Category: Equity

Corvel Corp – Annual Report

Corvel (Nasdaq: CRVL) announced their year-end results (10-K). The company has such fanfare that it has precisely zero analysts following it, so the automated news generators couldn’t even tell you whether they ‘beat’ or ‘missed’ expectations. There are few (USA) domestic companies that have billion dollar market capitalizations that have zero analyst coverage.

Their fiscal year ends on March 31st, so this was their Covid year. Revenues dropped about 7%. Margins, however, remained consistent. They made reference in their last quarterly conference call to streamlining real estate leasing costs as they were able to seamlessly ‘go online’. This can also be seen in the recent dramatic drop in IFRS 16 asset/liability for leases vs. the previous quarter. Year-to-year, lease obligations are down by half, and this is explained by the company projecting that renewals will not be exercised.

The company has nearly doubled in share price since last year. Valuation-wise, they are at about 50 times the previous twelve months of earnings. Needless to say, this appears to be rather rich, but the earnings should accelerate in the upcoming fiscal year as employment in the USA continues to expand, especially as Covid supports terminate.

Although it looks like that revenues and net income has flat-lined over the past three years, there will likely be an upward trajectory going forward. In addition, note the historical ROE numbers of 20%+. The ROE number next year will be down as the amount of cash on the balance sheet will serve to be a drag on the denominator, but this will likely be transitory.

I also believe the stock has been a positive recipient of automatic index buying. Trading of the stock is thin, with spreads typically a dollar or so. The company is currently on the S&P Smallcap 600 index, although it is well below the liquidity threshold for the index. Their market cap, over $2 billion, is creeping up to the point where they are getting into mid-cap territory.

Historically, the company has engaged in a capital allocation policy of repurchasing shares (they repurchased approximately 100,000 shares, or about half a percent of their shares outstanding in the past quarter at an average of US$104). Despite this, the company has been building up cash on the balance sheet, and the US$140 million they have at fiscal year end is an all-time high. I do not think management is of the type to suddenly declare a treasury policy of purchasing Bitcoins with spare US dollars. They also have little use for excess capital – they continue to engage in the usual R&D that software companies should be doing. In a paradoxical sense, this lack of capital reallocation is a negative in that the corporation cannot “snowball” retained earnings into more fruitful endeavours (unlike an acquisition machine like Constellation Software (TSX: CSU)). CRVL management is very happy to stay in their niche and only make the tiniest steps outwards from their strategic niche.

Operationally, they are in a dominant position, which explains the valuation. Indeed, when compared to companies like Constellation, they are trading at 85 times past earnings. On an absolute level they are expensive, but relatively speaking, it is in the ballpark. Another metric is price-to-sales, and also this makes Corvel cheaper than CSU. I would make the claim that CRVL’s niche has a much stronger competitive moat and justifies a premium valuation as a result. Their management is even more reclusive than CSU’s Mark Leonard. This is a trivial analysis, but a few of the factors swimming in my head when I look at this company in my portfolio and wonder if I should reallocate.

For many reasons, I will not be. I do not know what price the shares will rise to before I say enough is enough and seriously think about the sell button. I can easily see them staying where they are currently for a lengthy period of time, but I can also see reasons for them to head up to $200 and higher.

My only regret was not picking up a little bit more when I did, but at that time in the Covid crisis, there were many other things floating on my radar at the time. This is probably the least dramatic investment in my portfolio at present. They consume a disproportionately lower amount of attention in relation to their size in my portfolio, which is in the top 5.

When will Cenovus or CNQ buy out MEG Energy?

MEG Energy (TSX: MEG) is an oil sands producing company with a very good asset – it occupies a prime bitumen producing location at Christina Lake, Alberta. The type of mining is the typical steam-assisted gravity drainage project that, one you put in the required capital expenditures and intellectual prowess, has a relatively low rate of decay. It will produce for decades.

Geographically speaking, the company is out of options. There’s little in the way of synergies as they are surrounded by Cenovus and CNQ’s properties. There isn’t much of a choice beyond optimizing the primary asset they own (which is very valuable) and generate cash. The asset will be producing for decades.

They are properly capitalized – approximately US$2.3 billion in debt securities, with maturities on 2025, 2027 and 2029, in addition to an undrawn credit facility. They made some (retrospectively) stupid hedges on WTI which will cost them a few hundred million in lost opportunity costs in 2021 (approximately a third of their production is hedged at US$46 WTI), but they claim this was to fund the existing year’s capital budget in the event that crude crashed. CEO Derek Evans was formerly the CEO of Pengrowth Energy, and the only reason why Pengrowth lasted as long as it did before it was unceremoniously bought out for 5 cents a share was because they hedged a ton of production before oil prices tanked.

After Line 3 and TMX become operational, egress issues will likely subside and at current prices, they will be generating a significant amount of cash. While they do not give out dividends at present, it probably won’t make much difference in the end equation – they are likely to get consolidated by one of the two in the title of this post.

Notably, MEG rejected a hostile takeover from Husky in 2018 (which was offered at a higher price). From a strategic perspective, Cenovus (which took over Husky at the beginning of this year) would make the most amount of sense – they would own the majority of the bitmuen complex around Christina Lake. They have been busy digesting the Husky merger, but there’s probably ample room for a stock swap. MEG at the end of December 31, 2020 also had a $5.1 billion non-capital loss carryforward, so this would survive a merger and constitute a non-trivial tax asset for an acquirer.

This analysis is by no way a secret – they have been a logical target for ages. We will see.

Rocket Lab SPAC

Vector Acquisition Corporation (VACQ) is a SPAC that has an agreement to merge with Rocket Lab.

Rocket Lab is SpaceX’s number one private competitor, but it has several competitive disadvantages. One is that Rocket Lab’s product offerings do not include heavy launches. The other is that their rockets do not land by themselves (although they are reusable to a certain extent).

As such they are receiving a valuation of much less than SpaceX’s private placement valuation (SpaceX was estimated to be around $70 billion). Rocket Lab’s enterprise value was estimated to be around $4 billion.

The revenues scale accordingly – Rocket Lab estimates around $70 million in 2021, while SpaceX is reported to be around $2 billion in 2019.

Just like most SPACs, they promise a quadratic increase in revenues:

If I had a nickel for every SPAC that promised such a revenue trajectory… I’d be richer than had I invested in these SPACs!

Space launch systems are very capital intensive and there is a certain economy of scale that is required to do this successfully. Blue Origin (Jeff Bezos’ firm) is another competitive in this domain (and of note, they have seemingly failed to get that point of scale). It could entirely be the case that the launch for small satellites (especially constellations of micro-satellites) is a competitive space where no firm will receive outsized profits – instead, the profitability will be through differentiation and also cost controls (SpaceX’s landable rockets would likely give them a cost edge over competitors at present). The differentiation will most certainly be with maximum launch capacity – there is only so much you can do with weight limitations on satellites.

The other component of competitive advantage in space is government relations. They are a significant source of revenue, especially in the military domain. Nobody is better in GR than Elon Musk.

I’ll be watching this one, but at the offering price I’m not interested. SpaceX receives a premium valuation for very good reasons.

Bye-bye FLIR

I unloaded my FLIR (Nasdaq: FLIR) today at US$58.25/share. Past 10 year chart for reference before the company disappears this quarter:

I’ve been stalking this company for ages. I originally did a very short post on it from July 2011, but never got around to purchasing the stock until the Covid crisis in April 2020.

I wrote about the Teledyne acquisition here which occurred at the beginning of the new year.

I am not typically a large-cap S&P 500 company investor. I make rare exceptions now and then, but for the most part I prefer the smallcap space. FLIR investors will receive 0.0718 shares of Teledyne per FLIR share and US$28 in cash. Teledyne has had an excellent track history of integration acquisitions, although their style of acquisitions have been bolt-on and tuck-ins, and FLIR is a mammoth acquisition for them, the largest in their history. I don’t know if they can execute, although strategically given their product portfolio, it makes sense. Financially, TDY is expensive, but they are also in a business domain that is relatively stable and should continue producing stable cash flows going forward. They will also be a positive recipient of passive index money from the S&P 500 (a larger fraction given how their market capitalization will increase post-merger). But that said, they are too large for me, and hence my decision to eliminate them from my portfolio. I paid about a 30 cent merger arbitrage spread (or about 0.5%) which worked out much better than Atlantic Power!

There few decent alternatives for re-investing at the moment. I am feeling quite conflicted about things in the market, so I continue to reduce exposure.

1 Year Losers

About a year ago was the bottom of the COVID-19 market crash (March 23, 2020). It was a very fateful day where the maximum amount of margin selling hit the street and prices were at their lowest.

So it is instructive to run a stock screen and find out which stocks have NOT risen over the past year. We get the following (I’ve limited it to those with a market cap of above $50 million):

Over 50% loss:
Just Energy – JE (they’re still trading in the USA for US$1.78 a share, but in today’s topsy-turvy world where Hertz is still over a dollar, maybe bankruptcy will be good for their common stock!)
Medipharm – LABS
Calfrac Well – CFW
BELLUS Health – BLU

30-50% loss:
Helix BioPharma – HBP
AKITA Drilling – AKT.b
Aptose Biosciences – APS
Oryx Petroleum – FORZ
Wall Financial – WFC

20-30% loss:
None

10-20% loss:
Nighthawk Gold – NHK
Patriot One – PAT
Morguard – MRC
Transat – TRZ
Postmedia – PNC.b
Shore Gold – DIAM
Noranda Income Fund – NIF.UN
Resverlogix – RVX
Tetra Bio Pharma – TBP

0-10% loss:
Trilogy International – TRL
Currency Exchange – CXI
VIVO Cannabis – VIVO
Knight Therapeutics – GUD
Metro – MRU
Aurinia Pharma – AUP
Invesque – IVQ.u
Loblaw – L

Casual observations

A lot of biotechs in the list, and then seconded by some oil drillers.

The names that stick out at me are Morguard (perennially trading well under book), but this is not my typical type of investment. There might be a time for them to shine once again – when you mention “perpetually trading under book value”, E-L Financial comes to mind (TSX: ELF) and even they have received a tailwind recently. I also note two of the major grocery chains are on this list (albeit with minor amounts of changes for the year), but these companies are well known, well valued and quite frankly not interesting. In the smallcap realm, Currency Exchange is a very odd business which got my attention during COVID as a travel recovery stock, but for various reasons I declined to pursue it.