KeyStone’s Stock Talk Show Episode 259.
Great to chat with you again – I will kick off the show building off last weeks segment as promised with a brief piece on how many stocks should you own and our solution for a simple portfolio build. To crush our ratings once again, my cohost Mr. Aaron Dunn is back, with segment about reviewing and fine tuning a portfolio, which should dovetail well from my segment. In our Star and Dog segment Brennan starts with his Dog of the Victoria Gold Corp (VGCX:TSX), which cratered around 90% in the last week, after the company experienced a heap leach pad incident at its Eagle Gold mine – is it an opportunity or should the company be avoided – Brennan will let you know. His Star of the Week is Netflix Inc. (NFLX:NASDAQ), which this week is back at its all time high hit in late 2021 – Brennan let’s you know why an if it is justified. Finally, Brett answers a viewer question on RE Royalties (RE:TSXV), a renewable energy generation facilities royalty and loan provider through a non‐dilutive royalty financing solution to privately held and publicly traded renewable energy generation and development companies. The stock is flat on the year but down substantially from its $1.50 high in late 2020 / early 2021. Brett let’s you know if this royalty payor is an opportunity or one to avoid.
Let’s get to the show –my cohost, Mr. Aaron Dunn – and the killer B’s, Brett, and Brennan.
Let’s start with what not to do!
Mass Diversification – The Broken Model
This is the basic model most Canadians deploy through their Big Bank advisors. And includes a mix of 5-15+ funds and ETFs.
Each fund holds roughly 100 stocks – typical funds hold 50-150 stocks.
Each fund holds too many stocks and mirrors the market return or the segment return they follow but underperform due to the high fees. And your portfolio underperforms, Particularly when you include the 1% advisor fee.
Of course, this is one of the funds you typically own…most advisors will place you in 5-10 funds (we have seen far more). This is extrem overdiversification for those trying to beat the market….But don’t just take my word for it…
To hammer the point home… I reference Bill Gross..
So your question now should be
How many stocks should you hold?
According to modern portfolio theory, you’d come very close to achieving optimal diversity after adding about the twentieth stock to your portfolio (just under 20 stocks).
Diversification makes sense to a point.
Generally, we do not want you buying 2 or 3 stocks – even if we or you have put in all the research in the world – too much company specific risk. As an extreme example of this, if you were to hold stock in Tesla – what would be considered a CEO driven company, if it’s CEO, Elon Musk, heaven forbid, were to pass away, that would likely have a dramatic negative affect on the stock. (funny thing is, since Elon bought Twitter, this example is becoming less and less valid, but I think you get my point) You cannot mitigate this company specific risk if Tesla is one of 2 or 3 stocks you own. If it is one of 20, you can handle it, you can help allay that company specific risk
On the flipside, there is no point in buying 50 or 100+ stocks – and creating a complex, fee heavy portfolio that mirrors the market. This is what we like to call Wait for it….Diworsification
How do we recommend you build your stock portfolio.
Take control.
If you want to beat the market, you cannot be the market.
Create your own simple equity portfolio.
: Building your stock portfolio.
We call it – Focussed Diversification
THIS IS KEY – Build a 15 to 25 stock portfolio, gradually, over a period of 12-24 months – do not buy all 25 stocks in the first, week, month or even year. Traditional advisors will buy 5-15+ funds or ETFs right when you step in the door. This crystallizes your entry point – if you are near a top and face a significant decline, it can take a significant amount of time to recover if you face a significant correction (remember a 50% loss requires a 100% gain to get you back to even).
While no strategy is perfect, building over a 1-2 year period…
- Reduces risk/exposure to short-term market correction – this is a strategy we have had clients employ for decades.
Provides flexibility to add positions as new opportunities become available.
Process:
- Start with 3 to 5 initial positions.
- – Use Recommendations from KeyStone’s Quarterly Cash ETFs report to find where to hold any cash in your portfolio – currently paying 4.5%+. We update this quarterly with recommendations to get you paid the highest dollar on cash on the sidelines – all clients have access to this report.
- Add 2 to 3 new stocks per quarter as new information/research is released.
- In practice, this is an example of what the structure of a portfolio built with a Focussed Diversification Strategy will look like.
7-10 stocks in deployed into our 3 core areas of research – Canadian Small-Mid Cap growth stocks, Core Canadian Dividend Growth Stocks, and Core US Growth Stocks.
I put together a simple allocation example
Simple Allocation Example:
$500,000 portfolio:
20 Stocks with an equal weighting.
$25,000 in each stock ($500,000/20 = $25,000).
ONE OF THE GOALS HERE IS TO SHOW YOU…
How impactful one great stock can become – to show you WHY we recommend building a portfolio with our Focussed Diversification Strategy.
($500,000 portfolio).
$500,000 Portfolio – 15 years ago, Boyd was included on an equally weighted basis. Today the one stock is work $3.18 million. Just one stock is now worth nearly 7 times the entire original portfolio. All 19 other stocks could have gone to zero and this portfolio would still be in excellent shape – of course we are also looking for growth in a solid percentage of the other 19 stocks as well – but it shows you the amazing power a truly great stock can have on your portfolio if you combine the right research with a portfolio built with this model.
If you had a $1 million portfolio…that one stock would be worth $6.4 million today…
The returns are even better if we use Hammond Power in the example as it has now outperformed Boyd.
The Dog of the Week is: Victoria Gold Corp (VGCX:TSX)
The stock is down approximately 20% in the last week and down about 90% in the last week, where it now trades at a Price of about $0.83 and a Market Cap of $72 Million – and the question on everyone’s mind is what is driving the stock substantially lower in such a short amount of time?
Slide 2
Well, on June 24th, 2024, Victoria Gold experienced a heap leach pad incident at its Eagle Gold Mine – its only producing asset – which suspended the mines operations, damaged infrastructure and leached cyanide solution into the surrounding environment.
There is a lot of speculation what this might mean for the future of the mine which employes 500 people and could mean a prolonged shut down or possibly even the “end of the mine”.
In Q1 2024 the mine produced 29,580 oz. of; and in 2023 about 166,730 ounces. And production at the Eagle Gold Mine for 2024 “WAS” estimated to be between 165,000 and 185,000 ozs of Gold…. Which of course is now no longer expected. And on top of this, the company has about $196M in net debt on the balance sheet… which is certainly a concern as its revenue and cash flow are now idle.
Now this is something that we discuss with our clients all the time, as when someone decides to invest in a commodity-based company we are faced with the additional risk factor of a volatile commodity. But on top of this, there is heightened operational risk in the mining industry, as things tend to take a long time and there are many disruptions and incidents… such as the recent heap leach pad incident.
Slide 3
The Star of the week is: Netflix Inc. (NFLX:NASDAQ)
The stock is up 5% in the past month, and 43% over the past 6 months, where its currently trading at:
Price: $675.36 (BACK AT ITS ALL-TIME HIGH REACHED IN LATE 2021).
Market Cap: $290 billion
Description:
Now, Netflix really doesn’t need an introduction, but it offers entertainment services such as TV series, documentaries, films and games across various genres and languages.
Slide 4
Now lets take a look at what’s driving the increase:
- First and foremost, the company’s strong financial results are driving the share price higher:
- Average Paying Memberships were up 14% Y/Y to ~265M.
- Total revenue grew 14.8% Y/Y.
- GAAP EPS was $5.40, an increase of 84% compared Q1 2023.
- Now netflix does have Net debt of just under $7.0B but this debt is sustainable considering the company produced FCF of $6.91B in the last twelve months.
2. for what is driving the share price gains is that Management increased the company’s FY2024 Operating margin guidance from 24% to 25%. And expects revenue growth to be 13-15%.
A concern in the past by many analysts is that Netflix wasn’t going to be able to continue its strong track record of financial growth. But management indicated that on top of providing quality engaging entertainment, looking forward to 2025 the company is looking to scale ads to be a more meaningful contributor to the business.
Netflix has been doing a great job at engaging subscribers, with the Roast of Tom Brady reaching the largest ever weekly viewing total for a one-off special. And on top of this, Netflix is looking to host the Mike Tyson vs Jake Paul boxing fight which is now expected to Take place in November 2024.
So all-in-all, given the strong fundamentals, healthy growth, and optimistic outlook for the business, Netflix has taken our coveted spot of Star of the Week.
YSOT RE Royalties (RE:TSXV)
1)
RE Royalties Ltd. symbol RE on the TSX Venture is a renewable energy generation facilities royalty and loan provider through a non‐dilutive royalty financing solution to privately held and publicly traded renewable energy generation and development companies. The company’s portfolio is comprised of solar storage wind hydro and biogas, located in Canada, the US, Mexico and Chile. The company is a dividend payer, currently at a yield of 8.2%.
2)
The stock is trading at $0.49 making it a flat year to date.
3)
However, zooming out we can see the company has fallen dramatically from its $1.50 high in late 2020 / early 2021.
4)
So let’s look at the company’s financials to see if it has value at the current price.
As RE Royalties is a financing company it is important to look at the investments and how they are structured.
The company invests in both preoperational and operational assets. The pre-operational matters particularly for revenue out output-based royalties as the company will not receive payments during the initial period as there is no output.
The company does a mix of royalty financing and loans as well as mixed. The difference is royalties will be based on some sort of output whether it be revenue, or dollar per watt, if you look at oil and gas it might be barrels of oil, just some share of the output. Whereas loans will be independent of the output paying a fixed or variable interest rate over time with a potential repayment of the principal at the end of the life of the loan. As well there can be a mix of royalty and loan.
5)
The reason why I bring this up is over 90% of the revenue and finance income that RE receives is classified as finance income. $2.4 million of $2.6 million is classified as loan income during the last quarter. The company has been structuring most of its deals as royalties now which is generally more financially beneficial over the loan term if the underlying asset performs.
6)
If we look at the last quarter, they closed 3 deals with royalty or partially royalty structures.
Clean Communities Corporation a 4 MW solar construction project in Alberta which was comprised of a $1.7 million loan over 5 years and a 5.0% 20-year royalty afterwards.
Revolve Renewable Power corp, a total of 23 MW hydro and wind in BC and Alberta, once again we see this hybrid royalty loan, a $4.0 million 36-month loan with a 0.5% royalty during the loan and 1.0% after repayment.
The last addition during the quarter was Revolve DG a $415 thousand loan for rooftop solar for a Mexican food manufacturing business, with once again a royalty on top this timer a 5% revenue royalty for 15 years.
So, as you can see the company despite its name is largely involved in loans as well, even if an overall hybrid approach is the goal.
7)
So now, if we look at the last quarter we can understand why the majority of the top line is generated from finance income despite the fact that the company does have royalties that will come online in the future. I will add as well when we talked to the CEO last year, he believed at the time more of the revenue should be classified as royalty, but the accountants of the world disagreed. But the company did have an overall financing income of $2.6 million a nice increase from the prior year’s $1.8 and this growth has been a strong trend.
Moving down the income statement, the company does have a significant financial expense as it uses green bonds to finance its investments. Green bonds are bonds that are limited to certain “Green” uses but offer a lower than otherwise obtainable interest rate, overall the use of green bonds is beneficial for RE as the restrictions don’t really limit RE as they are already looking to invest in green projects. The company had a finance expense of $0.9 million, with outstanding green bonds of $36.6 million.
Ultimately the company ends up with a net income of $659 thousand or $0.01 per share. We’ve seen the trend for EPS flip between the range of net income per share of $0.01 and net loss per share of $0.01 each quarter for the past couple of years.
8)
The dividend, a great 8.2% yield, doesn’t have a huge margin of safety in its current form, as the EPS and cash flow either barely support the payment of dividends after the green bond interest payments or is a deficit. The company does have a nice cash balance of $14.6 million but when you are looking at dividend sustainability you don’t want to see a constant reliance on existing cash as that should preferably be used for other investments and at that can only last for so long if deficits do occur.
9)
Concluding,
The company is growing its financing and royalty base quite consistently which is a positive.
However, the dividend and interest payments do not leave any room for growth through internal cash flows. The growth through internal cashflows is a great inflection point for royalty companies as they are less dependent on external financing which can have a myriad of issues when it is relied on. If the company is able to get to the point where the royalties do come online and start to provide a significant portion of the revenue in the next few years it could hit that internal cash flow inflection point. But for now, it still has a ways to go, leaving it as a Monitor to see if it can get there.