KeyStone’s Stock Talk Podcast Episode 162
We are back this week to look at the crazy volatility – mostly to the downside – in North American markets have produced to start 2022. Ryan takes a brief look at the yo-yo action in a number of well-known tech stocks over the past week including Microsoft Corporation (MSFT: NASDAQ), Alphabet (GOOG:NASDAQ) (Google), Apple Inc. (AAPL:NASDAQ), and Amazon.com Inc. (AMZN:NASDAQ) on the plus side and Netflix Inc. (NFLX:NASDAQ), Meta Platforms Inc. (FB:NASDAQ) (Facebook), PayPal Holdings Inc. (PYPL:NASDAQ) and the rest of Tech generally, on the negative side.
From our mailbag, Ryan answers a question on Cathie Wood’s ARK Innovation ETF (ARKK). Aaron reviews what went wrong this week with Meta Platforms owner Facebook, the largest social media platform in the world, with 2.9 billion money active users. Meta dropped nearly 26% Thursday after the release of its fourth-quarter results – in a historical loss. Aaron, let’s you know why. Finally, Brennan answers a listener question on EcoSynthetix Inc. (ECO:TSX), which offers a range of sustainable engineered biopolymers that allow customers to reduce their use of harmful materials, such as formaldehyde and styrene-based chemicals. The stock has pulled back to start 2022 but has posted positive gains over the last year and five-year periods. Brennan examines whether the fundamentals of the business justify the gains.
YSOT: PayPal Holdings Inc. (PYPL)
We got a number of questions on PayPal this week – from listeners and in our client chats. It is a business we like and monitor, but have not recommended due to valuation concerns. It is the latest in a cautionary tale of valuations – the market appears to be reminding investors, that valuations do indeed matter. The company reported decent growth in the quarter but missed earnings slightly and guided to lower growth this coming year – about 15% vs 18%. The growth guidance is the concern. The company expects to add 15 to 20 million new accounts in 2022, down from the 48.9 million added in 2021. A year ago, PayPal set out plans to double its active accounts to 750 million by 2025. At its 2022 pace, it will not come anywhere near that goal.
Having said this, in a normalized valuation period, this likely doe not lead to a stock losing 25% of its value in one day, particularly such a large business and particularly a stock that had correctly nearly 45% in the past 6-months. However, when a company with high or premium valuations growing at 15% stumbles even slightly, it can get punished. The company is now in the range of 26 times forward estimates (estimates that will likely have to be lowered) and maybe starting to look more interesting on a valuation basis, but it multiple is still well above the growth rate – om other words it is still not historically cheap. Again, PayPal has dropped 60% in less than 6-months, and on a valuation basis, it may still not be on sale.
Price action in big tech over the past week.
Beat Earnings, Positive Outlook:
- Microsoft: revenues +20%, net income +21%, widening operating margins, demand remains strong across much of the business
- Google: revenues +32%, beat on the top and bottom lines, announced a 20-to-1 stock split
- Apple: largest single quarter in terms of revenue ever, sales +11% despite supply chain challenges, most profitable business (Services) +25%
- Amazon: net sales +22% in 2021 to $470B, revenue +9% YoY, AWS 40% growth and $71B run rate with 30% operating margin
- Netflix: expects to add 2.5M users in Q1 vs. 6.93 M analysts estimates, increased competition, increased prices amid slowing growth
- Facebook Meta: – Aaron will go over it in more detail..but they missed earnings, weak guidance, stagnating user growth, lost > $200B in market value in a day
- PayPal: – we went over…missed earnings, slowing user growth (last year it had a goal of 750M new accounts for 2022, now it expects 15-20M), weak full-year guidance
Is it time to start buying Cathie Wood’s Ark Innovation ETF?
To begin, what is the ARK Innovation ETF (ARKK) – ARKK is an actively managed Exchange Traded Fund (ETF) that seeks long-term growth of capital by investing under normal circumstances primarily (at least 65% of its assets) Invests in stock that follow its investment theme of disruptive innovation.
Areas of interest include:
- DNA Technologies and the “Genomic Revolution”
- Automation, Robotics, and Energy Storage
- Artificial Intelligence and the “Next Generation Internet”
- Fintech Innovation
Run by recent market darling, Cathie Wood – which other than Tesla, does not own mega-caps and last time we checked FAANGM’s….but a number of potential disruptors and innovation stocks. To be clear, the fund performed very well for a 3-4 year run as money piled into these stocks. But, the Ark ETF has lost billions with its unit price down 38% in the last 3-months and approximately 50% over the past year.
Again, I reiterate what I said in reference to PayPal – It turns out, valuations matter (particularly when we face uncertainty – including inflation, rising rates and dwindling stimulus). So, has Cathie Wood gone from hero to zero in 6 months? Perhaps the answer is somewhere in between. We appreciate the fund believes that innovative businesses centered around artificial intelligence, robotics, energy storage, DNA sequencing, and blockchain technology will change the way the world works and deliver outsized growth as industries transform – we see long-term potential in these markets as well. And Aaron will speak to this in his segment…
But the market tends to remind you, that one cannot just pay any price for most stocks.
I took a look at the valuations on the top holdings in the fund now – after many have dropped 50%+ percent in value – are they attractive now?
We will take the giant Telsa out of the equation – although its valuations are certainly elevated.
To give you some context: the average market PE is 22.5 at present. Only one has a PE of under 30 – Coinbase – and its earnings are actually expected to decline in the coming year. 7 of the 12 companies do not have any current earnings or even adjusted earnings and the price-to-sales multiples have decreased, historically they remain high.
Again, most of the stocks in this fund have lost 50% of their value this past year, so one can only imagine the valuations on average in the fund 3 and six months ago before the stealth correction. Many traded at 50-100 times sales – particularly the SaaS business. To give you an idea of how overvalued these businesses were – here is a quick breakdown on the peak valuations on some of the best true disruptive tech companies over the past couple of decades.
As you can see – even in this list of true once-in-a-lifetime investments, not one ever came close to a price-to-sales multiple of even 45.
Perhaps ARK will achieve some long-term wins like Tesla that will boost the fund. We love innovation and see the value in paying up for great businesses. But we prefer paying a little more or a reasonable price for a great business rather than “any” price. As such, we would pass on the ARK flagship ETF. It just does not meet our criteria – or at least the primary assets in the ETF do not meet our criteria.
Meta Platforms Inc. (FB: NASDAQ)
Current Price: $233
Market Cap: $660 billion
What does the company do?
Meta Platforms (formerly Facebook Inc) is the owner of the Facebook app, which of course is the largest social media platform in the world, with 2.9 billion money active users. Meta also owns Instagram, Messenger, and WhatsApp. Advertising sales represent more than 90% of the company’s total revenue.
Meta’s stock price took a huge plunge this week, declining 25% on Thursday after the release of its fourth-quarter results. That’s a loss of market value of over $220 billion in a single day. Rarely do you see a company of Meta’s size take such a plunge in a single day. Of course, there are very few companies Meta’s size.
What happened? The short answer is that Meta missed analysts’ earnings expectations and reported weaker than expected guidance.
The company reported Q4 earnings per share of $3.67 on revenue of $33.67 billion compared to consensus estimates of $3.83 per share in earnings and $33.44 billion in revenue. So, Meta’s revenue actually came in slightly above estimates and earnings per share fell short of estimates by about 4%. Hardly seems like it justifies a 25% drop in a single day.
Meta also released guidance for year-over-year revenue growth of 3% to 11% in the first quarter of 2022. This would be a significant drop in revenue growth relative to the previous years. The 3-year average revenue growth rate was almost 30% annually. This is a big drop but still, Meta was trading at 24 times earnings before the results were released so its not like it was being priced as if it was expected to produced consistent 20% to 30% revenue growth for the foreseeable future.
What’s really going on here? The big move down is largely about competition. We had Facebook as a Dog of the Week last year as well and one of the things we pointed out was the competitive pressure of social media platforms like TikTok and Snapchat which are much more popular with younger users.
Also, Facebook always seems to be in the crosshairs of negative press, and discussions about the dissemination of fake news and disinformation. The company is often held largely responsible for the polarization of society, politically and socially, and has been accused many times of willingly and knowingly allowing its platform to be used for nefarious activities in order to produce a profit.
We are not here to discuss the social ramifications of Facebook or social media in general. But between more competition, Facebook has lost its ‘cool factor’ among younger users and a constant stream of negative press, its not hard to understand why many investors are quick to hit the sell button on any kink they perceive in the company’s armor.
What’s our take? Ultimately, the single-day drop of 25% in Meta’s share price is likely an overreaction. The company is trading at about 17 times earnings today which is now a significant discount to the market and FAANG stock group. Growth will decline and may even go negative for a while, but we don’t see any clear signs that the company is falling apart any time soon. The company’s investments and journey into what is referred to as the Metaverse could even be the beginning of a new leg of growth; although its too early to tell.
That said, we are not ready to hit the buy button on the company at the point. There is a lot of uncertainly in Meta’s future and we already have standing recommendations on two other FANNG stocks that have more predictability in their businesses, far better growth outlooks over the near term, and have produced much better performance over the last 2 years.
The most shocking part of that analysis is that you state you were not hip to what the kids think is cool these days…that floored me.
Changes in Apple’s IoS system – privacy changes raised concerns. FB is not able to track and target users as well.
Your Stock Our Take
Came in from Gord
EcoSynthetix Inc. (ECO:TSX)
Current Price: $5.11
Market Cap: $303.5 Million
What does the company do?
Ecosynthetix is a renewable chemicals company specializing in bio-based materials from natural feedstocks, such as potato, tapioca and cornstarch, as an alternative to petroleum-derived feedstocks such as formaldehyde and styrene-based chemicals.
The company’s two flagship products are ExoSphere Biolatex – used in paper and paperboard packaging industries (makes colourful graphics stick to glossy paper) and DuraBind biopolymers which are a no added formaldehyde binder system used in the production of wood composite panels.
- The company’s strategy is to:
- Diversify from Paper and Paperboard market into both the wood composites market and personal care markets.
- Ecosynthetix made its IPO in 2011, raising over $100M at $9 per share.. and it appears that since then, the company has been just milking this cash balance:
*Definitely how the company is staying afloat.
- I find it interesting that the company is buying back its shares even though it’s not yet profitable. Where during the first three quarters of 2021 the company cancelled 200,400 common shares for consideration of $0.8 million.
Recent Financial Results: (Q3, 2021)
- Revenue was up 57%, to $4.7 million compared to the same Q last year.
- Growth was from higher sales volume along with higher average selling prices.
- Net Loss was $(800,000) compared to a loss of $(600,000) thousand for Q3 2020.
- Adjusted EBITDA loss was $(116,000) thousand compared to $(227,925) for Q3 2020.
- Balance sheet – $40.8 million in cash, with no debt.
- Valuation basis, the company trades with a trailing P/S of about 18x sales. Even if we estimate that the company can get back up to its high watermark of ~$23M in fiscal 2021, the company still trades at 13x sales.
Plus, long term, the company has struggled to really grow revenue and has never really broken into profitability. Where in 2013 the company posted revenues of $22.2M then they declined to $13.3M in 2016, then back up to $18.4M in 2019.
With EcoSynthetix I believe the lack of consistent growth and profitability over the past decade is really the primary concern for me. It looks like a decent company in the fact that they are playing on the theme of sustainability and have a healthy balance sheet with the goal of diversifying out of its primary market of paper & paperboard clients. But with the spotty history and the business trading at 18x trailing sales, it’s just way too pricey for us, which would keep us on the sidelines.