Equity – Page 40

Atlantic Power – good quarter

Other than Atlantic Power’s (TSX: ATP) Cadillac biomass plant blowing up on September 22, 2019 (see my writeup here), it was a very good quarter for the company.

The quantification of the Cadillac power plant situation is the big news of the quarter. Most notable is that while this incident took the stock price down about 25 cents per share (my worst estimate was 39 cents per share, present value, for a complete write-off of the whole project permanently), the actual impact has been quantified by management as approximately $3 million as insurance will pick up the reconstruction bill in excess of a $1 million deductible and business interruption will cover the cash flow shortfall at an expense of 45 days deductible. Dividing this by 109 million shares outstanding gives an estimate of about 3 cents per share of damage that this accident caused.

It’s pretty obvious since playing defence since 2015 (which consisted of a major de-leveraging and expense reduction campaign by new management), they have been making smaller acquisitions here and there that will likely contribute to 15%+ returns on investment. In Williams Lake, BC, the company struck a 10 year deal with BC Hydro to operate their biomass plant in non-peak snowmelt season. While management has not quantified the exact impact on the financial returns on this (citing procurement of fuel costs and other competitive aspects) reading between the lines it appears this will contribute reasonably well to the bottom line after some initial start-up costs.

As the company has been busy using discretionary capital to fund future 15%+ acquisitions, they have been lighter on share repurchases. There has been a nanoscopic amount of share buyback activity (2,067 shares) at US$2.27/share, while they bought back 12,000 preferred shares (AZP.PR.B) which continues to chip away at the cash burn from those financial instruments. The company still has $24 million in discretionary cash – if they choose to do nothing, this will continue to build while the debt gets paid off.

Eventually the equity market will start to ramp up the share price to reflect this. I don’t know whether it will be tomorrow, next month, or next year, but the 5 year stock chart is very deceptive and not a reflection of where the stock should be (which is higher than the prices in the past 5 years). Yield investors can also do well by buying the preferred shares, but why settle for a volatile 8% yield when you can get a probable 50% in the next couple years on the equity?

Another mid-stream Canadian oil and gas producer bites the dust – Pengrowth Energy

… I’m not talking about Ovintiv either (TSX: ECA), which is pretty much an admission that any dot-com name for a company has already been taken up, so companies now have to resort to pharmaceutical-style naming conventions for their firms.

Pengrowth (TSX: PGF), which I have written about extensively in the past on this site, announced on Friday they were going to accept a takeover bid of CAD$0.05/share plus the payout of debt. The amount of debt outstanding was approximately $700 million and the total purchase price is $740 million.

The effect on their stock price was fairly dramatic:

It reminds me of the expression I tell people around me when they mention that something is cheap at 20 cents per share – “When it goes to zero, your loss is always the same – 100 percent”. In this case, investors took a 75% haircut on the last Friday of trading after the announcement.

This is the next (former) mid-tier oil and gas player to effectively go belly-up, the previous one being Bellatrix Exploration. At the rate things are going, only Suncor will be the last one standing in Canada.

The buyout of Pengrowth is going to be interesting for a couple reasons.

One is that the press release does not make mention in any way of any shareholder consent agreement from Seymour Schulich, who owns 28% of the company. Perhaps he is planning on taking a huge capital loss. One does not do big merger deals without getting consents from major shareholders with deep pockets, so the absence of this is very mysterious. To reverse the merger will cost some other suitor $45 million dollars – in light of the existing deal, this is a huge windfall that would be paid out if somebody were interested in the assets.

However, I deeply suspect in the shopping around process they couldn’t find anybody that was willing to finance the company at an acceptable price. The management information circular that will come out should yield some further clues on the process they undertook.

The other is how the deal is structured – Cona Resources used to be public, but it was majority owned by the Waterous Energy Fund, which is relatively secretive in its dealings (it is private). Waterous took its minority share of Cona private in May 2018 and we can infer from its SEDAR filings that were available that this entity is still not making money. Cona was bought out at about 45% of book value ($2.55/share on 101 million shares) coupled with $332 million in debt.

That said, Pengrowth, stripped of its leverage situation, actually makes money. Not a lot (especially in the current Canadian context), but while I am not surprised that shareholders are taking a massive bath on the company, I am surprised that this is the best agreement they could find. I am guessing the existing debt holders were completely unwilling to consider a debt-for-equity swap.

If Canadian oil and gas does come back from the dead, however, Pengrowth’s thermal oil assets are top notch and Waterous will be making a mint on this one. They effectively are going to wait this one out until the climate gets better. Parking $740 million of capital to do this seems like a reasonable gamble. I can see why they made it.

My last position in Pengrowth was in their unsecured convertible debentures, which matured at par in early 2017. I’ve been tracking it ever since and have taken no positions in their stock.

Genworth MI Q3-2019: Steady as she goes

I’m catching up on quarterly reports, so these posts are coming in a little late. This will be a short one.

Genworth MI (TSX: MIC) reported their third quarter results. They are largely unsurprising and they continue to be a cash machine as there have been no material issues concerning the Canadian housing market (as it relates to the mortgage-insurable side of the business – the high end market in Vancouver, BC is getting slammed because the provincial government is massively increasing the cost of carry for $3 million+ assessed value properties). Loss ratio is 18%, expense ratio is 20%, and they continue to take in a ton of cash simply because mortgage delinquencies and defaults are incredibly low.

As a result in this year, they’ve declared special dividends of $1.85/share so far and also have spent some capital on share buybacks – although since their currently share price is above book, management opts for the special dividend route.

There are only two issues that I will note.

One is that there is a brief mention of the impact of transition away from Genworth Financial’s shared services – since MIC’s majority stake (56.9%) is being bought out by Brookfield Business Partners, MIC will have to build its own services currently being purchased from Genworth, and this will cost money. It is also not entirely known about the exact impact of this, whether Brookfield intends on using Genworth MI as a currently existing cash machine, or whether they have strategic plans for the entity. The common shares are also at $53, which is significantly above the book value of $46 (which historically has been a rare situation) and it is almost as if the market will expect a follow-on bid to take the rest of the 43% out of the market. We will see.

The other note is that the company’s portfolio of preferred shares has also been a victim of the 5-year rate reset plague which has depressed prices of such preferred shares – they are now sitting on a $107 million unrealized loss on their current fair value of $494 million – or 18%.

Otherwise, the company seems to be doing very well. There does not appear to be any hints that CMHC wishes to apply any semblance of pricing pressure in the marketplace, which would be the biggest risk to MIC’s share price. One would have presumed that the Government of Canada would want to make life more affordable for the middle class homebuyer, but I am the first one to know that the words coming out of politicians’ mouths should always be verified by the actions of the bureaucracy underneath them!

Aphira is still deeply cash flow negative

I couldn’t resist looking at the financial statements of Aphria (TSX: APHA) since I observed the marijuana sector today has received quite the bid. Today Aphria released their quarterly results and with the following by-line:

Aphria Inc. Announces Second Consecutive Quarter of Profitability and Positive Adjusted EBITDA

Looks good, right? There’s a lot of retail investors in these marijuana stocks, and most of them don’t read the detailed financial statements.

So when glossing over them, I notice this is a textbook case of “announced profits and positive adjusted EBITDA does not mean the company is making money”. Let’s dive further – this is a pretty good case study for beginning investors to learn how companies manage to put the most positive spin on their financial statements.

Look at the cash.

We look at the balance sheet to start with. The first red flag comes in the form of the very decreased cash+marketable securities balance. Sometimes in companies they have to invest initially (e.g. property, plant, equipment) in order to make money. Sometimes companies have large debt payments.

In this case, roughly $22 million went to accounts receivables. Normally receivables should correlate with revenues, but in this case, APHA’s Q1-2020 net revenues ($126 million) were actually LOWER than Q4-2019 ($129 million). Uh-oh…

Inventories and biological assets went up $21 million and $11 million, respectively. (Notes 6 and 7, which we will dive into below).

Capital assets went up $39 million.

All of this accounts for about $93 million of the $105 million cash burn. The rest of it, while interesting, I will disregard for the rest of this analysis – it isn’t the bulk of what’s happening. We’re trying to figure out where the cash is going.

Note 6, inventory:

I will give an example of what is going on here. Just looking at “Harvested cannabis”, the company spent $15.5 million to harvest this. “Capitalized cost” means they converted it into inventory using cash, without it being considered an expense. The “Fair value adjustment” of $20.3 million is management deciding that the value of the harvested cannabis is that much higher, and it can be reflected as such on the balance sheet. The process of doing this is a gain on the income statement, which I will show later.

The questions at this point is whether:
a) Is this estimate accurate? I have no idea.
b) Can the company actually sell this harvested cannabis at or greater than the adjusted value of $35.8 million?

Accounting-wise, inventories are governed by the rules of IAS2, which roughly states that inventories are kept at the lower of cost or net realizable value. These products are distinct from the biological assets, which are governed by IAS41.

Note 7, biological assets:

The key lines here are “Changes in fair value less costs to sell due to biological transformation” and “Production costs capitalized” for $25.2 and $29.8 million, respectively. This is effectively the company deeming that their growing process is facilitating an increase in value of their inventory when it is eventually transferred to that column, but in order to realize this, they need to sell the product!

Note 9, capital assets:

This actually looks reasonable. The company spent $37.9 million on production facilities, equipment, and construction-in-progress, which makes sense if you are a marijuana producer. The quantum of expense can be debated, but the nature of these types of expenses appear in-line with the type of business they are engaged in.

So how does APHA claim profitability?

This dog’s breakfast of an analysis of the income statement drives a couple points:

1) The claimed profits are primarily on the basis of the fair value adjustments through Notes 6 and 7 in the financial statements (to the tune of $17.9 million)
2) And some finance gains on Note 27 (I will not bother getting into this).

In reality, the company is blowing a lot of money on inventory. It is very difficult to take the assertions of profitability seriously unless if you believe that the stated fair value gains on the inventory and biological assets are real and can actually be realized with real sales at the stated values.

I give no valuation opinion at this time other than to state that at $7.10/share (or $1.8 billion market capitalization at 252.7 million diluted shares outstanding) I am not interested in buying.

It took me about 5 minutes to gloss through these financial statements, but about an hour to present it in the very hurried form above. If I spent a couple extra hours, I could have really polished up the presentation, but this was enough for me. If you found this at all useful, please let me know.

Gran Colombia Gold spinning off Marmato

Ladies and Gentlemen, hold onto your wallets!

TORONTO, Oct. 07, 2019 (GLOBE NEWSWIRE) — Gran Colombia Gold Corp. (TSX: GCM, OTCQX: TPRFF) (the “Company” or “Gran Colombia”) announced today, further to the press release of the Company dated September 16, 2019, that it has entered into a letter of intent (the “LOI”) on October 4, 2019 with Bluenose Gold Corp. (TSX-V: BN.H) (“Bluenose”) in respect of the proposed acquisition by Bluenose of certain mining assets (the “Mining Assets”) at the Company’s Marmato Project located in the Department of Caldas, Colombia (the “Transaction”).

Gran Colombia has two operating mines. One is Segovia, which produces the substantial majority (89%) of its gold. The other is Marmato. They have three other potential avenues, all of which are not operating. There is Zancudo, which they optioned off to IAMGOLD for exploration and potential development. There is their Venezuelan properties, which is a “good luck if they democratically elect a new government before the country is completely destroyed” situation, and finally the Chicharron project which is being reflected in GCM’s equity investments in Sandspring (TSX: SSP).

The press release above is an attempt to spin off their Marmato operation in another publicly listed entity.

Marmato is currently undergoing exploration and finalization of another development project that will expand the mining capacity well beyond the 25,000 ounces/year it currently is producing. The initial plan was an open pit mine, but now that is revised in a tunneled project. Needless to say, this will consume gigantic amounts of capital.

The finance deal is very questionable for GCM shareholders.

Bluenose will be the recipient of a reverse takeover. After accounting for a 1:10 reverse split, Bluenose has 10.6 million shares outstanding. The current corporation is a shell (a few bucks on the balance sheet, no debt). GCM will be throwing in its Marmato asset for 28.75 million shares, notionally valued at $2/share.

Is an existing mining operation producing 25,000 ounces of gold a year (US$37.5 million top-line) worth a capitalization of US$43.1 million?

GCM will also be throwing in another $5 million for 2.5 million shares and warrants to purchase at $3. Bluenose will also sell to the public 5-7.5 million shares at the same terms.

It’s going to take a lot more money than this to get the mine up and operating.

There is also an insider relationship involved. On November 2, 2018, the following was announced by Bluenose:

The Company has been advised that Frank Giustra and his related entities will acquire an aggregate of 11,700,000 post-consolidated common shares of the Company representing 11.14% of the issued and outstanding post-consolidated common shares of the Company pursuant to a private transaction. Radcliffe Corporation, Fiore Financial Corp. and Fiore Farms Inc. (companies indirectly owned by Mr. Giustra) will acquire an aggregate of 4,000,000 post-consolidated common shares, representing 3.81% of the issued and outstanding common shares of the Company. Canada Life Ltd. through an investment account controlled and directed by Mr. Giustra) and The Giustra Foundation (a charitable organization controlled by Mr. Giustra) will acquire 7,700,000 post-consolidated common shares of the Company representing in aggregate 7.64% of the issued and outstanding shares of the Company. Following these transactions, Mr. Giustra will have indirect ownership and/or control, over an aggregate of 11,700,000 post-consolidated common shares of the Company representing 11.14% and would have indirect ownership and/or control over an aggregate of 12,050,000 post-consolidated common shares representing 11.43% on a partially diluted basis, assuming the exercise of 350,000 incentive stock options granted to the Giustra Foundation.

This was probably the connection that lead GCM to choose Bluenose as the reverse merger candidate.

Finally, what is most interesting is the following:

The closing of the Transaction will also be subject to the following conditions, amongst others:

…

all liens and encumbrances in respect of Marmato Panama, Marmato Colombia and the Mining Assets granted in favour of the holders of the 8.25% senior secured notes due in 2024 shall have been released and discharged, on terms and conditions satisfactory to Bluenose, acting reasonably;

This remains to be seen how this will be resolved. Noteholders are not simply going to give up security to the Maramato asset. It will cost GCM something to get the noteholders to agree to it. Will noteholders receive shares/warrants in Bluenose, will they receive cash, or will they receive a boost in their coupon to compensate for the loss in collateral? (Disclosure: I own a not insubstantial amount of GCM notes.)

Either way, I view this as a negative for GCM shareholders.