Revisiting Teledyne

It’s always good to review some companies that have crossed your radar in the past – the library of knowledge that gets built up becomes an investing competitive advantage when the market decides to vomit.

Teledyne (NYSE: TDY) got on my radar when they acquired FLIR Systems (I was a shareholder of FLIR at the time). They are competently managed, in a market space that is relatively insulated (they have a lock on certain technologies and are strategically well positioned). However, they took on a ton of debt when they took over FLIR and here is the salient table:

We see a structure that is $550 million variable, and $3.4 billion fixed rate. Clearly the highlight debt offering was the $1.1 billion of 2.75% notes due April 2031!

TDY currently makes an annualized operating income of $900 million. Current annualized interest charges are approximately $100 million. The residual after income taxes will be poured into debt repayment over the next few years. However, the problem from an investor perspective is that this capital has an effective return limitation – for instance, the 0.65% notes due on April 2023 (half a year from now) will effectively be re-financed at higher rates via the credit facility. Ironically, the Federal Reserve increasing interest rates improves the return on capital of TDY’s debt repayment and because most of it is fixed for the next 9 years, an increasing interest rate structure should not harm the company too much.

However, the debt burden poses significant limitations on shareholder returns (traditionally this has been in the form of share buybacks), in addition to making the valuation from an EV/FCF perspective even more expensive. The share buyback history of TDY in itself is a fascinating story – the last time they did so was in 2015.

Despite the business being great, it suffers from the same problem I identified when the FLIR takeover was happening – it is just too expensive. They did crash down to $200 during Covid, where they may be worth considering. Unfortunately if it got to this point, there’s likely to be a lot of other stuff on sale at the same time. But I continue keeping it on the radar.

Late Night Finance with Sacha – Episode 22

Date: Wednesday October 12, 2022
Time: 7:00pm, Pacific Time
Duration: Projected 60 minutes.
Where: Zoom (Registration)

Frequently Asked Questions:

Q: What are you doing?
A: Q3-2022 review, some economic thoughts, market scans, and time permitting, Q+A. Please feel free to ask them on the zoom registration if any questions.

Q: How do I register?
A: Zoom link is here. I’ll need your city/province or state and country, and if you have any questions in advance just add it to the “Questions and Comments” part of the form. You’ll instantly receive the login to the Zoom channel.

Q: Are you trying to spam me, try to sell me garbage, etc. if I register?
A: If you register for this, I will not harvest your email or send you any solicitations. Also I am not using this to pump and dump any securities to you, although I will certainly offer opinions on what I see.

Q: Why do I have to register? I just want to be anonymous.
A: I’m curious who you are as well.

Q: If I register and don’t show up, will you be mad at me?
A: No.

Q: Will you (Sacha) be on video (i.e. this isn’t just an audio-only stream)?
A: Yes. You’ll get to see me, but the majority will be on “screen share” mode with MS-Word / Browser / PDFs as I explain what’s going on in my mind as I present.

Q: Will I need to be on video?
A: I’d prefer it, and you are more than welcome to be in your pajamas.

Q: Can I be a silent participant?
A: Yes.

Q: Is there an archive of the video I can watch later if I can’t make it?
A: No.

Q: Will there be a summary of the video?
A: A short summary will get added to the comments of this posting after the video.

Q: Will there be some other video presentation in the future?
A: Most likely, yes.

Bank of Canada governor speech

Tiff Macklem gave a speech today in Halifax, trying to rationalize getting blindsided by inflation. Key quote:

At the time, we assessed that the effect of these global forces on inflation was likely to be transitory. Historical experience has taught us that supply disturbances typically have a temporary effect on inflation, so we tend to look through them. A year ago we expected inflation in goods prices to moderate as public health restrictions were eased, production ramped up and investment in global supply chain logistics picked up. In hindsight, that turned out to be overly optimistic.

I’m surprised his speechwriters haven’t sanitized the word “transitory” out of his vocabulary yet.

The forward-looking payload of his speech is on the “Inflation Expectations” sub-heading. Essentially the Bank of Canada is on a mission to target inflation expectations, rather than inflation itself because the key risk is entrenchment of expectations:

That’s why we are so focused on measures of expected inflation. We use a range of surveys and market-based measures to assess expectations of future inflation, and they show us that near-term expectations have risen. Survey results also indicate that consumers and businesses are more uncertain about future inflation and more of them expect inflation to be higher for longer. So far, longer-term inflation expectations remain reasonably well anchored, but we are acutely aware that Canadians will need to see inflation clearly coming down to sustain this confidence.

They will keep raising rates until they’ve triggered this sentiment, which is likely to happen when the labour market has transformed into one where people are grateful for employment (read: no more upward wage pressure) and the economy goes into the tank.

Until things blow up, my nominal trajectory for Canadian short-term interest rates will be:

October 26, 2022 – +0.50% to 3.75% (prime = 5.95%)
December 7, 2022 – +0.25% to 4.00% (prime = 6.2%)
January 25, 2023 – +0.25% to 4.25% (prime = 6.45%)
March 8, 2023 – +0.25% to 4.50% (prime = 6.7% – think about these variable rate mortgage holders!)

Note that the Bankers’ Acceptance futures diverge from this forecast – they expect rate hikes to stop in December.

We might see the Canadian 10-year yield get up to 375bps or so before this all ends, coupled with the Canadian dollar heading to the upper 60’s.

Recall that interest rates only started to rise on March 2, 2022. It typically takes a year for these decisions to permeate into the economy (capital expenditures cannot start and stop on a dime unlike interest rate futures).

By the end of the first quarter of 2023, things will have gone sufficiently south that people will be begging and pleading for a stop to the torture. There will obviously be a decline in discretionary demand by this point. The question is whether this will actually impact inflation expectations. I’m not so sure – expectations is also a function of public confidence and the question is whether we have seen anything to actually restore confidence – I don’t see anything on the horizon in this respect.

The litmus test is the following – say somebody handed you a stack of $10 million dollars and gave it to you a 10-year rate fixed at the current prime rate (5.45%) (which is a luxury only investment grade corporations would get at the moment). What would you do with it?

Probably most of you reading this would say “invest it in XYZ”, but say I put a future condition on the loan, which would be that you actually had to invest it in a physical capital project involving machinery and equipment and the like (and not through the construction of yet another self-storage facility either!). What would you put your money into?

Signs that you should be looking for a different CFO

Does anybody read financial statements anymore, or do they just let the automated financial data scraping services compute all the ratios for you automatically?

You might think the mix-up regarding the date formatting was a one-shot thing, but no, it is also on the income statement, equity statement, cash flow statement, and notes 3, 4, 11 and 14.

If the CFO isn’t even reading these financial statements, what makes an investor think the company is being run in good hands?

This is another example of what happens when people become overly reliant on push-button systems – eventually two things get lost – one is how the push-button machine works, and the other is the reason why we have to push the button in the first place.

I have caught on occasion some pretty bad typos or formatting errors in financial statements but never have I seen such a blatant presentation error on dates as this one.

Xebec Adsorption – Bankruptcy and CCAA

Words you never want to hear if you’re an equity holder:

Xebec Adsorption Inc. (TSX: XBC) (“Xebec” or the “Corporation”), a global provider of sustainable gas solutions, announces that it will file today an application with the Superior Court of Québec (the “Court”) for an initial order (the “Initial Order”) under the Companies’ Creditors Arrangement Act (the “CCAA”) and seek recognition of the Initial Order in the United States under Chapter 15 of the Bankruptcy Code.

Since Xebec isn’t exactly a household name, here is a description of the business:

Xebec Adsorption Inc. (“Xebec” or the “Company”) is a global provider of clean energy solutions and specialized in the design and manufacture of cost-effective and environmentally responsible purification, separation, dehydration and filtration equipment for gases and compressed air. Xebec’s main product lines are biogas upgrading systems for the purification of biogas from agricultural digesters, landfill sites and waste water treatment plants; natural gas dryers for natural gas refuelling stations; associated gas purification systems which enable diesel displacement on drilling sites; hydrogen purification and generation systems for fuel cell and industrial applications; on-site oxygen and nitrogen generators for industrial, energy and healthcare applications; and services for compressed air and gas businesses.

Since the beginning of 2021, the stock chart does not look pretty:

At its final demise, the company had 155 million shares outstanding, which means at 51 cents per share, it still had a market cap of about 79 million.

Financially, the company was bleeding cash this year and they had blew a covenant on their credit facility (their total liabilities to tangible net worth ratio was exceeded) and thus people reading financial statements would have had some sort of hint this would happen. Goodwill and intangibles amounted to $237 million on their balance sheet, while total equity was $260 million and needless to say the $42 million in net losses for the half year tipped the balance.

It is not a complete loss, however – they have $50 million of cash and restricted cash on the balance sheet, offset by $85 million in debt. While their business is awful (gross margins were less than 10% of revenues in the first half, while SG&A was about 40%!), balance sheet-wise it is not a huge train wreck. Perhaps after restructuring they might make a better go of it, but I doubt equity holders will get any recovery from this one.

While the increasing interest rate environment will likely contribute to further CCAA and bankruptcy filings in the future, in the case of XBC, this one looks to be entirely by self-inflicted wounds. The business isn’t profitable.

I did not own any shares at any time.