Stock Talk Podcast Episode 271 Show Notes

KeyStone’s Stock Talk Show Episode 271.

Great to chat with you again – I will start this week with a small segment from our recent live Webinars on whether not you can gain meaningful exposure to potential 10x Small-Cap Stocks through Big Bank Small-Cap funds. In our YSOT segment, Aaron addresses a viewer who is looking at some higher yielding stocks that have potential to do well as interest rates fall. The viewer came across Doman Building Materials (DBM:TSX), which has a yield of 7% and asks if it is sustainable. Brennan answers a viewer question on Atlas Engineered Products Ltd. (AEP:TSX-V), a management team we will be sitting down with this week to interview.  Atlas is a consolidator that designs and manufactures trusses, floor panels, and wall panels, and distributes engineered wood products. The company is profitable and has grown revenues significantly long-term, but faces tougher market conditions near-term,  characterized by weak housing starts and permits caused by elevated interest rates – conditions that are expected to persist for the balance of 2024. Brennan let’s you know the current financial picture and what we look to ask management this week. Finally, Brett takes a viewer question on Simply Solventless Concentrates (HASH:TSX-V), a micro-cap which develops and manufactures cannabis products including prerolls, concentrates, and distillates amongst others. The business bucks the trend in the segment by being profitable and has seen a significant increase in its share price since its December 2023. Can the gains continue, or with Simply Solventless be another Cannabis stock to go “up in smoke”.

Let’s get to the show – my cohost, Mr. Aaron Dunn – and the killer B’s, Brett & Brennan.

Poll Question.

One of the core areas of our research is profitable, growing small-cap stocks. We just completed a Webinar on how and where to find 10x stocks – or essentially great long-term growth stocks. The data tells you that profitable micro-caps businesses are a fertile ground for identifyng potential 10x stocks.

So one of the areas we explored in the Webinars was “How to gain meaningful exposure to profitable potential 10x micro to small-cap stocks.” When I say this I stress the word meaningful, because we want to design a portfolio that is well positioned to actually benefit from holding a great capital compounding small-cap. 

In theory – if you hold an index ETF on the entire Canadian market – you have exposure to every stocks – so you are exposed to the next great small-cap, but it if is 1 tenth of one tenth of your total portfolio – even if it doubles, triples or runs 10x – it still has little impact on your overall returns. 

One of the avenues we explored was by investing in a Big Bank run “Small-Cap” mutual fund.

Why, because, in theory, owning a small-cap Fund to gain exposure to small-cap stocks makes sense – and most big banks have a small-cap fund (just like when you need something on the Internet, you know there is an “app’ for that, in the financial world, the big banks have created a fund for that. It is one thing they are great at doing – creating products that are saleable to investors. Let’s take a look at one of the Big Banks’ flagship Small-Cap funds to see how well you can gain exposure to quality small-cap stocks and potentially benefit from the next 10x stock.

Our sample Canadian Big Bank Small-Cap fund – TD’s Canadian Small-Cap Equity Fund – (not picking on TD, all the Big banks have a similar form of this fund).

Below is a quick snapshot of what this fund holds holds.

Just based on the holdings alone – there are so many problems with this fund.

Number 1 – far too many stocks – in the Webinar we showed participants that you can have a optimally diversified portfolio with just 25 stocks (in fact it is less than 25 stocks) – this fund has 116 small-cap stocks – far too many stocks to gain exposure to a segment but as I alluded to just a minute ago….the real problem is that by constructing a fund with this many stocks, even if one of the stocks happens to be a Boyd or Hammond Power (small-caps from our coverage that have gained 10,000% and over 20,000% respectives, its impact on the fund is neutered as it is one of 116 stocks this small-cap fund owns. So even if the stock performed incredibly in a year – gaining 100% – that would likely add less than 1% to the gain of this fund. Of course this would be one of 5-10 plus funds you own, so your gain, in your portfolio if you owned a truly great 10x stock would be likely a 10th of a percent – you are not gaining meaningful exposure to a great 10x stock through a fund like this.

The funds construction alone is enough to make it a complete non-starter as a means to participate in great small-cap growth, but the more you explore what this “Small-Cap Fund” is actually invested in, you find that a significant number of its top 10 holdings are definitely not small cap stocks.

Canadian small-cap definition.

Generally, market participants consider Canadian small-caps to have a market cap of $800 million or less.

To be included in a Canadian “Small-Cap” Fund most stocks should hold market caps of under $1 Billion (some small exceptions due to performance gains).

The top holding in this fund, Celestica, has a market cap of $7.88 billion, which nearly 10 times the upper limit of what is considered a small-cap in Canada, the second largest holding, Ivanhoe Mines, has a Market Cap of $25.47, 31 times large than what is considered a small-cap in Canada. Number 3, Arc Resources, has a MC of $13,56 billion, Fairfax has a $38.42 billion market cap. Do you see where I am going with this?  In fact, not a single stock in the top 10 holdings of this “Small-Cap Fund” is actually by the most generous of definitions a small-cap stock. Now as I point out the fact that there are zero small-caps in this small-cap fund I feel like – Jeff Goldblum in the first Jurassic Park movie when they are touring Jurassic Park and no dinosaurs show up through the first 3 or 4 exhibits and he turns to the camera and says…are there going to be any dinosaurs on your “dinosaur” tour….

Not only are there no small caps in the top 10 holdings nearly half of these companies qualify as US large caps – they are not even in the ballpark of Canadian small-caps…the more you look at this fund, which is marketed to Canadian investors as a Small-Cap fund, the more silly the entire exercise becomes – it helps the big banks sell exposure to a segment of the market which is saleable because small-caps historically outperform…

But as you can see, If you want actually want to participate where the most 10x stocks are found – you should not buy this fund or the other big bank funds that mirror it.

I have been researching and recommending Canadian small cap stocks for a quarter century. There are never more that 25 I would buy at any given time- (most of the time it is far, far less – think 5-10 stocks) that have the quality and trade at a reasonable price. But somehow all of these funds manage to find 100 plus and be invested in them all at one time. Poorly thought out poorly constructed from a return perspective. They are just engineering by the fund companies to sell an idea – small caps good- and make money off that idea – not designed to pick great companies and try to outperform.

If you want to mirror a small cap index, just buy a low cost small cap etf, like the iShares Russell 2000 ETF

If you want to use small cap as part of the growth area of your portfolio buy them individually and use good research.

My take –

Building your stock portfolio. (get some help from a research source you trust).

Take control.

If you want to beat the market, you cannot be the market.

Create your own simple equity portfolio.

Build that portfolio with a mixt that looks more like this: 

– in fact, most Canadian portfolios have little to no exposure to great growth oriented small-cap stocks.

YSOT Updating Atlas Engineered Products

Atlas Engineered Products (AEP:TSX-V)

Price: $1.32

Market Cap: $84.8M

Description:

Atlas Engineered Products designs manufactures and sells engineered roof trusses, floor trusses, and wall panels. The company also distributes a range of various engineered wood products for use by builders of residential and commercial wood-framed buildings.

The company’s strategy is focused on profitability and organic revenue growth within its current markets, and the pursuit of a roll-up acquisition strategy to consolidate similar companies operating in the truss and engineered wood products industry across Canada.

Slide 2

I covered Atlas back in February 2023 and again in July 2024, and at the last time I covered it I indicated that the business was not cheap trading at 40x trailing earnings and 15x EV/EBITDA given the market is anticipating the company’s recent investments to propel the financials over the next 2 years.

So quickly updating on the business.

Slide 3

The company has made 8 acquisitions since going public in 2017. With the most recent acquisition in August 2023, when it acquired Léon Chouinard et Fils Co. Ltd. located in New Brunswick which I touched on in July when I covered the stock. CLICK And just last week the company announced  that it completed due diligence for a truss manufacturing company located in Western Canada and intends to close the transaction in early Spring of 2025. Atlas will now start working on a share purchase agreement for the purchase price of $3.8 million in cash and stock, plus a working capital adjustment. The acquisition target generated 3-year average revenues of over $11 million, net income of approximately $950,000 and adjusted EBITDA of approximately $1.15 million.

Slide 4

On June 26, 2024, Atlas closed its bought deal and concurrent brokered private placement for aggregate gross proceeds of $14.5M through the issuance of 10.8M common shares at a price of $1.35 per share. So the share count should now be closer to $69M shares outstanding.

On June 6th, the company announced that it accepted proposals for the installation of robotic automation equipment at three of its locations and that it has made initial deposits to secure the installation of equipment. The robotics installation is expected to have a total cost of just over US$7 million for all three locations. And the robotic automation is anticipated to double the board-foot output of roof truss manufacturing while providing “potentially significant” cost savings.

And I saw an estimate from Cormark which placed the estimated robotics initiative to cost CAD$25-$26M over the next two years with a new greenfield facility accounting for $15-$17M and the investments expected to increase truss manufacturing capacity at about 400% at Hi-Tec, 100% at LCF (which is the last acquisition they made) and 50% from Clinton, with expected lower operating expenses and approximately 50% reduction in labor costs… And the robotics upgrades are expected to be completed over the next 2 years.

Slide 5

Now moving to the Recent Financials (Q1 2024):

• Revenue increased 34% to $15.1M, due to acquisitive growth and organic sales growth.
• Adj. EBITDA was up 50% to $3.1 million due to an increase in revenue.
• Net income was down 10% to $705K or $0.01 per share due primarily to the amortization related to the intangible assets of the LCF acquisition.
• Balance sheet had $20.0M in cash, with $29.9 million in debt and leases, providing a net debt position of $9.9 million. And the company has a trailing net debt to EBITDA multiple of 1x which is reasonably.

Slide 6

And just looking at the outlook, management indicates that markets continue to be very competitive in 2024 given rising interest rates which have affected the housing market (and the company’s near-term growth). But the company notes that it recognizes the need to be ready for a potential significant increase in demand as interest rates decrease during 2024 given the number of homes still needed to be built to support Canada’s population growth.

Slide 7

Okay, so I thought it would be representative to show some rough pro-forma numbers for FY 2025 which is allowing the stock to hold up quite well despite headwinds across the sector given elevated interest rates.

So if we include FY2023 financials as a base, and add 7 months from the LCF acquisition which was closed August 2023, as well as 8 months of the new acquisition which we are hypothesizing will close in May 2025, along with potential 50% labor savings from the robotics investments… we would be looking at revenue of ~$71.7M, Adj. EBITDA of ~$20.9M and net income of ~$12.8M.

Now keep in mind, I am making assumptions here which may or may come to fruition including cost savings being realized in FY2025 (which may only come in FY2026) and does not include any unexpected acquisition costs or a drag on earnings from investments…. As well as assuming the acquisition will close in the Spring of 2025… specifically in May. So take these figures with a grain of salt, but CLICK if we use these figures the company is trading at about 6.6x forward earnings and with an EV/EBITDA multiple of 4.5x.

SLIDE 8

Conclusion:

So, as you can see with my proforma numbers, the stock is holding up quite well given the assumption that forward numbers will look quite well. Plus, the shortage of Canadian homes appears to provide a good runway for growth for Atlas.

And whether I think it’s a buy sell or hold, I think it really comes down to whether an investor believes Atlas will be able to fulfill their new upcoming capacity and capitalize on the potential cost savings which could grow earnings over the next few years. But just like Hadi had said to us previously, elevated interest rates could disrupt the company’s near-term growth.

We will be speaking with management on Thursday this week to get some more insight on the potential cost savings, strategy and ability to fulfill capacity, and for us to get more color on the current market environment given elevated interest rates. So if you have any questions that you would like me to ask management, please comment them on Youtube and I will try to make sure we ask them.

YSOT Simply Solventless Concentrates  HASH TSXV

1) 

Simply Solventless Concentrates HASH on the TSXV develops and manufactures cannabis products including prerolls, concentrates distillates amongst others. The company developed the Astro Lab and Froothooty brands in-house and has acquired Lamplighter Royalty, Zest and Rilaxe brands over the past year. As well closed on the acquisition of CannMart expanding production capabilities just this month.

2)

The stock IPO’d on the TSX venture in December 2023 and has since risen 155% to $0.51 a share and a $38 million market cap. Strong performance post IPO.

3)

The company has changed significantly over the past year, so we need to have that in mind when looking at any financial metrics, as you’ll have one-time costs, capital structure changes, and revenue and cost structure changes just to name a few,  which can create messy financials and limit any comparability year-over-year.

4)

A quick look at Q2 financials,

The company had:

• Gross revenue of $4.2 million
• Net revenue of $2.9 million
  • Which is post excise task
• A gross margin of 59%
• Adjusted EBITDA of $952 thousand
• EPS of $0.024.

All of these were significantly higher year-over-year and even quarterly largely due to the various acquisitions so not really a great comparison, but the company did note organic growth.

5)

At the end of Q2, the company had $110 thousand in cash with short-term debt of $965 thousand and leases of $1.3 million, resulting in a net debt position of $2.1 million. So at the end of the quarter, the company needed to raise cash to manage working capital, capital equipment and for the acquisition of Cannmart, which it did in July by placing 15.4 million units which consisted of a share and half warrant at $0.25 a piece, raising $3.85 million less fees. Which after the cost of Cannmart will put the company in a net debt position of roughly $0.6 million, but will likely be different by the end of Q3.

The company has been building up an inventory of both raw materials and processes, now at $12.4 million, to prepare for growth expectations. Taking on additional revenue does increase risk as if the company is unable to meet its sales expectations it will need to sit on the inventory for longer which can cause working capital issues resulting in the need to raise capital.

6)

The share structure will likely change significantly assuming the current share price remains in the same ballpark. The company at the end of Q2 had 53.8 million shares, the company issued 15.4 million shares after the quarter, 26.5 million warrants exercisable at $0.20 plus the further 7.7 million issued after the quarter at $0.40 and 1 million at $0.25 to Cannmart as well as 4.9 million in stock options at $0.19. If all are exercised the company will have  109.3 million shares outstanding, a 103% increase from the Q2 outstanding and would receive $4.3 million in cash from the exercises.

7)

The company has been providing guidance.

For Q3 2024, the company expects gross revenue of $7 million, adjusted EBITDA of $1 million, and normalized net income of $1 million. As well as projecting an exit run-rate of $33 million, slightly below the previously projected $34 million, the company had in its July slides.

Further, they reiterate their projected 2024, exit run rate of $40 million revenue, $6.2 million adjusted EBITDA, and $6.0 million annualized normalised net income.

I will note run rates especially exit run rates do have risk embedded in the assumptions as they imply the continuation of the current financials, but has the benefit of being more forward-looking.

However, it is not uncommon when a company undergoes a significant operational restructuring like Simply Solventless Concentrates has, as trailing results are too distant from the existing operations.

8)

Using the projected exit run rates for Q3, the company trades at an adjusted run rate P/E of 10.6 times, or when fully diluted, 15.5 times. If the company is able to grow and exit Q4 at its projected rate it puts the diluted adjusted P/E at 9.3 which becomes more appealing but needs to be executed.

9)

So concluding,
The company is not trading at a high valuation but this is likely due to the current risks.

The balance sheet isn’t great while the last raise helped tide things over, the company needs to start funding its operations from internal cash flows.

The company does have that share dilution overhang which at current prices will all be executed, given the discrepancy between the strike prices and current share price.

The company needs to execute its projections, the price of the stock implies significant weight on relying on the projections at this time. So any material misstep could cause the stock price to plummet.

So really this is just a monitor and evaluation at this time, as it is not a screaming buy if the projections are hit but does carry significant risk if things do turn sour, which we have seen many times in the past within the Cannabis industry.