KeyStone’s Stock Talk Show Episode 279.
Great to chat with you again this week. I will start our YSOT segment with a follow up on Atlas Engineered Products Ltd. (AEP:TSX-V), a profitable micro-cap which designs manufactures and sells engineered roof trusses, floor trusses, and wall panels. We have interviewed management and generally like the business, but it faces some near-term headwinds, and we take a look at the Q3 numbers. Aaron will answer a viewer question on Roblox Corporation (RBLX:NASDAQ) which operates a user-generated online gaming platform where users can create, share, and play games developed by a global community. The company has posted strong revenue growth and is now growing free cash flow – with shares up 24% in 2024, is it an opportunity or still overvalued? Brett follows up his segment on MicroStrategy (MSTR:NASDAQ) a stock we are fielding no shortage of questions on. MicroStrategy is essentially a Bitcoin treasury company. The stock is up a whopping 461% year-to-date and Brett let’s you know why, what the company does and if it is sustainable. Finally, Brennan goes macro for his segment, talking the US yield curve’s un-inversion, and the Spread between CAD and US interest rates and its implication on FX.
Let’s get to the show – I welcome my cohost, Mr. Aaron Dunn, and killer B’s, Brett and Brennan!
Our Poll Question this week?
Do you own shares in any of the Big 5 Canadian Banks (RBC, TD, BMO, Scotiabank, CIBC)?
What does Atlas do?
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. These include single family homes, townhouses, multi-story wood-framed residential buildings, commercial buildings, and agricultural structures.
The company’s strategy is focused on profitability and organic revenue growth within its current markets and Atlas is an active industry consolidator, having expanded inorganically to eight locations from one in 2017.
Atlas is a company we like, do not own right now, but continue to monitor it. We MONITOR hundreds of companies, so this does not mean we will buy, but is meets enough of our criteria to be interesting.
YTD Stock Performance.
While the stock is up around 9% on the year, it is down 28% of its year highs – let’s take a look under the hood on the most recent quarter.
Q3 2024 Highlights.
Revenue of rose 16.2% to $16.5 million from $14.36 million in Q3 2023.
Adjusted EBITDA of $3.05 million, represented an increase of 3% year-over-year.
Net income after taxes was $914,458 or $0.01 per share in Q3 2024 compared to net income after taxes of $1.3 million or $0.02 per share for the three months ended September 30, 2023.
Let’s examine the numbers a bit closer.
Revenue Growth:
15.2% Q3 Growth: Powered by acquisitions (organically revenues was down 6.3% Y/Y) and growth related to engineered wood products and walls. Atlas’s push into wall panels was on display in the quarter, with the product line up 119.0% Y/Y, representing 11.5% of total sales from 6.2% in the prior period – while it was expected, we note that the negative organic growth continues to show softness in end market.
Underperformance in Adj. EBITDA relative to revenue growth:
due to the tougher market conditions that led to Management sacrificing margins for volumes – a theme Management called out on its Q2 conference call. More specifically, Q3 housing starts were down 6.2%, and two of AEP’s key provincial end markets, ON and BC, underperformed dropping 17.8% and 8.4%, respectively.
Valuations:
High valuations based on expected 2024 earnings which are down year over year.
There is an expectation of a jump in 2025 – market dependent and we continues to see a general slowdown in Canada, so this would have to be second half weighted – even on this, at over 23 times next years expected EPS, the stock is not cheap near-term given the volatility and uncertainty near-term in the contruction market – the housing shortage should provide a ready market longer term, but we may find a more attractive entry point before this.
EV/EBITDA (TTM): 8.99.
EV/EBITDA (2024e): 10.97.
EV/EBITDA (2025e): 7.57.
Looks better, but just fair given the uncertainty.
Positives.
Recent rate cuts – quoting activity increases, which should translate into sales in 4-6 months, indicating potential a return to growth in 2025.
Gross margins could revert to Atlas’s more normal 27-30% range from less than 25% by the second half of 2025.
A growing housing shortage in Canada.
An accretive M&A pipeline that continues to build.
Conclusion
We like the business and the longer-term consolidation potential – we do note that consolidators walk a very tricky line – many can acquire, but to grow Cash flow or earnings on a per share basis is difficult as the share counts can rise over time to fudn revenue growth – we will monitor this.
Good long-term growth – but it has levelled and declined near-term:
Near-term – Note: Near-term delay in the LCF and Hi-Tec robotics initiative (estimate for revenue generation pushed back to Q3/26).
YSOT Microstrategy MSTR:NASDAQ
1)
MicroStrategy symbol MSTR on the NASDAQ is a Bitcoin treasury company. The company was previously an analytics and business intelligence company, but the vast majority of assets are now Bitcoin, so we are going to focus on the Bitcoin holdings.
2)
The stock is trading at $384 a share with a market cap that includes both share classes of $90B. The stock is up a whopping 461% year-to-date.
3)
So what is Microstrategy’s Bitcoin Treasury Strategy?
Microstrategy’s goal is to accumulate as many Bitcoins as possible on a per-share basis. The legacy software division was effectively breakeven last quarter prior to corporate expenses, so how can they be accretive without profitable operations, and positive cash flow operations?
The company plans to raise $42 billion split between shares and convertible debt by 2027, but is well ahead of that pace, as since the end of October has raised $13.5 billion.
They are issuing debt now which is now all low or 0% coupon rate convertible debt which is an important factor which we will get into in a minute. As well as selling shares at a premium to the net asset value or NAV.
4)
For a fund or ETF, the NAV is normally equal to the market price of the unit, give or take a few pennies.
This is not the case for Microstrategy, the equity value premium to the Bitcoin NAV, ignoring the other assets, which it does have some of but not a significant amount, is roughly 2.85 times, or a 185% premium. So when they issue shares they are able to accretively add per share Bitcoin because right now on a per $ basis, a shareholder has about $0.43 of Bitcoin and removing the debt comes to a $0.35 NAV. So when they issue $1 per share and buy Bitcoin that $0.35 of NAV per share ticks up trending towards $1. This has the limit of needing to trade at a premium to the underlying Bitcoin value. Michael Saylor the very vocal CEO stated in an interview they are “selling dollar bills for $3”.
I will add that they refer to the accretion of Bitcoin per share as “Bitcoin yield” which in my opinion is marketing at best and misleading at worst, the Bitcoin itself isn’t creating a yield it’s just raising capital. The asset being Bitcoin is not generating the return. The only way this works is if the stock trades at a premium to the NAV.
5)
Now the Convertible Debt. Convertible debt is effectively a bond plus a call packaged together. The call is an important part of Microstrategy, the company benefits from the volatility of the stock. As volatility goes higher the value of a call moves higher. From Microstrategy’s point of view, they are selling volatility. The benefit of the convertible bond is that this allows Microstrategy to have lower coupon rates or 0 coupon debt, only needing to pay back the face value at maturity. Call options do have value, so although there are no or little coupon payments there is still an implied interest rate. The sum of the present value of the interest payments is equal to the call value.
The purchasers of the convertible bond likely do not want the shares they want to do some sort of Gamma trading which benefits from volatility, they want the volatility to be as high as possible for as long as possible, and they do not care if the stock price rises or drops only that the price moves, the more the better. They are trading, not looking to hold shares.
As it is debt, it does result in leverage, which is roughly 1.2 times right now this will shift higher if the value of Bitcoin falls or additional debt is added. If the bonds are converted into shares eventually you do lose that leverage.
6)
However, that 1.2 times is in respect to the NAV.
Breaking leverage down to a simple idea it is having greater economic exposure to the asset than the capital you’ve put in. With margin trading, you take on a loan to get more of the asset than you put in, similarly with options you gain more economic exposure.
If you are buying Microstrategy stock you need to pay that premium to NAV, roughly 185% right now. You do not have economic leverage in excess of the capital you put into the share value at this time. The company may be levered on their balance sheet but the economic exposure to Bitcoin is 0.43 times, as I mentioned before on a per-dollar basis. You are not levered overall at these prices of Microstrategy shares, in fact, you are under-exposed to Bitcoin. The company’s performance detached from Bitcoin returns even with its levered balance sheet.
7)
Concluding,
Traders will love the stock due to the volatility, if you want to trade it realize how volatile it is and that Bitcoin does not drive the underlying value at this time. If you want to gamble like Brennan has just be aware of the risk.You are overpaying for Microstrategy shares, just consider what Michael Saylor said himself in another light. You are holding $1 at the cost of $3 right now, the same reason they can issue shares to add Bitcoin is the same reason you are overpaying. To get the same return as Bitcoin you need the premium to hold. The core reason why the stock has risen to the degree it has this year is the premium expansion, it can disappear just as easily as it came. If Bitcoin does pull back like it has many times before, expect an even sharper correction in Microstrategy as the premium will likely contract or vanish.
Simply, if you want to spend $3 on Bitcoin exposure actually get $3 of Bitcoin exposure and just buy an ETF. I would want to get my money’s worth.
Yield Curve December 2024
Slide #1
I thought I would do a follow up segment on the inverted yield curve as I discussed the yield curve inverting back in late 2022 which remained inverted for almost the last two years….. and reached its lowest level since 1981. But the yield curve has been flattening and recently uninverted this fall.
SOOO, I THOUGHT THAT I WOULD GO INTO WHAT THIS ALL MEANS AND EXPLAIN HOW THE YIELD CURVE HAS HISTORICALLY PERFORMED IN RELATION TO THE BUSINESS CYCLE.
Slide #2
What is the yield curve?
Yield Curve – Shows the relationship between yields and maturities of bonds with comparable credit rating. SO for this exercise I AM GOING TO BE LOOKING SPECIFICALLY AT THE U.S. TREASURY YIELD CURVE which is a comparison of government-issued bond yields of different maturities.
Typically when we are measuring the yield curve we are looking at the difference between the rate on the 2 year maturity and 10 year maturity treasury.
So generally:
- Shorter-term yields tend to represent what investors believe will happen to central bank policies in the near future.
- Longer-dated maturities represent investors’ guess at where inflation, growth and interest rates are headed over the medium to long term. (Term Premium)
And because of this, the yield curve tends to be upward sloping – like the yield curve I have up on the screen from February 2017- because long term bond investors are being compensated with a Term Premium for the greater uncertainty of growth and inflation risk of holding a bond long term.
So as you can see on the screen, the shorter the maturity of the bond, the lower the interest rate, and when we get all the way up to the 10-30 year bonds, they have yields at around 2.5%-3.2%.
Slide #3
However, in late 2022 and early 2023 we have seen this “normal” upward sloping yield curve go “inverted” as bond investors are demanding a premium for short term bonds, and long term investors were anticipating inflation and long-term rates to decline as the economy slows due to short term rates being elevated. And as of Monday, August 14th, 2023, this is what the yield curve looked like while it was still inverted.
Now in the finance industry the inverted yield curve is generally seen as an indicator of a coming recession over the next 6 months to a year…. BUT, over this period of time when the yield curve for treasuries inverted – the economy continued expanding.
Slide #4
How has the yield curve generally acted in the business cycle?
- At the peak of a cycle, the yield curve tends to be Flat or Inverted because the economy is ripping, and inflation begins to become an issue, leading central banks to raise short term rates, and long term bond investors begin to anticipate for growth, inflation and interest rates to decline.
- As the economy goes into a contraction, central banks begin to decrease short term rates as inflation subsides from the economy slowing, so the yield curve begins to steepen.
- At the trough of the cycle, the yield curve becomes very steep because inflation is quite low and the central banks have interest rates very low to help stimulate the economy out of the downturn.
- As we go into the recovery and up-cycle the yield curve tends to flatten as the economy heats up, inflation increases, and the central bank increases short term interest rates.
But again despite seeing the yield curve invert (WHICH ITS SUPPOSED TO DO AT An ECONOMIC PEAK), we have continued to see the U.S. economy expand.
Slide #5
And because of this there has been a lot of debate on whether the yield curve is still a good predictor of the business cycle as we have seen an inverted yield curve in unison with continued strong economic data. And now, the yield curve is beginning to “steepen” which is typically what we see during a contraction (like I just went over).
So are we headed for a recession? Who’s to say….. as an inverted yield curve has given false signals in the past and last time I did this segment I went over how Goldman Sachs indicated that this time is different because the term premium is “well below” its long-term average (or in other words investors are not being compensation for the risk of holding long term bonds).
But regardless if we head into a contraction or not, as an investor, understanding how the yield curve has generally acted in relation to the business cycle is a good piece of information to know.
Slide #6
Now I wanted to extend this conversation a bit further to the difference between U.S. and Canadian Interest Rates (or essentially the spread between the country yield curves) and what this implies for the Canadian/USD exchange rate.
Now the Canadian and American economies are closely intertwined and tend to perform similarly. And typically we do not see much economic divergence, but this is one of those times as the Canadian economy is slowing much faster than the U.S., resulting in different monetary policies and inflation expectations. And as you can see up on the screen, the blue line is the spread between 10-year U.S. & Canadian Bond yields, where investors can get much better bond returns in the U.S. compared to Canada at this time. And the red line is the USD/CAD exchange rate, so the higher the red line goes, the more the Canadian dollar is devalued.
Now the reason for this relationship is that higher interest rates in the U.S. compared to Canada will increase foreign investment – as investors look to hold U.S. bonds over Canadian – which directly impacts the demand for Canadian and US dollars impacting the exchange rate. Now there are other things at play here which are impacting the devaluing of the loonie, such as the fear of Trump tariffs. But again I just wanted to highlight the interest rate spread and the implication for the exchange rate.
