Provided to subscribers August 8th.
Here is the latest from Canadian Value Investors!
Portfolio update
PBR update
Another odd lot TNET
Quick pitches from around the web
Other bits - Short selling is getting more dangerous, Canadian accounting shenanigans, and some investing history
Portfolio Update
There have been a few changes since the last update:
PBR Dividend Policy, Credit Rating Upgrade
Disclosure: We remain long PBR.A.
Since our last update, Petrobras has announced a few things. Most importantly:
1) Their highly anticipated new dividend policy. It sounds just fine; a middle ground we expected and not the dire outcome some expected. The new shareholder remuneration is based on 45% of Operating Cash Flow minus investments vs 60% of Operating Cash Flow minus capex. The quarterly distribution model is maintained and Q2 has been announced (see table). They have also incorporated the ability to now repurchase shares and these repurchases would be considered as part of shareholder remuneration. We are fine with some repurchases at current multiples, but would not want to see the dividend replaced exclusively by repurchases (which does not appear to be the plan). The buyback program will be done under a pilot of the net twelve months and expected to buy back 157MM preferred shares or 3.5%.
2) They also announced their sustainable capex target. Again, in line with our assumptions (assumed 20% FCF disappears, actual number 6-15%). These investments are supposed to be profitable per their guidelines, but we assume they will not be and hope to be wrong. As a side note, we expect Canadian large cap / integrated oil companies will ultimately spend similar levels (just look at the Pathways Alliance CCS budget, never mind other initiatives) and do not think this is fully priced in by the market yet.
3) S&P changed the outlook of its credit rating from stable to positive as a “reflection of the improved outlook of the Federative Republic of Brazil”.
Here’s the new plan, and the new dividend policy.
“Rio de Janeiro, August 7, 2023 – Petróleo Brasileiro S.A. – Petrobras, in relation to the news released in the media and as disclosed to the market on 06/01/2023, informs that the Strategic Plan 2024-2028 will have as a driver, among others, the forecast of low-carbon CAPEX for the range between 6% and 15% of the total CAPEX for the first five years of the new Plan, in compliance with current governance practices, the commitment to value creation and the Company's long-term financial sustainability.
This driver is aligned with the strategic elements that should be included in the plan, allowing the Company to (i) act in low-carbon businesses, diversifying the portfolio in a profitable way and promoting the perpetuation of Petrobras; (ii) operate in our businesses in a safe and sustainable manner, seeking decreasing emissions, promoting diversity and social development, contributing to a just energy transition and to the training of sustainability experts; and (iii) seek innovation to generate value for the business, supporting operational excellence and enabling solutions in new energies and decarbonization.”
For those keeping track, dividends are ~18% yield so far this year if you bought in the spring like we did while the stock is up 20-40% depending on the purchase. We still like the company at the current price.
For context, even with the increase in share price, this is how it is trading relative to a few well-known names using recent analyst estimates available to us. They have different assumptions than we do, but directionally it provides an indication of how they are being priced relatively using similar analyst assumptions for oil prices. Should PBR trade like Saudi Aramco or Chevron? Probably not, but maybe not so relatively cheap either. The key concern remaining for us is will their domestic diesel/etc pricing remain profitable, or will political pressure crush margins?
Maybe Lula isn’t so bad. “Brazil’s Leftist President Is Getting Things Done. The Markets Love It.” https://www.marketwatch.com/articles/brazils-leftist-president-is-getting-things-done-the-markets-love-it-9124bffa
Another odd lot - TNET
Disclosure: We do not currently own this but might purchase.
TNET is repurchasing shares at $107 vs ~$105.50 currently and they have an odd lot provision. Upside is ~US$149, closing by as late as September 13th. ~17% IRR. Do your own due diligence. We are on the sidelines due to account rebalancing and transfers. Details here: https://www.bamsec.com/filing/110465923086012/2?cik=937098
Quick Pitches from around the web
These are ideas we are evaluating, but currently have no position.
Gulf Island Fabrication turnaround
No Called Strikes Investing @NCSI_SA - $GIFI. Fabrication company that sold off an unprofitable shipyard division, made an accreditive acquisition, and is building a more robust backlog. All kick-started by a new CEO who I have a lot of respect for. Downside protection is a healthy cash balance and undervalued assets
CVI note: Market cap $57MM, but EV only $15.4MM considering net cash. New CEO (2019) turnaround three years in.
https://seekingalpha.com/article/4576264-gulf-island-fabrication-overlooked-unloved-and-undervalued
A quick look at the numbers.
Alto Ingredients ALTO– Jeremy Raper
Founder of Raper Capital is pushing for change at Alto Ingredients, Inc. (NASDAQ: ALTO), a producer and distributor of specialty alcohols and essential ingredients. On June 29, 2023, Jeremy published "An Open Letter to the Board of Alto Ingredients, Inc." on his website. An interview of the situation can be found here. https://youtu.be/yj3mg-r6q9E
Just yesterday, the CEO stepped down. Maybe something will come of this push indeed. https://www.globenewswire.com/news-release/2023/08/07/2719709/0/en/Alto-Ingredients-Announces-Executive-Leadership-Changes.html
Short selling is getting more dangerous
Another case study of the increasing dangers of shorting failing businesses. Yellow Corp declared bankruptcy, but not before its stock rallied 170% or so, reportedly due to “meme” investors. We continue to not short companies, maybe the odd put.
Example of what the discussions are like - https://www.reddit.com/r/DishTards/comments/15dwqp5/final_yellow_company_dd/
Background article - https://www.bloomberg.com/news/articles/2023-08-06/dan-loeb-surrendered-but-meme-army-still-hits-bears-for-millions
Accounting shenanigans overseas? How about right here at home in Canada
Hay & Watson has been blackballed. Thankfully, it is not the auditor of any of our holdings. We checked. In general, we are concerned about looser accounting and the regrowth of cancers like fifteen row “adjusted EBITDAs”. Maybe we are overdue for another big scandal and accounting standards overhaul.
TORONTO, August 5, 2023 – The Canadian Public Accountability Board has terminated the registration of Vancouver-based accounting firm Hay & Watson, Chartered Professional Accountants as a participating audit firm with the national audit regulator. The termination, which comes almost one year after Hay & Watson was banned by the CPAB’s counterpart in the United States, the Public Company Accounting Oversight Board, effectively bans the accounting firm from audit engagements of public companies.
https://www.canadian-accountant.com/content/profession/cpab-bans-hay-and-watson
A little bit of investing history
St. James Investment Company did a great quarterly letter covering a little bit of investing history.
https://stjic.com/wp-content/uploads/2023/07/STJIC-Adviser-Letter-2023-Q2-Final-3.pdf
If the S&P 500 was weighted equally, rather than by market capitalization, its performance over the last three years looks anemic. The equal weight index provides a better understanding of the breadth of the market and the economy. Of course, not all stocks are equal, as some hold greater significance than others. Some businesses are poised to benefit and grow more due to the ongoing AI revolution. One could argue that the aforementioned five companies provide substantial exposure to AI, potentially unleashing a wave of creative destruction. However, caution is warranted when 25% of the entire U.S. stock market capitalization is concentrated in just seven technology companies, trading at materially different earnings multiple of the remaining 3,687 businesses.
At its current price of $423, Nvidia is valued at forty times its annual revenue. If one heroically assumes that the company manages to compound revenue by 50% per year for three years, it will "only” trade at a multiple of twelve times hypothetical sales in 2026...hardly a screaming bargain. Of course, market history has an interesting way of repeating itself. The most exaggerated technology bubble occurred in 1928-29 when the Radio Corporation of America (RCA) captured the imagination of every speculator on Wall Street. RCA’s trading volume sometimes accounted for 20% of the total volume on the New York Stock Exchange. At the stock price peak in September 1929, the company was "valued" at $665 million. Sales increased from $65 million in 1927 to $102 million in 1928 to $182 million in 1929. Therefore, at the peak of the RCA stock buying frenzy, the company was "valued" at a multiple of "only" 3.6 revenue. Forty-five years later, in 1974, RCA’s annual sales were $4.6 billion, yet the stock price bottomed that year at $38, about one-third of its 1929 stock price high.2 While most rational investors consider Nvidia ‘slightly’ overvalued, market momentum could push fantasy valuations higher. Comparing the 1929 period of RCA and the current situation with Nvidia in 2023, one observes a similar pattern where most stocks experience decline while a handful of large companies powered the major indices higher. In both instances, unsuspecting investors maintained the illusion that the "market" was healthy.