March 13, 2019
On just another regular Tuesday, I felt the sudden urge to write up an update on what’s happening in my portfolio.
Good Wednesday Morning Fellow Investors!
I’ll try to keep it brief this morning (as brief as Zach can). The market has changed significantly since my Annual Review at the beginning of January. One thing I discussed is that it is very likely that the economy is closer to the next recession than it is to the last one (2008). As such, I am slowly repositioning my portfolio as opportunities arise. This includes focusing on cash-rich, recession-resistant companies trading at reasonable valuations.
I will briefly discuss these topics:
- Shopify
- Focus Companies
- My Discussion with BluMetric CEO
1. Shopify
I was very fortunate to come across this company near the end of 2016. It was the start of a long-held tradition of borrowing investment ideas from other investors working harder than me (great strategy by the way). In this case, it was the Motley Fool. I’m not entirely certain how I figured out the company name from their cryptic promotional emails, but I did. And boy am I glad I did.
Shopify has single-handedly made me look like a good investor. Some may ask what my portfolio performance would be if I removed Shopify—I just watched an interview where Ryan Irvine from Keystone Financial was asked the same question regarding Boyd Income Fund. Ryan laughed it off and said, “Well, you need your winners!” Ain’t that the truth!
Today, I decided to sell my position in Shopify. What changed?
I first bought Shopify at $53 and then doubled down at the end of 2017 at $121. Each of those times, Shopify was trading around 15x annual sales. By no means was it ever cheap—this was still a very high premium, but reasonably justified in my opinion for an amazing business with minimal competition.
Last year the company recorded just shy of $1.1B in revenue. In the fourth quarter their revenue grew 54%. For 2019, they expect their revenue to grow 39%, though they have a long history of exceeding their guidance.
Right now the company is valued just shy of $30B. That’s almost 30x last year’s sales! Sure, they have $2B in cash, so if you take away that, it’s closer to 25x, but still absurdly high.
Based on my assumption that an economic recession is likely to occur within the next 3 years, I expect that there will be a time where Shopify trades in the 5-10x sales range. If a recession were to occur at the end of 2 years, I estimate Shopify’s revenue would be about $2B annualized (though it could easily be worse), which would result in a $20B valuation at BEST ($160 per share if there is no further share dilution, which is very unlikely), which is a pretty bad 2-year return from today’s share price.
Part of my hesitation with Shopify is that I am constantly bombarded with dropshipping “gurus” on the internet, many of whom use Shopify as their platform. I personally have strong conviction that many of these “businesses” are unsustainable during an economic downturn. I think many will cease to exist and therefore stop paying Shopify their monthly fees. These behaviours are eerily similar to the crypto boom and others booms that have occurred in prosperous times before crashes (look at what happened to Nvidia during and after).
It’s not Shopify’s fault and I still think they’re an exceptional business, much like Nvidia.
Ultimately, there’s a good very good chance that things get better before they get worse for Shopify. I recall hearing so many stories of investors regretting selling out on Netflix, Amazon, Starbucks, etc. before they got REALLY big. I do ultimately envision Shopify becoming a $500B or even $1T company one day, so buying at $30B or a $10B valuation really doesn’t matter in the long term. The company will still likely grow $400B+ from my cost. Be assured thatShopify will very likely be one of my largest holdings again. Is it dumb for me to try to time the market? Sure. This is also partly an experiment for me as a relatively new investor.
Aside: I recently sold half my position in Kraken (PNG.V) for similar reasons. Check out Gerry Wimmer’s simple guidelines for appropriate small cap valuations (of course they vary depending on company growth).
But I’d be crazy not to try avoiding a 60% potential draw down in a company I own, especially considering that I see so many opportunities to invest in companies that can go UP that much in two years.
Which brings me to…
2. Focus Companies
“Cash-rich, recession-resistant companies trading at reasonable valuations.”
Constellation Software (CSU) was one of these companies for me at the beginning of the year, and sure enough, they announced a special dividend for the first time in their company’s existence: $20/share as opposed to their regular $1/share, ridding much of their cash. Though this is merely coincidence, it shows the power of this strategy.
EnWave (ENW.V) is perhaps my primary exception to this strategy as they are just growing too fast for me to not heavily invest. Check out their recent earnings.
Boyd (BYD.UN) is also a minor exception, but they are in a fairly recession resistant industry with fantastic management. I have been adding lots to them. Read their incredible story here.
Definitely not an exception though, and one I’m adding heavily to, is Knight Therapeutics (GUD), with more than 70% of their assets in cash. Read this excellent write-up on them here. This is 100% an investment in the CEO, Jonathan Goodman, and his capital allocation abilities.
I never thought I’d touch the medical industry, but Knight’s business model makes sense to me. They essentially take products that are proven in other countries and license and distribute them in Canada on behalf of companies who don’t know Canada well. Goodman is not shy in saying that their business would not exist if Canada’s regulatory environment was efficient. Check out the company presentation.
These are the small caps that are hot on my radar:
- RIWI (RIW.V): I literally just learned of this company yesterday morning. Once again it’s an idea I’m taking from someone that worked harder than me. Trevor has an excellent write-up here. Oh, and you should definitely subscribe to his FREE research reports (insane…). I am VERY excited about this company from what I have briefly read. I still have to do more due diligence, but there is a good chance I put a decent chunk of change in this company. They essentially do surveys better than anyone else to make predictions better than anyone else (like way better).
- Intrinsyc Technologies (ITC.V): basically an engineering consulting and design company for super cool and cutting-edge products. Seems like a bunch of nerds just having a fun time designing stuff. Their results are impressive and growth trajectory seems likely. I still have to do more research on the company, but check out the corporate presentation.
- Destiny Media (DSY.V): their website still uses the free version of Squarespace, so that tells you something. But seriously, check out their investor presentation and read the transcript of their most recent earnings call. I really like the management and the business. The only downside is the growth potential doesn’t seem huge as the music market overall isn’t that big. I’d prefer to buy the company a bit cheaper because of this, but I could be misvaluing their growth opportunity.
- BluMetric Environmental (BLM.V): see next section
Disclosure: I do not own any of the above small caps, but I could very likely buy any or all of them in the next 3 days.
I am still watching Dollarama (DOL) like a hawk, though it seems I might have to wait until after their next earnings release for the valuation I want. I could also miss out on a great opportunity—fortunately I have no shortage of investment opportunities (see above).
And Tucows (TC) is still probably one of my favourite companies, but their valuation is definitely quite rich, so patience is required.
Lastly, MTY Food Group (MTY) is approaching a very tempting valuation. It’s difficult because they’re definitely not a recession-resistant company, but certainly well operated. Read their fascinating story here, and why buying small caps can pay-off big time.
3. My Discussion with BluMetric CEO
Scott MacFabe, CEO of BluMetric was very gracious to take 15 minutes of his morning to answer questions from a pee-wee investor like me.
Scott took over the company almost exactly a year ago, and I was inspired when I read his recent Report to Shareholders. I highly recommend reading it (it’s short I promise).
My notes from the phone call were pretty sub-par (I’m still learning), so if I seem vague in the details, it’s because I haven’t put in the time to find/report them. To get the best understanding of the business, go to SEDAR and read the MD&A of their most recent quarterly results.
BluMetric is in a lot of environment-related businesses. I’m not going to break them down, but I will highlight some key businesses, one of which is their Reverse Osmosis technology, both for purification and desalination. This is oddly something I have been quite passionate about over the years (my friends can confirm), so this got me excited.
I liked the company, but was concerned about the culture. Glassdoor reviews were underwhelming during the prior CEO’s tenure, so I wanted to know what Scott was doing about it, since he mentioned it in his Report to Shareholders. This was the purpose of our call.
On the call, I learned that Scott has been quite active (he continued to reiterate how busy last year was). When he first joined the company, he removed outside counsel that many employees were unhappy with. He hasn’t heard complaints since. He emphasized that he believes there is a lot of untapped knowledge within the company.
He also closed El Salvador operations to focus their business strategy on key markets. And their team spent a significant time honestly identifying the markets where they really thrive (ie. not lying to themselves about success in certain businesses).
Most importantly though, he has implemented 4 “engagement counsels,”each one representing a different age cohort, and each represented by 1 person. These are broken down by years experience: 0-15, 15-25, 25+, and Emeritus (“retiring but wanting to stay engaged”). He said at any time he can (and does) reach out to these 4 representatives to get their feedback on various issues, and he personally addresses any issues that they bring up. He said he meets with them at least once a month.
I was honestly very impressed by this. It is so rare for companies to have effective means of communication with all their employees. This was exactly the kind of response I was looking for. He also said that internal promotions are awarded to those who have a history of looking out for others. Again, I could tell Scott was very genuine about this, and not just saying this to make me happy.
Scott decided to join the company because he has friends who were unhappy there and he wanted to improve the situation for them. This seemed like a major motivation for him, and as someone who works with his friend, I can say it is a very meaningful motivation.
Now more about the business. From what I understood, they have basically two businesses, a technology based one, and a environmental consulting one (“professional services”). The latter would include services such as evaluating groundwater and surface water conditions for a mine
Scott says historically they have been subject matter experts for the Department of National Defense (DND) in regards to all things water. BluMetric has their own fabrication plant for water treatment equipment just “down the road” from where he was. Some of this is used for industrial Reverse Osmosis as I mentioned before, others is used for emergency response, in which he mentioned the Canadian Armed Forces and the Haiti earthquake an examples, and this is an area that they actually want to focus on more.
Historically, it seems like BluMetric has done a lot of work for government agencies. But recently, they won a big contract with Seaspan Shipyards, a private and global company, for desalination systems on their ships, and Scott reiterates that this is a very big deal for them because it strengthens their credibility in the industry.
Now I know I wasn’t thorough with the details, but the proof is in the results, and already in his short tenure, Scott has made an impact, with 2018 earnings up 63% over the prior year. The business they are in is very “lumpy,” ie. revenue is inconsistent and not necessarily recurring, but I have a very good feeling about their leadership and potential for growth. Further, since a lot of their business is with government agencies, this revenue is usually fairly reliable.
To end off, here is the company’s description of Scott’s experience (emphasis added):
“Scott MacFabe is a strong and experienced executive with an extensive and varied background in environmental consulting in both Canada and the United States. He has been responsible for acquisition integration, and has led sizeable operations that served large clients and provided solutions to complicated environmental challenges. Most recently, Mr. MacFabe worked with an executive management team to reorganize and expand a premier US water/industrial/environmental firm. As part of that expansion, he was responsible for the development of a team which won and successfully executed the single largest design/build remediation project in the history of the firm. Earlier in his career, Mr. MacFabe helped to build an industrial/commercial consultancy firm and grew its sales to $50 million. His company was acquired by a major public multinational environmental consulting firm and he stayed on to assist with integration and to grow their Canadian operations. A Waterloo graduate in hydrogeology, Mr. MacFabe holds both professional hydrogeology and geology accreditations.”
Trading at 10x earnings and 5x EBITDA, the opportunity seems bright!
Once again, thanks for taking the time to read today, and if you would like to see my prior writings, the archive can be found here. As always, I’m just an email away 🙂
Cheers,
Zach
“We make a living by what we get. We make a life by what we give.”
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