Posts In: Gannon on Investing

Points International (PCOM): A 10%+ Growth Business That’s 100% Funded by the Float from Simultaneously Buying and Selling Airline Miles

Points International (PCOM) is a stock Andrew brought to me a couple weeks ago. It always looked like a potentially interesting stock – I’ll discuss why when I get to management’s guidance for what it hopes to achieve by 2022 – but, I wasn’t sure it’s a business model I could understand. After some more research into the business, I feel like I can at least guess at what this company is really doing and at how this helps airlines. My interpretation of what the company is doing is sometimes a bit different than what I’ve read about in write-ups of this stock on Value Investor’s Club, Seeking Alpha, etc. The company’s own investor presentation doesn’t lay things out quite the way I will here. So, everything you read in this initial interest post should be consumed with the understanding that it’s my best guess of how this business works – and that guess could be far off the mark.

Points International has 3 segments. One of these is “Loyalty Currency Retailing”. That segment produces more than 100% of the company’s economic profit because the other 2 segments together add up to a slight loss, break even result, etc. depending on the exact year or quarter. At this point, I see no reason to assign any value – positive or negative – to the other two business segments. Points International also says it serves a lot of different clients. It mentions a total of 60 clients who it does some work for. However, only 30 use even one of the company’s “Loyalty Currency Retailing” functions. As a side note: in a YouTube video I saw, the company’s President seems to mention the number 36 in reference to Loyalty Currency Retailing – so, when I say “30” going by the company’s reports to regulators and so on, the actual number may now be 36 but I’m not 100% sure that’s what the President was referencing. So, I’m going to keep saying they have about 30 out of 60 clients actually allowing them to do any Loyalty Currency Retailing. Loyalty Currency Retailing is the only business that produces value here. So, all profits are from only 30 (or so) “partners”. Customer concentration seems extreme here if you read the note that 70-75% of revenue comes from 3 partners. However, gross profit is the more meaningful measure here. I would just cross out revenue and replace it with gross profit for most discussions of this company. The one exception would be “float”. I’ll discuss that later. It’s possibly best to treat gross profit as this company’s top line revenue and to treat the reported revenue as a form of “billings” as other marketing companies might put it. So, gross profit concentration is such that 80% of gross profits comes from 12 partners. Based on other things the company says, I would assume these partners are airlines based in the U.S. and Europe. I think the concentration here is really that almost all profits …

F.W. Thorpe: A Good Business Making Durable Products that May Have Already Peaked

Today’s initial interest post is a company I like a lot. It’s trading at a price that could be justifiable – possibly – based on that company’s past performance. But, it’s not a stock I’m going to give a very high initial interest level too. The reason for that is uncertainty about the future.

I’ll get to that uncertainty in a second. First, I want to describe what FW Thorpe does. The company makes lights. I won’t go into too much detail here. You can always read a company’s annual report for yourself. So, I hate to go into analysis free re-hashes of a company’s basic business model. I’ll do that a little here, though, because I don’t want you to think FW Thorpe makes light bulbs for your house.

The company’s focus in on professional lighting with the lowest cost of total ownership. It makes lights for everything from clean rooms to warehouses to retail shops. FW Thorpe’s products are used for street lights, in tunnels, up on the ceiling of the office you may be working in now (though, if you’re not in the U.K. or the Netherlands – it’s a lot less likely that’s an FW Thorpe product). The company also makes lighting for emergency signs. It has a business unit that seems to me to be focused on making emergency sign lighting that complies with regulations while looking aesthetically pleasing (the customers all seem like locations that care about the look of the interior of their building). Some lighting is used to illuminate advertisements and things like that. It’s a whole variety of professional lighting where the main focus is not having the cheapest initial purchase price. It’s about what the lighting does and how little it’ll cost you in electricity bills, replacement, etc. over many years into the future.

Basically: FW Thorpe makes lights. Decades ago, lighting was not a very durable product. But, that changed in recent years. Unfortunately, not so recent that we’re still in the middle of this shift from more disposal lighting to more durable lighting. What was once often fluorescent (and incandescent) lighting became LED. As you probably know, a lot of governments put in rules phasing out incandescent lighting. Many of these rules were put in place anywhere from 5-15 years ago. So, again – we’re talking about a tailwind that was stronger in the past than it will be in the future.

I’m sure there are people reading this who know more about the lifespans of incandescent, fluorescent, and LED lights. But, from what checks I could make – it seems that a typical LED light can have a life as much as 10 times that of a typical fluorescent lamp. I was, however, able to find references to some fluorescent lamps designed to have similar lifespans to LED lights. So, companies have probably always been working on extending the lifespan of any of these types of lighting. For us as investors here – the problem is that …

Gamehost: Operator of 3 “Local Monopoly” Type Casinos in Alberta, Canada – Spending the Minimum on Cap-Ex and Paying the Maximum in Dividends

Today’s initial interest write-up is a lot like yesterday’s. Yesterday, I wrote about an Alberta based company paying out roughly 100% of its free cash flow as dividends. In fact, that company was paying almost nothing in cap-ex. Today’s company is doing the same. It pays almost everything out in dividends. And it doesn’t spend much on cap-ex. So, cash flow from operations translates pretty cleanly into dividends. And like yesterday’s stock being written up (Vitreous Glass) – today’s stock being written-up (Gamehost) probably attracts a lot of investors with its high dividend yield. As I write this, Gamehost’s dividend yield is a bit over 8%. Like the dividend yield on Vitreous Glass – that sounds high. But, you need to be careful. If a stock is paying almost all of its free cash flow – and, in fact, almost all of its cash flow from operations in this case – out as a dividend, then you might need a much higher dividend yield than you’d think. There are three reasons for this. One, if the company pays everything out in dividends then it’s obviously not paying down debt or buying back stock or piling up cash. So, the free cash flow yield is no higher than the dividend yield. A dividend yield of 8% sounds amazing. But, a stock trading at 12.5 times free cash flow (for an 8% free cash flow yield) isn’t unheard of. It’s still cheap. But, you need to do some research to make sure there aren’t good reasons for it being that cheap. Two, the dividend coverage ratio is obviously 1 to 1 on a stock that has a dividend payout ratio of roughly 100%. A stock paying out just one-third of its earnings as dividends can see its earnings drop by 65% and still cover the dividend from that year’s earnings. Any decrease in the earnings of a stock with a 100% payout ratio would threaten the dividend. Three, it’s usually hard for a company to grow it sales, earnings, free cash flow, etc. over time if it retains literally no earnings in any period. For some companies, it’s not impossible. But, for a stock like Gamehost – which does have a fair amount of tangible assets – it’s impossible to organically grow those things aside from just capacity utilization increases. Luckily, Gamehost’s properties are currently operating far below capacity. When I describe what these properties are and – most importantly – WHERE they are, you’ll see why.

Gamehost’s EBITDA and other measures of earning power peaked about 5 years ago. The company operates both hotels and casinos in Alberta. It also provides food and beverage services in those hotels and casinos. The company claims to have 3 segments – casinos, hotels, and food and beverage. It also owns a strip mall. However, the only real source of profit we’ll be talking about here is the first segment: casinos. The other segments don’t lose money. They make a slight profit. And they do …

Vitreous Glass: A Low-Growth, High Dividend Yield Stock with Incredible Returns on Equity and Incredibly Frightening Supplier and Customer Concentration Risks

Vitreous Glass is a stock with some similarities to businesses I’ve liked in the past – NACCO, cement producers, lime producers, Ball (BLL), etc. It has a single plant located close enough to a couple customers (fiberglass producers) and with an exclusive source of supply (glass beverage bottles from the Canadian province of Alberta that need to be recycled) and – most importantly – the commodity (glass) can’t be shipped very far because the value to weight ratio is so low that the price of transportation quickly exceeds the price being charged for the glass itself (absent those shipping costs). The stock is also overlooked. It’s a microcap with fairly low float, beta, etc. It’s also a simple business. And capital allocation is as simple as it gets. The company pays out basically all the free cash flow it generates as dividends. And operating cash flow converts to free cash flow at a very high rate, because the company spends very little on cap-ex.

That’s most of the good news. The one other bit of good news is the stock’s price. As I write this, the stock trades at about 3.60 Canadian Dollars. I did a quick calculation of what seemed to be the normal trend in dividends these past few years. The company pays out a quarterly dividend that pretty much varies with quarterly cash flow from operations. So, it’s not a perfectly even dividend from quarter-to-quarter. But, it seems fairly stable when averaged over 4, 8, 12, etc. quarters and compared to cash flow from operations. If we do that – I’d say the current pace of dividends seems to be right around 0.36 cents per share each year. In other words, the dividend yield is 10%. There are other ways to estimate this. For example, we can use the price-to-sales ratio (EV/Sales would be similar, the company has some cash and no debt) and compare it to the free cash flow margin we’d expect. Then assume that all FCF will be paid out in dividends. Again, we get numbers suggesting future annual dividends are likely to be a lot closer to 10% of today’s stock price than say 5%.

There is some bad news though. One bit of bad news is the difficulty I’ve had in this initial interest post verifying certain important facts about the business. In preparation for this write-up, I read 3-4 different write-ups of this stock at various blogs, Value Investors Club, etc. I read the company’s filings on SEDAR (the Canadian version of America’s EDGAR). While I believe the information in the blog posts to be true -they’re getting those facts from somewhere, I can’t independently verify certain things about the supply agreement, the specific customers buying from Vitreous Glass, etc. Having said that, nothing I found in the accounting and in the filing overall really seemed to contradict what I read in the blog posts. And I did notice some stuff in the accounting that matches up pretty strongly with the …

Psychemedics (PMD): A High Quality, Low Growth Business with a Dividend Yield Over 7% – And A Third of the Business About to Disappear

Psychemedics (PMD) is a micro-cap stock (market cap around $50 million right now) that trades on the NASDAQ. It is not – by my usual definitions – a particularly overlooked stock. The beta is about 0.53 (low, but many stocks I’ve written about have much lower betas). The share turnover rate – taking recent volume in the stock and multiplying it to see how much of a company’s total shares outstanding would turn over in a given year at this recent rate of trading – is 102%. Again, that’s not an especially high number for the market overall. It might not be high compared to the stocks in most people’s portfolios. But, it’s very high for any sort of truly “overlooked” stock. There are some possible explanations here. Some recent events have caused Psychemedics stock to be especially volatile (this suggests the low-ish beta of 0.53 is more the result of very low correlation with the overall market than of actual low volatility in the stock) and insiders own very few shares of this company. In fact, there’s a ton of float and very few long-term investors in this stock. To give you some idea: insiders all own about 3% or less of the stock individually (and less than 10% taken all together) and Renaissance Technologies (a quant fund) was the largest holder of the stock as of the last proxy statement. This points to a stock that is not closely held by insiders, not generally held by long-term investors, etc. So, it trades a lot. It may not be overlooked. But, it’s still a micro-cap stock. And there’s a decent chance you haven’t seen a longer write-up of this particular stock. So, I do consider it overlooked enough to at least do an “initial interest post”. This is that post.

Psychemedics is in one line of business: hair testing for drugs. Actual testing services make up over 90% of revenue in any given year. The rest of revenue is all very closely related revenue such as charging for the actual collection and shipping of hair samples (in some cases). This is really just a drug testing company that uses hair to do the tests. That’s all you need to know. Historically, almost all revenue and earnings and so on came from the United States. Almost all costs still do come from the U.S. The company is headquartered in Massachusetts and rents about 4,000 square feet there, the actual lab is a rented facility in Culver City, California. Although the lab facility is rented – the equipment is owned. Psychemedics in an asset light business with one exception: it owns a lot of lab equipment. The company depreciates the equipment over 5-7 years. If you do the math on what the equipment was valued at gross, what cap-ex on the equipment is, etc. – this is the one asset heavy part of the business. The company’s assets really consist of technical know-how and a bunch of lab equipment for drug …

Vertu Motors (VTU): A U.K. Car Dealer, “Davis Double Play”, and Geoff’s Latest Purchase

Accounts I manage own some shares of Vertu Motors (VTU) – bought last week – but, far less than a normal position. Whether we end up owning a full position – that is, having something like 20% of the portfolio in Vertu – or not depends mostly on whether the stock’s price comes down and stays down for a while. As I write this, shares of Vertu trade for about 40 pence. They were as low as 31 pence not too long ago.

I wrote the stock up last year. For my initial thoughts on Vertu, read that post. For a good overview of the entire U.K. auto industry and the various publicly traded companies in it – read Kevin Wilde’s post.

I’m going to spend most of this post talking about whether Vertu is cheap enough to buy now. Before I do that, I should talk a little about Cambria Automobiles (CAMB). I had planned to do a write-up of Cambria before writing up Vertu. I decided not to. My reason for skipping a write-up of Cambria is that I realized I just didn’t have much to say about the stock. Cambria has somewhat better margins and inventory turns than Vertu. So, the actual business provides a bit higher returns on tangible invested capital. On top of this, Cambria has not issued more shares over time while Vertu has. Vertu did two very costly capital raises – both many years ago – that severely diluted existing shareholders at low values versus tangible book. This has had a big influence on the outperformance of Cambria as a stock over Vertu. One possible explanation of this is that top insiders at Cambria own between 40% and 50% of that company. At Vertu, the two biggest insiders combined own something closer to 5% of the stock. Management’s incentives for compounding PER SHARE wealth at Cambria are greater than they are at Vertu. Until recently, Cambria’s management talked a lot more about the kind of metrics shareholders care about than Vertu did. In the last couple years, this seems to have changed – with Vertu’s management using a lot of the usual buzzwords about shareholder value. And then – in the very recent past – Vertu’s actions followed those words. The company bought back over 2% of its shares outstanding in the first 6 months of this year. Those purchases were done at very big discounts to tangible book.

That explains my increased interest in Vertu today versus years ago. It doesn’t explain my reasons for preferring Vertu over Cambria. I should be clear here. I don’t really think of it as preferring Vertu over Cambria. Ultimately, I didn’t decide Cambria wouldn’t outperform Vertu – it may FAR outperform Vertu for all I know – I just decided to pass on Cambria. In a recent podcast, I told Andrew “We almost never bet on change.” I suppose you could argue a bet on Vertu is a bet on a …