Stock Talk Podcast Episode 284 Show Notes

You are listening to KeyStone’s Stock Talk Show – Episode 284

Great to chat with you again this week. I will kick off the show revisiting the valuation gap between small & large cap stocks, a topic we started focussing on in mid 2023. I will present a short snippet from a presentation I did on Monday of this week at a conference in Vancouver. I will quickly show the significant opportunity in small-caps – if the valuation gap narrows. In our YSOT segment, Aaron answers a viewer question on NowVertical Group (NOW:TSX-V), a data analytics and AI solutions company that provides comprehensive software and services to private and public enterprises. A listener asks Aaron if the stock has 10x potential as NowVettical undergoes a transition – selling off less profitable assets, paying down debt, and focussing on profitability. Aaron looks at the company’s progress and if the stock offers us an opportunity. With Donald Trump being sworn in this week, we have seen an uptick in questions on Bitcoin, with a focus on Bitcoin ETFs. Brett tackles several Bitcoin related questions endeavouring to answer all your Bitcoin questions in one segment. Finally, Brennan answers a viewer question on MDA Space Ltd. (MDA:TSX), a provider of advanced technology and services to the rapidly expanding global space industry. The company is profitable and posted impressive growth in 2024 – valuations are on the higher end, but if growth can continue Brennan will let you know if MDA Space offers potential value.

Poll question.

Yesterday I gave a brief presentation at the Vancouver Resource Investment conference.

One of the items I touched on was the valuation gap between small and large cap stocks. I will go over a snippet of that presentation today.

I started taking note of the widening valuation gap in favour of small-caps around mid 2023 and noted it as a potential opportunity to find high quality, earnings driven smaller companies at a discount.

I presented on this in early Fall of 2023 when we had already begun to take advantage of the mispricing with new BUY recommendation in our Canadian Small-Cap Research.

Let’s take a quick look back to Fall 2023 – see the relative valuations at that time, what we did and where we are today. In the early November there was a very significant valuation gap between Large and Small-cap Stocks here – large caps represented by the S&P 500 and small to mid caps represented by the S&P 600.

(S&P 500 Large Cap forward PE was then 17.4. Vs. Small-Cap: 11.5 – a greater than 50% premium – large caps vs. small-cap on average PE). Again, there were some excellent opportunities in higher quality earnings basis micro to mid cap stocks.Now I often see analysts take a retrospective look at great buying opportunities in the past – which is frankly easy. The key is, how did you react at the time. How did your take action – this is the key for our clients.

Our first recommendation as the valuation gap hit its highest point was the Cipher Pharma our  second was VitalHub – both have gained just over 300% in a year and a half.

But my point today, is to revisit these relatively valuations and see if the opportunity remains in place – the rainbow spaghetti looking chart shows the relative forward PE valuations currently for US Mega Cap, Large Cap and Small to mid-cap stocks.

Let’s give you a simpler look at just the numbers.

While the valuation gap has narrowed slightly –  the Forward PE on the Large Cap S&P 500 is 21.2. vs.   the Small-Cap S&P 600 Forward PE of 15.2. ( it remains at a 40% premium). Large cap stocks vs. small-caps.

To put this in perspective for the better part of the past 25 years, Small-caps, due to their higher growth profile, have traded with premium PE multiples to their large cap brethren.

Opportunity.

The continued inversion of the ratio continues to create an opportunity.

If this multiple were to reverse in favour of small caps as it held for the first 20 years of this century, there remains significant upside in small-caps.

The specific case of Small Caps.

The S&P 500’s gains over the past 18 months have been powered by a handful of mega-cap technology stocks – valuations stretched on this end of the market.

While the small cap segment underperformed in 2024 (I will note that we saw significan outperformance in KeyStone’s high quality, profitable small cap names), and broadly the segment has been quietly gaining momentum for the better part of a year as new themes including “de-globalization reshoring, and lighter regulation are positive for the segment.

The opportunity continues to be centered around the valuation gap between small and large stocks.

Average multiples on profitable small-caps remain at a significant discount to their large-cap and, in particular, the premium priced mega-caps.

In Summary

The multiples continue to favour the small.

The ten largest constituents in the S&P 500 index account for ~36% of the overall index and trade at a forward P/E of ~32x.

The remaining 490 stocks in the S&P 500 trade at a forward looking ~21x.

The S&P 600 Small-Cap index currently trades around 15.2x. For the first 20 years of this century, small caps traded with premium multiples relative to large caps.

A reversal of this premium would be powerful for small-caps, even a narrowing is a positive.

With this in mind, we are issuing new small-cap buys, this week to client!

Bitcoin ETFs & Risk

1. We’ve had a few general questions about Bitcoin ETFs and then position management and just general considerations for holding Bitcoin as an investment. With Trump now in office some sort of Bitcoin reserve is being floated as well as launching his cryptocurrency, it seemed like a good time to go through these questions. I will be focusing on Bitcoin in this segment, and I will preface this by saying holding Bitcoin or any cryptocurrency has never been a KeyStone recommendation.
2. Moving to Bitcoin’s recent performance it has been strong setting a new all-time high over the weekend of roughly $109 thousand. Over the past year, the total return was 165% stoking more investment interest with continued high returns currently trading at about $105 thousand
3. A quick overview of Bitcoin ETF pros and cons if you are looking to invest in Bitcoin. The biggest benefit is the ease of use, with self-custody or holding through a cryptocurrency it is more complicated for most people. With self-custody, you can make mistakes when transferring and purchasing, losing your keys which is effectively the same as losing a wallet of cash amongst other hurdles if you wish to go that route. These are not impossible hurdles to cross but many people just have peace of mind letting a third party hold their investments. A couple of the drawbacks of ETFs are you are letting someone else handle your assets they will charge you a fee or MER, and you can only trade during normal stock market hours unlike with self-custody or through a cryptocurrency exchange being 24/7. But if you are looking at Bitcoin as purely an investment asset not to use like a currency then ETFs are likely suitable for you.
4. Just over a year ago now, in the US spot BItcoin ETFs were listed and a couple of years ago spot Bitcoin ETFs were listed in Canada. Recently BlackRock launched a Canadian Bitcoin ETF symbol IBIT that is linked to their American one which looks to be the lowest fee in Canada at 0.32%, which the Fidelity Bitcoin ETF symbol FBTC soon followed by lowering its fee to 0.32% as well. The other benefit is it will likely have higher liquidity and lower bid-ask spread given it is linked to the American-based ETF.  So just generally good to see more competition in the Canadian ETF space as they were significantly worse offerings compared to the US when the US spot ETFs hit the market. If you are looking to invest through an ETF there are no significant differences between ETFs’ past MERs and liquidity which do change over time but even then the MERs are very low compared to just general market volatility so don’t stress too much about 0.01% difference if an ETF changes there fees.
5. So now changing pace for the next couple of slides, why would you even want to hold Bitcoin in a multi-asset portfolio? Traditionally you’ll likely have heard of the 60/40 portfolio 60% equity and 40% bonds, as different asset classes have lower correlations with one another you can have a higher risk-adjusted return using modern portfolio theory. Bitcoin can be used similarly as it does not have a high correlation with equities. Correlation between assets does shift over time as it is a statistical relationship based on price. The chart I have up is Bitcoin’s correlation with the SP500 for the prior 30 days over the past 5 years, and as you can see it is not consistent on 30 days, with correlation dropping slightly negative at points meaning a slight inverse correlation and has high as .8 which is quite a high correlation. But for the most part, it does hover around that 0.4 correlation which is positive but not an exceedingly strong correlation, and if you look at longer-term correlations past 30 days you get in the same ballpark of correlation. I’m not going to go into how you implement modern portfolio theory as it does get complicated and outside of the scope of this segment as well as depending on your other holdings, but the point of this is just to show there is likely some diversification benefit based on historic price movements, which I will also say the standard caveat past performance is not indicative of future performance.
6. Now looking at Bitcoin Volatility, it is quite a volatile asset, to say the least, however, volatility has been slowly trending down over the long term which is not surprising as higher-value assets tend to have lower volatility as more players are in the market. But, Bitcoin still has high annualized volatility over the last 30 days of about 43%. Just for a point of reference, the SP500 is roughly 15% over the past 30 days. So even, though Bitcoin volatility has trended down it is still a highly volatile asset.
7. Next, the drawdowns of Bitcoin, which is just how much the price fell from its prior all-time highs, in this chart, you can see that Bitcoin has repeatedly fallen significantly, with the most recent major drawdown being roughly 75%, and if you go back to 2012, although a very different market structure Bitcoin fell over 90%. So do hold Bitcoin whether through an ETF or otherwise, you need to accept you can lose the majority of your capital, and as the past does not guarantee the future it may not come back to the same point in the future.
8. A couple of points to tie this all together if you do wish to invest in Bitcoin look at the risk of holding. ETFs are a suitable way to hold Bitcoin as an Investment.What I would say is the easiest risk management approach is position sizing don’t bite off more than you can chew, assume that Bitcoin can and will drop by 70% or more, or even just assume your position will effectively fall to 0. Also the larger the position is the fewer diversification benefits it will have as when you increase a position size relative to your portfolio it will have a higher correlation. Set a rough position size maximum and if it exceeds that lower your position to lower concentration. Obviously what people are comfortable with will vary but generally, an initial position will be in the low single-digit percentage 1 to 3%. But ultimately, invest in what you are comfortable with, if you do believe Bitcoin is going to fall to 0 and has no value, simply just don’t allocate towards it. Don’t have a fear of missing out when you do see high returns as that can lead to poor investment choices.

YSOT – MDA Space Ltd.
from a new client, Bryan – “Can we have another review of MDA Space. The company has seen a lot of growth since Aug of 2023 from $8 to $30. Perhaps its at full or overvalued, but would be interested in your take”

(MDA:TSX)

Price: $27.41

Market Cap: $3.37BM

Yield: N/A

Description:

MDA is a leading provider of advanced technology and services to the rapidly expanding global space industry. The company primarily serves the US and Canadian Governments. The company has three segments; Geointellegence, Robotics & Space Operations, and Satellite Systems.

And if we look at the most recent quarter, about 60% of revenue came from Satellite systems, 24% was robotics & space operations and 16% was for Geointelligence.

Slide 2

We have covered the stock on the podcast before, and the last time was in April 2023. Since then the stock had had a strong run, up about 300%. So let’s take a deeper dive on the business to see what’s driving the stock and see whether it is fully valued or not.

Slide 3

Now looking at the recent quarter of Q3 2024.

• Revenue increased 38% to $282.4M, driven by higher work volumes across the business with strong contributions from the Satellite Systems and Robotics & Space Operation’s businesses.
• Gross profit margin was 27% compared to 28% for the same period last year.
• Adjusted EBITDA was $55.5M, up 30% from the same period last year. Adjusted EBITDA margin was 20% which is in line with the company’s full year Adj. EBITDA margin guidance of 19-20%.
• Net Income was $29.5M, up 217% driven by higher operating income and higher other income. And if we look at adjusted net income it was $34.7M (or $0.28 per share), which was an increase of approximately 60% y-o-y.
• Operating Cash flow was $258.8M, up from a loss of last year.
• And backlog of $4.6 billion at quarter-end provides good revenue visibility for 2025 and beyond and was up 49% compared to Q3 2023. The year-over-year increase in backlog is driven by new order bookings including the $1billion award for Phases C/D of the Canadarm program announced in Q2 2024.

So generally, I just want to pause here and say fundamentally the business has been performing quite strong with good growth in backlog, which has been translating into both top line and bottom line growth in the mid-to-high double digit range.

One thing that I would like to point out here though is that due to the nature of their business, results can be naturally lumpy, but the recent trend in financials over 2024 are certainly leading to the increase in the share price.

• The balance sheet is in a net debt position of $259.1M. Which provides a trailing net debt to EBITDA multiple of about 1.4x. This compares to when Brett covered them last when they had a net debt to EBITDA multiple of 1.3x. And like Brett pointed out in April 2023, the company has hedged about $225M of its credit facility with interest rate swaps, so it is not overly sensitive to interest rate changes.

Slide 4

Now looking at valuations and forward guidance, the company recently increased their guidance when they reported Q3 2024 results. Now looking for growth in revenue of about 31% over 2023, and Adj. EBITDA to grow 19%.

Management also noted “We continue to expect favourable working capital contributions related to the Telesat Lightspeed program to result in positive free cash flow in 2024 allowing us to continue to deleverage our balance sheet”

And now looking at the valuations, MDA is trading at about 48 times trailing accounting Earnings, 32 times adj. earnings, 17.5 times forward adj. EBITDA guidance, 19 times trailing adj. EBITDA, and a price to CFO of 8.6 times. Generally given the recent growth in earnings, I do not think the current valuations are insane, but the stock is certainly trading at a bit of a premium IMO.

Slide 5

And quickly just looking at a couple of operational updates:

• In Q3 2023 the company broke ground on their satellite systems facility expansion in Quebec which will add 185,000 square feet of advanced manufacturing capacity. The facility is expected to double satellite manufacturing capacity and is expected to be operational in the second half of 2025.
• Telesat (another public company) partnered with MDA back in 2023 to be the primary satellite contractor for the “Telesat Lightspeed Constellation”. And in December they announced they had completed the spacecraft’s preliminary design review and plan to transition to the program’s engineering and manufacturing phase.

Slide 6

So to conclude here on MDA Space Ltd:

• Growth in backlog, top-line revenue and earnings have propelled the stock higher in 2024.
• The balance sheet remains relatively healthy with a net debt to EBITDA multiple of 1.3x.
• The valuations of 17.5x forward 2024 Adj. EBITDA and 32x trailing Adj. EPS are premium multiples. But given the recent growth, I do not believe they are unreasonable. And the additional satellite manufacturing capacity coming online in 2H 2025 is intriguing for future growth.
• I believe the stock is closer to fair value in the near-term, and one must pay a bit of a premium to own the stock. But long term I think it’s a decent business. Keep in mind, revenues can be very lump quarter-to-quarter, and one should continue to track order backlog and bookings to get a sense of the business’ direction.