KeyStone’s Stock Talk Show Episode 275.
Back our research Trip to LA’s LD Micro Cap Conference, it is great to chat with you again as we prepare for our last Live Webinars of 2024 – get your tickets today – and, of course, the epic conclusion to the side-show production the U.S. election has become. I will start our YSOT show answering viewer question on Converge Technology Solutions Corp. (CTS:TSX) an IT service provider offering hardware, software, managed services and professional services to its mid-market clientele. Converge is well followed by the Big Banks and Brokerages in Canada, because it does a good deal of investment banking, but it is a stock we have continued to advise avoiding. After pre-releasing lower Q3 guidance recently the stock is down 32% in the last month – we will let you know if the drop alters our opinion on the stock. Brett takes a look at Super Micro Computer (SMCI:NASDAQ), a provider of application-optimized high-performance server and storage solutions. While only down 6% YTD, the company is off 78% from its peak putting in a very volatile 2024 to date – Brett let’s you know why and if we continue to recommend avoiding the stock. Finally, Brennan answers a viewer question on Toromont Industries Ltd. (TIH:TSX), which provides specialized capital equipment in Canada, the United States, and internationally. The company is a dividend aristocrat having grown its dividend consistently for the past 35 years. We will let you know if this high quality business offers growth at a reasonable price today.
Let’s get to the show – my cohost, Mr. Aaron Dunn is under the weather today – and the killer B’s, Brett & Brennan.
We have 3 upcoming Live Webinars – focussed on what stocks to buy in a falling rate environment, a simple way to build a 15-25 stock portfolio and, how to uncover the next 10x stocks – we would love for you to share with your audience the details once again. I have included them below. Let us know when you can send this out – thank you!
Contributing editor Ryan Irvine and his associate Aaron Dunn are offering three Live & on-demand investor events in November. Titled “The New Stock Portfolio – Dividend Growth Stars as Rates Fall & the Next 10x Stocks”.
Who should attend? Investors looking for unique profitable stock recommendations (Dividend & Small-Caps), & advice on building a better 15-25 stock portfolio.
What is included?
- 9 Traits to help you uncover the Next 10x Stock – the simple formula that allows KeyStone to identify and recommend 10x and even 200x stocks including Hammond Power (HPS.A:TSX) up over 24,000%.
- With Rates Falling Dividend Stocks are Rising – do not miss out! Get our Top 3 Dividend Growth Stocks for 2025.
Proof is in the Results – Fall 2023 Keystone recommended 2 Cash-Rich Stocks:
- Cipher Pharma (CPH:TSX), a profitable, growing specialty pharma stock at $3.89. Today, the stock trades at $16.54, up 325.19% – the best performing TSX stock.
- VitalHub (VHI:TSX), a profitable, growing healthcare software stock at $3.24. Today, the stock trades at $9.47, up 192.28%
Do not miss out on this Fall’s Top BUYs – Attend the Live Webinar and Get 6 profitable small-cap stocks to BUY today; 1) our top cash-rich SaaS stock, 2) top dividend growth stock (5% + dividend), 3) cash-rich profitable gold stock, 4) the 2 top performing unknown digital financial stocks in Canada, and 5) two cash-rich small-caps trading under $3.00.
Live or on-demand webinar events will be held as follows:
November 7th at 7 pm Pacific time
November 12th at 7 pm Eastern time
Tickets: Early Bird: $29.95* | VIP: $79.95*
* Attendees receive one or three of (1) KeyStone’s Fall 2024 Top 4 Dividend Growth Report ($599). (2) Fall 2024 U.S. Mid-Cap Growth Stock BUY Report ($599). (3) On-Demand DIY Stock Investing Webinar – “How to Find the Next 10x Stock” ($79.00).
Or purchase The Complete VIP Stock Portfolio Building Package (live or on-demand).
November 16th at 11 am Pacific time/ 2 pm Eastern time
Cost is $1,999 for a ticket and The Complete VIP Stock Portfolio Building Package. It includes a one-year VIP Membership, a 5-hour live/on-demand webinar, 15 high conviction growth and dividend growth stocks to buy, 100+ annual Q&A sessions, three analyst calls, all special BUY/SELL reports, and more. You save 45% or over $1,700 compared to the normal retail price for these services.
It is expected all these events will sell out so book now and take advantage of the free gifts offered.
Poll Question.
Goldman Sachs recently released its S&P500 10 year outlook and it made headlines. Goldman expects an annualized return of 3% over the next decade. Citing heightened current valuations and significant market concentration resulting in less diversification. The expected 3% return is significantly below the last decades realized 13%. For the next decade do you expect the S&P500 to perform better or worse than Goldman’s 3% expectation? Goldman Sachs Report:
YTD Stock Performance.
It is also down 75% from its 2021 highs.
Why did has the stock dropped 32.82% in the past month – the drop is largely the result of the company’s October 24th announcement that it was lowering Q3 guidance.
Let’s take a look at that guidance:
The pre-release was as follows:
- Gross profit of ~$158.0 million (down -9.1% from Q3 2023) vs. prior guide of $172.0 to $178.0 million (a 10% reduction at the midpoint).
- Adjusted EBITDA of ~$32 million (down -22.3% from Q3 2023) vs. prior guide of $43.0 to $47.0 (a 29% reduction at the midpoint).
The reduced results were attributable to a few factors. Certain billings, which were expected to land in Q3, have been pushed into Q4 and FY 2025. Additionally, there was lower-than expected demand in North America related to data center, networking, and storage solutions due to budget constraints, as well as IBM’s mainframe product cycle and a challenging Y/ Y compare. In addition, the end user device refresh cycle has been pushed out again, with expectations that buying will ramp up in by mid 2025. A good deal of negatives here near and mid-ter.
Let’s take a quick look at the company’s Q2 FY 2024 numbers.
Revenue was down in Q2, Adjusted EBITDA was up, but again, on an accounting basis – non-adjusted, the company continues to lose money.
While the EV/EBITDA may look attractive, we do not expect much growth in EBITDA and view EBITDA (in this case it is an adjusted figure) as a less than optimal way to value mid-cap, net debt businesses with low margins.
The free cash flow multiple shows a less than attractive valuation – to give you an idea of why – we were able to buy a far higher margin software small-cap at this time last year at under 10 times FCF – that company – Vital Hub is up over 220% over the past year while Converge drops.
And the PE is non existent as the company is earnings negative.
Conclusion
Converge faces a weaker end market near-term, a drop in revenue, earnings, EBITDA and cashflow is forecasted this year, and optimistically, slight recoveries in FY 2025.
For a company with significant net debt,
- Expected Adjusted EBITDA Margin Q3 FY 2024: 5.2%
- Expected Adjusted EBITDA Margin FY 2024: 6.2%
- Expected Adjusted EBITDA Margin FY 2025: 6.6%
And a business that still continues to lose money on an accounting basis, Converge just does not meet our basic criteria.
This company receives plenty of analyst coverage, despite being a low margin, low organic growth and now debt heavy business that really does not have a compelling investment case. It receives coverage because it is consistently doing what Bay street Big Banks are looking for – raising capital, making acquisitions etc – transactions that make the Big Banks and brokerages money. But the business is not making much money and shareholders have, unsurprisingly seen significant capital destruction over the past 3 years on the stock.
Perhaps the business is sold one day, but this is not the structure of business that we would recommend or see as driving long-term value for our clients – because Converge is well covered on Bay Street, we expect to continue to field many questions on the company, but as we have stated in the past, unless something fundamentally changes with the business, we expect to continue to advise investors to avoid Converge.
YSOT SMCI Super Micro Computer
1)
Super Micro Computer symbol SMCI on the Nasdaq is a provider of application-optimized high-performance server and storage solutions. The company develops and builds server solutions and storage systems at scale with its Building Blocks Solutions. The company manufactures motherboards, server racks and enclosures but the CPUs, GPUs, Storage, and memory amongst other components are bought and then integrated into a server.
2)
The stock has had a turbulent year, to say the least. The stock is trading at $26.77 a share down 6% year to date, which doesn’t sound so turbulent. However, the stock skyrocketed to over $120 at its peak, which is now down 78%. The market cap is currently at $14 billion.
3)
A quick overview of the timeline of the negative events that have followed the stock since its all-time high in March.
April 19th the stock fell 23% as the company did not provide preliminary results like it had done so in the past. Which generally just worries the market when you see a shift from the norm of a company’s actions.
August 7th, the stock fell 20% after poor preliminary results, notably weak margins, with a gross margin of only 11%, compared to prior quarters in the last couple of years being in the 15-19% range.
August 28th, Hindenburg Research released its short report on the company causing the shares to fall 19%, with alleged fraudulent accounting actions.
September 26th, the Wall Street Journal reported that the US Department of Justice was probing SMCI causing shares to fall 12%.
Then October 30th, brings us to a massive share price collapse of 47% over the past few trading days as SMCI’s auditor Ernst & Young resigned. Which I’ll get deeper on in a minute.
4)
The company has released unaudited results for Q4, with revenue of $5.3 billion up 143% year-over-year.
BUT gross margins are now significantly lower at 11.3%. The expectation is still for revenue growth, but top-line growth does not mean much when you can’t convert it into profit, and declining margins restrict the possibility.
The company does state it expects margin compression only to be near-term and return to the normal range before the end of fiscal 2025 once its block solutions ship on mass. And just coming out today, it is being reported initially by Digitimes, that Nvidia is rerouting orders previously with SMCI to other providers, which could throw a wrench in growth as well as margins as economies of scale are needed.
The company earned $0.55 on a diluted per-share basis accounting for the 10-1 share consolidation.
5)
The core factor of what I highlighted when I covered the stock early this year in March, is that it was very expensive. Just looking at the price to sales you can see the company shifted from a price to earnings bellowing 1, prior to the AI boom, upwards of 7 times, and we are now back at the 1 times range. In my opinion, the stock was extremely overvalued in the prior and eve
Valuing the company using the currently stated results, the stock is trading at a trailing P/E of 13.3 times, and a trailing price to sales of 0.9 times. More in line with historic results.
If management can be believed which I wouldn’t believe, the stock is now trading at roughly 0.5 times Fiscal 2025 sales, which is cheap even by historic standards before the AI boom.
So right now, the bull case is effectively believing management projections and even past data.
6)
The reason why I and others put doubt on the management is.
The company has not filed its 10-k annual report ending June 30, 2024.
- The company has since had its Auditors, EY, resign after having significant concerns over internal control, board independence, and transparency. SMCI quoted EY’s resignation letter stating:
- “We are resigning due to information that has recently come to our attention which has led us to no longer be able to rely on management’s and the Audit Committee’s representations and to be unwilling to be associated with the financial statements prepared by management, and after concluding we can no longer provide the Audit Services in accordance with applicable law or professional obligations.”
- As part of being listed on the NASDAQ, the company has to file a timely which for SMCI was at the end of September. They got an extension, if they don’t file by November 20th, they could be delisted unless they provide a credible plan to file. If they do provide a plan and it’s accepted it pushes out the date until February 2025.
- The impact of delisting can directly impact the ability of institutions to own the stock as well as breach its debt covenants.
Management does not expect to need to restate fiscal 2024 results, but the fact the Auditor resigned should not be understated. As it does pose a risk of delisting as well as restatements, which could further eviscerate the stock price if either or both occur.
7)
So overall, just simply put I wouldn’t touch the stock. Under a long-term fundamental investment philosophy if you can’t rely on the financial statements or the management which I believe so to be in this case the company is effectively radioactive, you don’t want to get near it.
But even then The company is now facing increased competition from the likes of Dell, HP among other players. A big reason for the growth was they moved first into AI-focused server solutions with liquid cooling, which other players have now caught up in the shift in design. SMCI was nimble, but the first-mover advantage can only take you so far. So I have a hard time buying into the growth story for the long term even if the financials are correct. The risks are just too high.
