Verdmont Capital

Thursday, December 18, 2014

Copa Holdings (CPA:$98.90) - All I Want for Christmas is some Copa Stock

We have been chipping away at Copa Holdings (CPA:$97.90) over the past few days. Our bullish view is predicated on the belief that the stock oversold, it is a very well-run airline and it offers a very attractive dividend yield of roughly 4%.

Copa Holdings provides international airline passenger and cargo services – most people would refer to the company as “Copa Airlines.” The company is based in Panama and has been growing at a very healthy clip. They now service many routes throughout Latin America, the Caribbean and North America. The company is a true Panamanian success story, growing exponentially since its humble beginnings roughly 50 years ago.

Living in Panama, and flying frequently to Copa’s growing list of destination cities, we have come to know the airline quite well. It is a very well-run company and the carrier of choice for many of us when we embark on personal or business related trips.

The stock came on our radar screen because noticed that airline stocks in general were rocking alongside the recent selloff in oil. It is well-known that the airlines are huge benefactors when the oil price corrects, given that oil/fuel is a main cost component for these companies. In addition to boosting profits at the company level, falling oil is also a boon for the consumer in general, as they have more disposable income at hand. This disposable income often ends up in the hands of the airlines, as people choose to travel more when they find some free cash.

CPA has underperformed significantly as of late. Other airlines companies have been enjoying a sizeable rally in concert with the steep correction in oil prices.

Copa Holdings vs. Global Airline Stocks – 6 Months

Global Airline Stocks vs. WTI Oil (inverted) – 6 Months

Looking at the above charts, the stock immediately jumped out at us as a buy. The next question of course is – what are we missing?

Much of the underperformance can be attributable to Copa selling off in sympathy with other Latin American equities. You can see that Copa has been trading with a high correlation to other regional equities, whereas airlines in general have been trading in line with global stock market indices.

Copa vs. MSCI Latin America – 6 Months

US Airlines vs. S&P 500 – 6 Months

Copa’s correlation to Latin American equities cannot completely be dismissed. The severe correction in oil does present a challenge for the region and emerging market economies in general have been under pressure as of late. Copa does not operate in a vacuum, as a result, were Latin America to see further destabilization due to a slowing economy, volatile local currencies, or rising US interest rates, the stock would in all-likelihood get pinched. These potential developments represent the key risks associated with buying Copa here, and any potential investors need to be mindful of these pressures.

As a group, we are comfortable with these risks, as they represent long term factors that always need to be considered when investing in emerging market economies. In other words, they are nothing new, just capturing the headlines at the present time. Were Copa  trading at highs, these risks would mean more to us. However, the stock is currently bouncing off of 52 week lows, which we believe indicates that the market has more than discounted these concerns.

Copa’s current trading multiples underscore this point. Copa presently has a P/E ratio of 9X and a forward P/E multiple of 9.8X based on one year forward earnings estimates. This compares favorably to the global airlines benchmark, where airline stocks in general are trading at a trailing P/E of 21.5X and a forward estimated P/E of 15.2X. This is a very hefty discount.

Copa Holdings – Trailing P/E and 1Yr Forward Estimated P/E Ratio – 5 Years

Bloomberg Global Airlines Index – Trailing P/E and 1Yr Forward Estimated P/E Ratio – 5 Years

Copa’s discounted multiple relative to its global peers is that much more severe when one takes a closer look at the numbers. We mentioned at the start of this piece that Copa was a well-run airline. That claim was not purely from a passenger/service standpoint. When you peel back the financial curtain, Copa holds up extremely well relative to its peers - the little airline that could.

In terms of growth and profitability, Copa’s numbers are best in class across the board. Some standout numbers to us are the growth in sales, operating margin and return on equity. The company has been very profitable.


When we asked ourselves if we were missing something on the company, we immediately had a look at its balance sheet, as this is typically where the bodies are buried. No problem there, and in fact, Copa has one of the strongest balance sheets in the sector from what we can see. The company’s debt situation is in good standing and its dividend payout ratio is only 15%. This suggests to us that the company’s dividend is not under any jeopardy at the present time.


The stock appears cheap across the board when looking at various valuation metrics. Of special interest to us are the aggregate analyst earnings estimates and target price.

Firstly, you can see the below spreadsheet that analysts have depressed estimates over the short term, reflecting some of the recent issues impacting the company. Copa should return to its normal growth trajectory, as reflected in long term estimates of 5.6% (which look out 5 years).

Secondly, it is worth noting that the stock is currently trading at a large discount to aggregate analyst share price estimates. Analysts are forecasting a share price of $130/sh over the next 12 months, whereas the stock is currently trading at $98.90/sh. Certainly, analyst price targets should be taken with a grain of salt. That said, the aggregate price target is based on 17 independent analysts. If we were missing something significant on the company, it would in all likelihood be picked up by this group, who slice and dice the numbers ad nauseam.


You can also see in the below chart, that only 40% of analysts have a buy rating on the stock at the present time. This is the lowest it has been in 5 years. We have found in the past that this is a good contrarian indicator when following well covered stocks. It is a good indication that sentiment has soured, and correspondingly, it suggests that there is ammo on the sidelines to push the stock higher when analysts begin to rerate the stock a “buy.”

Copa - Aggregate Analyst Price Target and Ratings – 5 Years

CPA has had a sizeable bounce since we started buying it on behalf of our clients last week. The stock has bounced from its 52wk low of $88.12/sh to its current price of $97.90/sh.

Copa Holdings – 1 Year

Even with the recent pop, we believe clients can feel comfortable about buying Copa at current levels. The stock should continue to move higher as it plays catch-up with other airlines companies. Copa is extremely well run, remains cheap relative to its peer group and offers a dividend yield of close to 4%. The company also enjoys a very strong balance sheet, which supports the current dividend and affords management the flexibility to ride out any potential short term weakness in the regions it services.

Please call your Verdmont representative for additional information on Copa Holdings.

Tuesday, December 16, 2014

Canadian Junior Stocks - Rough End to 2014

There has been a wholesale liquidation of Canadian micro cap stocks. It truly has been a lost decade, despite starting with such promise in the early 2000’s and having pockets of very strong metal and energy prices.

The performance is even that much more abysmal when you consider that the broad equity market has been on a tear. When you pull up global equities relative to the TSX Venture Composite, you get what we refer to as a “hungry alligator” formation.

TSX Venture Composite (white) vs. the MSCI World Index (Green)  – 10 Years

Clearly, the Canadian spec market never recovered after the 2008 financial crisis. Central bank policy pushed people into large cap equities, which offered more stability given their diverse business models and attractive dividend yields. The junior market was also a victim of its early successes, suffering from a massive hangover in the form of way too much paper out there.

The onslaught in gold and silver stocks is well-known and has been a relatively slow bleed, beginning at the end of 2010. Since that time, junior gold and silver stocks have fallen close to 87%. Arguably, there has not been a worse sector of the market to have invested in over the past 4 or 5 years.

GDXJ – 5 Years

The one bright spot for Canadian micro cap investors had been the oil and gas sector. The recent sell off caught everyone by surprise, including ourselves. Out of all the commodity segments, the oil and gas space seemed to be underpinned by the strongest fundamentals. We thought oil was overvalued north of $100/bbl, so welcomed the recent correction. That said, we thought prices would stabilize in the $75/bbl range as the selloff played out. We were proven wrong in short order. Oil quickly blew through previous OPEC targets and the marginal cost curve for shale in the US did not offer the support we were hoping for.

Junior oil stocks have subsequently taken it on the chin. This is a big deal, because many speculators in Canada had stale longs in junior oil and gas stocks given their perceived safety. The thought process was that oil was relatively scarce and expensive to recover, which should keep energy prices elevated due to cost push pressures. Fast forward to today, and WTI oil is down from recent highs of $110/bbl, to todays price of $55/bbl. Junior oil stocks have fallen in concert, dropping  close to -50% in just under 6 months.

BMO Junior Oil Index – 1 Year

The correction in the oil sector has far reaching implications for the Canadian economy and the market in general. Below is a breakdown of the TSX Capped Index, or an index of the broad Canadian stock market. You can see that energy and materials represent 40% of the investible market in the great white north. That is a significant number. It is even greater when you factor in the spill over business that natural resources related activity has in other segments of the Canadian economy.

S&P TSX Capped Index – Sector Weights %
We are pointing out the importance of natural resources for the overall Canadian market because we have been seeing weakness in ALL Canadian junior stocks as we close out the year. It is quite frustrating to get pinched in non-resource small cap names when you made the correct decision to stay out of commodity plays. The correction in micro and small cap names has been severe over the past couple of months.

TSX Venture Composite – 1 Year

MSCI Canadian Small Cap Index – 1 Year

The oil correction has far reaching ramifications for the Canadian economy. For those investing in Canadian junior stocks, even non-resource related names, uncertainty about oil prices will continue to weigh on your positions until oil finds a floor. This will happen over the next few months, and we would argue, that oil price stabilization will result in a widespread rally in the stock market. We don’t think it is unreasonable for this to play out in the first quarter of 2015. The main risk to our call is a systematic event driven by the collapse in oil prices i.e. an implosion of the Russian economy or similar widespread credit event. We are watching these developments closely.

Please call your Verdmont representative to discuss our in-house view on the market and our current investment picks.

Friday, December 12, 2014

Verdmont Capital : Weekly Stories of Interest - December 12, 2014

EQUITIES



Notable Stories for the Week:

-Stock futures lower after biggest drop since October.

-Pressure on Chinese equities this week as Chinese leaders seek to reduce leverage and develop a transparent municipal bond market.

-Petrobras is tanking, and it’s dragging Brazil down with it.

-Japan’s central bank is in hurry to buy ETF’s breaking a four-year habit.

-A good overview on global investment markets for December.

-The major markets continue to move higher, but this equity rally has been unique in that you haven't seen the typical follow through in trading profitability.

-Any breakdown in OPEC solidarity could drive oil prices considerably lower.

FIXED INCOME

Notable Stories for the Week:

-The bond market doesn't look ready for what'll likely happen on December 17.

-When someone owes you money, and the return of payment comes in doubt, it always ends up with a knock on a door. No matter what level you are operating at.

-ECB issued a second round of long-term loans to banks as part of the plan to spur credit and boost inflation. Long dollar, short the Euro.

-Jeffrey Gundlach, co-founder of $60 billion investment firm, sees deflationary forces and muted wage growth making 2015 potentially a good year for bonds.

-A strengthening dollar is proving a costly headache to companies across the US and Europe.

ENERGY

Notable Stories for the Week:

-Here are the reasons oil just plunged to $59.

-Brent crude oil rebounds on Tuesday after hitting five-year low below $66 on Monday.

-How 6 commodities moved against 9 major currencies.

-The breakdown in oil could be a bad development for all commodities. Energy prices had been a floor under various commodities, given the cost push dynamics at work.              http://www.bloomberg.com/news/2014-12-09/cheap-oil-also-means-cheaper-commodities-amid-surpluses.html

-Drillers will have to drop prices by upwards of 20% to remain competitive in light of the fall in oil prices. This benefits the big boys, to the expense of the smaller players, who will bleed out far quicker trying to compete on price. The larger outfits will absorb the discounts because they will not want to lose market share in the downturn.                             

-OPEC report this week supercharged the oil selloff. The report highlighted how non-OPEC supply is on the rise and global demand has moderated. This could be referred to as a "double whammy".  

-There is a common view that falling oil prices are good for the global economy. This is certainly true. There are negatives to consider as well however. The fall in oil may be a bad omen for global economic growth and the potential for deflation. Oil prices are historically tightly correlated with global equity market and this relationship has broken down. Which begs the question, is oil oversold or the equity market overbought?

PRECIOUS METALS

Notable Stories for the Week:

-Gold miners find little solace in cheaper oil pressed by falling gold prices to cut costs, some are getting creative.

-Gold drops after upbeat retail-sales report, analyst sees gold heading back to record highs.

-Despite low prices, silver demand off the charts.

-Citigroup report sees palladium demand growing.

BASE METALS

Notable Stories for the Week:

-Mitsui & Co, a Japanese company, has acquired one of the largest coal mines in Mozambique to Vale signaling confidence in coal demand.
-Africa’s largest iron mining project in Guinea has been distressed by dust-ups and delays.

-Copper’s resilience won’t last.

-Nickel seen extending rally into 12015 by CLSA on ore stocks fall.

AGRICULTURE

Notable Stories for the Week:

-Lower demand in China caused Australian wheat exports at a 5-year low.

-El Nino conditions appear to have formed in Japan; the weather event can affect global agricultural markets as farmers contend with drought or too much rain, while also curbing the incidence of Atlantic hurricanes.

-Canola crusher joins stockfeed market.

-Africa “must rethink approach to agriculture investment”.

-Grain prices dip despite tighter corn, soybean stocks data.

OTHER TOPICS OF INTEREST

-Here are some investment ideas as we enter an era of divergence from Blackrock.

-Mercedes Is Getting Crushed In China by BMW and Audi.

-HSBC Warns Customers in Christmas Message: Your Homes Could Be Repossessed.

-Good analysis of the current state of the oil market.

-There is a "tender system" in place on Russian contracts. Ah, yeah, right.

-Say what you want about Bush and Cheney, but they don’t throw people under the bus.

Friday, December 5, 2014

Verdmont Capital : Weekly Stories of Interest - December 5, 2014

EQUITIES

Notable Stories for the Week:

-What stock traders are shorting like crazy.

-There are various stock market valuation models and most of them stink.

-Here’s what 2015 looks like for the 3 big emerging market regions.

-China looks bad, Europe looks worse.

-Bull market will continue to rally until the end of the year.

-Chinese stock market is in bull mode.

-Morgan Stanley stock valuation looks different from Goldman Sachs

FIXED INCOME

Notable Stories for the Week:

- Trouble with US energy sector junk bonds.

- Distressed debt has lost the most since 2008.

- Fixed income 2015 outlook from a European perspective.

- How long will low rates last?

- Interesting comments from Bill Gross on the global markets.

ENERGY

Notable Stories for the Week:

- Market reaction after OPEC decided not to cut production.

- Interesting article commenting the US as a competitor in the oil market and how Americans intend to play the Saudi’s game of chicken.

- Article offering safe drilling names for investment.

- Blackrock providing investment Ideas as oil prices and bond yields plunge.

- Some color on natural gas.

- Oil price is affecting Latin American economies

- Distressed situation for oil related junk bonds.

- Oil price transforming oil dependent-countries.

- American shale oil billionaire loses half his fortunes as prices plummet.



PRECIOUS METALS

Notable Stories for the Week:

- Gold rallied after Switzerland declared not to hold more gold in its reserves.

- Platinum production is recovering in South Africa

- Analyzing the gold and silver breakdown.

- Gold futures light on volume.

- Our buddies at Peirce Points point out a potential driver for recent gold price strength that has been talked about at great length in the market.



BASE METALS

Notable Stories for the Week:

- Chile will decrease copper output.

- Increased domestic vehicle sales and construction spending boost aluminum prices.

- Nickel rose substantially after a court upheld a ban on exports from Indonesia.

- Zinc prices holding up relatively well.

- Mining companies worried as China decreases consumption of key metals.

- Vale is one of the world’s worst performing major mining stocks

AGRICULTURE

Notable Stories for the Week:

- Oats are the cheapest they have been in two years.

- Rice market in Asia is slowing.

- Corn up on demand decent demand.

-John Deer outlook for global agriculture.

-Wheat prices soar on crop concerns.



OTHER TOPICS OF INTEREST

- Worker turnover is dragging down oil production at a time when plunging crude prices threaten Venezuela’s export revenue

- Despite falling short of promises a more serious asset-buying program on Thursday is coming to Europe

- Stocks on China’s biggest exchange plunged from a 2.7% increase to a 3% drop Friday, the most volatile swings since 2010

- ETF approaching $2 trillion in assets, approaching huge growth

- Astronomers are getting ready to take the image of the century

- How Bill Gross lost his empire at PIMCO

- Here is Hilary Clinton’s campaign song. Nothing screams cowboy boots, country music and pickup trucks like the Clinton Family.


Monday, December 1, 2014

Urban Communications (UBN.V:C$0.075) : Convertible Debenture Private Placement : Offering

Event

Verdmont Capital has capacity in the Urban Communications (UBN.V:C$0.075) convertible debenture private placement.

The company is raising up to C$2.5Mil to facilitate the continued implementation of its business plan. A portion of the proceeds will be used to discharge certain indebtedness to optimize the company’s balance sheet.

The debenture has a 30 month term and pays 8% per annum. The debentures are convertible into units of the Company at a price of $0.10 per share for a period of 30 months. Each unit consists of one common share and one share purchase warrant. The warrants are exercisable for a period of thirty months from the closing date to purchase one common share at $0.20.

The debenture is secured by the Company’s assets, which includes a 200 kilometer fiber optic network that runs through the densely populated greater Vancouver area. The debenture will rank pari passu with existing secured debt, meaning those participating in the current offering will have first priority against Urban’s assets.

Please see the attached news release for a detailed overview of the private placement and contact your Verdmont representative to indicate interest.

Allocations will be made on a first come first serve basis.

About Urban Communications

Urban Communications Inc. (Urban) is a public company listed on the TSX Venture Exchange under the symbol UBN.V. Urban currently owns and operates a 200 km. fiber optic network, passing through high density, high-rise corridors of Vancouver and Victoria, British Columbia. Urban is a Canadian Radio-television and Telecommunications Commission (CRTC) registered, non-dominant carrier.

Urban is preparing to launch a 1,000 Mbps (1 Gig) service into homes and offices. The Internet connection speed of these services will be up to 200 times faster than today’s average residential broadband speed. The new service is aimed to provide an enhanced customer experience because of improved quality of service for downloads, streaming, gaming and crystal clear high definition and 4K streaming video. For residential end users, Urban offers seamless access to broadband voice, data and video services with bandwidth to satisfy the most demanding requirements.

The capacity to bring fiber to the office gives Urban’s experienced business cloud services team complete quality of service control for hosted PBX, exchange servers, SIP, data storage and other cloud based business services. For building owners and managers, Urban’s fiber offers a value added feature to attract and retain tenants, requiring no capital investment from the property owner or manager.

Urban plans to aggressively launch a triple play solution including high speed Internet connection, phone and “Urban TV.” Urban TV is a fully compatible Android solution for delivering HD broadcast streams and video on demand (VOD) to subscribers’ televisions, tablets and smartphones.

Please see the company's current fact sheet and presentation for a detailed overview of Urban Communications. 


Our Thoughts

There are many standout elements to the Urban story and we believe that the current private placement represents a very solid investment opportunity. The highlights as we see them are:

  • We believe that the management team behind Urban has the skillset required to turn the company around. We have been dealing with John Farlinger, who was appointed company CEO this year. He instills a huge degree of confidence in the Urban Story and has a solid background of success. In our opinion, it is very rare to find an executive of his caliber associated with such a small company. 

  • The company’s mission is to provide end users with seamless access to broadband voice, data and video services. Their objective ties into many attractive themes in the market, which include: the demise of traditional cable for internet based TV (think Netflix), the ever expanding need for data into houses and businesses (1Gig Service), the push for deregulation in Canada and the company has a similar value proposition to that of Google Fiber (which is generating a lot of buzz). Here are some recent articles in support of these very powerful themes:







  • The company has 100% ownership of its fiber optic network that spans through high density areas in the greater Vancouver area (a map is in the attached company presentation). We have heard varying estimates on the value of the network, but it is being assessed anywhere between C$12-$15Mill, depending on whether you value the network based on its replacement cost, potential earnings power, or past transactions. The company has sold a portion of its network in the past for $8Mil, which lends confidence to current estimates.

  • The company aims to offer a better service at a better price. It is launching a 1,000Mbps (1 Gig) service into homes and offices vs. traditional networks that provide only 10Mbps. The company estimates their service will be up to 200 times faster than the average residential broadband speed available today. This leap in performance is game changer for the end user and the price is inline or better than what is out there. There is a legitimate value proposition for consumers in the form of instant downloads, high quality streaming and the support of multiple user devices at a given location.

  • The company’s fiber network runs parallel with many businesses and a multitude of residential high rises. The urban population in this area is dominated by young students and business professionals who are relatively tech savvy. This suggests that the market on Urban’s grid would have a need for improved broadband service and be familiar with the value inherent in Urban’s offerings. The company’s residential model is almost identical to that of Google Fiber (www.googlefiber.com) which has seen market penetration rates of 50%-70% in similar city centers. Urban is forecasting penetration rates in the area of 20%, which would bring the company to 1,000 residential subscribers by the end of 2015. We are aware that Urban is not in the same league as Google Fiber and a 20% penetration rate is still on the aggressive side. That said, given the company’s superior service offering and highly competitive pricing, we don’t believe that company forecasts are unreasonable.

  • The company currently has revenues of $40k per month, with aggressive plans to expand this in short order. In other words, this is not a complete early stage / Hail Mary type scenario.

  • Urban has a market cap of C$2.9Mil and a pre-money Enterprise Value of C$6Mil (when factoring in C$3Mil in existing liabilities). These are modest numbers from what we can tell. The business is all there: a credible team, the technology, the network, existing cash flow and the relevant licenses. This creates a value proposition in our opinion, especially in light of Urban’s existing network, which is arguably worth more than the company’s pre-money valuation.

  • The company has a competitive advantage given the sunk costs associated with the network. The majority of the companies that have failed to succeed in this space were crippled by the massive capex associated with rolling out a fiber network. Smaller companies are typically not afforded the time, nor the access to capital, to make a successful go of it. Urban is not handcuffed by these same headwinds as they don’t have to wrestle with a huge spend upfront.

  • Urban is a turnaround story with a new team, new strategy and a balance sheet that is on the mend. If the company executes on its business strategy to increase residential subscribers over the next 6 months, this could prove to be a pivotal moment. In our opinion, a successful execution of the business plan would translate into a share price much higher than current levels. Furthermore, we believe that Urban could  evolve into a natural takeout candidate for competing firms like Shaw and Telus, who have stale business models and antiquated networks.

  • The debenture is an attractive vehicle to get involved in the Urban story. The debenture pays an annual rate of 8% and has a very attractive conversion feature. The debenture holder can convert their holdings into units at a value of $0.10 per share. Each unit consists of 1 full common share in the company and 1 full warrant with an exercise price of $0.20. Furthermore, the debenture holders have first claim on the company’s assets, in-line with current debt holders. Total liabilities post financing will be roughly $6Mil, and even the most pessimistic valuations of the company’s network, suggest that debt holders should be made whole in the event of insolvency.
We believe that Urban Communications is a unique investment opportunity in an industry that is underpinned by very solid themes. The need for broadband services is a legitimate one, backed by changing consumer behavior and advances in technology. You have a quality management team that is fully revamping Urban’s strategy and overhauling the company. Were Urban to execute on their business plan, we believe there is lots of upside for investors at these levels. Furthermore, those subscribing to the debenture have a senior claim on the company’s assets, which creates a level of downside protection.
Please note, that an investment in Urban at this stage is still a high risk proposition and only those investors willing to shoulder this risk should consider investing in the current offering. The typical risks associated with investing in small cap companies apply. Some of the risks specific to the Urban story as we see them:
  • The company has an aggressive execution plan, that relies heavily on various assumptions. These include healthy penetration numbers and modest cost estimates. There is no guarantee that these assumptions are attainable or that the company will be able to deliver on its overall business plan.

  • Urban is at a critical juncture in that it needs to prove it can add subscribers in short order. Urban will in all likelihood need to go back to market in 6 – 12 months to shore up its finances. Were the company to stumble in this area, the ability for them to secure future funding would be placed in serious doubt.

  • There have been varying methods employed to estimate the value of the network and we have sought out opinions from a multitude of people. In spite of our efforts, there is no way to be 100% certain as to what the underlying value of the company’s fiber network is.

  • Urban operates in a very competitive and highly regulated market. As the company advances its agenda, there is no telling how its competition will react or how the regulatory environment may change.

  • There is key person risk in this story. The CEO, John Farlinger, is one of the leading factors behind our interest in Urban Communications. We are confident that he is incentivized to remain on board and committed to the company’s success. That said, were he to leave due to unforeseen circumstances, the chances of Urban succeeding would be drastically impaired in our opinion.
  
All things considered, we think that Urban communications has a good shot at success and offers a solid risk/return profile at these levels. As with all ideas we show our network, Verdmont Capital may be investing in the transaction alongside interested clients.
Please call your Verdmont representative for additional information on the Urban Communications private placement.