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

Ammo Inc. POWW – Do you feel lucky, punk?

Provided to subscribers September 25th.

Here is the latest from Canadian Value Investors!

• New idea – Ammo Inc. POWW – Do you feel lucky, punk?

• Ideas from around the web - Crowdsourcing

• Microcap conference highlight - How do you make 100x?

• Our portfolio impact score

Ammo Inc. POWW – Do you feel lucky, punk?

Disclosure: We own this one.

Do we like AMMO, Inc. because of its ticker, POWW? We do like fun tickers (PBR is still our favourite). However, we do try to not be biased by these things. Instead, we think that POWW is potentially significantly under-valued, definitely under-followed, and underlying improvements are hidden by accounting. It is a story of two companies, the first in turnaround and the Ebay-of-guns – gunbroker.com - hiding underneath with a new CEO focusing on the right things. This is our kind of story.

TLDR: Market cap is $234MM at $1.99 share price - Gunbroker throws off roughly $30MM (ignoring upside from new initiatives) and if valued at a high single digit multiple, of say 8x, you would get you a $100-200MM revenue ammo business and ~$40MM of cash for free. 

We always seek feedback on our articles, but more so than usual here. If you have any insight into this idea, send us a note! We currently have a relatively small position for the reasons noted below.

What is Ammo, Inc.?

We would like to start by saying this has a bit of a complicated history that we will attempt to explain briefly. It really is a tale of two companies, the original ammo company started in 2016 and then later the acquired gunbroker.com website.

Ammo came into existence in 2016 and prior to this was a shell/failed company:

“-On this date, our CEO and Chairman, Fred Wagenhals, acquired the outstanding shares of the former Company, resulting in a change of control

-The name of the company was changed to AMMO, Inc.

-The OTC trading symbol was changed to POWW

-As the sole director, Mr. Wagenhals approved a 1-for-25 reverse stock split

-A plan of merger was filed to re-domicile and change the state of incorporation from California to Delaware

-Under the domicile change, a new certificate of incorporation was filed increasing the number of authorized shares of common stock from 15.0 million to 100 million; establishing a par value of $0.001

On March 17, 2017, AMMO Inc. acquired all of the outstanding shares of a private company incorporated in the State of Delaware, using the same trade name "AMMO, Inc.".  The combined operations for AMMO, Inc. was reorganized as a designer, manufacturer, and marketer of performance-driven, high-quality and innovative ammunition products.

The Ammo Business

The original vision for Ammo, Inc. seems to have taken a shotgun approach. The idea was to purchase and/or make partnerships with companies and inventors to produce unique proprietary products, like streak visual ammunition (licensed from University of Louisiana at Lafayette). What is “streak visual ammunition” anyway?  https://youtu.be/uT7kdJq4bZA?si=TY-crshbIwnvukWm

Overall, this has been a bit painful so far. However, there have been two recent changes that are unfolding: 1) The Company opened a new manufacturing plant in Wisconsin in August 2022 and 2) Ammo is streamlining its product offerings to focus on higher margin products with lower working capital needs (e.g. making just shell casings instead of a complete bullet) instead of chasing volumes.

Unfortunately, similar to some other industries, the U.S. ammo industry is working through inventory overhang and customer over purchasing during COVID. An interesting case study is ammo.com (see chart below) - https://ammo.com/coronavirus-impact-on-ammunition-sales This macro environment has not been helpful.

Note: Financials are off-cycle, with FY2023 ending March 31, 2023 (i.e. the new plant opened mid-FY2023).

Gunbroker.com

What is gunbroker.com? The website was launched in 1999 by Steve Urvan. Over the years it became the eBay of guns (and was actually created because eBay banned gun sales). It is by far the largest online gun website in the U.S.  and has the same network effects of eBay while also benefitting from regulatory red tape slowing down competitors. 38% of FFL (Federal Firearms License) holders (think stores) use the site. An individual lists their gun and can sell it to anyone in the U.S. However, guns can only be picked up by purchasers at a FFL, which does a background check through the National Instant Criminal Background Check System (NICS) before handing it off.

We want to pause here on the potential value of the platform. It takes a bit of time to understand gun culture if you are not in it and we imagine some of our Canadian readers might be particularly unaccustomed. It is not just utility. Not all guns are equal. There are many types of buyers; many customize their guns and some collect antiques. Ever seen a Martini-Henry? https://en.wikipedia.org/wiki/Martini%E2%80%93Henry This makes an eBay platform very valuable for some buyers and it does not necessarily compete against the gun-Walmarts of the world.

The site takes a percentage of every sale and has 50% operating margins (~$30MM on a market cap of $234MM for the whole business). More importantly, it has these margins while not having any credit card processing, shipping assistance/service, or even a shopping cart. You literally have to buy one gun at a time and ammo and accessories are not to be found on the site, yet. See the plan below.

It was opportunistically purchased by Ammo in the middle of COVID. They acquired it for $240MM, albeit in a complicated deal structure that led to two years of board battles after Steve joined the Board. - https://www.globenewswire.com/en/news-release/2021/05/03/2221342/0/en/AMMO-Inc-Announces-Closing-of-Acquisition-of-GunBroker-com.html The two key issues were the vision for gunbroker (whether it should be a neutral platform or promote Ammo ammo) and Steve’s compensation for the sale (significant stock, which declined in price after the deal). It is a bit awkward that the combined entity’s market cap approximates the purchase price.

The Board problems appear to be largely settled (see background notes below), with the new CEO coming in a few months after the Settlement Agreement.

The Bull and Bear Cases

Crowdsourcing Ideas

We are always looking for new ideas. Here’s a great list we are looking through ourselves. https://x.com/ClarkSquareCap/status/1704297844402713043

See post for more ideas.

How do you make 100x?

This was one of our favourite talks at the recent Planet Microcap showcase. https://youtu.be/8oVfaLurCVI?si=ulmRga2xgzIznIQj

Our portfolio impact score

Unfortunately, our concentrated portfolio of things like coal, oil, and canned vegetables does not pass the impact test.