Thursday, January 28, 2016

Long Oil, Short Gold - Stop Trying to be Smart

Gold and oil are coming back together. This will continue to play out. Buy oil and short gold.

Oil vs. Gold – 5 Years

Gold is way too rich in relation to oil. Commodities are always mean reverting and this relationship has been tested for 200+ years. Is it different this time? No, it is not.

Gold vs. Oil – 30 Years

We are telling you the future, please listen to us.

Monday, December 14, 2015

The Pair Trade to End All Pair Trades - BUY (HYG:$78.83) vs. SELL (EMB:$105.40)

Buy US high yield corporate bonds (HYG:$78.83) over emerging market debt (EMB:$105.40).

HYG vs. EMB and Spread – 5 Years
Source: Verdmont Capital S.A., Bloomberg

The credit quality in the emerging markets is deteriorating substantially. This is being driven by slowing economic growth and overextended balance sheets. The breakdown is being supercharged by the fact 80%+ of EM principal and interest payments are priced in USD, which continues to gap higher relative to local EM currencies.

We believe that emerging market debt has yet to reflect the magnitude of these deteriorating fundamentals, whereas the breakdown in US high yield debt, suggests that segment of the market has already begun to discount future weakness.  

EMB wants to break lower. If it doesn’t, that would most likely be complimented by a pop in HYG.

EMB (top) vs. HYG (bottom) – 5 Years
Source: Verdmont Capital S.A., Bloomberg

If you prefer to see our thesis in picture form, it is best illustrated below.

Source: Verdmont Capital S.A.

Monday, December 7, 2015

Canopy Growth Corp (CGC.V:$2.85) : Be a Winner and Own the Leader

If you believe in the marijuana business in Canada, Canopy Growth Corp (CGC.V:$2.85) is the name to own.

Canopy Growth Corp – 1 Year
Source: Verdmont Capital S.A., Bloomberg

Canopy released Q2 numbers on November 26 and we believe that they were indicative of a company moving in the right direction and leading the charge in Canada’s emerging marijuana sector.

Financial and Operational Highlights from the Release
·         The Company reported Q2 sales of $2,466,121, a 44% increase over Q1 sales in Fiscal 2016. Year to date sales total $4,176,278.
·         The Adjusted Product Contribution, a non-GAAP metric which adjusts the reported gross margin by removing the fair value measures under IFRS, was 62% for the second quarter and 61% for the six months ended September 30, 2015.
·         Net income for Q2 was $3,929,514, or $0.05 per share on a diluted basis, inclusive of the unrealized gain on changes in fair value of biological assets. Year to date, net income was $4,941,297, or $0.07 per share on a diluted basis, inclusive of the unrealized gain on changes in fair value of biological assets.
·        The cash position was $7,726,240 at the end of the second quarter. After the closing the bought deal announced on November 18, 2015 and warrants exercised since quarter end, the Company will have cash and cash equivalents of approximately $24 million.
·         Patients at the end of the quarter is over 7,300.

Verdmont Capital’s Take on the Quarter
·         Revenues and earnings surprised analysts this quarter, driven for the most part by stronger than expected client onboarding.
·         The company continues to position itself to take advantage of any potential regulatory environment, which appears to be heading for a mix of medical and non-medical use on the heels of the recent Liberal party win. The Tweed brand, although appropriate for medical users, has a “fun” branding approach, which feeds well into the potential decriminalization of marijuana. Bedrocan on the other hand, will continue to employ a highly medical focused brand, as is evident by that segments packaging that has a clinical feel.
·         The creation of Tweed Farms, is looking borderline brilliant after the Liberal Party victory. Tweed Farm’s facility was bought for the equivalent of $400k hard dollars and has the potential to bring in upwards of $100Mil in annual revenue if operating at full capacity. The facility employs a bulk production approach, which would be an excellent fit for the non-medical segment of the market. Tweed’s move to diversify the business by bringing in a bulk approach was highly criticized by various market participants. We believe this shows how many players in the sector continue to have a poor read on the evolving industry.
·         Client acquisition and retention remains strong. CGC.V is serving ~7,300 patients at the close of Q2, as opposed to ~5,600 and the end of August. This strong ramp up in client acquisition, and limited customer churn, is representative of strong branding and excellent follow through on customer service.
·         Management has been fine tuning the Bedrocan order process post acquisition. The heavy lifting has been done here and management has indicated they will be onboarding clients under the streamlined approaching during December. This should prove to prop up onboarding numbers and get the company closer to 12,000 patients, which management has suggested will bring the company to cash flow positive status.
·         Canopy did a C$12.5Mil equity offering on the heels of the Canadian election. This was an excellent move in our opinion, as the company sapped a significant amount of capital that was due to come into the sector on the heels of the Liberal victory. Tweed has the strongest balance sheet in the sector, with ~C$24Mil in cash at the present time and minimal debt. This affords the company a lot of flexibility as the sector potentially moves to decriminalization. They have the cash to exploit various opportunities, the scale to attract US capital as it looks to come into Canada and it makes the company’s equity more valuable to pay for potential acquisitions.
·         What CGC.V has been able to achieve operationally over the past year has been exceptional. The company has the ability to register new patients in the morning, have them cleared for delivery the same day and have the order shipped and received the following day. This finely tuned ordering process has contributed the company capturing ~25% of total industry shipments.

Verdmont Capital’s Investment View

We have been investors in Canopy Growth Corp for some time. We invested in the company before it commenced trading, as we were blown away by the quality of management and the jump that they had on their competition. Fast forward to today, some 20 months later, and one backs into the same rationale for owning the stock.

When investing in an emerging sector, you want to own the leaders in the space. This could be referred to as the venture capital, or, the “keep it simple stupid” model. The logic behind this approach is that if a high growth / emerging industry is going to live up to all of the hype, the potential returns offered by the industry leaders will be for more than generous. Additionally, as serious money comes to the sector, in the form of strategic investors or institutional funds, they will park their capital with the winning stories that have the achieved scale required to succeed. 

When CGC.V began trading at the beginning of 2014, it was at the height of the medical marijuana candy scramble. This was when speculators came into the sector employing a shotgun approach, as anything with “marijuana” in the name was going to the moon. It is rare to find a company in this sector, or any early stage high growth sector for that matter, that ends up living up to all of the hype. We believe that Canopy has delivered in spades and prospered in a segment of the market that has proven more dynamic than we had originally envisioned. CGC.V Management has demonstrated that they have both the skill and the vision to adapt to the ever changing playing field.

We would like to tip our hat to Bruce Linton, Canopy’s Co-Founder. Bruce, along with the Canopy team, have put together one heck of company. It is worth noting they did this without trashing the competition, maintaining a positive message at all times and being true ambassadors to what is becoming an increasingly important industry in Canada. A good management team can make early stage investors look smart, which Canopy has done for us.

We continue to believe that CGC.V is the name to own if you believe in the marijuana business. Be a winner and own the leader.

Monday, November 23, 2015

Pivot Technology Solutions (PTG.V:$0.53) - Revenues Trump Margins - Stay the Course

Pivot Technology Solutions (PTG.V:$0.53) released earnings today for the third quarter ended September 30,2015. A detailed overview of these results can be found here:

The stock has been a bit soft today after the pre-market earnings release. We would not be too concerned about the weakness and continue to believe that PTG.V should be a key holding for those active in the Canadian small cap market.

Financial Highlights Q3 2015

·         Revenues of $414.5 million, up 15.2% compared to Q3 2014, attributable primarily to strong product sales.
o    Product sales of $373.0 million, up 16.9% compared to Q3 2014.
o    Service revenues down 1.7% to $37.1 million compared to Q3 2014.
·         Gross profit up $0.5 million, or 1.3%, to $40.7 million from the same period in the prior year. 
·         Gross margin for the quarter was 9.8%, down from 11.2% in Q3 2014. 
·         Adjusted EBITDA* came in at $6.3 million, down 25.6% from Q3 2014.
·        Adjusted for changes in non-cash working capital balances, the Company generated $4.8 million in cash from operating activities, as compared to $3.7 million for the same period last year.
·         On September 15, 2015, the Company paid its first ever dividend on common shares of CAD $0.0075 per common share.
·         On September 21, 2015, the Company closed a new, $200 million revolving credit facility through JPMorgan Chase Bank ("JPMC"), and terminated the previous facilities held with PNC Bank ("PNC").
·       On July 31, 2015, Pivot paid a $1.5 million installment related to the acquisition of Sigma Solutions, and subsequent to quarter end, on October 30, 2015, paid the final earn out installment related to that acquisition.

Verdmont Capital’s Take on the Quarter

We patched into the earnings call. We don’t know what was more disappointing, the soft margins achieved in Q3 or management’s lack of enthusiasm for what remains an incredibly well-positioned story. Here is our take:

·         Big beat on revenues relative to Cantor’s estimates. PTG.V posted $415Mil in revenue during the quarter vs. estimates of $355Mil. The top-line beat of $60Mil alone, represents 70% of the company’s current market cap of $88Mil.
·        Management indicated during Q&A that the surprise in revenue does not appear back end loaded. If that is the case, we would have expected a boost to 2016 revenue guidance. We understand the need to be conservative, but we also think a good story needs to be told when due.
·         Adjusted EBITDA came in soft at $6.3Mil vs. estimates of $8-$14Mil.
·         Margin issues were driven by lower-margin product sales, pricing pressure in storage and limited service sales. Disappointing, but all-good when one considers that PTG.V’s business is “lumpy.” Big orders skew revenues to a given business segment and associated margins over the short term. Revenues / market share are the hard part, margins should work themselves out over time.
·         Strong cash flow from operations at $4.8Mil, with $12.50Mil in cash at quarter end.
·         Contingency payments associated with past purchases are now out of the way.
·         The dividend is well supported moving forward. The company currently has a gross dividend yield of 5.5%.

Verdmont Capital’s View

We continue to believe that our clients should have a sizeable position in PTG.V. Granted, margins were a disappointment, but top-line growth remains incredibly solid. In a market where companies are typically adding value by cutting costs and getting creative with their balance sheets, a company beating on revenues is very attractive.

PTG.V has the scale and end-to-end business profile to prosper in an environment where enterprise IT becomes increasingly more complex and dynamic. Furthermore, the company’s underlying business should fare well under various scenarios for the global economy given the cost saving properties inherent in their offerings.

Investing in PTG.V offers a great risk/reward profile given that the company is currently trading at an EV/Sales of 0.15X and an EV/EBITDA of 3.71X. Global VAR comparables trade at 0.30X and 6.9X respectively. When one factors in a well-supported dividend yield of 5.5%, the case for investing in PTG.V becomes that much more compelling.

Please call your Verdmont Capital Representative for more color on Pivot Technology Solutions.

All of the regular disclaimers apply. If you do not do your own due diligence before investing in small cap stocks, you should not be investing in them. Some people used to refer to this as commonsense.

Thursday, November 12, 2015

Gold is Not Cheap - Own Oil Over Gold for the Zombie Apocalypse - OSK:$41.02 Looks Good as Well

If you are looking to buy a commodity, you should be looking at oil over gold. Remember, all commodities move together over time. This time will be no different, nor will the next time.

Gold is trading close to all-time highs in relation to WTI Oil. Looking at that relative value, and balancing that against the fact that global oil demand is inelastic and supply remains relatively scarce, what do you want to own?

Gold Bullion (top), Gold Bullion vs. WTI Oil (bottom) – 1982-to-Present
Source: Verdmont Capital S.A., Bloomberg

Now sure, as various gold bulls point out, the world is going to end and the zombie apocalypse is imminent. But you know what, we have thought about this, and we still think that oil over gold makes sense.

In our opinion, in order to do the mass killing that these zombies are anticipated to conduct, they will need zombie mobiles and transports to get around. There is no way they can cover that much ground and do so much killing on foot. These vehicles will need to be powered by refined oil products, whereas the demand for gold and how to trade it under such a scenario is questionable.

Now, please be reminded, that our thesis on oil vs. gold completely breaks down if:

1)   The zombies turn out to be liberal zombies, as liberals, no matter what form, hate oil. This is a key risk to monitor. There is a good chance that the zombies will be liberal, as liberals will try to appease their attackers, instead of fight them tooth and nail. At this point they will have their brains devoured and quickly be on Team Zombie. This will not be fun for them, as Team Zombie works longer than 4 hours a day, has a performance-based culture, there are no extended holidays and you can never retire, let alone at 40 with full benefits. To add to the misery, Zombies are completely racist. In fact, they are all-consumed by this racism, as their sole mission is to devour humans as we know them.
2)   These zombies are predominantly Eastern European, are female and/ or gay males. In this case, point A is remains largely relevant, and furthermore, jewelry demand will remain robust as looking fantastic will remain important. If they are going to kill, this group will want to do it with a certain degree of panache. They will appear much like the zombies in Michael Jackson's "Thriller" video. Tremendously mean, yet at the same time, flamboyantly dressed and incredibly gifted on the dance floor. In such an environment, gold demand should remain elevated.

So, if you are dying to be involved in the commodity complex, own oil over gold. There is tremendous relative value there and oil should outperform under various scenarios.

When all Hell breaks loose, another good stock to own is Oshkosh Corp (OSK:$41.02). This is a play on our zombie transport theme outlined above. 

We have discussed OSK in the past and have attached a corporate presentation below along with a video of their JLTV. OSK’s JLTV is part of a plan by the US DOD to phase out the poorly armored Humvee . OSK is a stock that should do relatively well when the world comes to an end.

Please remember to follow us on Twitter ( where we attempt to have some fun with the state of affairs out there.

Thank you for your time.

Wednesday, October 28, 2015

Vasco Data Security International (VDSI :$19.46) - A Great Stock in an Exciting Segment of the Market

Vasco Data Security International (VDSI: $19.46) is a standout name within the very attractive cyber security sector. We believe that now is an excellent entry point and that the stock is poised for significant upside.

Vasco operates in the cyber security market and is focused on providing authentication and digital signature solutions to financial institutions. This is a tremendously attractive industry, and by all indications, it should be into the foreseeable future. Please view a recent report on cybercrime done by PWC for a an overview of the underlying themes by clicking here.

It is worth noting that more than half of the top 100 global banks rely on VASCO solutions to enhance security, protect mobile applications, and meet regulatory requirements. VASCO also secures access to data and applications in the cloud, and provides tools for application developers to easily integrate security functions into their web-based and mobile applications. VASCO enables more than 10,000 customers in 100 countries to secure access, manage identities, verify transactions, and protect assets across financial, enterprise, E-commerce, government and healthcare markets. 

A detailed overview of the company can be found in its most recent corporate presentation. To view the presentation, please click here.

The stock has sold off lately, in sympathy with the cyber security space, and on the heels of “disappointing” Q2 2015 earnings (red “E” in chart).

VDSI vs. PureFunds ISE Cyber Security ETF (HACK:$26.71) – 1 Year (normalized)
Source: Verdmont Capital, Bloomberg

We believe that the recent selloff in cyber security stocks was a rational one. This segment of the market had become frothy on the heels of some high-profile cybercrime cases. So, we are not too concerned that the sector has taken a breather.

In terms of the earnings related selloff at the end of Q2, we believe that the market overreacted. The Q2 numbers were actually quite solid, with the company beating on both revenues and earnings. The market was disappointed with the fact that VDSI only affirmed full year guidance, as opposed to boosting it. In an overheated segment of the market, this was enough to send the stock considerably lower.

All of this has worked out in our favor, as we have not had a position in the stock. The weakness in VDSI, and the cyber security segment in general, has created a nice entry point.

The company just came out with Q3 numbers today. They beat on earnings and boosted guidance for the year. This is exactly the type of event we look for to wake the market up and reverse momentum to the upside.

The potential change in sentiment is complemented nicely by the chart, which has formed a base and has been trending higher.

VDSI – 1 Year
Source: Verdmont Capital, Bloomberg

When one looks deeper into the financial performance of the company, it is hard not to get excited about the name. The company is extremely profitable and has been growing at healthy clip.

Revenues – 10 Years (quarterly)
Source: Verdmont Capital, Bloomberg

Operating and Net Income – 10 Years (quarterly)
Source: Verdmont Capital, Bloomberg

EBITDA and Net Income Margin
Source: Verdmont Capital, Bloomberg

Return on Equity
Source: Verdmont Capital, Bloomberg

The company has no debt and a significant amount of cash on its balance sheet. VDSI currently has $184Mil in cash, which represents 24% of its market capitalization. With all of that cash on hand, and a significant amount of reoccurring revenue, the company could always look to initiate a dividend.   

Cash & Equivalents – 10 Years (quarterly)
Source: Verdmont Capital, Bloomberg

Current Market Capitalization, Cash, Debt and Enterprise Value
Source: Verdmont Capital, Bloomberg

VDSI’s strong balance sheet affords management a tremendous amount of flexibility. As mentioned, this could translate into the initiation of a dividend, or, the company could look to make additional bolt-on acquisitions. VDSI has a history of acquiring companies in an effort to improve its service offerings, which includes the recent acquisition of Silanis International for $85Mil. Silanis is an e-signature provider and its technology fits well with VDSI’s existing clientele. The Silanis acquisition is a textbook “buy vs. build” transaction, and in our opinion, a great example of a synergistic acquisition.

VDSI and Acquisition History – 10 Years
Source: Verdmont Capital, Bloomberg

VDSI is trading at a steep discount to aggregate analyst earnings estimates. Obviously, analyst estimates need to be taken with a grain of salt. That said, with a straightforward name like this, it signifies that we aren’t missing anything significant about the company’s future prospects. Additionally, we have found that when a company is trading at a steep discount to aggregate analyst price targets, it is often indicative of depressed sentiment and a good time to buy.

Aggregate Analyst 12M Price Target and Price Spread – 5 Years
Source: Verdmont Capital, Bloomberg

We also like the fact that the Chairman and Founder of VDSI, Ken Hunt, has such a large position in the company. He owns 23% of the shares outstanding, which is very significant for a company of this size. This serves to create an alignment of interests with shareholders, but it also signifies that the company has maintained its entrepreneurial heritage.  If the Founder of a successful company is still there, when he could have cashed out long ago, it indicates that there is still lots of upside in the business.

Ken Hunt, VDSI Chairman, Share Holdings – 15 Years
Source: Verdmont Capital, Bloomberg

Looking at VDSI’s current valuation, it becomes that much easier to pull the trigger. The company is trading at 10 year lows in terms of its absolute and relative earnings multiple. We find it hard to rationalize the fact that VDSI is trading at a discount to the overall market given the growth profile inherent in the cyber security business and the company’s stellar financial performance.

P/E, Forward 1Yr P/E, Relative P/E vs. the S&P 500 – 10 Years
Source: Verdmont Capital, Bloomberg

In summary, we believe that an investment in VDSI at current levels represents an outstanding risk/reward profile. The company’s underlying business is supported by strong secular tailwinds and it already has an extensive list of top-tier clients around the globe. VDSI’s financial performance has been spectacular and the company has a lot of flexibility to moving forward given the strength of its balance sheet. We do not believe that VDSI’s discounted trading multiples are justified.

Thursday, October 22, 2015

McDonalds (MCD:$110.67) - Where's the Beef, Son?

We have been reading some negative news about McDonald’s (MCD:$110.67) as of late. Really bad stuff, like the brand is dead, the menu is out of touch, the new CEO is failing to turn the company around, etc. This brought our attention to the name.

We like bad news when it is associated with mega brands, as the value of a brand is next to always underappreciated. A barrage of negative news, when associated with a quality brand, is often indicative of a nice trade shaping up.

McDonald’s beat this morning, which may suggest the company’s prospects are on the mend.

The chart also looks interesting, as the stock has just broken to new multi-year highs after being range bound for the past few years. Not only is the breakout of interest, it is hard to find quality stocks that have only been treading water, as the major indices have been on a tear.

MCD – 5 Years
Source: Verdmont Capital S.A., Bloomberg

MCD vs. the S&P 500 – 5 Years (normalized)
Source: Verdmont Capital S.A., Bloomberg

Unfortunately however, it appears as if the breakout, along with the hungry alligator formation vs. the S&P 500, is not enough to get long MCD. When one takes a look at the company’s recent financial performance, and reconciles those numbers against MCD’s current trading multiples, it becomes evident rather quickly, that there is no meat in this trade.

MCD’s Q3 earnings release from this morning leaves little to get excited about. Sure, they are a step in the right direction, but they ultimately represent a beat of very depressed expectations. Same store sales in the US improved, rising 0.9% YoY, but global sales were still down -6.5% YoY and net income was up a modest +3.7% YoY based on cost cutting.

These results suggest that the turnaround of MCD is still in its infancy stages. Looking at recent trends in growth, profitability and solvency, the numbers have all been moving in the wrong direction for some time and by a wide margin.

Q Rev Gth YoY% (orange), 5yr Avg Rev Gth YoY% (green) – 10 Years
Source: Verdmont Capital S.A., Bloomberg

Qtr EPS Gth YoY% (green), 5yr Avg Qtr EPS Gth YoY% (orange) – 10 Years
Source: Verdmont Capital S.A., Bloomberg

Return on Capital, Return on Equity – 10 Years
Source: Verdmont Capital S.A., Bloomberg

Debt-to-Assets, EBITDA-to-Interest Expense – 10 Years
Source: Verdmont Capital S.A., Bloomberg

The above metrics are of course backward looking, it is the change on the margin that matters. We fully understand this, and an earnings beat by a turnaround story, along with a nice chart as outlined above, typically signifies a great long opportunity.

That said, when we look at where McDonald’s is trading in terms of various multiples, it is not priced anything like a turnaround story. With multiples close to all-time highs, on both an absolute and relative basis, investors are not being compensated for the risk they are taking in assuming the company’s fortunes have changed.

MCD:  P/E, 1 Year Forward P/E, Relative P/E vs. S&P 500 – 10 Years
Source: Verdmont Capital S.A., Bloomberg

Although we are not buyers of McDonald’s at current levels, we believe shorting it outright is fraught with its own risks.

First and foremost, it is reckless to short a stock that just broke to new highs on an earnings beat, regardless of the underlying fundamentals. The technical breakout could be enough to keep the stock elevated for longer than expected. Ideally, to short it, you would like to see it fail to hold today gains, as it would represent a false breakout.

MCD – 5 Years
Source: Verdmont Capital S.A., Bloomberg

The MCD breakout coincides with a pretty significant short position. The short interest ratio for the stock (shares short/average daily volume) is at 10 year highs. This represents depressed sentiment, but more importantly, the earnings beat may have shorts looking to cover.

MCD: Short Interest Ratio, Short Interest, Volume – 10 Years
Source: Verdmont Capital S.A., Bloomberg

Additionally, only 30% of the analysts covering the stock have a “Buy” rating on the name. This is very low for well-known company with a decent dividend yield. Shorts could be exposed to a number of upgrades as analysts try to compensate for the fact that the share price is now trading through their aggregate 12 month forward price targets.

MCD: Aggregate Analyst Ratings, 12 Month Price Target and Target-Price Spread – 5 Years
Source: Verdmont Capital S.A., Bloomberg

In summary, we had a look at McDonalds today, thinking that the breakout on the earnings beat could represent a decent trade. The stock has digested a lot of negative news associated with declining profitability, increased competition and uncertainty around its corporate strategy. Looking at the company’s trading multiples, we just don’t believe that MCD offers a good risk/reward at current levels. Once the momentum associated with the technical breakout takes a breather, the stock could represent a nice short.