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

Solitron Devices, Inc. (OTCPK:SODI) Is Tim Eriksen building a baby Berkshire?

Provided to subscribers June 22nd.

Here’s the latest from Canadian Value Investors!

  • Graftech Note Issuance – Oof

  • Need to park cash? Use SHV

  • Solitron Devices, Inc. (OTCPK:SODI) Is Tim Eriksen building a baby Berkshire?

  • Bonus Bloomberg – Defense spending is booming

Graftech NYSE:EAF New Note Issuance

Disclosure: We do not own this.

We posted about Graftech on May 28th (see member post). Oof. First, operational hiccups at Graftech $EAF last year are still hanging around causing sales problems almost a year later, and now another $25MM a year of CF disappearing to higher interest costs vs a year ago. This effectively covers the term facility so at least covenants probably aren’t a concern now. Still on the sidelines. https://www.graftech.com/investors/news/news-details/2023/GrafTech-Prices-Offering-of-450-Million-of-Senior-Secured-Notes/default.aspx

Need to park cash? Use SHV

We usually do not carry much cash, but sometimes we are between ideas and trades. One place to park your cash is ishares short-term treasury ETF, SHV. Why SHV? It only holds U.S. Treasury bonds that mature in less than 1 year, so you have very little duration risk. Current yield to maturity is 5.11%.

This is the best we have found for a as close to riskless ETF to park cash. We have not been able to find a Canadian dollar equivalent; all of the ETFs we have looked at have long duration and/or corporate issuances. We have no interest in taking on either of these risks with our cash. If you have a better U.S. dollar ETF or an idea for a Canadian dollar denominated one, please let us know!

https://www.ishares.com/us/products/239466/ishares-short-treasury-bond-etf

Solitron Devices, Inc. (OTCPK:SODI) Is Tim Eriksen building a baby Berkshire?

Disclosure: We currently own this.

For readers that have been around for awhile, you know that we have been following Solitron Devices, Inc. for a few years now. Our first article was May 2022 - Reading the Turnaround Tea Leaves - followed by an update in July. Our writings have typically focused on things that we have acquired but have had several requests for articles covering what we have not purchased and why. This is a great example. We think there might be something here, but have not yet pulled the trigger. Here’s why.

Since our last update, CEO Tim Eriksen and company have been busy.

As a quick refresh:

-Solitron makes power control modules/junctions/etc, for weapons systems and airplanes like the B-52 bomber. This is typically sticky business supporting the life of the system, so long as you perform. And lives can be long, shown best by the B-52 that has been around in one form or another since 1952.

-Tim Eriksen, activist investor turned CEO, is a few years into a turnaround with major step changes, including moving their facility to a cheaper/better owned facility and is in the middle of rationalizing and improving production.

-The U.S. government continues to prioritize smaller contractors as part of their Increasing Opportunities for Small Businesses policy (see original article).

-We stayed on the sidelines last year primarily because 1) we were unsure of the success of their plant move (i.e. what true run-rate sales and costs would become), and 2) we were unsure where they would put their cash. We now have an answer to one and almost both questions.

-Since our initial check, the Ukraine war has create a bit of an embarrassing weapons stockpile problem for the U.S. “Slower manufacturing and expenditure of reserves in Ukraine have many worried about the state of U.S. munition stockpiles and military readiness.” https://www.heritage.org/defense/report/rapidly-depleting-munitions-stockpiles-point-necessary-changes-policy

Our initial analysis and July update was as follows. How have things gone? They just provided their (off-cycle February) 2023 year-end financials.

Key highlights:

1) The trickle down of the U.S. stockpile problem leading to sales – “As we noted in our fiscal third quarter release, in December 2022 the President signed the $1.7 trillion omnibus spending bill.  Included in the bill are appropriations to replenish supplies used in Ukraine and to increase stockpiles.  A number of programs are included in the spending, including two that represent Solitron‘s two largest revenue sources.  The increased stockpiles program is a multi-year program that we currently expect to add approximately $20 million in total revenues starting in late calendar 2024 and running through 2028, or approximately $4 million annually.  Actual contract awards are expected to occur by the fall of 2024.”

2) Sales were impacted by the plant move as expected. “Bookings were strong in the quarter, exceeding $3.5 million and backlog finished at $9.1 million, our highest quarter end level since February 2021.” We note that some 2022 sales were actually pulled from 2023 in advance of the move.

3) Most importantly, it looks like Tim and Co are indeed trying to use the company as platform to grow into something larger through public holdings and acquisitions (see notes below). They had $4.3MM of cash and investments at year-end. For us, this means we need to ignore the surplus cash and instead make assumptions about expected returns.

“We had significant unrealized gains on investments during the fiscal fourth quarter and fiscal year 2023. In the middle of the fiscal year the Board approved a revision to our approach toward investments to allow for more concentrated positions. We purchased 1.1% and 1.5%, respectively, of the outstanding shares of two small community banks that were recipients of the Emergency Capital Investment Program (ECIP). …

On June 1 Solitron signed a non-binding term sheet for a potential acquisition of a target company which produces electronic components primarily for the medical industry.  We are now in a due diligence process which is estimated to last approximately 75 days.   The terms set forth in the term sheet contemplate that, if completed, the acquisition would be funded from cash and securities on hand.  An initial payment of approximately $3.0 million would be due upon close.  Additional earnout payments of up to approximately $450,000 each would be payable over each of the next three years.   The target company produces electronic components primarily for the medical industry.  Revenue for 2022 was approximately $5.9 million as compared to $5.5 million in 2021.  One customer accounted for approximately 90% of revenues.   We can make no guarantees that the transaction will be able to be consummated, or if it is that it will yield the results or benefits desired or anticipated.”

They are also doing concentrated bets on holdings; these appear to crossover with Tim Eriksen’s fund. https://www.eriksencapitalmgmt.com/manager

We had significant unrealized gains on investments during the fiscal fourth quarter and fiscal year 2023.  In the middle of the fiscal year the Board approved a revision to our approach toward investments to allow for more concentrated positions.  We purchased 1.1% and 1.5%, respectively, of the outstanding shares of two small community banks that were recipients of the Emergency Capital Investment Program (ECIP).   Due to increased interest rates, we also moved most of our cash to treasury bills which is considered Short-term investments on the balance sheet.    

Our takeaways

-

Bloomberg - Defense Spending is Booming

Bloomberg - Has the Ukraine war started a new arms race? Yes, to judge by figures published on Monday by the Stockholm International Peace Research Institute, a think-tank. Global defence spending rose by 3.7% in real terms in 2022 to a record $2.24trn. It shot up by 9.2% in Russia and septupled in Ukraine. Farther west in Europe, military spending grew by 3.6% to levels unseen since the end of the cold war.

Yet the picture is fuzzy. The economic burden of armed forces, at 2.2% of GDP, remains close to its post-cold-war low. In part, the world economy has grown. Of the biggest arms spenders, America was flat and China dipped as a share of GDP. But many of the promised spending increases are yet to come. Inflation may abate. And geopolitical tension—a long war in Ukraine, and talk of a future one between America and China—will push countries to buy ever more weapons.