May 2020 – wild times

Today wraps up another month in the markets.

This quarterly report is going to shape up to be one of the most interesting since the 2008-2009 economic crisis. May was a very active trading month. Indeed, something very rare is that my usually very concentrated portfolio has been flattened like the COVID-19 curve – today I count 18 separate issuers that I own either equity or debt positions in (some more concentrated than others). There is an additional three separate positions in various futures contracts. There are more balls being juggled up in the air than ever in the history of my portfolio.

I was caught very badly with the onset of Covid-19, but just because you lose a bunch of money on the way down doesn’t mean you have to earn it back in the same manner. Things are going to be a bit more tricky in the next month – predicting correctly the nature of the post-Covid normalization is where the bulk of the money will be made.

An investor wins in the Covid-19 era by avoiding where there is less likely to be demand. Although I’m sure a few of my picks are going to be duds, the nature of what happened (culminating March 23, 2020) will result in winners that will, by the virtue of mathematics, become more concentrated, while the laggards will naturally reduce in proportion to the overall portfolio.

But overall, there is still an obvious tailwind for the market. This is taking the market sailboat that we are all on in a forward and upward direction. The wind is going to slow its gusting (i.e. central banks will soon start to normalize monetary policy), but just because the wind slows down doesn’t mean the ship stops sailing forward. There’s momentum and plenty of participants that want to convert their zero-yielding cash into assets at ever increasing prices. The winners and losers of Covid-19 are well known by this point, and institutions have their sales data to place their near-insider bets on various retail agencies. Headlines now are concerned about racism and police brutality, geopolitical and electoral politics, another sign of normalization.

Finally, here is an un-testable prediction – on Saturday at 12:22pm Pacific Time, you can watch Elon Musk’s SpaceX launch a couple astronauts into space. While this might not seem like anything special, if this launch is successful, the S&P will rise faster than the rocket that took them up into space. I’ve always thought that SpaceX and not Tesla, SolarCity, Boring or Paypal is the gem of Elon Musk, which would explain why it’s not publicly traded.

Corvel Corp

Here is another quick post.

I took a substantial position in the past month in Corvel Corp (Nasdaq: CRVL). Now that it’s rocketed up, I can write about it. Corvel’s domain is primarily in the software processing of workers’ compensation, insurance and related claims processing. They are vertically integrated to the extent that they provide the software and management systems.

I have been tracking this company for nearly 20 years, and owned and sold it over a decade ago, but I’ve been keeping an eye on it ever since (which assists the due diligence effort since there is such a long institutional history in my own mind). I finally had my opportunity.

It is a very unusually managed company. The pioneering manager (Gordon Clemons) still owns 9.4% of the company and sells bits and pieces now and then. He came on board 1988. The pioneering shareholder, Jeffrey Michael, owns 37% of the company through a holding company, and this was from 1990. They have since passed the baton to the next round of management, which does provide some succession risk (what happens to those shares?). Both Clemons and Michael have kept very low profile, along with current management. Almost nobody has heard of this company despite them doing over half a billion in revenues a year. They inhabit a niche that has very high barriers to entry. Their capital allocation strategy has also been relatively unusual – the underlying business makes a lot of free cash flow (after R&D) and all of that capital (up to the end of 2019, approximately $514 million) has gone into the repurchase of shares. They do not employ debt – indeed, not only did they not use their credit facility but they got rid of it in September 2019.

Their capital allocation strategy is uncommon. They maintain a cash float, and reinvest the rest of the proceeds in their own stock. As long as you assume the company will continue making money at the rate they are doing, these buybacks are extremely value-added over time. This makes past stock charts less comparable to present day situations. As of December 31, 2019, they have bought back nearly 2/3rds of their shares outstanding, at an average of US$14.25/share.

CRVL’s sensitivity to Covid-19 was primarily related to raw employment figures – their revenues are ultimately derived from employment and insurance factors. Their fiscal year end is in March and they released the annual results, which were in-line. The April to June quarter will show a slowdown, but after that, things should normalize.

While revenues will take a minor hit during COVID-19, as employment normalizes (in whatever form), Corvel will achieve its track record in annuity-like income and will be priced at a higher multiple than it was during COVID-19, which needless to say was lower than its ambient norm.

The company maintains a significant competitive advantage. Their pricing power will not erode too much as a result of the economic turmoil.

Needless to say, this is one trade I wish I made larger. My investment style is far too cautious at times.

Royal Canadian Mint ETR premiums

In Canada you can directly invest in gold by buying (TSX: MNT), which currently represents 0.0105808 Troy ounces per unit (this goes down slowly to reflect the 0.35% MER).

Normally the trading price of this product is close to the net asset value, but presently there is a huge premium involved.

This second as this is being written, the NAV is $24.81 while the market value is $26.99.

This is an 8.8% premium above NAV, which is very expensive and more so than it has typically been, especially during and after the CoronaCrisis.

You can redeem for physical with 10,000 ETRs, which would be good for 105.808 troy ounces, or nearly 3.3 kilograms.

The redemption fee for this (assuming you receive 3 kilobars, and the remainder in gold maple leaf coins) is about US$2,500, plus shipping and insurance. This is roughly 1.3% of the whole purchase price.

One would intuitively think that the NAV premium would be restricted somewhat to the cost of delivery.

Because you can’t just deliver physical gold to MNT, the only method to equalize this arbitrage is for the Royal Mint to sell units of MNT to the public at a premium to NAV (skimming the difference).

Torstar Acquisition

In January, which felt like a very long time ago, I wrote about Torstar. In fact, at one point I owned shares in the company, but during the CoronaCrisis, I dumped my small stake (which to my mystification, was one of the few companies to receive a bid at the time) simply because the rest of the stock market was on sale.

What is ironic, however, is that a couple business days ago, I put in an order to buy in the low 30’s, but never got hit.

A couple trading days ago (Monday, May 25, 2020), the stock rocketed up from about 33 cents up to 48 cents on about 150,000 shares of volume (this is really unusual for Torstar stock, which is very slow moving):

On first glance, this appears like blatant insider trading. How could it not?

Today (May 26, 2020), the stock buying tapered and some people clearly not in the know dumped stock:

And finally, Tuesday evening, the announcement that NordStar will be buying Torstar for 63 cents per share, cash. NordStar is run by a prominent former Fairfax executive (that still sits on the board). Fairfax already owns about 40% of the non-voting Class B shares and got the consent of the Class A owners, who cashed out at a price that is magnitudes different than how things were a decade ago.

I am guessing Fairfax’s involvement will be acquiring some media clout for a relatively inexpensive price. At 63 cents per share, NordStar is paying $51 million (minus FFH’s ownership, $33 million) in exchange for a company with $69 million in unrestricted cash on their balance sheet, with relatively little on the liability side on their balance sheet. The big black eye is the 56% equity investment in VerticalScope, which is barely generating cash but has a $150 million debt on their balance sheet (I suspect when the ownership changes, that NordStar will be jettisoning this anchor in short order). Operationally speaking, however, I suspect advertising revenues are going to continue to crash and it will be interesting to see how NordStar can re-purpose this investment.

Finally, it isn’t quite clear how much influence Fairfax will have in this, but something makes me suspect there is more behind the scenes.

While I am slightly unhappy that I did not get some Torstar shares in the low 30’s (I was rather late to pulling the trigger), the number of shares I was looking to purchase would not have been material even if I had received an execution on my order. Basically I was caught sleeping and this was another instance of a company that had pulled away from my limit orders.

At least I can take this thing off my watchlist now.

Firing on half cylinders

It has been an infinitely frustrating process when you place long orders and have them completely blown away (unfilled) by market action. Like we are not talking about missing by a dime or two, we are talking missing out by 5% gap up trades.

That said, the majority of the portfolio that has been invested in the market has caught a huge tailwind. I expect it to continue.

Remember during the 2008-2009 economic crisis where in retrospect you could just stick your fingers on a multi-year stock chart on those two years and pretty much where things ended in 2007 where were they were trading at 2011? That’s the sort of scenario I envision happening, except about as fast as it did coming down.

I always remember the cliche of that psychologically there is a feeling of regret when there is a winning trade that you always wish that more capital was deployed. Tempering that feeling is knowledge of hindsight bias – one usually never thinks about the scenario where the trade goes south.

I’m going to make an observation which may or may not come to fruition. During the CoronaCrisis, I noticed that Kitco and other physical gold vendors were having significant capacity issues which is a sign of very high retail activity. Most of the inventory was sold out or shipping delayed until well into June. My speculation is as the market and economy makes a recovery that gold will continue to lag again in favour of other commodities despite the extremely loose monetary policy. Once the S&P has peaked, it’ll probably be a better time to get into physical gold – chances are by then the Canadian dollar will also have appreciated.