to go out of the list. I believe that due to the lack of change in the fundamentals or management incentives, there is little new to add. This is supported by the recent results that again showcased all this and continued to negatively impact the share price. I first wrote about TA in March last year.

My ‘eulogy’ is the following:

This stock has obvious conflicts of interest present. The insiders continue to milk the operations through a nonsensical arrangement of lease improvements, which increase the rent paid to RMR group (headed by the infamous Portnoy family). The insiders also set up the company as LLC (rare for a public company), which prevents any dispute to be held in court (but rather it needs to go through an arbitration), and also prevents anyone from owning more than roughly 9%, which then prevents a change in the status quo.

All this burdens the already unexciting operations, which are struggling to create a significant profit even despite the lower oil price, which should have acted as a tailwind for TA.

Finally, I would stress that whenever you will read articles that tout the stock as a buy due to the ‘obvious undervaluation,’ check if they talk about the management. If not, it is better to pass. There was quite a number of these articles during the time I was writing about the company. Almost none of the authors bothered to refute my findings or even acknowledge the possible risks associated with these.

I might comment underneath my older TA articles if I spot something major or might even write something should it be sufficiently material, but I am not going to look at quarterly results as closely as I did before.

Once again, thank you for reading my research!

Best,

Jan

P.S. Please do let me know if you think that the way I present the review is missing something.

Disclosure: I am/we are long WILC, SGMA, AEY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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