Coronacrash update 2

Needless to say, along with the rest of the financial universe, I’ve doing some very rapid weekend research, but have also taken the time to get outside, exercise, enjoy the somewhat cloudy weather and thank my blessings that my fever-free cold that I caught a week and a half ago is finally going away. I’m really getting the impression that a lot of people’s mental health has been sharply declining – decades later, I’m sure historians will figure out that rapid-fire social media is the root cause of all of this social insanity.

Anyhow, over the past 5 trading days the TSX Composite has dropped 8.9%. It has been one of the sharpest short-term market declines I can ever recall in my history in the stock market – only rivalled by the 2000 tech crash and 2008 financial crisis. Going further back we also have the 1987 and 1989 analogies which exhibited huge one-day crashes, but what we have seen were multiple gap-down days.

See the big volume spike on Friday? That’s a lot of demand for people to flush stocks into cash. It didn’t help that the TSX itself shut down mid-day during one of those panic days. Always remember that in a given trading day the total shares outstanding and the cash outstanding is always constant, it is the price level of the stocks trading that is different, representing a higher “pressure” to unload shares and obtain cash vs. the opposite.

Presumably a lot of stocks have gotten hit in the past five days. When looking at the large-cap market, most of the major names (e.g. ENB/PPL, banks, energy producers, SLF/MFC/GWO/IAG insurers) have been hit pretty badly, but in general, the hit has been a relatively even distribution. Even boring staple companies like Rogers Sugar are down about 10%, the index average. One can infer that the selling pressure has been blanket-wide.

On the US side, even Berkshire (the whole world knows Buffett is sitting on a huge cash stack waiting for the markets to crash) is down 10% from a week ago.

When looking where the damage is disproportionate (which is where you can usually find the better bargains, ideally through mass margin selling) we have the following screen of companies (one day I will increase the width on the template of this site so these tables can display better):

TSX losers at the end of February 2020

5-day change in share price below -20%;
Market cap above $100M;
Share price above $1
RankSymbolNameLast5d%chgMktCap ($M)Comments
1ALS-TAltius Minerals Corp9.13-82.56384Metals
2IMV-TImv Inc.2.95-52.5149Preclinical Bio
3DRT-TDirtt Environmental Solutions Ltd2.42-41.4205Manufacturing
4MUX-TMcewen Mining Inc1.21-30.86481Metals
5AXU-TAlexco Resource Corp2.01-30.45239Metals
6BLDP-TBallard Power Systems Inc12.06-30.452,816Alt. Energy
7OSK-TOsisko Mining Inc2.8-30811Metals
8PTM-TPlatinum Group Metals Ltd2.52-30157Metals
9BU-TBurcon Nutrascience Corp1.23-29.31118Plant Protein
10DII-A-TDorel Industries Inc Cl.A Mv4.2-29.05122Wholesale Retail
11VET-TVermilion Energy Inc13.46-28.932,093Energy
12TMR-TTmac Resources Inc1.6-28.57184Metals
13SBB-TSabina Gold and Silver Corp1.33-27.72394Metals
14APY-TAnglo Pacific Group Plc2.2-27.63430Metals Royalties
15SEA-TSeabridge Gold Inc13.22-27.24830Metals
16OVV-TOvintiv Inc15.51-25.754,030Energy
17STLC-TStelco Holdings Inc7.14-25.63633Base Metals
18USA-TAmericas Silver Corp3.15-25.36260Metals
19MAG-TMAG Silver Corp11.38-24.59985Metals
20FVI-TFortuna Silver Mines Inc3.93-24.57630Metals
21EQX-TEquinox Gold Corp9.73-24.521,104Metals
22LMC-TLeagold Mining Corp3.25-23.89926Metals
23TVE-TTamarack Valley Energy Ltd1.29-23.67290Energy
24OGC-TOceanagold Corp1.96-23.141,220Metals
25FR-TFirst Majestic Silver Corp Common10.13-23.022,125Metals
26SVM-TSilvercorp Metals Inc4.27-22.64739Metals
27SCL-TShawcor Ltd8.42-22.25591Energy Services
28ORL-TOrocobre Limited2.31-22.22618Metals
29WPRT-TWestport Fuel Systems Inc2.53-22.15344Alt. Energy
30BBD-A-TBombardier Inc Cl A Mv1.02-22.142,320Aerospace
31MDNA-TMedicenna Therapeutics Corp3.19-22112Preclinical Bio
32SSL-TSandstorm Gold Ltd7.84-21.911,401Metals Royalties
33SMT-TSierra Metals Inc1.8-21.74292Metals
34GOLD-TGoldmining Inc1.45-21.62210Metals
35HEXO-THexo Corp1.46-21.08415Cannabis
36PG-TPremier Gold Mines Ltd1.24-21.02261Metals
37DOO-TBrp Inc55.03-21.014,882Snowmobiles!
38MOZ-TMarathon Gold Corp1.26-20.75225Metals
39EDR-TEndeavour Silver Corp2.14-20.74295Metals
40HSE-THusky Energy Inc6.39-20.726,423Energy
41LAC-TLithium Americas Corp5.53-20.55496Metals
42PRN-TProfound Medical Corp17.5-20.53267Medical
43WDO-TWesdome Gold Mines Ltd8.54-20.481,178Metals
44IFP-TInterfor Corp11.93-20.41802Forestry
45PAAS-TPan American Silver Corp26.57-20.335,574Metals
46LGD-TLiberty Gold Corp1.1-20.29261Metals
47AYM-TAtalaya Mining Plc2.62-20.12397Metals
48NEO-TNEO Performance Materials Inc7.97-20.06305Metals
49OR-TOsisko Gold Royalties Ltd11.03-20.011,738Metal Royalties

The metals companies (mostly gold-related) are all crashing simply because the price of gold itself has gone into the gutter after day 2 of this crash – gold is not a safety valve if your desire is to hold onto cash rather than assets (think 1929-style deflation). In general, I do not see much value in these types of companies. Thankfully my exposure to gold is strictly limited in (TSX: GCM.NT.U) which will be automatically cashed 30% at the end of March, and it would take a catastrophe of huge magnitude for the rest of the notes to not mature gracefully.

The other companies are energy, and for obvious reasons they are not doing well.

The remainder of companies have interesting features, but for example, a company like Dorel Industries (TSX: DII.B) has exposure to China simply because they have some manufacturing operations there.

So oddly enough, despite this crash in stock prices, I don’t see too much value in the TSX directly as a result of this. Yes, things are cheaper relative to a week ago, but they don’t appear to be dirt cheap.

Even when scanning the TSX fixed income list, the debentures that are trading low are doing so for very obvious reasons (e.g. Just Energy is sitting at 38 cents on the dollar because there is a very real risk that their senior secured creditors are not going to allow a refinancing). There are some issuers in my opinion that are trading near par that should be trading much lower (i.e. their actual credit quality is less than the price of their debentures indicate), but very little in the way in the opposite direction.

The preferred share market has also slide down and has not been immune to the downturn, but this is probably because the 5-year government of Canada bond rate has also slipped – from 1.29% beginning the week to 1.07% ending. This has a disproportionate effect on those rate-reset preferred shares.

When there are huge volatility spikes down like this, there are likely to be soul-crushingly large rallies up, usually at the point where most of the active sentiment has already shifted into a “cashed out” mode. The “risk on” stocks that get hit the most are typically the ones to bounce back up, at least in the very short term. After that, it’s anybody’s guess.

Finally, my barometer of the “Coronapanic” is Alpha Pro Tech:

This measures people’s psychology in a stock chart. This company has 13 million shares outstanding and one look at the volume chart shows the story – it’s traded its entire stack of shares outstanding more than 5 times as people have flipped shares like pancakes.

I must say I badly under-estimated the impact of this Coronavirus and I can clearly be counted in the leagues of people that thought this would blow over and life would go back to normal after a brief panic. When this will stop, who knows – but there is one constant in the markets and that is there is the most money to be made and lost in panics, which is why I’m paying hyper-vigilance despite being poorly positioned going into this thing.

Coronapanic guide

Just when I thought I was streaming towards a good first quarter, the bottom falls out of the market! Going from a healthy single digit percent gain to slightly negative is quite disappointing.

I do not know when this market panic is going to end. If the fourth quarter of 2018 analogy applies, we will see around an S&P 2700 level before this all ends, over the course of three months. My intuition says it will be a shorter period of time since the spike down was so heavy.

Central banks that will be injecting yet more capital into the financial system to stabilize things, but we are going to find out the impact of what happens when a country mostly shuts down due to the flu. Imports, exports, supply chains, etc., will all be affected.

The selling that has been going on was indiscriminate. The first real day of the plunge, gold went up while the S&P went down. However, in the second and subsequent days, gold and the S&P equally went down, which suggests that this is a rush for liquidity rather than a rotation for safety.

When you get a rush to liquidity, it can be very profitable to time the bottom, but understanding where that point is another story. When it ends the companies that make money and are relatively unaffected will bounce back, and bounce back hard.

The trick in these times is not to get your account cleared out, whether it is through self-induced panic or getting a margin call. Indeed, this is exactly when you have cash for.

Making investment comparisons

This post is a little more abstract, but the thinking should be fairly easy to understand. The revolves around the concept of hurdle rates, and making comparisons to baseline investments.

I’ve been reviewing a bunch of companies that have balance sheets that have tangible (or nearly tangible) financial assets that when netted against their liabilities are trading below liquidation value. An example of this would be Input Capital (TSXV: INP) which Tyler has tweeted about, in addition to SM keeping me informed by email.

In the case of Input, taking their December 31, 2019 balance sheet as-is without mental adjustments, gives them a $1.24 book value. At a current market rate of 71 cents, that’s trading at a 43% below book discount. Assuming the asset side of the balance sheet doesn’t have more write-down surprises, the company on the income side still makes a modest amount of cash on their canola/mortgage streaming business, albeit at a rather high cost on administration (as a percentage of assets). If they decide to wind down, shareholders should be able to get out with a mild positive. Their mortgage portfolio will amortize and the board of directors can command management to fire themselves and call it a day.

So lets assume I have a chunk of cash, and I’m evaluating this option for the portfolio. To be clear, I’m not interested, and INP has very poor liquidity – typical trading volumes in a day is less than CAD$10,000. Piling onto our list of assumptions, let’s say liquidity is no concern.

The question is: What do I compare this to?

If I compare this to the simple risk-free cash amount (e.g. the brain-dead option is (TSX: PSA) which yields a net 2%), then yes, Input Capital looks fairly good by comparison. If INP materially winds up in 3 years and captures 90% of its present book value (conservatively assuming they lose a bit in the process of wind-down), that’s a 16% CAGR gainer. You’re effectively getting 14% net on the risk-free option – the risk of this not happening is what you’re getting this 14% spread for (such as the critical assumption on whether they choose to liquidate or not!).

However, things are not so easy in our multiverse of investment options.

For instance, you have other choices. Coming up with baseline options is vital for making comparisons. Other than the risk-free option (government bonds or for smaller scale amounts of money, PSA), there are surprisingly a lot of companies out there trading under book value that appear to be making money.

Perhaps the least glamorous, most boring, but relatively safe option is E-L Financial (TSX: ELF) which owns nearly all (99%+) of Empire Life, 37% of Algoma (TSX: ALC), and 24% of Economic Investment Trust (TSX: EVT). At the end of Q3, its book value (stripping the $300 million of preferred shares outstanding) was $1,421/share while its market value today on the TSX is $814, which is a 43% discount below book value, identical to INP’s discount today. ELF also from 2009 to 2018 compounded its book value by 9.7% annually, and clearly is a profitable entity.

So we compare two opposing options: INP and ELF – why in the world would you choose INP? The only reason would appear to be a chance of a quick and clean liquidation over the next few years, and that is measured against ELF earning 10% of book value over those three same years, and staying at a 43% below-book valuation. The only thing you don’t get with ELF is an interesting conversation at a cocktail party.

The baseline comparison of ELF compounding book value at 10% a year creates quite a hurdle for other below book value investments – the underlying mis-valuations must be very severe in order to warrant an investment in other vehicles. When scanning my portfolio, all of the common share investments have clear rationales for expected returns higher than this hurdle rate.

When you compare to real bottom of the trash barrel options like Aberdeen International (TSX: AAB) which are trading 85% below book value, why would you want to put investment capital into a sub-$100 million market capitalization entity when there is a perfectly viable option that is clearly a legitimate firm, and has a very good track record of building its balance sheet? (For those financial historians out there, many years ago Aberdeen was subject to a bruising proxy fight where an activist tried to take over the board for the purpose of realizing book value, but the management was successful at fighting it and then proceeded to fritter away the company into what it is today – a 3.5 cent per share stock – shareholders got what they deserved!).

As a final note, the presence of fixed income options that appear to give off very high low-risk returns tends to make such comparative decisions really difficult. For example, Gran Colombia Gold’s notes (TSX: GCM.NT.U) are linked to the price of gold and give out more yield when above US$1,250/Oz. Given the seniority of the notes (they were secured by the company’s primary mining operation), even at the baseline gold price, the notes represented a very low-risk 8.25% coupon. At current gold prices, the coupon effectively rises to around 15%. It is difficult to compete against such investments, except in this specific instance they must be capped as a reasonable fraction of the portfolio (if the mine had an implosion, explosion, earthquake, etc., then there would be trouble). The opportunity is now gone since the notes are now in a redemption process and the remaining principal value will be whittled away with quarterly redemptions at par values below market trading prices, and the rest of it will likely get called off after April 30, 2021 (at 104.13 of par).

I won’t even get into comparisons with the preferred share market, where there are plenty of viable options with little risk that will yield eligible dividend yields roughly in the 6% range that would require an economic catastrophe of huge magnitude before they stopped paying out. The ebbs and gyrations of the underlying business itself is almost irrelevant to most of these preferred share issuers (e.g. Brookfield preferreds will likely pay dividends in your lifetime and mine). People, however, do get confused on the “stopped paying out” part of preferred shares vs. them losing market value – the preferred share trading today at 6% might look good to leverage up money at 2.2%, but if those preferred shares start trading at 7% or 8%, you might be the unwilling recipient of a margin call or the margin calls of others.

To conclude, just because an investment looks good on an absolute basis doesn’t mean the research stops there before hitting the buy button – making comparative measurements is just as important. Nothing precludes one from buying into both options; after all, if there is no correlation between the two investments and your success rate is 70%, you’ll hit your target on at least one investment half of the time.

Yellow Pages Q4-2019: Dividends re-instated

(Past post on Yellow Pages – November 2019)

Yellow Pages (TSX: Y) reported Q4-2019 results today and it featured the first balance sheet since its 2012 recapitalization where it did not have any senior secured debt. This was eliminated at the beginning of December.

The quarter also featured a shade under $30 million in free cash generation, or a shade above $1/share. The most impressive aspect of the business is that cash flows through operating activities actually increased year-to-year despite revenues dropping from $577 to $403 million. It pays to focus on profitable business and management has had an insane laser focus on cost containment. I have not seen anything like it in my entire investing history.

A business cannot last very long if revenues drop 30% a year, and if they can stem this challenge, which I believe they will, the stock will be going much higher than the $11.70 it closed at yesterday.

The only debt remaining is a $107 million issue of convertible debentures (TSX: YPG.DB) which will be redeemed at the earliest possible moment at par, on May 31, 2021. If they redeem earlier they pay a 10% pre-payment fee, which makes no sense to do it currently. The conversion price is $19.04, and if they start making a significant impact on their revenue decline while keeping 38-40% EBITDA margins, it will likely be the holders that decide to convert into shares when the redemption is announced.

Finally, because the shackles of the senior secure debt are finally off, management has the flexibility of engaging in capital allocation decisions involving dividends and share buybacks. I was expecting some sort of equity buyback decision (there is a considerable incentive to seeing a higher stock price both from an insider perspective but also equitizing the convertible debenture), but instead, management announced they will pay 11 cent quarterly dividends in Q2-2020. This works out to a 3.8% yield on the $11.70 closing price.

A dividend also creates some interesting implications for how the stock trades. Once again, it will be on the radar of Canadian income ETFs. My suspicion is that Yellow Pages will continue to receive an uptick of activity as passive vehicles slowly get back into the stock. If the market capitalization gets even higher, it will start getting into the liquidity range of even more ETFs. This is yet another example of how momentum is a valid market strategy – passive vehicles often weight their investments by relative market capitalization, and when that goes up, you have to buy more without caring about the price…

My own model and fair value assessment of this stock suggest it should go higher. So far they have generated cash better than my initial estimates when I got into the stock in the first place.

Who would have ever thought – Yellow Pages started as an income trust and was a ‘stable’ producer of distributions. I bet few people thought in 2011 (when they slashed dividends to zero) that they’d ever see this day.

Disclosure – presently, this is my largest holding.

USA Democratic Presidential Primaries

I will promise not to hijack my own website with too much in the way of US politics, but it does influence the markets in general as the current president will manipulate stock markets in a manner that best suits his political fortunes. Also the perception of Trump’s re-electability will have an impact on capital flows.

Back in my year-end report, I wrote:

USA Politics

In my previous year’s report, I made an educated guess that President Donald Trump would make all the gestures of running again for president but not actually run. Looking at the lead-up to what is a presidential election year, I am going to back out that prediction, mainly because of the competition that Trump is facing.

Odds markets have the following:

Biden: 2:1
Sanders: 3:1
Warren: 5:1
Buttigieg: 8:1
Bloomberg: 16:1
Hillary: 27:1
Yang: 34:1

In my scorecard, I would rank Sanders #1 probability to win the thing. My guess is that Bernie Sanders (“authentic”) is going to give the Democratic Party establishment a run for their money, much more so than when he did in 2016. The evidence is in the fundraising figures. The fact that he has gone through the entire primary process before is a huge assist in terms of his campaign structure and this cannot be underestimated.

Likely to place second is Pete Buttigieg (“young”, “first (credible) LBGT presidential candidate”). He checks the correct Democratic Party boxes.

Third will be Elizabeth Warren (“establishment”). I would view Warren as having a better chance than the other establishment candidate, former VP Joe Biden. For the life of me, I can’t understand why Biden has been ranked so highly other than incumbency.

Bloomberg has the huge disadvantage of trying to replicate what Trump did to the Republican party, but it won’t work. And in the very rare chance he actually did win, I do not think he would contrast well to Trump in the general election, and everybody knows it.

I am fairly certain on my Sanders / Buttigieg projection, and absolutely certain that Biden is toast (he will likely give up after South Carolina, which is his strongest state, and held on the leap year day February 29, 2020), but the question is where the establishment vote is going to end up – originally I thought it was going to be Elizabeth Warren, but now it is looking like a contest between her, Amy Klobuchar or Michael Bloomberg. Interesting times indeed. Warren’s performance in the technology-error riddled Iowa caucus is good enough to give her credibility in New Hampshire (and geographically it is a closer state for her), but in future primaries, it will be interesting to watch that Democratic establishment vote.