KeyStone’s Stock Talk Show Episode 255.
Great to be back. I will start this week’s episode by detailing how rate increases changed the growth stock equation and how we used this theme this past Fall to recommend two unknown Canadian Growth Stocks to our clients producing two stocks that have jumped over 100% in less than 9-months. We will also tease a recent recommendation that holds $85 million or 28% of it market value in cash with no debt, just saw earnings increase 296%, and can be bought today at roughly 8.75 times earnings cash out. In our YSOT segment Aaron begins with a viewer question on Autodesk Inc. (ADSK:NASDAQ), a leading global software company that primarily through its AutoCad solution provides 3D design, engineering, and entertainment technology solutions. The share price has dropped since early April of this year after it initiated an internal investigation regarding some of its reported financial numbers. This week, Autodesk reported that it will not restate or adjust numbers and also announced its preliminary guidance and outlook – Aaron reviews the recent news. Brennan will revisit a past YSOT on CloudMD Software & Services Inc. (DOC:TSX-V), which provides mental, physical and occupational health services, healthcare navigation, absence management and healthcare productivity tools in both Canada and the United States. We have answered questions on CloudMD in past segments when the stock traded at $0.60 and $1.80. With the company now trading at $0.035, we are pleased to state that we have not found any value in the business in the past and have taken a pass on the stock. Brennan will let you know where this cautionary tale is today. To close, Brett answers a viewer question on Reddit (RDDT:NASDAQ), which unsurprisingly, owns and operates the website Reddit, an online network of unique communities, that allows users to dive into experiences built around their interests, hobbies and passions. The company IPO’d in March 2024 at $34 a share but quickly jumped after opening. The shares are now at $55.30, up 9% from the close on the first day of trading and Reddit has now reported its first quarter as a public company – Brett takes a look at the company’s financial picture following the release.
Let’s get to the show – we welcome my cohost, Mr. Aaron Dunn and the killer B’s, Brett, and Brennan.
It’s so great to see the Oilers in the Stanley Cup Finals…or not.
Brennan, a fair whether Oilers fan, is shocked that I am not over the moon and now cheering for his now beloved Oilers because they are the only Canadian team remaining – like that somehow should obligue me to switch allegence..a practice that he is only to familiar with and scream “Let’s go Oilers”
Let me give you a simple example. It’s universally known that Boston Red Sox Fans Hate the Yankees – correct? OK.
Here is the scenario – the Yankee’s, as they have in the past, beat the Red Sox’s in a playoff series…then the go on to face the Toronto Blue Jays. Do you think for one moment Red Sox’s fans would even consider then cheering for the Yankees just because they were the only US team in the series..They would sooner sell their first born, than cheer for their hated Yankees in a series against anyone.
So, no, I wil not be cheering for the Oilers.
In fact, I will be cheering on my Florida Panthers in Victory. I kid.
Fall 2023 Theme Playing Out in Real Time – Rate increases changed the growth stock equation.
This past Fall after completing research for our Cash-Rich Canadian Growth Stock Report, one intriguing theme developed. The research for this special report includes manually screening 3,500 Canadian stocks for profitability, strong net cash (more cash than debt) balance sheets, and growth. After looking at thousands of balance sheets and cash flow statements, it was clear that the significant post pandemic rate increases had changed the growth stock equation.
This theme created a tremendous opportunity. Growth companies with net cash were positioned with a significant advantage.
Two to three years ago, a decent cash flowing growth stock could get funded (debt) for 3-5% or lower in some cases (lower in some cases).
Today, if they can get it, they are paying 8.5 to 12%+. In some cases, their cost of growth capital is 3-5 times higher.
Our thesis at that time (do not read) Strong Balance Sheets Critical:
..was that strong, growing net-cash businesses were positioned well and should be rewarded over the next year and
similar but overleveraged businesses were in for tougher times.
Simple EXAMPLE –
Let me give you a specific real-world example from our research that will outline and show the success of this strategy over the past 9-months.
The following is based on two real companies we considered recommending in late Summer/early Fall 2023.
Both are profitable Specialty Pharma businesses in licensing, acquiring, and selling unique drug treatments primarily within Canada. I will simplify the two situations here for my example, but financially, the major difference was found in their balance sheets:
- Company A $50 million in net cash
- Company B $50 million in net debt.
When that debt could be had for approximately 3%, while we still preferred Company A or net cash company, with Company B or the net debt company paying only $1.5 million in interest, it was not truly affecting cash flow or the businesses’ ability to execute on its growth strategy. Today, with debt costing 10%, Company B is paying $5 million in interest. That figure has become material and is eating significant cashflow.
On the flip side, Company A ($50 million net cash business) has no debt service payments, and as a bonus is now being paid 5%+ or $2.5 million a year on that cash (where it was receiving effectively zero just 24 months ago). The net benefit to the cash rich versus the debt heavy business is $7.5 million ($5 million it is not paying for the costly debt and $2.5 million in bonus interest). Company A benefits from with a $7.5 million swing largely by positioning itself with a strong balance sheet.
But the benefits of strong balance sheet in this environment, don’t just end at better cash flow. Growth businesses, by definition, are looking to grow. Highly leveraged businesses are operating with one hand or even both hands tied behind their backs in a higher rate environment and, as a result, are less able to execute..
But the benefits of strong balance sheet in this environment, don’t just extent to better cash flow – all of these companies are looking to grow – highly leveraged businesses are operating with one hand or even both hands tied behind their backs in a higher rate environment and, and are in a weaker position to execute their growth strategies.
Whereas companies with net cash have so many capital allocation avenues that are great for creating shareholder value. Included in their quivers are share buy backs, dividends, investing in their business, or buying other businesses to grow.
Your question could now be – does all this balance sheet business make a lick of difference in terms of share performance? In the investing world, it all comes down to returns and the differences in performance between Company A and Company B could not be more pronounced over the past year – and they could be the tip of the iceberg.
My real world example:
There were two Canadian Specialty pharma businesses our team sat down with management and reviewed this Fall. The first, Company A and the one we recommended, Cipher Pharma (CPH:TSX), is business that sells the number one doctor prescribed acne treatment in Canada. Cipher had a profitable core business, ~$50 million in net cash, and we recommend it at $3.89 in late August.
The other company Medexus Pharmaceuticals Inc. (MDP:TSX) was another profitable, Canadian Specialty pharma, business then trading at $3.00. Since we selected the net cash Cipher and recommended it as a BUY, the company has bought back over $6 million in stock with its cash, added cash and recently closed at $9.00, up 131%.
On the flipside, Medexus the debt heavy company we chose not to recommend continues to service that debt, and as a result, is inhibited in its growth ambitions, closing recently at $1.60, down 47%. A massive 9-month swing.
Warren Buffet once said, “A rising tide floats all boats….. only when the tide goes out do you discover who’s been swimming naked.” We have witnessed this over the past year in the small-cap arena. Solid growth stocks that have been disciplined, cash accumulators are now in a great position to be advantageous cash allocators. On the other hand, over leveraged businesses are in trouble
Cipher currently ranks as a HOLD in our research after a strong run, but has solid long-term growth potential.
We continue to favour strong balance sheets (often with net cash positions) in many of the growth oriented Canadian & U.S. stocks in our Small-Cap coverage.
Finally, I will tease a Recent cash-rich Canadian Small-Cap BUY recommendations from our Canadian Small-Cap research.Recent BUY recommendation – a unique and under-the-radar small-cap that works with growth business such as DoorDash, Lyft and Uber. This high growth, but low-priced stock, just posted real earnings growth of 296% in its last quarter.
- The stock has already gained 20% since our recent recommendation, but with its growth profile, big name customer list and strong fundamentals, this may be just the beginning.
- This under-followed growth stock holds around $85 million or $1.76 per share in cash with no debt. Based on our 2024 expected earnings and removing this cash, the stock can be bought today at roughly 8.75 times earnings – a low multiple given the growth and strong balance sheet.
- Another undervalued small-cap with excellent growth that can be found nowhere else.
CloudMD Software & Services Inc. (DOC:TSX-V)
Price: $0.035
Market Cap: $10.7 million
Description:
CloudMD provides mental, physical and occupational health services, healthcare navigation, absence management and healthcare productivity tools in both Canada and the United States through its integrated connected platform ”Kii”.
The company has two divisions:
- Health and Wellness Services which provide organizations with an Employee & Family Assistance Program (EFAP), Mental Health Care (Coaching, Therapy, Treatment for Chronic Conditions), Health Coaching, Medical Assessments, Occupational Health and Absence Management, all through our integrated connected platform Kii.
- Health and Productivity Solutions division which offers health and productivity tools intended to create a better experience for those needing healthcare. Such as Remote Patient Monitoring.
Slide 2
I have covered CloudMD a few times on the podcast, once back in 2020 when it traded at $0.60 per share and again in the summer of 2021 when the stock was trading in the $1.80 range. And both times I highlighted that the company had great growth in revenue (driven by acquisitions funded by share issuances and debt) but the stock was trading at expensive multiples given the hype in telemedicine and the company was continually losing money. And as such, I said that we would stay on the sidelines.
Slide 3
As I mentioned, CloudMD was growing rapidly, acquiring many clinics and pharmacies, but in 2022 and 2023 the business began restructuring and divesting assets, selling its B.C. based primary care clinics and Cloud Electronic Medical Records and practice management software to Well Health for approximately $5.75M. As well as its U.S. based medical records, practice management, and revenue cycle management assets for approximately $8.3M in 2023..
And as Karen Adams, CEO of CloudMD commented – she said – “We are divesting non-core assets and focusing on our core business to drive organic growth, improve margins and move towards profitability next year. We will continue to reallocate capital from the sale of non-core assets back into the organic growth of the company and ensure we maximize the potential of our faster growing and higher margin EHS division.”
Slide 4
Looking at the financial results over the past 8 quarters, the divestments have driven some improvement in gross profit margins to slightly below 40%, but the company is still losing money on an adjusted EBITDA basis and EPS basis….
In Q1 2024, revenue was essentially flat, Adjusted EBITDA was an ever so slight gain of $122 thousand, and EPS was a loss of $(0.02) per share.
Slide 5
Given the company has no profitability, if we value the company on a trailing price-to-sale multiple, it currently trades at 0.12x…
This is a stark contrast from when I covered the stock on the podcast in 2020 and 2021 when it was trading at 5x and 9x trailing sales, respectively. And there were many people out there that were trying to justify these high flying multiples at that time.
Slide 6
If we look at the balance sheet, including restricted cash, the company has about $7.7M in cash, with debt and leases of $24.5M, providing net debt of $16.8M. And given the business doesn’t even have any Adjusted EBITDA… this debt is certainly a concern..
The company’s share count is also something of a concern given it has over 300 million common shares outstanding. And as I said back in 2021, “it’s not that a company cannot issue shares to grow accretively, but it is a much harder process to do so, and I noted that I was concerned with the business considering the company has no profitability and would likely continue to dilute shareholders”. And as such….. the company went from about 100M shares in 2021 to about 300M shares today….
Slide 7
Since July 2023 the company had been conducting a strategic review to address the company’s liquidity issues, which were largely the result of the number of acquisitions completed over the last four years and impacted the company’s ability to remain a going concern given the company’s inability to generate positive cashflow to support the debt.
As such, on May 15, 2024, the company announced that it would be going private through a transaction with CPS Capital, which has agreed to acquire all of the outstanding shares at $0.04 per share…..
Shareholders will be voting on the matter… but I think overall we can see the failure of management to prove out the business model. And as I had concluded multiple times before, we were staying on the sidelines given the inability of management to prove out the business model as it grew revenue with no mind to the bottom line, the health of its balance sheet, or the amount of shares that it had outstanding.
Slide 8
Now we don’t get them all right, but we certainly made the right call by saying that it was wise to avoid investing in CloudMD.
Just because a company can issue shares and acquire businesses doesn’t mean that it will be successful. And overall, this just enforces our investment philosophy of how important it is to ensure that a business is able to generate cash flow before investing. It mitigates undue risk of possibly investing in a business which will only dilute shareholders and destroy investor capital over time.
And I will leave you with a few negative comments we got on our previous videos covering CloudMD…
