KeyStone’s Stock Talk Show, Episode 180
Great to be back with you again this week. The markets are never boring and over the weekend Finwit was all a flutter once again, calling issues at Swiss investment bank Credit Suisse, Europe’s Lehman Brothers moment. We also look at a tweet from “Big Short” famed investor, Michael Burry, in which he references persistent sky-high valuations in US markets. We also have an epic stock battle which pits Aaron against myself in a no-holds-barred cage match on Canadian software giant Constellation Software Inc. (CSU:TSX). Constellation acquires mission-critical specialized software companies. Aaron argues the bull case and I crush the poor sap with the logical bear case. In our Your Stock, Our Take segment, Brennan compares Canadian listed steel giants Stelco Holdings Inc. (STLC:TSX) and Algoma Steel Group Inc. (ASTL:TSX). The latter’s saw its share price drop last week after operational issues hit its latest quarter and recent lower steel prices will make for tough comparable moving into the next quarter.
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Welcome, my cohosts, Aaron and the killer B’s, Brennan and Brett!
Credit Suisse – Europe’s Lehman Brothers Moment?
Fintwit was all a flutter over the weekend calling issues at Swiss investment bank Credit Suisse, Europe’s Lehman Brothers moment – a reference to the bankruptcy of Lehman Brothers on September 15, 2008 which was the climax of the subprime mortgage crisis. Generally speaking it’s the point at which one company’s disaster becomes everyone else’s problem, as happened in September 2008 when the losses Lehman Brothers had made by betting on America’s subprime mortgage market became insupportable.
Who is Credit Suisse?
Credit Suisse Group AG is a global investment bank and financial services firm founded and based in Switzerland.
Primary Areas of Operation:
- A) a Swiss bank and wealth arm serving rich people – doing well at present.
- B) an investment bank that’s losing share with no prime brokerage this was largely due to the Archegos Capital collapse – which was trader Bill Hwang’s family office / hedge fund which , blew up in March 2021 after making massive, wrong way bets – ongoing cases with big legal liability and fines from the pathetic oversight of this operation.
c] A fund distribution suite, “AllFunds” which is not that great a business.
Credit Suisse’s stock has dropped -56.67% YTD in 2022 – this is driven by sharply lower EPS expectations. In 2021 analysts forecast 2.00 Franc’s a share of ’23 eps and now only expect .64 cents (a 68% decline)
Over the weekend there was a sharp rise in spreads on the bank’s credit default swaps (CDS), which offer protection against a company defaulting on its debt – this is what some on FinTwit and Reddit were calling Europe’s Lehman moment.
Is it? Not likely, at least the market is not close yet.
I will quote some figures from a Tactical Trader Alex Good:
CDS are a bit hard to understand, so he instead focussed on Credit Suisse’s bonds. The 2025 Credit Suisse bonds pictured below trade at 6.4%. Compare this, for example to Ukraine 2025 debt trading at 67%. Talking about Ukrainian debt default makes sense. CS debt default – less so.
Credit Suisse’s bonds are not pricing a pending credit event because as of the July Quarter, Credit Suisse’s CET1 capital adequacy was at 13.5% – within the bank’s own target and well above the 8% intl regulatory requirement or the 10% Swiss hurdle.
In the pre 08′ era, sub 5% CET1s were common.
Constellation Software Inc. CSU:TSX
Price: $1,960
Market Cap: $41.5 Billion
Dividend Yield: 0.20%
Company Overview
Constellation Software Inc. (CSU:TSX) is a Canadian software conglomerate. Constellation acquires mission-critical specialized software companies. The company’s goal is to create a vertically integrated portfolio of software companies to allow the acquired companies to become and maintain being a leader in their respective industries.
The company operates six groups Volaris, Harris, Jonas, Vela, Perseus, and Topicus. All of these can be seen as “little” Constellation Softwares having the ability for each management team to exercise their discretion when it comes to acquisitions with minimal corporate interference. The company expects these groups to begin having further sub-groups to operate more independently, resulting in more mini-Constellations.
The company has been a massive success story gaining over 10,000% since it listed in 2006 and a solid 178.71% over the past 5-years. But as they say, the bigger they are…the harder they fall…eh Aaron?
Bull Case
- Constellation grows by acquisition, but it has a problem, tech valuations remain high, debt is more expensive and the company has negative organic growth.
- Q2 free cash flow was down significantly and cash flow from operations was down 55%.
- High valuations: PE of 61, and price to FFO of 24, an EV/EBITDA of 22 times with $1.52 billion in net debt.
- Organic growth is on the shrinking from 14% in Q1 2021 to 7%, 4%, 1% and -2% in its last quarter.
- Without organic growth, CSU needs acquisitions but due to the size of the management is having issues finding suitable acquisitions which meet its initial criteria – paying out a special dividend in 2022 as it couldn’t effectively deploy its capital.
- Constellation is not a bad company, but is it the right time to buy high valuations, negative organic growth in the face of a recession – Growth-by-acquisition works, until it doesn’t – the only logical answer is no!
Bear Case
- CSU one of most successful stocks in Canadian market history.Proven business model and strong fundamentals across the
board. - Tremendous track record of financial success. Growth and profitability in every year.
- Revenue has growth by nearly 6 times over the last 10 years from $900 million to $5.1 billion and net cash flow has grown by almost 10 times.
- Recent financial performance continues the trend with Q2 revenue up 30% and constant currency organic growth of 2%. 5% organic growth last year.
- The many billions invested into acquisitions over the years have been funded primarily with free cash flow. The company rarely issues shares and maintains a healthy balance sheet.
- CSU’s stock has been resilient through the tech market crash. The share price is down only 5% over the past 12 months while many
comparable software stocks are down well over 50%. - The valuation is about 35 times trailing cash flow which isn’t cheap but you have to pay a little more for the highest quality assets and we must consider that this is growth at a reasonable price.
Your Stock Our Take
We had a question on Algoma Steel (ASTL) and someone posted on one of our older Stelco (STLC) videos so I thought that we would compare the two similar businesses.
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Stelco Holdings Inc. (STLC:TSX) – engages in the production and sale of steel products in Canada, the United States, and internationally. It offers flat-rolled value-added steel, including coated, pre-painted, cold-rolled, and hot-rolled sheet products, as well as pig iron and metallurgical coke. The company sells its products to customers in the construction, automotive, energy, appliance, and pipe and tube industries, as well as to various steel service centers.
Algoma Steel Group Inc. (ASTL:TSX) – produces and sells steel products primarily in North America. It provides flat/sheet steel products, including temper rolling, cold rolled, hot-rolled pickled and oiled products, floor plate, and cut-to-length products for the automotive industry, product manufacturers, for the light manufacturing and transportation industries, and infrastructure.
Both of these companies have come under question due to their low valuations following the rise in Steel Prices during 2021/2022 and the subsequent increase in profitability for both.
| STLC:TSX | ASTL:TSX | |
| Price / Mkt Cap. | $34.85 / $2.18B | $9.04 / $938.1M |
| Dividend Yield | 3.5% | 2.9% |
| Dividend Payout Ratio (MRQ) | 3.9% | 3.4% |
| Growth (MRQ) |
Q2 2022 Rev. up 13% Y-o-Y. Adj. EPS was up 14% Y-o-Y and Adj. EBITDA was up 13%. |
Q1 2023 Rev. up 18% Y-o-Y. EPS down 47% Y-o-Y and Adj. EBITDA was up 27%. |
| Guidance | Adjusted EBITDA in Q3 is expected to be materially below the Q2 level, and further weakening is expected in Q4 assuming the lower prices and shorter lead-times being experienced currently fully impact results and prevail through the remainder of 2022. |
Q2 2023 Adjusted EBITDA is expected to be in a range of $75 million to $80 million. (Y-o-Y decline of 82%).
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| Balance Sheet (MRQ) |
Net Cash of $1.203B. – (55% Mkt Cap.) |
Net Cash of 1.041B. (110% Mkt Cap.) |
| Use for the cash?? |
Commence substantial Issuer bid to purchase up to 30M shares outstanding, at $35 per share for an aggregate purchase amount of $1.05B. (retiring about 47% of shares) Stelco also increased its quarterly dividend to $0.30 per share from $0.20. |
Just finished substantial issuer bid where it purchased for cancellation 41M common shares at a purchase price of $9.75 per common share, for an aggregate purchase price of approximately $400 million. Finished recently.. So I believe this $400M will be coming off the cash balance in the next quarter. |
| Valuation |
Trailing PE of 1.5x TTM EV/EBITDA of 0.4 times. |
Trailing PE of 1.1x EV is NEGATIVE. |
Both businesses are heavily reliant on the price of steel, which is why each management team is guiding toward weaker quarterly results over the next few quarters. But it is great to see that both companies are aggressively retiring shares while they are cashed up from a period of increased profitability.
My short and sweet conclusion is that if one was looking to purchase either stock in the near term, I think that patience may pay off as both company’s need to lap through their difficult comparable results from steel trading in the $1,800 range. As ultimately, the trailing numbers will look better than the forward numbers…. So once these numbers are lapped and both companies push for growth into 2023/2024, I think it would be good to revisit each story to really get a gauge on the growth going forward and what their valuations look like.
But nonetheless, it will be very interesting to see how EPS is affected from all of the share buybacks.
