Category: Security Analysis

Forced Seller + 25% FCF Yield = Interesting Civeo Stock $CVEO

Reading Time: 4 minutes

Today will be a quick idea on Civeo. The bottom line is that CVEO stock trades at ~25% FCF yield, is only ~2.5x levered, and there is a “forced” seller I think is driving down the stock.

Ok – “forced” seller is kinda click bait. The company completed an acquisition a few years ago, giving the seller some stock as consideration. That seller is now blasting out nearly every day, which I get into below.

Background

Civeo provides hospitality services to commodity industries. So think about remote locations where companies are mining precious metals and pumping oil and gas, Civeo provides lodging, food service, and housekeeping for those companies.

Commodity prices generally have been completely bombed for several years now, particularly where the company participates. This includes oil, liquified natural gas, met coal (the coal used to make steel), and iron ore, though demand has still been OK (as I noted in this oil post). The nature of the business also means they typically are in highly commodity driven areas – Australia (given their met coal and other metals help serve the China / Asia demand), Canada (oil sands) and the US E&Ps.

As you can see, the stock has not performed too well in this environment.

The company currently operates around 28 lodges covering 30,000 rooms. They also own a fleet of modular assets that are typically used for short-term stays in the US and Canada.

“Forced Seller”

ANYWAY –  if you were to look at the company’s insider transactions, it would look UGLY. The Torgerson’s have sold 3% of CVEO stock (almost $7MM) in near-daily blocks since August 2020.

That is until you realize the Torgerson family were the sellers of a company Civeo bought, Noralta Lodge, for $165MM. Of the total purchase price, $69MM was issued in equity to the holders of Noralta.

This was a little over 3 years ago at this point, so no surprise following a COVID scare + some time since you’ve sold your business that’d you would just want to move on.

The Torgersons still own 11% of the company, so there is a long way to go, but I can’t call the end of this technical factor.

Nearly 25% FCF Yield

The seller is obviously not selling because the value of the CVEO stock looks too rich.

On the latest call, Civeo management guided to $55MM of FCF. This compares to a market cap of ~$230MM. Previously, the company used FCF to delever (after levering up for Noralta), but now that it is at 2.5x, there is a bit more flexibility. As I’ve talked about, I like these busted balance sheet names as they start to improve, but are still in the penalty box of equity holders.

When a stock trades at 25% FCF yield, the market is saying there is high bankruptcy risk. I don’t think that’s the case here. The term loan and revolver mature in 2023 and they generate plenty of FCF to keep lenders happy.

Fortunately, the COVID snapback has caused commodities to rip. If they stay elevated, who knows, but I think it will at least help the company extend contracts on existing lodging facilities and maybe sign some new ones (that will also help any concerns with credit facilities, but again – I’m not concerned there).

There is a bit of a spat going on between China and Australia over trade, but I think it’ll be sorted out eventually. Either way – this was included in mgmt’s FCF guidance. Secondly, the company announced it renewed several key Australian contracts on its latest call.

Back to the FCF yield guidance – there should be pretty good visibility. You have a set number of rooms available on site, you talk to your customers about need and what they are planning for the year, and you have a general gauge of commodities (are they up or down, is demand up or down) so you can try to win more business. This makes me believe FCF guide is a decent one to bank on.

Last thing I’ll say, the past 3 years the company actually generated $63MM of FCF on average. There was some working capital movements there, but it doesn’t seem unreasonable at all to me.

M&A Target (Seriously)

Using “M&A target” as an investment thesis is weak… yet here we are.

Typically its weak because its like, yeah sure… in SOME scenarios, this COULD get acquired (especially in a deal hungry private equity market), but any time I hear that, it doesn’t come to fruition.

In this case, Target Hospitality received a buyout offer from TDR Capital. Now, it was apparently a really cheap price of $1.50 and now Target Hospitality is trading at $3.40. Target Hospitality currently trades at 7.25x ’21 EBITDA vs. 6.0x for CVEO. HOWEVER, Target is also pretty levered still at 5x EBITDA vs. 2.5x for CVEO. Their cash flow has also been much less consistent. 

I also think the capital markets are supportive and perhaps this company would be better suited as a private company, rather than a $230MM public company. Just saying.  

Fresh Look at AgroFresh Stock $AGFS

Reading Time: 6 minutes

AgroFresh is a company that sells 1-MCP, a chemical that helps slow down the ripening process of fruit and vegetables. You know how you can eat apples all year long? Did you ever think that’s strange given harvest season is September-October? With 1-MCP, apples can be stored for a year. That’s right – sometimes you are eating year-old apples. I’ve been following AgroFresh for years and there are certain times when the skew on the stock becomes very interesting.


Disclaimer

This is a quick idea today and I need a disclaimer upfront. This is not investment advice and I use this blog as an investment journal. The subject company today is very risky. You should expect that I may invest in this company and then quickly move on if I see a quick return. You should do your own due diligence.


Key Issues

Anyway, back to AgroFresh stock. The issues have always been:

  • They were bought by a SPAC, which raised red flags given SPAC deal dynamics. AgroFresh stock has not been a good performer since then.
  • It was a carve-out from Dow Chemical, who knows a thing or two about chemicals. So their choice to sell a high margin business was odd (Dow later re-invested in the company through the open market).
  • They have a decent amount of debt (recently refinanced, though expensive).
  • This typically was viewed as a 1 product, 1 market company (viewed as only Smartfresh 1-MCP product with apples).
  • One patent had rolled off in 2015 and more were coming in 2019 and 2020. It was unclear whether earnings would collapse or not

Each of these are valid issues  with AgroFresh stock. The last issue is the most important one in my view. As you can see below, the gross margins and EBITDA margins are super high. They do about $71MM in EBITDA, with 42.5% margins, and only have $3MM in capex (less than 2% of sales) so have extremely high FCF conversion.

Excluding the intangibles assets from their buyout and cash, they have $153MM in assets, but do $71MM in EBITDA – that’s a super high ROIC and highlights the intellectual property and high service model is creating a barrier.


So why is this worth a look?

Frankly, I think the risk / reward is getting very compelling. I’ve made a decent amount of money in stocks the rest of the market thinks is going bankrupt, but where I think the odds are more likely it does not.

First of all, they generate a lot of FCF. Despite a new onerous debt restructuring entered into last year (their prior term loan matured in July 2021, so it was about to become “current”), I still think we’re accruing cash to equity at around 20%. As mentioned a lot, I like good companies with bad balance sheets. This may just be an OK company with a bad balance sheet, but thats OK.

Debt Refinancing

The debt deal was entered into because the company had an upcoming maturity. They got a new $275MM term loan at L+625bps with a 1% floor, which foots to about $20MM of interest per year. I think they’ll be able to refinance that at a better rate, but the loan does have 101 hard call protection until July 2021.

More importantly, they have a seriously onerous convertible pref equity that was put in place by Paine Schwartz Partners (PSP). It accrues at 16% (half cash / half PIK in year one). Call protection is determined by a multiple of invested capital, which also seems aggressive:

If they can take this pref out before July 2021, Agrofresh will need to pay 1.5x the pref amount of $150MM, which is ~$225MM (it is actually less than this, because MOIC includes original issue discount + coupons, but you get the idea).

Otherwise, Agrofresh has to pay 16% interest while this thing is outstanding. For me, I’d want that out of here as fast as possible. On the other hand, if AGFS takes it out in year one, it’s basically like paying 50% interest. I guess that’s the cost of capital during a pandemic when you have a maturity coming due.

Here’s how the pref shakes out, assuming they PIK the minimum amount each year (the PIK interest is added to the balance). As you can see, the PSP pref is brutal because the high rate incentivizes a refi, but the make-whole is large too so it is actually better to wait a bit and execute on your business plan.

There are some other green shoots. Agrofresh won an IP lawsuit against UPL, one of the largest ag chemical companies, and was awarded over $30MM. They can actually use this to paydown the preferred at more favorable terms. Obviously there are two good outcomes of this that I don’t need to directly spell out for readers.


Patent Protection

Smartfresh is the flagship product for Agrofresh. Fortunately or unfortunately, the patent that still applies to a bulk in revenue still lasts until 2022. So unfortunately, it is still a wait and see story.

And what does management say about competition, otherwise? It’s not really new. Here’s a quote back from 2016 (by the way, this TruPick product they are talking about it what they won the lawsuit for):


Optionality

The last thing I’ll say is there is other optionality in this investment. Essentially, take this chemical and apply it to other fruits and vegetables that could be preserved. Man, avocados go from too hard to too ripe way before I’m even ready for it.

So far, they’ve actually done a decent job. Back in 2014, the company was 88% apple-related sales. Now it’s just 60%.

It seems like the company wants to aggressively expand here. Part of the management teams bonus is tied to it (25%).


Management Alignment

Speaking of bonuses, I like that mgmt has a decent amount of options that are way out of the money at $2/share. Mgmt was also in the open market in 2019 buying at $2.35/share.

However, I’m not super thrilled that total comp is around $2MM / year for a company doing $71MM in EBITDA with abysmal stock performance so far.


So why now?

AGFS stock has been a value trap to some extent.

  • Refi that expensive preferred capital  and potentially the term loan.
    • Fortunately or unfortunately, the credit market is aggressive right now and many companies will be able to survive this cycle that wouldn’t have survived past ones.
    • In reality, perhaps they should come to market with a 9% unsecured bond. It’d be juicy in this market (and HoldCo PIKs are trading at lower yields)
    • AgroFresh could do a $375MM deal to takeout the pref + TL and still come out with cheaper cost of capital all-in.
    • Doing this would free up capital for the common shareholders
    • I think they may be able to do something by July 2021. But thesis isn’t predicated on that.
  • Sentiment feels bad on it. Stock seems completely washed out. I like that. Slightly positive news would send it higher.
    • I like the skew: If I see patent weakness or too much competitive threat, can likely exit before losing the whole position. If they surprise to the upside, even modestly, the stock will re-rate very quickly (especially with the leverage).
    • Small wins are meaningful: If AGFS gets a $10MM win, that’s much more incremental to them because they are a microcap.

$NXEOW Warrant Recap (& Maybe Post-mortem) $UNVR

Reading Time: 3 minutes

It’s been awhile since I’ve discussed the Nexeo warrants, which are now tied to Univar’s stock performance following the acquisition. At one point, I’m pretty confident this blog was the go-to place for information on the merger and its impact on the warrants.

Unfortunately, none of that matters now. We have 145 days to expiry and the strike price is $27.8034 vs. UNVR currently trading at $20.64. History would tell me that this isn’t unsurmountable, but it may not be likely that UNVR is in the money.

But  I try to be an optimist (especially because I still own a lot of NXEOW), so I do have a couple points on why I think the warrants could possibly make it. To be clear, I’m grasping for straws here because Univar really needs to make it to $30 to get the warrants sufficiently in the money.

UNVR has materially underperformed its peers  

This chart compares returns for a broad set of chemical stocks. UNVR has materially underperformed, but that makes no sense. UNVR distributes these company’s chemicals! If the suppliers are doing well, odds are UNVR should be doing well.

If UNVR had performed in line with the average of these names, it would be at $28.70 right now, not closer to $20.

Macro Data is Suggests Chemicals Should be in Strong Demand

Ok, the last chart was pretty hand wavy. But it makes sense why the chemical stocks have ripped. The underlying data is suggesting a really strong economy.

PMI is “an index of the prevailing direction of economic trends in the manufacturing and service sectors. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting”

So PMI is a measure of expansionary or declining conditions, with 50 being neutral. Clearly we are expanding in these markets.

This isn’t a perfect comparison, but look at PMI vs. the basic materials index. You can see the correlation in their performance. The only thing to remember is that XLB is a basket of stocks that should build value over time whereas PMI can only bounce between 0-100.


In my view, there’s no reason why UNVR shouldn’t be performing better. Commodity prices have improved, industries such as autos and housing (which consume a lot of chemicals) are doing much better. And all of UNVR’s suppliers are doing much better. I guess we’ll find out if they can close the gap.


Post Mortem

Since this may not pan out, I’ll go ahead and write my brief post mortem. I DON’T have regrets investing in these warrants. I say that despite the fact that I stand to lose a decent chunk of change on them.

I had strong conviction Nexeo was being underappreciated by the market and the warrants were a levered bet on that view. Nexeo was indeed taken out, despite tons of pushback from people saying Univar wouldn’t ever do it. I saw the opportunity to possibly 6x my money with downside being the ticket to play the game.

Once people digested what the acquisition meant, the warrants basically doubled in a day. But there are some real lessons here.

  • First, try to avoid warrants in companies that play in commodities. Commodities can swing to the upside putting you quickly in the money, but it can obviously go the other way too.
  • Second, pigs get slaughtered. When you’re up a lot on a warrant or call option, just get out. I should have sold all my warrants and just bought UNVR’s stock if I thought it was still good (even though in hindsight I know it has underperformed now).
  • Third, don’t be duped by a long time to expiry. “I have so much time until these warrants expire… a lot can happen”. Yes, a lot CAN happen. Including a global pandemic.  I should have instead said, “you know what, I think Nexeo / Univar will build a lot of value over 3 years and I should just ride the equity”

Why Hasn’t Autozone Stock Re-rated with Other Pandemic Winners? $AZO #COVID19

Reading Time: 3 minutes

I just did a post where I evaluated my holdings of Apple following its recent surge, which looks to be a quite big move for the US’s largest public company. One thing I didn’t really discuss in that post was that Apple may have re-rated recently due to perception of it being a pandemic winner. If your sales have held in well this year, or even increased, you are viewed as either defensive or on a continued growth trek. In turn, your stock has rocketed up.

Here’s a list of stocks that I would say fall into that category. I can’t include them all, but you get the point:

FB Chart

FB data by YCharts

The S&P total return is ~5.5% at this point in the year.  Home Depot is doing well because housing is holding in well, and the pandemic is causing people to reinvest in their homes. Same store sales were up ~24%+! No wonder Home Depot has surged.

The same is true for other retailers, such as Target or Wal-mart, which despite possibly missing the back-to-school shopping season (which is big bucks) they are reporting some of the best comps in years.

So let me take off some of the true high fliers and compare Autozone stock and other auto part retailers to these names.
FB Chart

FB data by YCharts

If you’re having trouble finding the auto retailers on this busy chart – they’re all at the bottom!

This is odd to me. O’Reilly reported +16% SSS comps for Q2 and a 57% increase in net income. Advance Autoparts has a different fiscal period, but they reported 58% increase in EPS on a 7.5% SSS comp.

Why is that? There are several reasons.

  1. In recessions, people keep their car longer and do more work themselves. See my post on AutoZone for some discussion on their comps after the 2008 financial crisis.
  2. After reaching about 7 years in age, cars tend to need more work. The average age of a car in the car parc today is around 12 years
  3. Retailers focused on cleaning products and other pandemic needs consumers would need and auto parts took the back seat. It’s likely that the pure-plays auto stores picked up share

So I fully expect Autozone’s sales to benefit when they report at the end of September. And if this current crisis persists, then their increased comps will likely persist as well.

I’ve been watching street estimates for Autozone. They still sit around pre-pandemic levels. My guess is AZO handily beats these estimates, though admittedly there are some tough comps (believe there were additional selling days in the prior year).

Look, I’m a long term holder at the end of the day and I wouldn’t recommend trading around a  quarter. All I’m saying is you have (i) a high ROIC business that (ii) historically has returned every dollar of FCF to shareholders that (iii) is probably benefiting in COVID where (iv) estimates might be too low. I like the set up.

Should you hold Apple stock here? $AAPL

Reading Time: 6 minutes

I’m an Apple shareholder and the meteoric rise in Apple stock has me questioning whether I should hold on or move on.

One problem with this, and why I don’t think Buffett will sell, is opportunity cost. Selling Apple stock to hold cash isn’t really a great option right now. Yes, yes, cash has option value in itself, but the only reason why I’d be selling is my scant perception is that Apple stock has gone up really quickly and so maybe it is “fully valued” at this point.

Personally, whenever I sell a really high quality company due to valuation – that ends up being a bad decision.

Think about what this would mean right now if you count yourself as someone who is a “traditional” value investor (i.e. someone who looks for low P/E stocks) – this means selling a really high quality company to probably go invest in a lower quality company trading at a low multiple. Not a particularly great trade-off in my view. That multiple is probably low because of low growth, low ROIC, high cyclicality or some other reason.

If I stay on this broad topic, I also think the market is rarely so grossly wrong on a blue chip, top component of the S&P500. Yes, we have had instances in the past where everything just gets overbid in a mania (a la, the tech bubble where even GE was trading at 50x earnings). Also there are plenty of cases where the leaders of the S&P at  the start of the decade aren’t there by the end of it. But largely the market is a pretty good weighing mechanism.

In sum, tech bubbles are rare. But the stock market being a pretty good estimator of company value? Not so rare.  One reason why active management is so hard.

Frankly, if you’re reading this and thinking the stock has gone up too much, you’re probably anchoring to when Apple stock traded at 14x EPS and now trades for 30x without really much thought as to why 14x was right / wrong and 30x is wrong / right.


Ok, back to my view on Apple’s valuation. What do we need to believe here?

First, I like to go a look at Apple’s estimates for some expectations investing. I see that consensus is expecting the company to generate ~$75-$80BN of FCF for 2022-2023.

So let’s say they generate $77.5BN and using a short-hand 20x multiple of FCF (or 5% FCF yield), that’s a $1.5 trillion valuation. Wow. That would be a $363 pre-split price compared to $487 price at the time of writing. What else am I missing?

Well cash on hand is something else. Apple has $93BN of cash & equivalents (another $22/share) plus long-term investments (which is essentially Apple’s hedge fund) which is another $100BN (or $23/share). Yes, Apple has $100BN of debt, but they could have $0 of cash, be 2.0x levered and still be high investment grade. I’m not concerned whatsoever about that debt, so don’t view it as unfair to net the cash.

Add the cash together with the value of the business and you get $363 + $45 of cash, for a quick-hand value of $408 / share. Now, all of this was a very cursory estimate. For example, I change my math from a 5% FCF yield to 4% FCF yield, the price I get is $498/share. At this point, it’s hard for me to say that 4% is any worse than 5%.

I traditionally say my equity IRR over the long-term will approximate the FCF yield + the LT growth rate in the stock. So a 10% FCF yield in a low-to-no growth industrial will probably be around the same return as a 5% grower at 5% FCF yield (as long as you have long-term confidence in the FCF ). Can Apple compound earnings at 6% from here for a 10% total return? Maybe not, but all they need to do is 3% for a 7% return. And for an annuity-like business like Apple, that is as Larry David would say – pretty, pretty… pretty good.

Right or wrong, in a world of 0% interest rates, consistent cash generators will be bid up pretty high. Here’s a quick sample of companies and their FCF yields for 2021. Apple comparatively doesn’t seem crazy.


Of course, there are some other drivers for Apple recently.

The core driver for Apple here has to be the upgrade “super cycle.”

    • If you’ve been invested in Apple for a long time, you understand the stock goes through cycles and I’ve written about it in the past. It’s frankly frustrating, but the function of short-termism.
    • To rehash it, Apple’s sales go through a lull as a large proportion of users upgrade every 2 years or so. So there are big booms and then lulls and the Y/Y comps don’t look great.
    • That’s also when people hark back to the good ol’ days of Steve Jobs and say Apple can’t innovate anymore (right, like the iPad, Watch, AirPods and software moves show the lack of innovation…).
    • The story really has always been the same, but bears repeating. You don’t buy iPhone for the phone, you buy it for iOS. It has always been a software company and they continuously expand on that (AirPods being the latest hardware move, health monitoring seeming to be the next).
    • Heading into a new phone cycle is when people start to realize better results are on the come (and I have no back up, but I would say leading up to the launch is great, after launch Apple then starts to underperform again as people typically expect them to announce a new UFO and are disappointed when it’s just a new phone everyone will buy).
    • ANYWAY – the next upgrade cycle could be huge, especially if Apple is able to launch it with 5G with meaningful new speeds. I’ve seen estimates saying that nearly 40% of iPhone users are due for an upgrade. That would be a huge boon to Apple.

Apple’s bundling could create a “services” powerhouse

    • First you need to understand how profitable “service” business are. Apple has 64% GAAP gross profit margins for services. I assume its CAC must also be much lower than other players, again because of the iOS ecosystem
    • Services is growing well and could become a higher and higher % of earnings over time. Services gross profit has nearly doubled since the end of FY2017 and is now $31BN.
    • Something else to think about: Apple grew Service sales by nearly 15% Y/Y in the latest Q. But COGS only rose by 5%. That’s big operating leverage.
    • These recurring revenue streams are not only valued highly, but has a positive feedback loop in keeping everyone in Apple’s ecosystem!
    • Apple next launched “bundling” most recently and this could be a game changer.
    • Apple reported on its Q3 call that, “we now have over 550 million paid subscriptions across the services on our platform, up 130 million from a year ago. With this momentum, we remain confident to reach our increased target of 600 million paid subscriptions before the end of calendar 2020”
    • Those are huge figures in comparison to a Netflix and Spotify which have 193MM and 140MM paid subscribers, respectively.
    • Again, I view this as classic Apple. They changed the game with iTunes and made it tough to compete. The same could be true with whatever they bundle.
    • Apple could bundle Music, TV+, News, Cloud storage, as well as new growth arenas like gaming and perhaps health monitoring. Charging a low price for all these services / month might mean low profit at first, but huge scale benefits. You also drive your competitors down.

Bundle services… Bundle hardware

    • What if you were offered $100 off a product bundle if you bought a watch, iPhone/Mac, and AirPods together? Look, I only have 2 out of the 3, but I’d be tempted.
    • Apple wins despite the discount because they move more hardware and increase adoption of the iOS ecosystem
    • Then they push the software bundle. Rinse and repeat.

Each of these items make it a bit more exciting to be an Apple shareholder, but more importantly, they may be things that current estimates don’t factor in yet. In other words, especially the latter two items here, there could be further upside surprises.

Nothing I can see jumps off the page to me to say, “holy cow – GTFO.” So I’m staying put.