Black swan events – Geographical diversification

Any time a company you invest in has a significant concentration of its revenues (and/or income) derived from a single geographical source, there is always risk of this sort of thing happening:

DEDHAM, Mass., Sept. 23, 2019 /PRNewswire/ — Atlantic Power Corporation (NYSE: AT) (TSX: ATP) (“Atlantic Power” or the “Company”) disclosed today that its Cadillac biomass plant, located in Cadillac, Michigan, is currently offline following a fire at the plant on September 22, 2019. The plant’s sprinkler system activated and the fire was extinguished by the local fire department. The fire did not result in any injuries or known environmental violations.

The cause of the fire, extent of the damage, and time required to repair the facility are unknown at this time. The Company is assessing the extent of the damage to the facility and will be reviewing the incident with its insurance carriers.

Atlantic Power would like to thank all area first responders for their support during this incident.

The Company expects to provide a further update with its third quarter 2019 financial results when it has determined the extent of the damage, the schedule for the plant’s expected return to service and the financial impact.

The Company would note that Cadillac contributed $3.4 million to Project Adjusted EBITDA in the first six months of 2019, or 3% of total Project Adjusted EBITDA.

I ask myself whether this could have been picked up in advance, and the answer would have been “yes”.

On the Cadillac News website, early this morning, the following article came up:

CADILLAC — Firefighters battled a blaze at Cadillac Renewable Energy for several hours early Sunday morning.

According to a Cadillac Fire Department press release, shortly after 2 a.m. they received what was being reported as a structure fire at Cadillac Renewable Energy on Miltner Street in the industrial park.

Upon arrival, firefighters noted heavy fire conditions in a large biomass power generation facility. All employees had safely exited the building prior to fire department arrival. At the time, there were three employees on shift.

Firefighters used defensive tactics and elevated water streams to knock down the fire. Once the fire had been reduced in size and severity, conditions allowed firefighters to enter the facility and continue the extinguishment process.

After several hours, the fire was fully extinguished. Damage was primarily confined to one area of the facility, however, significant damages to that portion were noted.

No employees, civilians, or firefighters were injured.

An investigation into the origin and cause of the fire is ongoing. Additional information regarding the investigation will be provided once it becomes available.

The Cadillac Fire Department was assisted at the scene by Haring Township Fire Department, Cherry Grove Township Fire Department, North Flight EMS, Cadillac Police Department, and the Cadillac Utilities Department.

Of course, I’m not the type of person to put an alert on “Cadillac Renewable Energy” or the myriad of subsidiaries that Atlantic Power operates as on my alerts table. I don’t think most people are.

The news hit the airwaves at the first yellow triangle in the following chart:

An enterprising small scale trader could have reasonably gotten about 10,000 shares of liquidity at the bid at the 2.53-ish mark and if they were clairvoyant, could have covered a dime under and made cool thousand. Anything larger than that size and a short term news trader would have run into liquidity issues.

In terms of the actual financial damage, if the plant is out of commission permanently, a very simplistic analysis would be the removal of $6.8 million EBITDA, discounted 10% to June 2028 (when its power purchase agreement expires), or about $39 million present value, assuming EBITDA translates into all cash. That works out to 36 cents per share!

The article noted, “Damage was primarily confined to one area of the facility, however, significant damages to that portion were noted.” – this suggests that there will be a bunch of money spent on repairs and the plant will get up and going again. Insurance should also mitigate some of the damage, although it is not clear whether they just have a facilities insurance or they also have a business interruption policy which would cover the cash flow in the event of a business interruption.

However, the underlying lesson is the following: if a company you owns has one core asset that products the bulk of cash flow (I’m thinking of Gran Colombia Gold and Segovia when I write this), there is always the lingering risk of a single event causing major damage. Hence, there is some value to diversification.

Low price to sales ratios – Tailored Brands

This might sound obvious, but the most amount of income you can generate from a dollar of revenue is one dollar. Eventually taxes will kick in, and that will go down to a net profit margin of around 74%, depending on what province you live in. Then you add in expenses such as salaries, or cost of goods sold, or marketing, and that net margin goes lower. Finally, you have non-operational expenses such as financing which will bring the number even lower.

However, it all starts with revenues – if you can’t bring in anything on the top line, it is guaranteed that you won’t see anything flow to the bottom!

Which is why one of the periodic value screens I typically conduct are companies that have low price to sales ratios.

Most typically they trade that way because they are either in debt/solvency trouble, or in traditionally low margin industries (or both) – if your gross margins are 10%, you better be selling a lot of product in order to cover the other fixed expenses. It is one of the basic premises of my original CMA designation (now merged as CPA) to construct methods to judiciously track the linkage between the top line and the proper allocation of overhead expenses to different divisions.

However, if a company with relatively high top-line sales is not producing good financial results, there are value opportunities if one is lead to believe that management can tweak things to either induce higher profitability or to reduce fixed costs in a manner that will not endanger revenues. These results do not show up in historical financial statements, but when they do appear, the results can be very dramatic.

The most recent example of Francesca’s (Nasdaq: FRAN) fits the definition of dramatic:

FRAN has 3.06 million shares outstanding, so at the end of July they were about a $10 million market capitalization company. I’ll skip the bulk of their corporate history (they were one of those high-flyer retailers that caught tailwinds before they became like the next beanie baby), and their Q1-2020 result (note: their fiscal year ends January) was horrible – $87 million in sales, $9.7 million loss in operations. The trajectory looked like they were going into Chapter 11 (they did have some net cash on the balance sheet but not a ton).

Fast forward to Q2-2020, and a miracle happened – $106 million in sales, $1.4 million income from operations. The stock went haywire as you can see – especially given its low float. It’s very interesting to see when a company with 3 million shares outstanding has a day with 20 million shares traded in volume.

What’s interesting is some very smart people (or insider trading) edged the stock up a few days before the quarterly release. The day after Q2 was announced, the stock doubled and proceeded to wipe out the short sellers (on August 30, 2019 there were 1,163,624 shares that were short!).

Retail fashion is currently an industry that is getting killed because of a confluence of factors. There is the typical Amazon effect – most retailers are in malls, and malls have less traffic these days because people are discovering the experience is a pain in the ass. There are other transient factors, but in general the industry is taking it on the chin.

Reitmans (TSX: RET.A) is a good example. I can get a chart of their stock from October 2016, and place a ruler on my computer screen at a downward 30 degree slope, and it extrapolates to today.

Just because it is cheap doesn’t mean it is a good value – these cases can be classical value traps.

We move onto an interesting case, Tailored Brands:

Tailored Brands initially got on my radar a few months ago because it was on Michael Burry’s 13-F form. Burry is somebody that I have been aware of well before his “Big Short” days, specifically when he wrote on MSN Money at the turn of the millennium (his write-up on American Physician’s Capital was complete genius). Needless to say, I respect his thought process greatly. I was wonder what the heck he was thinking with TLRD, but I guessed the general thesis involved. He eventually explained some of his thinking in a 13-D filing indicating that he has been accumulating shares between $4.30 to $6.00.

Putting a long story short, his letter was that the company still makes money and if management believes in the business, they should scrap the dividend ($36 million a year) and instead buy back shares and increase the EPS materially.

This hype from Burry (who recently went public after a multi-year hiatus with an investment in Gamestop, another retailer, which I do not believe is a good decision because they are truly vulnerable to the Amazon effect) presumably got the short sellers in trouble (in the first week of September, there was an obvious spate of short covering – this is what happens when the stock goes up 40% in a short period of time!). Short interest is VERY high – 23.3 million shares as of August 30. The quarterly report is what got TLRD back down to earth again.

Looking at their financial statements, TLRD does look cheap from a price to sales perspective – annualizing the first 6 months, they sell $62 in revenues for every share outstanding. Operating income is still $91 million for the first half, although definitely going down.

The balance sheet isn’t great, but it is a manageable position – they have a large line of credit that extends out until April 2025 ($884 million outstanding), and a senior note ($229 million) which matures on July 2022. The senior notes trade around 99.5 cents on the dollar with a YTM of 7.2%. Right now the credit market does not look like it is locking out TLRD. Most of this debt acquired in the takeover of Joseph A. Banks (another clothing retailer) which was a total disaster. TLRD also has a large amount of lease liabilities, similar to other retailers, and more visible now due to IFRS 16.

In the last quarterly report, the company also listened to Burry and cut the dividend to zero, and made noise about buying back shares. This was actually a good sign.

When a company reduces its dividend to zero (a brave decision), in addition to the negative psychological sentiment associated with it, there is also the effect of having income funds dump the stock due to the investment policy, not to mention retail people that are deluded into believing the yield statistic they see on the stock is sustainable. There will be the technical effect of a lot of forced selling after the quarter, and I believe we are seeing it presently. The question is how many shares will get force-dumped, and when will the short sellers cover.

It is interesting how at one point the cost to short TLRD went as high as Beyond Meat for a few days – signs that borrowing is getting tougher.

Tailored Brands is mostly associated with the Men’s Warehouse brand, and in Canada it is Moore’s. The question is whether men’s fashions (suits and the like) is still subject to the Amazon steamroller. I would think this segment of retail fashion is less vulnerable than Reitman’s.

So the question is whether management is capable of clotting the bleeding. Guidance for the 3rd quarter was awful (sales down roughly 5%). Operationally management does appear to be getting into a better and more profitable niche (customization), and the question is whether they can pull it off competently.

The risks are pretty obvious. The situation can get worse. The operating income to debt ratio is quite high. Fashion is fickle, and I don’t even want to divulge on this website publicly the last time I bought a suit. That said, I think men’s fashions are less fickle than women’s, but if we get this much-anticipated recession or economic slowdown it will also not help the company’s financial fortunes – a suit is the last thing on the shopping list when one is worried about their employment (note: the Men’s Warehouse still made money during the 2008-2009 economic crisis).

That said, there was a pretty good reason why this thing was trading at $24/share a year ago. It could easily get there again – a couple quarterly reports with stabilization will do this. They set the bar very low for Q3. The CEO also put up $72k of his money into the stock after the quarterly report, which is better than nothing.

I’m buying shares in the low 4’s. It will not be a large position, but my price target is $20/share.

Normally I do not like these sorts of companies for a few reasons. One is that there are too many eyeballs tracking this, especially now that Burry has made his 13-D filing public. I am not typically a “follow Buffett” type of investor – usually when I read about something from another source, I use it as an exclusionary criterion. However, there is a good chance the market sentiment is so negative that the chances of a less negative outcome are a lot better than the consensus.

If it works out, I’ll buy a cheap suit.

Cost of shorting Beyond Meat

I received the following spam:

Instantly I thought… the hype is dropping off like what happened to the Beanie Babies – I’m guessing that consumer retail demand is probably starting to wane. Beyond Meat (Nasdaq: BYND)’s IPO lockup expires at the beginning of November and this is when another flood of shares will presumably hit the markets.

Beyond is trading at $148/share presently, or a market cap of $9 billion. This is a lot higher than it actually should be.

Unfortunately this revelation is not unique as there is a very large lineup of people that want to short this thing.

Even assuming I can get a borrow, if I were to short 100 shares of BYND at current market prices, I’d have to pay $88/day in interest expenses (another way of thinking about this – 88 cents per share per day!) in order to maintain the short!

Conversely if you believe for whatever reason this thing isn’t going down, you stand to make a fortune on raking in the borrow fees on the stock if you use the right broker.

What about options?

Using December as an example, a call option near-the-money (strike 145) is $8 at the midpoint, while a put option at the same strike is $31.40!

Even deeper in the money (e.g. strike price of $175) your break-even, even if you get a mid-point execution is $116/share, or basically paying a 22% premium to short the stock.

Even paying a spread (e.g. making a bet that BYND will be lower than $120/share by December expiration) by buying the 150 put and selling the 120, your effectively are paying $21.15 (again, assuming mid-point option trades) for a maximum $8.85 profit IF the stock goes to $120 or below in a few months.

This is one beyond expensive short sale!

Taking an investing break until after the election

So far, this has been a crappy quarter to date. Although thankfully it isn’t a quarter where I should have gone all-index (the S&P 500 is down ever so slightly), I really feel like I have badly unperformed – so far I’m underwater about 150bps or so, which is not a good feeling. My decision-making faculties have not been in focus. For the year, I’m still barely in the black, but my relative performance benchmark has been horrific. If I was an 8 cylinder engine, I’m firing on about 2 of them.

That said, I have sold off and cashed a lot of the portfolio and I will only start to consider re-deploying after the upcoming Canadian election. There will be a lot at stake, especially with respect to the oil and gas industry.

It is pretty evident by the non-presence of the Canadian government at the Trans-Mountain pipeline appeal that the incumbent Liberals are not really interested in seeing the project proceed – or at least they’re happy to stall it out. The six motions (concerning the second round of consultations with First Nations) received no evidence from the government – it seemed pretty likely that if the government did provide evidence, the appeal court would have likely struck down the appeal application.

So this is a pretty polarizing election. If the Conservatives don’t get a majority government, it is likely that status quo will continue – avoiding Western Canadian investments will generally be wise as Liberal governments tend to focus on Toronto and everything east of it (Bombardier, SNC Lavalin, etc.).

The oddsmakers at 338 right now are projecting a 70% chance that the Liberals will get the most seats, but this will undoubtedly change through the campaign. In 2015, at this point the NDP were leading polls nationally, but this changed pretty quickly!

In 2019 we have the following:

In other words – the campaign will matter. Those lines will shift trajectory as people start to dial in – I figure around mid to late September.

A comprehensive list of TSX Exchange Traded Debt

(Most recent post on this was September 4, 2020)

Over two years ago I lamented there was no good consolidated list of TSX-traded debentures available.

I’ll give Felix Choo some credit for resurrecting a digital version of this. In general, his lists are about half of the exchange traded debentures on the TSX.

After consolidating a bunch of information together and going through a hundred documents or so on SEDAR, I am finally in a position to publish an authoritative list of debentures (109) and notes (3) that are trading on the TSX.

I have not included TSX Venture, but in case if you were wondering what you were missing on the TSXV, only a handful – 22 tickers among 18 issuers. Maybe I’ll add them in the future.

The entire list (as of September 3, 2019) of TSX-listed debt instruments (convertible debentures, exchange-traded notes) can be accessed at the following shared Google Sheet linked here.

I’ll give the standard disclaimer: I have tried to make it very accurate, but things can slip through the cracks.

Other than trying to make this a “real-time” sheet (can anybody give me a good automated source of debenture quotations that doesn’t involve a $2,000/month Bloomberg Terminal?), comments to improve this would be appreciated.