The SandBox Boom: Quick Review of The Frac Sand Market (NYSE:HCLP; SLCA)

In previous posts, i’ve mentioned how the fracking technology has changed the oil and gas insdutry (License to Drill).  A pressure pumping market has emerged and with it, needs for million of tons  tons of propants. A propant is a material allowing to keep opened a fracture induced by fracking. One of  The most popular propant is… sand.

The market for sand as a propant has grown a lot since a couple of years. According to my investigations, this has lead the price for for sand (meeting propant specifications), from 20$ a ton, up to 40$ a ton.  The consumption rate is still  still forecasted to grow in the next few years, albeit at a slower pace.

Peter Lynch has mentioned in one of his book, a stock story about a sand pit, indicating that this was a classical case of economic moat: the material is so worthless that the key criteria for being competitive is…  the transportation cost.  A sand pit can outsell any competition, as long as  competitors are relatively far away. 

Hum… a growth market, economic moat?  One thing leading to another, I’ve researched and a couple of stories on this topic. Let’s consider for example Hi-Crush Partners (NYSE:HCLP). This provider sell frac sand through closed long term contracts. The stock, issued in August, offers a very interesting dividend.  Couple months later, the story seems less interesting. They lost  a key customer, the gas market in the US is saturated, so the pressure pumping business has slowed down. Might not be that easy to replace the customer. As for economic moat… I made a simple search with our friend google (just type Wisconsin frac sand). Yuk! with the pressure pumping business boom, dozens of sand pits have opened, all in the SAME areas. In clear: Hi-Crush has few, if no competitive edge vs other sand pits, offering the same product, facing similar transportation costs, with the same customer bassin. Not what I would call the best situation.  Not the kind of stock that fits my criteria.

Put it in comparison vs U.S. Silica Holding (NYSE: SLCA). The company has much more competitive advantages, deserves multiple geographic areas, does research to improve  the material and is diversified in two key markets: propants and other industrial material.  I would bet on that one for survival… and I I would consider investing maybe in it, if they had a regular dividend policy.

Review of another comeback from the Internet era: Mediagrif (TSE:MDF)

I Invested this fall in Mediagrif, arounf 17$. Sadly, I missed the runup since last year (from 10 to 17$).  For my defense, I can say that I did followed it during the Internet era… But like many other internet era stocks, I stoppped following these stories years ago, when it was clear it was going nowhere. That it did… from 2000 to 2009. The story has changed since then, and attracted my attention back to it.

This tech company comes back from a major shift in business focus and important changes of upper management since 2009. They are now focussed on exploiting niche specifics B2B (business to business) or B2C (business to customer) portals. These portals offer a good stream of recurring revenues and cash flow, as most of these portals are based on subscription or per usage basis. Most of these B2B and B2C are somewhat protected by economic bareers of entry. There are some competitions, but for most, significant money and time is required to compete. Most of these portals are targeting specific communities. So, Once a critical mass is reached, the portal becomes a standard tool for the community. Changing to another portal could happen, but is no easy matter.  If the B2B portal is properly operated, and offers value added functionalities, enhanced regularly, customers have no reasons to switch.

They made some acquisition (intertrade in 2010, Les pac.com in 2011) and intend to continue growing by acquisition. The dividend have been increased regularly since 2009, up to 0.36$/yr today. A recent stock issuance of 2 million shares has been done recently, mostly to repay the debt of their last acquisition. The number of share has then grown from 13,8 to 15.8 million (14.5% dilution). Their balanche sheet is now clean of debt.

Some plus and minus worthy of mention:

+The company is directed by Claude Roy, a well known name in tech companies (just google his name fo find out more). M. ROY is also a heavy insider buyer and owns a significant portion of the company (+20%).

-The « Les Pac » acquisition was far from cheap (6.5 times sales and I estimate 12 time ebitda…). It will be interesting to see how they can leverage that pricey acquisition, considering that B2C portals are more vulnerable to competition than niche B2B portals.

-Some b2b portals are not really owned by Mediagrif, but rather operated under a renewal agreement with an external entity. If an agreement if not renewed, this may impact the results.

+MSr Roy has stated ambitious objectives for the next three years of tripling the company size. 

-This will likely require more stock issuance and/debt.

Conclusion:

A good balance sheet, a stream of recurring revenus and cash flow, multiple niche markets protected by bareers of entry, a CEO who has delivered value with his previous job at Logibec, but… A well priced stock in the near term, that could become a backburner for more potential growth in the next few years.

I have few expectations for the next quarters.  Everything is based on judicious future acquisitions with this stock. The dividend offers some revenue while waiting. This stock might eventually replace Calian Technology in my portfolio.

Special SItuation: SNC Lavallin (TSE:SNC)

Another divestment decision: SNC LAVALLIN (TSE:SNC), I quickly bought and diverted from it. The scenario I based my investment decision on was for the company to come back from its problems and be like it was before, and clearly, what is unfolding is not in the right direction.

Allegations, rumors and accusations are fusing over multiple contracts from multiple regions of the world. So this regards being perceived less and less as a « regional mishap ».

What troubles me as investor is that if those things are true and that the problem is systemic, then the company has less incentive to win and complete contracts by being competitive and efficient. Plus, those things are a distraction to upper management from following the day to day business, as well as a major reputational risk. In similar situations, other companies had to change their names (example: Arthur Andersen now called Accenture I believe).

That beings said, considering that I have no edge on such complex and gigantic company, and that my scenario appears less likely… The conclusion was to divest. Better be safe than sorry.

Apple: Where is the Wow factor now?

Now that we are in the last stretch before year end, it’s to time to start talking about divestment decisions. My most recent one was to divest from Apple.

At first view, it seems hard to justify: The stock is still cheap,  there is a dividend, the growth still there. However, after almost doubling my inital investment, the question i am asking to myself is:  Within the next five years, could this stock still provide me a decent 15% return? A five year 15% return means basically that the stock doubles every five years. Could Apple still double within the next 5 years? Hum… Sales growth is great, profitability is still good but because of the fierce competition, is a bit down; Balance sheet is incredible and their recurring revenue model is still churning out wads of cash flow. 

However, the new products are refinements, not new concepts.  Hard to justify paying a premium for products where competition is offering something similar, if not sometimes technically better…. I personnally bought my first smartphone last month… and it was not an Iphone (it was a Samsung Galaxy 3).

That being said, I am not saying that Apple wil become the next Xerox. That would be ironic, since they in fact made the initial discoveries leading to the renewal of Apple in the 80’s (read about their story, it’s fascinating).  They still might surprise us. As an investor, that would be speculating a tad too much on future prospects. You might ask: How come I did invest in it last year? At this time, the risk reward ratio was way more  compelling than today.

One key thing I’ve learned in my experience: for tech stocks: staying king of the hill is tough.  Let’s see from the watch list how this unfolds.

The SmartAmateur Investing Mantra

Regular readers know I am a fan of Peter Lynch.

In one of his book (« Beating the Street ») Lynch mentions his meeting with a primary school (yes, a primary school !) where children were taught the basis of investing.  At the very end of the meeting, the children recite a list of maxims in chorus.  I found the maxims very interesting and invite you to read the book.  Over the years, I have devised my own set of maxims, loosely inspired from this tale. Here are my ones:

1- A good company usually increase its dividend every year and proceed to regular buyback.  One of the first thing I check on a company, is how they reward investors, and of course, if they have the means to perpetuate that policy.

2-You can lose money very quickly but  it takes a long time to make money. For 99,999% of « We, The People » this is a reality we have to keep in mind. Opportunity to make money quickly exist…. but very few of these are legal or not credulous investors traps… In other words: if you see opportunities for easy money in the market… be cautious. Another key aspect about time, is that keeping good stocks a long time, generally reduces the risk of an investment. I kept some of my winner stocks for years before divesting.

3-The stock market is not a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price. Markets are volatile, as it is in their nature. Investors must cope  with this volatility and learn that when the price goes down it does not mean they are wrong, and when it goes up, it does not mean they are right either.

4-You have to research the company before you put your money into it. Research means: looking at the balance sheet, looking at the business plan, the competition, the industry, the economic moats, until you feel you can talk about the company for at least FIVE minutes.

5-Diversification is important, because out every five stocks, one will do great, one bad, and the three others OK. Diversification is also a great protection against ignorance, specially when you invest in industries you are less familiar.

6-Exception to maxim #5: If you are NOT ignorant, focus on your winners. Few know it, but Peter Lynch admitted that with some pension funds he managed, his performance was better that its famed Magellan star fund. Why? because these pension funds were less restrictive on the proportion of a stock he could own. If I recall, Magellan was limited to 5%, while some pension funds allowed 20%. The latest allowed him to increase position on his biggest winners. An amateur investor has none of these restrictions. However, a careful risk/reward ratio assessment is critical, and you better be NOT ignorant about the company. I personnally used that approach half a dozen time in 20 years., with positions sometimes reaching 50% of my portfolio on one stock.

7-Keep an open mind. Don’t fall in love with your stock. Growth stocks will eventually stop growing (even Apple !). Revenue stocks could eventualy have difficulty paying dividends. Companies can have great ideas to create value and profits that may not work. Economic context and obsolescence can quickly alter an investment scenario. One of my first big winners in the 90’s was a furniture maker company called Shermag. That company does not exist anymore today, because of the chinese competition.

8-Whenever possible, invest where you have an edge. I am working in the IT sector and while not all my stocks are in this sectors, I did get some decent winners here.  Don’t forget your amateur edge either: small investors can invest in small cap companies much easily than could big investors.  In my case, most of my biggest winners were companies with less than 250 millions caps.

9-Revenue stocks are great, but on the long term, growth stocks is where you will make most of your money.  For every bank with good dividend (example: Scotia Bank) and decent growth, quadrupling every 10 years, you wil find more and bigger winners in growth stocks.

Finally, one of the most important and difficult maxim to apply:

10-Recognize your errors: making money with all your investment decisions is difficult, if not unrealistic. Admitting that an investment decision is wrong is never easy. It is important to realize that to achieve a decent performance, you only need a couple of performers in your portfolio. My very own situation for the year 2012, perfectly illustrates that point: three big winners (Tecsys, Apple and Dollarama), some future prospects on the back burners, some with decent dividends and some bad decisions I eventually removed from the portfolio quickly.

Tecsys: Something is happening. Something wonderful!?

Tecsys released very good numbers today.  I was agreably  surprised by the dividend hike and the size of the quarterly EPS.  Listening at the conff call, they indicate that the organic growth they are expecting will still require more employees.  You can refer to these previous posts about Tecsys for more detailled information :  post1 and post2.  For a software company, the headcount is a one of the key metric to evaluate how the business goes.

With the actual stock price (2.30$), it allows an entry point with a very compelling risk reward ratio. If the growth stalls, the dividend offers some support at this level. If this company continues rewarding investors as they do, with constant buy back and regular dividend increase plus on top of it, a greater organic growth, we might see something wonderful: a potential multi-bagger. 

The next quarters will tell how things will unfold. On my side, i have increased significantly my position on Tecsys in the portfolio.

Summer Reading: Free cash flow vs Earnings

For those of us looking on summer reading related to investment, here is a book demonstrating why it might be interesting to look at companies from another angle. The book is a bit pricey, but very interesting. I personnally grant significant importance at the cash flow generated by a company (I generally avoid companies with negative or low cash flow), and how it is being put to use (such as increasing capacity, sales, or… dividends and buybacks).

The extract below is from a globe and mail article at the following link: http://www.theglobeandmail.com/globe-investor/investment-ideas/number-cruncher/free-cash-flow-its-better-than-profit/article4408732/. I suggest you read it. They provide at the end of the article, a list of companies scoring pretty well on free cash flow. Dollarama is among them.

Free cash flow (or FCF) is cash available for investors after the company has funded its cash costs, its receivables and inventory and its capital expenditures. In his book, Free Cash Flow: Seeing Through the Accounting Fog Machine, author George C. Christy, CFA, makes a compelling case for the importance and impact of free cash flow on a company’s true value.

Mr. Christy quotes Alex Pollock of the American Enterprise Institute (AEI): “Every calculation of net profit reflects choices from among competing theories of accounting. … They are matters of opinion … not matters of fact. … Profit is an opinion, cash is a fact.”

 

2012 mid year assessment part 3: The rest of the pack

The rest of the portfolio can be spread into two categories:

1-Recently acquired, so too soon to conclude about their performance SNC lavallin (TSE:SNC)  and (TSE:MDF) falls in that category. I will elaborate more about Mediagrif in a specific post. SNC was bought because the entry point looked good below 40$.

2-Neutral or negative performance

Imperial Oil (TSE:IMO) stock is negatively impacted by the lower oil prices, particularly the oil sand crude. However, a closer look at the company shows they are not in bad shape, far from it. As explained in this post on pipelines, Imperial is an integrated company. What they produce, they can refine.  What they refine is not impacted by the same factors than oil markets. I expect that the refining portion will mitigate the impact of the production portion.  They plan to convert one more refinery to use oil sand crude (theirs and those of competitors), and they signed a long term letter of intent with a pipeline project  for Asia. That being said, this is the kind of stock testing your patience.  They invest so much in developping their capacity that they slowed down a lot on the dividend increase and share buyback that imperial’s long term investors were used to in the past 30 years until 2008. The actual price is a good entry point, for patient investors. In a couple of years, with a production rate doubled, better oil prices, resuming of dividend increases and share buybacks… The stock should strive way more than today.

Tecsys (TSE:TCS) just released its final 2012 quarter.  I’ve got a positive performance on it this year (+15%), but because the stock is so thinly traded, I do not account it so far. The volume I hold, were I to sell it, would drive the price down to my entry point. I have a post here giving more details on Tecsys. Some numbers are good (increase of backlog, increase of numbers of employess (+20%), increase of sales). Others are neutral (same level of eargnings, cash flow, recurring revenue, timid share buy back (most buybacks were for cancelling out employee options)). They key thing is the number of employees… Their headcount  numbers have been quite constant over the years. A 20+ increase is quite significant, and it is normal that short term, it drags earnings and cash flow down. Let’s see how things unfold in the next few quarters. This might be the beginning of something. NOTE: there was some insider buying since June. I would not jump to conclusion with a small buy signal, but as I said, this might be the beginning of something.

First Service Canyon (TSE:FRC) is being impacted by the project cuts from gas companies and the negative results from competitors (Trican Well Services (TSE:TCW)).  They have not yet released their results, but their last M&A (Management comments and Analysis)  hinted at what was coming.  In retrospective, I might have been a bit too optimistic with this stock (see this post). The good thing is that my entry point was relatively low (2011 greek scare at 10.65$), and the generous dividend dampers volatility on the stock. I will reevaluate my situation with their next quarter release.  I suspect it will be either waiting for better times (their dividend is only 20% of their free cash flow, balance sheet is  solid) or finding better stories. Waiting with a 6% dividend is not that bad… We will see.

Conclusion: so far, the portfolio performance is driven by two high profile growth stock, and thus more exposed to volatility.  I expect I will need some positive contribution from my other stocks to reach my objective… We’ll see how it unfolds in the next quarters.

2012 mid year assessment part2: The winners

Let’S talk about the winners:

Since the beginning of the year, the two big winners are without contest Apple (+50%) and Dollarama(+40%). Two high profile growth stocks. I owned them for about a year now, and they almost doubled.  Apple  is still cheap by all standards. The stock is evolving according its level of cash (about five times) not its growth prospects. Apple is facing more and more competition, however. Even if it is cheap, and offers a dividend, high profile stocks like Apple are highly volatile. I bought the stock because it was dirt cheap vs its growth, and it still is. A hold to me. Like any growth stock, particularly technical ones, the key question is always how long will this last? I might take partial profits later in the year.

Dollarama: the perfect growth stock story.  I am still surprised to see how popular this retail chain is. I just came back from vacation from the Lac St-Jean region, where I saw lots of customers buying a couple of dozens of items at the cash register. Except for the stock price (a bit pricey), all the lights are green (profits, growth, same sales store). Couple of hilights I retain from the latest quarterly results: the success of the higher priced items. 50% of their sales are now from higher priced items;  the new stock repurchase plan; their cash flow is incredible and they plan to introduce 3$ items, while adding new store. A stock to hold. I might buy more, if I resolve myself to buy the stock at this level. The good thing with retail stocks is that they do not become obsolete as quickly as technical stocks…. That being said, at the first blip, expect volatility.

Calian techbology achieved +24% since the beginning of the year  including the generous 6% dividend.  Since I owned the stock (bought last year) the performance is 12.7% including the dividend. This previous post provides more info on Calian. Apparently, investors were scared away by the government budget cuts; they came back when they saw the impact seems negligible on Calian business so far. That being said, there is nothing on the radar showing some kind of growth. The stock repurchase are slowing down too. They made a small acquisition of a chain of clinics in the previous quarter. We will wait for a couple more quarters to  find out what else could happen with this stock, who is a member of the ten/ten club (ten bagger in ten years or less)

 

2012 mid year assessment part#1: Divestment and Investment decisions

Well, well, well.

Here we are, with another year unfolding so far like the last three ones: good start, down, stalled. If the year continues like the other ones, we’ll likely finish near the winter summit.

We are still in the positive side, but quite halfway from my yearly 15% objective.

Let’s start elaborating the major divesting and investing moves since this winter:

1-Divest from Gasfrac (TSE:GFS): From the start, this stock was speculative and not fitting my usual investment criterias. I was curious about their new fracking technique, until they demonstrated that having a good idea is one thing, making it profitable is another. With the actual gas market, and their negative cash flow,  they might have difficulty surviving.  I divested just in time from this.

2-Invested and divested from Manitoba Telecom (TSE:MBT):  With the new CRTC rule, I was attracted by the fat dividend and the possibility of being acquired by a competitor (in clear, a fat dividend with a lottery ticket). Since then, the possibility of m&A appears more remote. The rumor is that the market does not value the assets as much as MBT does. The company itself is not fitting my basic criterias. TIme to redeploy into another story.

3-As indicated in previous post, I divested from Glentel (TSE:GLM): the growth story has hit a wall.  So far, my decision to divest had saved me from a big drop.

4-Invested in SNC Lavallin (TSE:SNC): SNC had been a ten bagger, and should have been on my list for a long time ago. Except that I am reluctant to invest in something i do not have an edge or don’t understand. Try understand what is the competitive edge of a company with contracts in 100 countries? I decided that the recent drop was an opportunity to get in with a relatively decent risk reward ratio.  Hopefully, this might help mitigate my ignorance…

5-Invested in Mediagrif (TSE:MDF): I will elaborate more on that stock in another post. The stock was fairly valued when i invested, but I was interested by the recurring revenu models of all the B2B and B2C web portals they host and manage. They recently raised their dividend. I am not expecting great short term move on that stock. Long term however…