SODI, POWW, Petrobras, and more investing ideas from around the world

Provided to subscribers October 18th.  

Here is the latest from Canadian Value Investors!

• Solitron SODI /Ammo, Inc. POWW Updates

• Petrobras – Highest production ever

• Investing in Japan

• Ideas from around the world - Investing in Bhutan

• China Tensions

We would first like to say that we do not mean to be doomsayers, even though our portfolio being weighted towards guns, oil, and canned vegetables might give this appearance. They are just the best opportunities we have found at the moment and, oddly enough, the original purchases were not driven by the macro tailwinds we are having. We are actively seeking out happier ideas. If only the LEGO Group was a public company. https://www.lego.com/en-us/aboutus/lego-group

Solitron SODI /Ammo, Inc. POWW Updates

Disclosure: We continue to own these.

Since our last update, Hamas attacked Israel and concerns it might turn into a much larger issue has brought even more attention to defence/gun companies. Here is a chart of our two related holdings as well as some large cap peers that we do not own. Ammo appears to be outrunning the rest on no news. There does seem to be an uptick in garbage posts on Twitter about it (see next), which might be playing a role given the small market cap (previously ~$200MM, now ~$300MM).

Solitron provided a bit more color on their acquisition of Micro Engineering. We also found the actual stock purchase agreement via a filing. Here you go.  https://www.sec.gov/Archives/edgar/data/91668/000165495423011547/sodi_ex101.htm

Effective September 1 Solitron closed its acquisition of Micro Engineering Inc. (MEI) based in Apopka, Florida. MEI specializes in solving design layout and manufacturing challenges while maximizing efficiency and keeping flexibility to meet unique customer needs. Since 1980 the MEI team has been dedicated to overcoming obstacles to provide cost efficient and rapid results. MEI specializes in low to mid volume projects that require engineering dedication, quality systems and efficient manufacturing.

The transaction was structured as a stock purchase. An initial payment of $3.0 million was made at closing. Additional earnout payments of up to 7.5% of annual revenue, or approximately $450,000 each, would be payable over each of the next three years. MEI produces electronic components primarily for the medical industry. Revenue for 2022 was approximately $5.9 million (unaudited) as compared to approximately $5.5 million (unaudited) in 2021. Unaudited operating income was approximately $1.3 million in 2022 and approximately $1.2 million in 2021. One customer accounted for approximately 90% of revenues in both 2021 and 2022.

The full stock purchase agreement includes full balance sheet for the working capital adjustment calculations. The table below is from the end of the report; it appears that YTD net income is running below 2021/2022, but maybe the business has some seasonality to it.

Now that the new facility is up and running, things seem to be trending in the right direction for the core business.

Net Sales. Net sales for the three months ended August 31, 2023 increased 18% to $2,579,000 as compared to $2,187,000 for the three months ended August 31, 2022. The increase in net sales was largely due to customer delivery schedules.

Net bookings for the three months ended August 31, 2023 increased 39% to $2,231,000 versus $1,607,000 during the three months ended August 31, 2022. Backlog as of August 31, 2023 increased 85% to $8,785,000 as compared to a backlog of $4,755,000 as of August 31, 2022.

Petrobras – Highest production ever

Disclosure: We continue to own this.

The good news keeps coming for Petrobras. They recently beat their all-time high production while oil floats in the $80s.

Rio de Janeiro, October 16, 2023 - Petróleo Brasileiro S.A. – Petrobras informs that it broke its quarterly record for operated oil and gas production in the third quarter of this year, with 3.98 MMboed (million barrels of oil equivalent per day), 7.8% above the second quarter. It also achieved a monthly record for operated production in September, with a volume of 4.1 MMboed, 6.8% higher than in August.

Although the stock is up 70-80% year-to-date (depending on share series and currency), it has not really moved that much… now has it? Looking back to this day in 2019, Petrobras traded at around the same market cap and an EV / earnings multiple of ~18x, while today it is trading at EV / earnings of ~5x even though oil prices are more robust, debt is well managed, and actual operating performance is stronger. But maybe shares in this business really are just worth 3-ish times earnings. We will ponder this question while we continue to collect our dividends (about 20% YTD).

Investing in Japan

Disclosure: We have no positions except through Berkshire itself. 

Back in the middle of COVID, Warren Buffett bought five of the big trading houses in Japan. And in typical Buffett fashion, he has done fabulously well.

• ITOCHU Corporation TSE:8001

• Marubeni Corporation TSE:8002

• Mitsubishi Corporation TSE:8058

• Mitsui & Co., Ltd. TSE:8031

• Naito & Co., Ltd. TSE:7624

Interestingly, he has recently been adding to his positions. Maybe the party is not over with P/Es of around 10x currently. Why did he invest in the first place? Here’s an overview we found.

Value Punks' Daye Deng on why Warren Buffett $BRK invested in Japanese Trading Companies https://podcasts.apple.com/ca/podcast/yet-another-value-podcast/id1526149547?i=1000631149927

If the large caps are interesting, might not the microcaps be even more interesting? Some think so. We ourselves are interested, but we would be starting from scratch and are finding wonderful opportunities locally. Still, maybe we should look closer.

The Case for Japanese MicroCaps with David Baeckelandt, Head of Client Relations at SuMi TRUST https://podcasts.apple.com/ca/podcast/planet-microcap-podcast-microcap-investing-strategies/id1024217659?i=1000631057120

Ideas from around the world - Investing in Bhutan

Disclosure: We have no investments in Bhutan.

The Royal Securities Exchange of Bhutan (RSEB) is one of the smallest in the world with a total market capitalization of its listed companies totaling ~$700M at the time of this writing. The exchange opened in 1993 and offered electronic trading in 2012. There are currently 19 companies listed on the exchange.

https://opusletter.substack.com/p/investing-adventures-in-bhutan

China Tensions - First case of expropriation of Chinese assets in the U.S.?

Arkansas has become the first state to order that a Chinese company give up ownership of local land, amid fears of attempts by Beijing to malignly infiltrate and influence the U.S. through various means.

On Tuesday, Governor Sarah Huckabee Sanders announced that she was ordering Syngenta to relinquish its 160 acres of land holdings in northeastern Arkansas, accusing its owner of "posing a clear threat to our state." The Switzerland-headquartered agricultural chemicals producer was acquired in 2017 by the state-owned China National Chemical Corporation, and primarily trades in pesticides and seeds.

https://www.newsweek.com/china-land-arkansas-sarah-huckabee-sanders-1835652

Startek NYSE:SRT and Weekend Pitches

Provided to subscribers on September 2nd.

\Here is the latest from Canadian Value Investors!

• Long weekend reading – Pitches from around the web

• What does President Lula tweet about anyway?

• Startek (NYSE:SRT) back in play, Charlie Brown?

Quick pitches from around the web

Disclosure: At publication we do not have a position in any of these, but are evaluating.

The rise of Crocs (NASDAQ:CROCX) – Crocs shoes have taken the fashion world and value investing community by storm. We have never owned a pair and do not intend to, but always appreciate a remarkable growth story combined with thoughtful share repurchases. Is this a fad or a durable brand? https://unconventionalvalue.substack.com/p/whats-behind-the-rise-of-crocs

Thread here - https://x.com/andrewrangeley/status/1693695373410238968?s=12&t=S1ewsT6UpWXPOoivWFxT6w

Worthington Industries (WOR) – “Forthcoming “early 2024” spin-off of steel processing business could unleash more buyback, dividend, and/or M&A activity at the RemainCo”. Great piece on a neat situation. https://www.flyoverstocks.com/p/flyover-stock-worthington-industries

Mueller Industries (NYSE: MLI) – “Mueller Industries is a 100-year-old sleeper industrial machinery small-cap in the HVAC, refrigeration, and plumbing space. Although boosted by previously rising copper prices, Mueller’s revenue growth, profit margins, and returns on equity and capital are compelling. Underfollowed and underbought, the market assigns a deep discount to the stock price.” https://davidjwaldron.substack.com/p/mueller-industries-nyse-mli

Gypsum Management & Supply ($GMS) – “Another wonderful distribution business”. This one peaked our interest given our continued position in Taiga Building Products (TSX:TBL, please just buy us out at a nice premium Avarga) https://justvalue.substack.com/p/gypsum-management-and-supply-gms?utm_medium=reader2

And remember you can always copy Michael Burry of Big Short fame - https://x.com/burrytracker/status/1692287456543162718?s=12&t=S1ewsT6UpWXPOoivWFxT6w

Quick note Petrobras (PBR) - What does President Lula tweet about anyway?

As part of our approach to keep on top of Petrobras, we follow a number of accounts including El Presidente Lula. Tweets are high volume and interesting. https://twitter.com/LulaOficial/status/1696495122182029425

Petrobras’ new CEO Jean Paul Pratesalso posts, and sometimes important tidbits come up like information on refining pricing (one of our key concerns). E.g. the official narrative is that they are blaming gas station owners for high prices. https://twitter.com/jeanpaulprates/status/1658498615441014789            

Startek (NYSE:SRT) back in play, Charlie Brown?

Disclosure: At publication we own a small position in this.

Majority owner CSP is back at it again, trying to take Startek private. The new offer has no financing conditions and is 22% above the current share price. But, will it go through this time or are we poor Charlie Brown?

The new offer press release:

DENVER--(BUSINESS WIRE)-- The board of directors of Startek, Inc. (SRT) has formed a special committee of independent directors that is authorized to evaluate the non-binding proposal, dated July 18, 2023, by CSP Management Limited to acquire all the shares of Startek that it does not already own for $3.80 in cash per share. CSP is currently the beneficial owner of approximately 56% of the outstanding shares of Startek. CSP states in its non-binding proposal that it is not contemplating selling its interests in Startek or approving any combination of Startek with, or a sale of all or substantially all of the assets of Startek to, any other potentially interested party.

The special committee has engaged Gibson, Dunn & Crutcher LLP as its counsel and Houlihan Lokey, Inc. as its financial advisor to assist in its consideration of the proposal.

Startek cautions its stockholders and others considering trading in its securities that the proposal by CSP was received only recently and that no decisions have been made by the special committee about how to respond. A copy of the proposal letter from CSP is available as an exhibit to CSP’s statement of beneficial ownership on Schedule 13D/A as publicly filed with the Securities and Exchange Commission.

The Proposed Transaction

The offer per CSP’s filing:

On July 18, 2023, CSP EAF II GP Limited, as general partner of CSP Fund II LP (“CSP EAF”), an entity affiliated with the Reporting Persons, submitted an offer letter (the “Proposal”) to the Issuer’s board of directors (the “Board of Directors”) to acquire all of the outstanding shares of Common Stock of the Issuer not already beneficially owned by the Reporting Persons at a price per share of $3.80 in cash (the “Proposed Transaction”).

CSP EAF intends to finance the Proposed Transaction with fully committed equity capital, which will be provided by one or more investment funds affiliated with CSP EAF (such affiliated investment funds, together with CSP EAF, “CSP II”). The Proposed Transaction would result in a de-listing and de-registration of the Common Stock.

What’s different?

This time around, it is a largely different set of independent directors and a different advisor, but a new meaningful shareholder - MCI - is making some noise. In the macro, peers have also declined. Will this new lower offer clear?

MCI

One wildcard is MCI. Since the last go-around, MCI acquired ~7% of outstanding shares at a cost base of ~$4.20. They are not happy and have sent the Board a letter telling them so. MCI also owns call centers. It is possible that their position could help with a higher final bid. We are a bit confused by their purchase; they already knew the Startek CSP ownership control and should have been able to guess CSP would attempt to take the company private again.

Most importantly – “Further, unlike the recent Movate f/k/a CSS transaction, which CSP also controlled both sides of, a fairness opinion should be required this time by the Board of Directors (and/or Committee) to effect this deal. We hope that the Board, and particularly the Directors not affiliated with the controlling stockholder, will carefully consider these concerns, and take appropriate steps to protect the interests of the minority stockholders, including, but not limited to, requiring that a “majority of the minority” approve the take-private transaction. We believe such (a) requirement(s) is (are) generally recognized as (a) market protection(s) afforded to holders against self-interested transactions by a controlling stockholder and is a basis for a more favorable standard for review under Delaware Law. We call on other Company stockholders who may share our concerns to review and make their views known.”

Edgar here - https://www.sec.gov/edgar/browse/?CIK=0001031029

Board Changes

Since 2022, the independent Board Member composition has changed significantly. As a quick recap, the 2022 offer was rejected by a committee of independent directors, of which there were three (the rest are tied to CSP). Per the Q2 2023 report:

On July 18, 2023, CSP EAF II GP Limited general partner of CSP Fund II LP (“CSP”) has submited an open offer ("the Proposal") to acquire all of the outstanding shares of common stock (“Common Shares”) of Startek, Inc. (“Startek”) that are not already beneficially owned by CSP Management Limited at a price per share of $ 3.80 in cash. Subsequently, the Board of Startek has appointed a Special Committee comprising of three independent directors to evaluate the Proposal. The Committee has appointed independent advisors to assist them in their evaluation.

Their full rejection:

Special Committee of Startek Updates Stockholders on Status of Preliminary Non-Binding Proposal by CSP

September 9, 2022

DENVER--(BUSINESS WIRE)--Sep. 9, 2022-- The Special Committee of the Board of Directors of Startek, Inc. (NYSE: SRT) announced today that it has rejected the preliminary, non-binding proposal, dated August 8, 2022, by CSP Management Limited and certain of its affiliates (collectively, CSP) to acquire all the shares of Startek that CSP does not already own for $4.65 per share in cash. CSP is currently the beneficial owner of approximately 56% of the outstanding shares of Startek.

In July 2022, at the request of the Committee, management of the Company prepared an updated financial forecast (Forecast) for the 2022 calendar year and the four following calendar years 2023 to 2026. The Forecast projects annual revenue growth, beginning in calendar year 2023 and for the duration of the Forecast period, to exceed 5%. The Forecast projects that the margin for variable profit and for adjusted earnings before interest, taxes, depreciation and amortization, will steadily increase over the Forecast period, with the latter approaching 11% by calendar year 2026. The Forecast was reviewed by the full Board of Directors of the Company to ensure the Board's comments were reflected. On August 1, the Company provided the Forecast to the Committee. The Committee and its financial and legal advisors separately engaged in several additional discussions with management of the Company to assist the Committee in determining whether to adopt the Forecast for purposes of evaluating the CSP proposal.

Based upon this work, the Committee  to return the Company to improved financial performance over the Forecast period. The Committee adopted the Forecast for purposes of evaluating the CSP proposal. The factors that the Committee has considered include the trading history of Startek stock, financial analyses of Startek using the Forecast, the macroeconomic environment, the Company’s limited float and liquidity, the ability to pay of a financial sponsor such as CSP, communications that the Committee has received from shareholders, and CSP’s statement that it is currently not a seller of its majority stake in the Company. The Committee has determined, at this time, that the proposal at $4.65 is inadequate and not in the best interests of the shareholders of Startek.

Foros, the Committee's financial advisor, notified CSP on August 21, 2022 that the Committee had determined that the proposed price of $4.65 was inadequate and explained the basis for this determination as described in the preceding paragraphs of this press release. Since that time, rather than submitting a revised proposal, CSP has repeatedly requested more “specific directional guidance on how [the Committee] is thinking about value and price.” The Committee considered this request by taking into account that CSP already possesses the full Forecast and has understood since August 21 that the Committee is using this Forecast for its financial analysis of proposals by CSP. After considering this factor, as well as the Committee’s objective of maximizing value for shareholders, the Committee determined and informed CSP that it would be inappropriate and redundant to provide additional directional guidance to CSP beyond the explanations already provided to CSP. The Committee has reiterated to CSP that the Committee remains available to evaluate and respond to a revised proposal by CSP.

There can be no assurance that any revised proposal or definitive offer will be made or accepted, that any agreement will be executed, or that any transaction will be consummated.

Foros is serving as financial advisor to the Special Committee and Freshfields is serving as legal counsel.

So, the original committee was the three independent directors. What’s changed? One left (Julie) and two more came in. They never disclosed if it was a unanimous vote, but the member who left seems like one that would vote against, and new members were recruited and elected post-offer failure. 

Side note: One quick way to check historical Board Member composition is using the wayback machine (web archive), but of course pulling the actual filings is better and should be double checked. - https://web.archive.org/web/20220930095633/https://investor.startek.com/corporate-governance/board-of-directors/

Advisors – 2022 vs 2023

The financial advisor the Board has selected this time around is a top tier advisor for a company of their size. A fairness opinion from them could give Board Members comfort indeed.

2022 bid – “Foros is serving as financial advisor to the Special Committee and Freshfields is serving as legal counsel.”

2023 – Houlihan Lokey advisor and legal with Gibson, Dunn & Crutcher. Houlihan has been around for 50 years and was #1 in 2022 for M&A deals under $1B.  https://middlemarketgrowth.org/awards-2023-investment-bank-of-the-year-houlihan-lokey/

The Over-Under

Is there a bet here? Or maybe we should take George Bush’s ethos to heart – “Fool me once… shame on – shame on you. Fool me… you can’t get fooled again”? https://youtu.be/KjmjqlOPd6A For now, it is interesting enough to us for a small position.

American Coastal Insurance Corporation – A hidden gem, or hiding in the eye of a hurricane?

Provided to subscribers Aug 17

Here’s the latest from Canadian Value Investors!

• American Coastal Insurance Corporation – A hidden gem, or hiding in the eye of a hurricane?

• Suncor Q2 update; Petrobras note

• Other ideas from around the world

• Michael Burry is shorting, but what is he buying?

• Berkshire Q2 update and Buffett’s 44% CAGR

https://www.instagram.com/reel/Cvvwt12tRZn

American Coastal – A hidden gem, or hiding in the eye of a hurricane?

Disclosure: We own this one.

Sohra Peak Capital Partners recently posted a pitch on American Coastal Insurance Corporation (NASDAQ: ACIC). What are your thoughts on investing in a growing insurance company focused on niche insurance for smaller multi-unit complexes with a great reputation and a very nice twenty-year track record? What if this was an insurance company that provides hurricane insurance in Florida and was a subsidiary of a recently bankrupt parent?

[ACIC] a commercial property & casualty insurance carrier in the state of Florida that exclusively insures garden-style condominium and homeowner association properties against hurricanes and other catastrophe risks. American Coastal is a gem of a business hiding in plain sight. Since its founding in 2007, American Coastal has dominated its niche and captured 40% of its TAM. It has also delivered an average ROE of 23.1%, has demonstrated exceptional loss and profitability ratios, and has never had an unprofitable year despite withstanding several major hurricanes.

Shares appear exceptionally undervalued based on our EPS estimates of $1.89-$2.86/share over FY24-29 vs. share price of $5.63. Our estimates imply a FY24E P/E of 2.9x, FY25E P/E of 1.9x, and a P/BV and P/TBV of <1x by mid-FY25 while delivering 53% ROE. From FY25 onward, with a healthy capital surplus, American Coastal should return 100% of its incremental net profits to shareholders, which would imply a ~50% dividend yield and/or significant share repurchases. We see an asymmetric path for to appreciate from $5.63 today to $16.00 $22.00 over the next 24-36 months.

It is one of the better reports we have come across. Here is the write up. https://t.co/zWkMGn97AN

Here is the post - https://twitter.com/JonCukierwar/status/1689225931636809729

A key part of the thesis is that competitors have been leaving the space, which should help maintain and even grow underwriting margins. Some competitors have indeed left  (https://www.nbcmiami.com/responds/another-insurer-is-withdrawing-part-of-business-from-florida-what-happens-next/3070500/ ) while the Florida state-backed insurer (meant to be a last resort and primarily provides insurance to homes) is now the biggest (

https://www.bloomberg.com/news/articles/2023-08-10/hurricane-season-2023-florida-s-biggest-property-insurer-is-nonprofit-citizens ) and is trying to stop growing ( https://www.nbcmiami.com/news/local/floridas-largest-property-insurer-shifting-184000-homeowner-policies-from-citizens-to-private-insurers/3087706/ ).

We do not feel we have a lot to add beyond the write up and we do have a long position. If any readers have particular expertise in this niche, please reach out. Of course, as always, do your own due diligence.

Florida man rocks out to Slayer during hurricane

Suncor Q2 Update

-FFO of ~$3B+ YTD on lower than today oil pricing is not so bad. YTD brent was $79.80, and every dollar higher is $180MM AFFO, so with spot at $87 or so it would be another $600MM YTD. Refining is doing great.

-CEO Richard Kruger’s comments on the “refocus” is appropriate to us. https://www.cbc.ca/news/canada/calgary/suncor-too-focused-on-energy-transition-rich-kruger-says-1.6937360 Suncor got a bit lost, and I am glad they divested their renewables businesses that they had absolutely no competitive advantage in. Per the transcript: “The lack of emphasis on today's business drivers and while important, we have a bit of a disproportionate emphasis on the longer term energy transition. Today, we win by creating value through our large integrated asset base underpinned by oil sands. Discussions have occurred with our board of directors who are supportive of our revised direction and tone. And I would just leave this with more to come, but you can expect a sharper, clearer, more tangible articulation of how Suncor plans to win.”

-Importantly, we think the transition efforts are going to be forced anyway via things like the Pathways Alliance. We are still viewing the transition costs as either being $5-6B of hidden debt or a few hundred million of hidden annual capex.

-Repurchases are fantastic. What a table. We understand them slowing down on the repurchases; debt providers are not friendly and we would assume debt capital will be continually less available (coal is the canary). We are not too worried about it as they might hit their $12B net debt target early next year, and then they will switch to 75% of surplus FCF to repurchases.

As for Petrobras

We are still more bullish on Petrobras; seems like a better risk/reward (we own both, but a bit more PBR than SU). Petrobras just announced a big gas/diesel price hike, which them not doing was one of the biggest things I was worried about. https://www.energyportal.eu/news/brazils-petrobras-hikes-fuel-prices-after-abrupt-global-spike/163566/ We are keeping close tabs on this one. The CEO noted the increase on Twitter and is implying that gas station owners are to blame for high prices!

Other ideas from around the world

We have no positions in these companies but are evaluating.

“Cigar butt za Price/Earnings 2x” - SigmaTron International Inc. NASDAQ:SGMA is a circuit board assembly company that has made it to our screens a few times but we never had a chance to look into trading at a very low P/E. But is all as it seems? Currently do not own. Current market cap of $141MM. Great write up here (we suggest Google translate) - https://jakubkriz.substack.com/p/sigmatron-international-inc-cigar

Housing shortage? Why not look at engineered wood products? Atlas Engineered Wood Products TSXV:AEP “There’s no doubt that Canada is currently in the midst of a housing supply crunch and Atlas Engineered Products would be there to capitalize on this opportunity. $AEP.V is an ambitious growth company focused on acquiring and operating well-established, profitable businesses in Canada's truss and engineered wood products industry. The company's strategy involves both consolidating the fragmented industry through acquisitions and pursuing organic growth and efficiency improvements.” https://thechopwoodcarrywater.substack.com/p/strong-future-in-canadas-wood-products

Speaking of homebuilding.

If you are interested in staying on top of the housing industry, we suggest keeping tabs on the National Association of Home Builders. Here’s the latest on availability of materials for example.

https://www.nahb.org/news-and-economics/housing-economics/indices/remodeling-market-index

Michael Burry is shorting, but what is he buying?

We saw the headlines about Michael B of The Big Short fame’s new bet on the market crashing - https://www.telegraph.co.uk/investing/shares/michael-burry-big-short-stock-market-crash-wall-street/

Mr Burry’s firm, Scion Asset Management, has bought $866m in “put options” against a fund that tracks the S&P 500, the American benchmark index. These give investors the right to sell shares at a fixed price in the future and means that he could make a profit if shares fall.

Bearish news, of course, but the real story is more nuanced. He also went long bulk shippers and a whole of other things like WBD. With indexes dominated by a few very high multiple companies (see “The problem with the S&P” https://www.canadianvalueinvestors.com/cvi-club-ideas/2023/7/9/2023-mid-year-portfolio-update ), going short the index and long companies you believe are undervalued is a neat approach.

Berkshire Q2 update and Buffett's 44% CAGR

Here are the latest purchases at Berkshire in Q2. The Japan trade is amazingly timed and well done.

It brings to mind this article from Base Hit Investing we came across. https://basehitinvesting.substack.com/p/buffetts-44-cagr-and-various-types

“I've noticed three common themes with Buffett's recent investments in energy and Japan: low valuations, improving capital allocation, and rising ROIC's.

Warren Buffett initially invested in 5 Japanese stocks in 2020 and I don't think many people realize how successful this investment has been so far: That initial basket investment is up over 200%: a 3x in 3 years, or 44% CAGR on that initial investment. Each stock is up over 2x, one is up 5x, and the basket in aggregate up 3x.”

I see three things that Buffett probably saw (among other things) in Japan and also in energy:

1. Cheap valuations

2. Rising ROIC's

3. Significant change in capital allocation policies

Disclaimer - The content contained in this blog represents the opinions of contributors. You should assume contributors might have positions in the securities discussed and that this creates a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance whatsoever and are subject to certain risks, uncertainties and other factors. Information might also be completely out of date and may or may not be updated. No one here guarantees the accuracy of any information provided and none of the information should be construed as investment advice under any circumstance. Frankly, no information here should be used for any purpose except for entertainment (and we hope you enjoy).

Portfolio Update, PBR, odd lots, and pitches

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.