Stock Talk Podcast Episode 205 Show Notes

KeyStone’s Stock Talk Show, Episode 205.

Great to be back with you this week. We have a busy show and I will start with a brief segment on gold with the little yellow metal surging to within a stone’s throw of its all-time high. I will explore the “picks & shovel’s” approach to investing in the sector and highlight a favour we have recommended to clients over the past 2-years to participate in golds run. That company, is profitable, dividend paying small-cap Geodrill (GEO:TSX) which has seen its share price jump over 120%. In our YSOT segment Brett answers a question on Reitmans (Canada) Limited (RET.A:TSX-V), a Canadian retailing company focusing on women’s clothing, under the brands Reitmans, Penningtons, and RW&CO. The stock has had a strong run over the past year after emerging from bankruptcy protection, Brett gives you his take on the run. Next, in our YSOT segment, Aaron answers a viewer question on Consolidated Water Co. Ltd. (CWCO: NASDAQ) which operates water treatment plants and distribution systems, specializing in seawater desalination and water treatment facilities. They also manufacture and service water-related products and provide services for commercial, municipal, and industrial water treatment. The company saw its share price jump this week on solid earnings – Aaron gives you his take on this interesting stock. In our Star & Dog segment  Brennan’s Star is Chinese tech giant, Alibaba Group Holdings Ltd. (BABA:NYSE) which jumped 13% in the last week. After announcing it will split up its business unites. His Dog is Verde AgriTech Ltd. (NPK:TSX) which is Down 50% over the past 3 trading days. Verde AgriTech is an agricultural company which produces and sells fertilizers in Brazil and internationally. Brennan let’s you know why the stock is dropping so sharply.

I welcome my cohosts – Aaron, and the Killer B’s – Brennan and Brett.

This week we released a new report to clients which we will talk about next week in a segment. It is a first for our research and it is entitled KeyStone’s 2023 Cash Investment Product Report – Where To Park Cash In Your Portfolio For The Highest Return.

One question we often receive from clients is what should they do with the “cash” component of a broader portfolio. This can apply to someone who is just starting their portfolio-building journey, those with an existing portfolio that hold 5-10% in cash, or those that were “fully invested” but have recently sold shares in a company and need a place to hold that cash while they look to redeploy the funds.

With interest rates rising, the report describes, rates and recommended a number of simple highly liquid, low risk and low cost investment vehicles to park your cash and earn 4-5 percent. Far better than the minimal return you will get in a savings account.

Gold is Skyrocketing – 

Gold extended gains to above $2,000 an ounce on Tuesday this week as the dollar and yields fell, while weaker US economic data emboldened bets for slower rate hikes despite mounting concerns over oil-led inflation.

The precious metal is now roughly $35 away from trading at an all-time high of US$2,075 per ounce reach in August 2020.

One approach we have used to participate in the growth of a sector (particularly highly risky sectors like gold) is known as the Picks & Shovels Approach.

What Is a Pick-and-Shovel Approach?

Essentially, an investment strategy that invests in the underlying technology, services, or tools needed to produce a good or service instead of in the final output. It is a way to invest in an industry without having to endure the risks of the market for the final product.

This investment strategy is named after the tools needed to take part in the California Gold Rush (which is very appropriate for our case study today). While the allure of finding the next great godl mine is always sexy, it turned out the most profitable business to be in during the 19th-century Gold Rush was to be selling the tools every starry-eyed miner needed to find gold – the picks and shovel providers  were the ones getting rich, not those actually mining for gold.

With the price of gold poised to hit new all time highs, we update listeners on a stock we have recommended to our clients over the past two years which provides the tools necessary to find and increase the life of gold mines.

That company…

Geodrill Limited (GEO:TSX)

Recommendation: February 2021, Recommendation Price: $1.60

Price: $3.50 – stock is up 33.21% in 2023 and, over 120% including the dividend since KeyStone recommended the stock in 2022 at $1.60.

Market Cap: $ 163.99 Million

Yield: 1.71%

Company Description: Established in 1998, GeoDrill is a mineral exploration drilling services company to mining companies (primarily gold related) in West Africa, Zambia, and Peru. It offers reverse circulation, core, air-core, deep directional, reverse circulation grade control, water borehole, underground, mine blast hole, and horizontal drilling services. The company’s current fleet stands at 76 rigs (up 1 rig vs. Q3 2022), with an additional rig being manufactured and 4 currently being rented (will bring the total to 81). Approximately 60% of the fleet is tied up to existing customers over the next 3-5 years.

GeoDrill continues to expand globally, having signed its first ever contract in Chile this past quarter, as well as two new contracts in Egypt. The company’s client mix is made up of senior mining, intermediate and junior exploration companies.

What is Driving the Share Price?

• Recent Financials – A Strong 2022 – figures are in US dollars.

• • Revenue rose 20% to $138.6 million.
  • Net income jumped 34% to $18.9 million or US$0.41 or CAD$0.56 per share.
  • Achieved a Return on Capital Employed (ROCE) of 25% and Return on Equity (ROE) of 18%;
  • Ended the year with net cash (excluding right of use liabilities) of $9.8 million

• Delivered CAD$0.06 in dividends to investors in 2022 compared to CAD$0.02 in 2021;

1. Surge in the price of gold: From its lows in early November in the range of US$1,630, gold has risen 25% to US$2,040 – that is a significant rise in 4-months and bodes well for capital inflows into the sector at present. The more money that is raised in the sector, the more money goes into drilling and a company like GeoDrill can continue to benefit.

Our Take:

While the stock is up over 120% since our recommendation, from a valuation basis, GeoDrill currently trades at 5.8 times 2023 expected earnings and 2.65 times expected 2023 EBITDA.
A client recently asked if we saw GeoDrill as a takeover target. Firstly, we never make an investment in a company based on it being a takeover target as that is highly speculative. Having said this, go partially down this path, in terms of acquisition equivalents there is not an exact comparison, but Major Drilling (MDI:TSX) – the largest driller in this segment acquired McKay Drilling PTY Limited, a leading specialty drilling contractor based in Perth, Australia for an amount approximately C$75 million in 2021. This was approximately 4.7 times EBITDA. GeoDrill will have more than double the EBITDA of McKay this year, so it likely deserves a higher multiple. GeoDrill currently trades at roughly 2.65 times 2023 expected EBITDA. We would not buy GeoDrill or any company strictly on the basis of the business as a takeover target as this is poor strategy. What we do know is that GEO is likely to post a record earnings again in 2023. This have driven the share price over the past year and the current execution is strong.

Geodrill continues to offer a unique way to gain exposure to the gold price, without the geological and technical risk of mining. The stock trades at ~2.5x 2023 EBITDA, below its peers in the Americas and Australia which is not justified by the business fundamentals.

Caution: A word of caution – investing in commodity based stocks is very risky business. You have all the company specific risks you would find in any stock including the quality of the management team, the prospects for growth in the business, execution on stated targets, the cashflow, balance sheet, and price you are paying for the stock & and the market risk including general market sentiment & economic conditions PLUS you have commodity price risk. Typically, if the commodity the stock produces or is associated with goies higher, the stock does well, if the commodity moves lower, the stock does poorly – the degree to which the stock underperforms or overperforms the average of the sector can depend on the quality of the company, but the general direction is driven by the commodity price. So, even if management of a gold company does everything right in a given year, if the price of gold moves against them, it will likely not be a good year for the stock.

The Star of the week is: Alibaba Group Holdings Ltd. (BABA:NYSE)

Gained approximately 13% in the last week.

Where it now trades at:

Price: $98.39

Market Cap: $270 Billion

Description: 

Alibaba, through its subsidiaries, provides technology infrastructure and marketing reach to help merchants, brands, retailers, and other businesses to engage with their users and customers in the People’s Republic of China and internationally.

Slide 2

Driving the share price Gains:

Was a recent announcement on March 28th that the company would break up and split into 6 distinctive units, with separate CEOs and their own board of directors:

1. Cloud Intelligence Group
2. Taobao Tmall Commerce Group
3. Local Services Group
4. Cainiao Smart Logistics Group
5. Global Digital Commerce Group
6. Digital Media and Entertainment Group.

“The original intention and fundamental purpose of this reform is to make our organisation more agile, shorten decision making links and respond faster” – Chief Executive Daniel Zhang

Slide 3

The revamp comes a day after Alibaba founder Jack Ma returned home from a year-long stay abroad……. and by paving the way for Alibaba’s various new units to list, analysts and commentators believe the Chinese government may be signalling less hostility towards its tech giants. (which is a very different approach it has taken over the past 3 years)…

Now for shareholders of BABA, there remains little clarity on how and whether the new entities will be Spun-off (not to public but to current shareholders of BABA)….. But regardless of whether China wants to be seen as “more tech friendly” we still see huge risks with investing in the country.

Slide 4

The Dog of the week is: Verde AgriTech Ltd. (NPK:TSX)

Down 50% over the past 3 trading days.

Where its currently trading at:

Price: $2.66

Market Cap: $145.2 million

Description: 

Verde AgriTech is an agricultural company which produces and sells fertilizers in Brazil and internationally. The company offers multi-nutrient potassium fertilizer under the K Forte, BAKS, and Super Greensand brand names. It holds a 100% interest in the Cerrado Verde project, which is the source of potassium silicate rock, that includes 30 granted exploration permits covering an area of 45,734 hectares located in Brazil.

Slide 5

Driving the decline: 

2022 Results:

Year-over-year the financial results looked good, with revenue up 190%, EBITDA up 271% and EPS up 386%…. however, the company missed its 2022 guidance substantially.

And management noted the reason for the underperformance was: “When the war in Ukraine broke out, there were concerns about a potential shortage of potash. In reality, however, the market was oversupplied. Throughout 2022, many farmers refrained from buying potash due to the unprecedented soaring prices, resulting in 15% Brazilian potash imports and, consequently, a record inventory build-up. In Brazil, the last quarter of 2022 saw the convergence of several unfavourable factors, including pre and post-electoral tensions that drastically reduced investments by farmers. Moreover, two years of bad weather severely affected coffee harvests in Brazil, leading coffee growers to reduce expenditure on inputs.”

Slide 6

As of March 30th, 2023, Verde lowered its fiscal 2023 guidance:

** They are using a Price of US$450.

Slide 7

My take away here… management did a poor job gauging its production guidance… but realistically I cannot blame them. It is extremely difficult to gauge the forward financials of a business when its operations are extremely reliant on a volatile commodity. JUST LOOK AT THE PRICE OF POTASSIUM CHLORIDE here.. with it down over 50% YoY.

And the market clearly didn’t like the reduction in the 2023 guidance. Where even using the midpoint of its forward EBITDA guidance, the stock still trades at 11 times EV/EBITDA.

Now, the company is expanding its operations, but with tough comparables, headwinds in the sector, and reduced guidance – it is not surprising that the stock took a tumble.

YSOT RET.A:TSX

• Intro Slide

Reitmans Canada is a Canadian retailing company focusing on women’s clothing, under the brands Reitmans, Penningtons, and RW&CO.

Reitmans Canada symbol RET.A and symbol RET on the TSX venture exchange. The shares trading under RET carry a voting right and trade for roughly $4.27, while the shares under RET.A don’t carry a voting right and trade for roughly $3.57. It is not unusual for companies to have non-voting and voting shares but what is unusual is the price difference. Sometimes you’ll see different share classes have different dividend payment rights but in this case, it is merely the voting right difference. The voting shares are still largely in the hands of the Reitman family, giving them control over the company.

Reitman’s has been struggling since 2020.

The company filed for protection from creditors under the Companies’ Creditors Arrangement Act or CCAA in May of 2020, the height of COVID. After 19 months the company emerged from restructuring shedding roughly 160 stores, two brands and 1400 employees. The company currently has 404 stores across its 3 ongoing brands.

• Income Statement

Moving to the Income Statement.

For the fiscal Q3 2023, ending October 29th, 2022, the company had sales growth of 15.4% to $205.6 million. The company saw both higher transaction counts and transaction values as well as increased sales due to its growing e-commerce segment. Offset partially by net 9 store closings over the year.

The company saw significantly higher selling, distribution and administrative expenses increasing 28.3% to $102.4 million. The increase was largely due to increased operating costs in wages & performance incentives, advertising, and leases being connected to sales.

The result of the higher SG&A is a lower bottom line year over year, falling to $0.30 per share from $0.45 for continuing operations. We’re using continuing operations as a comparison because the company was still undergoing restructuring during the prior year. The company book a tax expense of only $67,000 for the quarter, and in previous quarters booked a taxable benefit.

On a year-to-date basis, we see very similar but slightly better results, with sales increasing 24.8%, SG&A increasing 36.9%, and continuing EPS incsreasing 9.6% to $1.03 per share from $0.94. The better results year to date compared to the quarter is because the first half of fiscal 2022 was weak given the company was still being impacted by COVID.

• Balance Sheet

On to the Balance Sheet.

The company holds $64 million in cash while having only lease liabilities of $77 million with no other financial debt. As the company is primarily a brick-and-mortar retailer the high lease liability is not unexpected. Net debt including leases is $13 million, which is reasonable given the size of the company and assuming sales don’t collapse like in 2020 it should not be a near-term risk.

Leases did increase substantially over the year due to restructuring, shifting leases to a standard fixed payment structure from a contingent percentage of sales. This also increased the right-of-use asset account which is the asset side of leases under this structure.

Given the recent restructuring, the balance sheet is relatively strong, but it was not the catalyst for the initial restructuring it was the evisceration of sales.

• Valuation

Valuation metrics for the company are generally quite weak in validity as the company has shifted significantly over the last year. For example, GAAP price to earnings is just over 1 times, largely due to restructuring gains and the operational changes along with it. As the major restructuring shifts occurred in the fiscal Q4 2022 we need to adjust some of the accounting figures resulting in large gains in earnings, the main being a settlement of liabilities gain of $88.6 million once the company exited creditor protection. This results in an adjusted p/e of 3.1 times. Further, the company had a slight taxable benefit we can add taxes back in for a 25% tax rate the price-to-earnings ratio is closer to 4.1 times.

Reitmans is shaping up to become a positive turnaround story but has significant obstacles to overcome. External to the company we could likely see a slowdown in consumer discretionary spending in the near future, which was the catalyst that sent the company into credit protection the first time. Internal to the company they need to stabilize earnings.

Q4 earnings ending January 2023 are to be announced on April 13th so we can see if they can continue a successful turnaround.