KeyStone’s Stock Talk Show Episode 272.
Great to chat with you again – I will start this week with a quick segment from our recent live Webinars which used past successes to identify three basic commonalities of 10x stocks. In our YSOT segment, Aaron reviews a question on a company we sat down with over the past week, CEMATRIX Corporation (CEMX:TSX), a manufacturer and supplier of technologically advanced cellular concrete products. Last week, management announced that unforeseen delays on some projects will impact the company’s 2024 revenue expectations, as a portion of the 2024 forecasted revenue will now be realized in 2025. Aaron give you his take on our sit down with management and the outlook for CEMATRIX. Brennan answers a viewer question on Element Fleet Management Corp. (EFN:TSX), the world’s largest automotive fleet manager with 1.5 million vehicles under management as of June 30, 2024. Shares have surged in 2024 following solid growth and a recent earnings guidance increase. Brennan let’s you know the current valuations and whether the share price gains can continue. Finally, Brett takes a viewer question on Softchoice Corporation (SFTC:TSX), which provides IT solutions ranging from implementation to management of IT environments. Brett gives you his take on the company which does not appear to be producing revenue growth, holds a net-debt position, paid a significant one-time dividend, and continues to pay a 2.77% regular dividend.
Let’s get to the show – my cohost, Mr. Aaron Dunn – and the killer B’s, Brett & Brennan.
Past success & the data.
- Real examples of stocks that have gained greater than 10x plus from KeyStone’s buy recommendations.
- The data.
In this quick segment, I will focus on the commonalities among past successes.
Let’s first take a look at Five 10x plus recommendations from our research.
5 amazing capital compounding small-caps we have recommended to clients.
Now I share them with you today mainly because they make us look smart – I kid.
What we like to do, is study the group and find the commonalties in each success story and use them to guide our future investment decisions. This group includes not only 10x stocks but 20, 50, 90 and even Hammond Power a 200 plus x stock. Truly portfolio changing stocks.
Generally, what can say about this group of 5 truly portfolio changing stock – what I will briefly explore today is the “commonalities” between these stocks to see if they can help us replicate these past successes in our future investment choices.
Let’s start by looking at size….
Size – by market cap, even a decade or so back, they were considered small companies – below see that not one had a market cap above $55 million Canadian –
As we see, Commonality 1) Each company started small before their share prices took off.
Let’s check industries to see if there are any commonalities here?
So we have, Electrical Equipment & Parts, Automotive repair services, Paint protection (auto), Engineering – Geothermal H&C, and Software. And if you think Auto repair services and auto paint protection are the same industry, you are stretching the truth. The correct takeaway here is, there is no commonality in their industries – in fact, the wide breadth or the industries appears to suggest there are far more important general factors at play.
Let’s take a look at basic financial metrics to see if we can find commonalities there.
The first metric we look at is…revenues – Did the businesses have any sales at the time of the recommendations –before they started their ascent?
Ding, ding, ding, we have a winner – or 5 winners in this case. Each businesses had produced sales prior to their ascent.
Using a more stringent financial metric – were the businesses producing net income at the time of the recommendation – again, before they started their ascent?
Once again, the answer is yes. Both not only were selling products or services, each were generating profits from those sales.
Now because net income is a more stringent and specific criteria, financially speaking, and all match the criteria, we are going to take profitability as a more statistically impactful commonality.
So Commonality Number 2 is profitability.
Let’s examine whether any of the businesses or stocks were well know to investors or covered widely or even at all at the time of KeyStone’s originally recommendation on the stocks.
In terms of coverage, Hammond, Xpel, and WaterFurnance had zero coverage on our recommendations, in fact it took over a decade for any real coverage to show up on Hammond Power – XPEL final got coverage years later when it jumped to the NASDAQ. Boyd had previous coverage but was abandoned, and Janna had a singular non independent analyst.
Generally, unless they were clients of KeyStone, the average investors had no idea these portfolio changing stocks even existed on our initial recommendation.
Basic commonality number 3 is that each of these stocks were significantly underfollowed or unknown at the time of recommendations.
There are many other factors including strong growth paths, good management, limited share dilution etc. that are relative commonalities between these 5 stocks, but I wanted to keep the exercise basic today, to give investors a basic, simple framework from which to start looking for the next potential 10x stock.
To summarize, 3 basic commonalities of past 10x stocks (from our 5 examples).
At recommendation (prior to ascent):
Small (small-caps).
Profitable (net income positive).
Unknown (no big bank buys).
Next week, we will see if the data backs up this anecdotal case for profitable, unknown, small-cap stocks.
YSOT –Element Fleet Management (EFN:TSX)
Price: $28.49
Market Cap: $11.5B
Yield: 1.68%
Description:
Element Fleet Management is the world’s largest automotive fleet manager with 1.5M vehicles under management as of Jun e 30, 2024. The company offers fleet services including vehicle acquisition, maintenance, accident handling, remarketing, and EV integration, to corporations, governments, and not-for-profits across North America, Australia, and New Zealand.
Slide 2
The last time we covered Element on the podcast was by Aaron in December 2023 while it traded at a price of $22.10. So over the past 9 months the stock has performed quite well, up approximately 30% – but lets dig into why we have see the positive share price performance and if we believe that it can continue.
Slide 3
Now moving to the Recent Financials (Q2 2024) – Keep in mind all in USD and if you go back and compare this analysis to Aaron’s video, note that all of the figures Aaron highlighted were in Canadian dollars… where the company now switched its reporting currency to USD.
As Aaron mentoned last time, the company markets themselves as a fleet management company which implies a service business. But there is also a lot of financing in the business as well, with 51% of revenue being from Services, 45% from Financing revenue (where essentially they are making loans & receiving interest for those loans), and then 4% revenue from Syndication revenue (which from my understanding is leasing services).
So actually, looking at the numbers here:
- Revenue increased 14% to $275M, led by growth across all revenue lines, with service revenue up 11%, financing revenue up 16% and syndication revenue up 42%.
- Net Income was up 15% to $102.7M, and adj. EPS was up 16% to $0.29 cents per share – both being driven by margin expansion, as Adjusted Operating Margin was 55.7% (60 basis point increase) which management indicates is from positive operating leverage as net revenue growth outpacing growth in operating expenses.
- Balance sheet had $83M in cash, with $8.7B in debt and leases, providing a net debt position of $8.6B. And the company has a trailing net debt to FCF multiple of 8.5x.
Slide 4
No moving to the company’s guidance, they recently raised it given the strong performance in the first half of the year, now up to revenue of $1.06B-$1.08B which is an increase of 11-13% over 2023. Adjusted EPS is now expected to be $1.07-$1.11 per share representing an increase of 9-13%, and Adj. FCF per share is now expected to be $1.32-$1.36 up 6-10% over 2023. HOWEVER, I will note that the company is removing any non-recurring costs associated with its strategic initiatives as well as the acquisition of Autofleet which may lead to a bit of a drag on Accounting Earnings as the acquisition is integrated.
And using this guidance, the stock is trading at 20x forward Adj. EPS and about 16x forward Adj. FCF while it is anticipating growth of about 9-13% in adjusted EPS. To put this into perspective when Aaron covered the stock it was trading at 17x forward earnings with expected growth of 14%. So relatively speaking the company is a bit more pricey for less anticipated growth (as compared to where it was at December 2023).
Slide 5
And just a few operational updates, as I noted, the company announced the acquisition of Autofleet on August 13, 2024, which is expected to close in early Q4 2024. I couldn’t find much information on the acquisition details itself such as price paid or its financials.
The company also provided a strategic initiative update which included the plan to optimize the business by centralizing the U.S. & Canadian leasing operations and establishing a strategic sourcing presence in Asia – expected to provide run rate revenue of US$30-$45M by 2028. Furthermore, in August the company also commences operations in Dublin and in April they announced commencing operations in Singapore.
SLIDE 6
Conclusion:
So, as you can see the strong financials results over the First half of 2024 has led management to increase their guidance for FY2024 and led the stock higher.
The yield of 1.68% is decent and the company continues to increase its dividend, up from an annual dividend of $0.10 per share in 2016, now up to $0.48 in 2024. With a payout ratio of ~30% GAAP EPS.
Fundamentally the valuation isn’t unreasonable on a forward Adj. EPS and FCF basis – but it may be on the higher end given nearly half of the business comes from financing revenue. And as Aaron mentioned back in his last segment on Element Fleet Management – it is difficult to value the company given the high composition of financing activity that the business conducts. As the valuation appears more attractive if we value it as a fleet management services business… but as a financing business we would anticipate the valuation to be lower given banks are typically trading around 10 times. And as a composition of total revenue, we are actually seeing net financing activity increase by a few hundred basis points as a portion of total revenue.
I will also note that the leverage remains relatively high.
All-in-all, we do not think that it is a bad company, their continues to be momentum in its financials, but at this time we continue to monitor.
YSOT – Softchoice (SFTC: TSX)
1)
Softchoice symbol SFTC on the TSX provides IT solutions ranging from implementation to management of IT environments. So, these are things like cloud database management, hardware lifecycle management to cyber security.
The company operates in Canada and the US. Softchoice breaks down its services into Software & cloud, services and hardware. The company has notable partnerships with Microsoft, Google, and Amazon – the big cloud hyperscalers.
Softchoice currently pays a dividend yield of 2.8%.
2)
The company IPO’d on the TSX in May of 2021 at $20 a share and has since fallen to the current price of $18.72, over the past 3 and half years.
3)
However, Year-to-date it is up 20%, as well as paying a significant special dividend of $4.00 during the year. So at least a good return so far this year.
4)
First, look at a high-level level long-term.
On a per-share basis, revenue has been declining, whereas although choppy EPS has generally improved since the IPO. The company does have seasonality with Q4 and Q2 being stronger, due to the customer year ending primarily in Q4, as well as Microsoft fiscal Q4 aligned with SoftChoice’s Q2 as Microsoft-related sales account for 29% of net sales.
Prior to the $4 special dividend, the company did have a declining debt position, but with the dividend being funded by debt, the company now has a higher debt load. This is something that we don’t like to see generally under a long-term hold view, as issuing debt to pay a dividend decreases the value of the company after the ex-dividend date, as you will no longer receive the dividend but have the weight of debt.
5)
Moving on to the Q2 earnings with figures in USD,
The company saw a 7% decline in Net sales to $193 million, however, it did have a strong revenue retention rate of 100% and gross profit did increase by 12% largely due to the improved margin in the software & cloud segment, increasing to a margin of 73% from 70%. Additionally, services improved offset by lower hardware gross profit. But the story of the business that drives the financials is the software & cloud side and we can see the segment driving the profitability.
Moving down the income statement operating profit increased by 16% to $22 million, powered by the increased gross margin partially offset by higher SG&A.
However further down we can see a rise in non-operating costs, primarily finance costs, substantially increased to $4.8 million, from an income of $1.1 million, last year the income was driven by foreign exchange. However, the change that is under management control to a degree finance costs primarily interest expense on the revolver they had increased to $5.8 million from $3.5 million, offsets $2.3 million of the $3.0 million operating profit increase. You can link that to the increase of the revolver to the special dividend earlier in the year. The revolver is now at $194 million up from only $39 million at the start of the year.
Ultimately resulting in net income falling 14% to $12 million and diluted EPS of $0.20.
6)
Moving the balance sheet
The company has a Net debt position of $190 million, primarily composed of the revolver that saw an uptick due to the special dividend. The company has a net debt EBITDA of 2.3 times.
As well, the company does have a lower current ratio of only 0.8 times, due to higher trade payables compared to lower receivables. The company has already engaged in receivables financing for $12 million of its receivables at about a 1.5% discount. This is generally not optimal as you are receiving less cash at the end of the day.
7)
Looking at valuations
The stock trades at a GAAP P/E of 22 times, a Price to free cash flow removing the impact of working capital of 20 times, and an EV/EBITDA of 12 times. I wouldn’t consider the company to be cheap even being software-oriented as the growth and risk does support a premium valuation.
8)
Concluding,
The company is profitable and is growing but growth has been choppy and not at a particularly high overall rate for the past year, and net sales on a per-share basis have been declining. EPS is more important than just pure sales but at a point, you need to support EPS growth with revenue growth as you can only get so much margin.
I don’t like issuing a special dividend that is supported almost purely by borrowing, or debt. There are times to do special dividends but in my opinion, if debt is required it lowers the long-term value of the company most of the time.
Further, the company has had to conduct receivable financing which can be another worry given the company’s not poor but not great current ratio driven by the trade receivables and payables.
Lastly, the valuation metrics are not overly appealing given the growth level and risk at this time.
