Update on the Research

I haven't had a lot of time to research any new companies lately. I have 20 or so that I have come across (and know nothing about) that I plan to have a quick look at. I'm about to sit down (in front of the Blackcaps chasing down Pakistan's 290) and look at these. Hopefully a couple will warrant a more in depth look and be an option for my 20k challenge portfolio.

A Theory on TFC

A Theory on the TFC Share Price

TFS Corporation (ASX:TFC) as a company has got stronger over the past couple of years. However, after a rerate two years ago the share price has gone backwards. Normally, I only focus on company fundamentals and not worry about the share price. I know if I've done my homework well the share price will take care of itself.

I still have the same belief in TFC. 

This quote from John Maynard Keynes is one of my favourites: "Markets can remain irrational longer than you can stay solvent". So here is me trying to explain what is most likely the market being irrational.

TFC are exposed to commodities. Their specific commodity is Indian Sandalwood. The market price of Indian sandalwood has gone up for the past 20 years. TFC are the only company that own a sustainable source of Indian Sandalwood. They also have long term agreements in place at $4,500/kg of oil (and more to follow), which is almost double the current market rate. And there it is, the word "oil". 

Take a look at the next two graphs. The first is the short rate of TFC. That is, people that are betting the share price will go down. The second is the crude oil price.

It may be a coincidence, but there is definitely a corelation between the two graphs. Does the market actually see a relation between the two? I cannot see any reasonable explanation. However, 8% of the total number of shares have been shorted.

Those that believe in the TFC story have a great opportunity to buy some shares on sale. With the strong fundamentals, and the potential that any significant price movement will force people to cover  short positions we could see a significant rerate in the not too distant future.

Entry Point Support Holding for MBE and TFC... So far

The timing of my purchases of MBE and TFC was based the recent price action. It goes without saying that my purchase price was attractive to me from a fundamental point of view.

MBE

MBE was oversold on the RSI, had just filled at gap between 29 and 29.5c, held above an old resistance line at 29c and bounced off the 200 day EMA. There was also good buy depth at 29.5 and 30.

A few days have passed and support has been tested and held a few times with good buy depth still at 29.5 and 30c. It looks like we have found a temporary bottom and evidence is building that the bottom has been found, however, tomorrow will be telling after today's 30c close.

TFC

TFC was a similar story to MBE. Hit oversold on the RSI after a big sell-off. Support rushed in at 129-130c and has held for a few days. There was a nice bounce today to close at 134c. There has been growing short interest in TFC over the past two years, and any sizeable rally could mean some short covering.

Second Purchase - TFS Corporation Beaten Down to a Buy

I have decided to initiate a position in TFC. I purchased 1700 at 130c. Once again I will split my position over two parcels (this time I will have more than 1 day between purchases!). The timing here involves an element of risk due to the recent substantial fall.

I have outlined the business in a recent post, but here are the facts behind my investment.

Monday’s price drop has potentially marked “capitulation” as the price was beaten down to close at 129.5c. The RSI shows it’s oversold, and there was good support coming in around the 130 level. Today’s pre-market shows very good support around these levels. There also is not a lot on offer on the sell side.

As mentioned in the previous post on TFC, it is very much a long-term play, with the significant future cash flow potential from large harvests still a few years away.

I believe the company is fundamentally undervalued at these levels. They trade on a trailing PE of 3.7 currently (SP of $1.30). Note this includes revaluation of plantation assets as they mature towards harvest. Some believe this is overstated. The revaluation assumes an end oil price that is much lower than what they have achieved with their agreements. I believe they have proved their business model and the revaluation is fair (it is also audited). Trailing Price/Cash EBITDA ratio (excluding non-cash revaluation etc) is 7.3. Cash EBITDA is forecast to grow by 5-10%. I believe reported NPAT will grow by more (last year this was 37% vs cash EBITDA growth of 12%) as it has in the past due to revaluation of assets.

Given my relatively short one-year timeframe (the market may continue to ignore TFC), I need a bit more than that to invest. Catalysts that I believe will have a positive impact on the share price this year are:

·         Announcement of agreements with new end markets

·         Financial results

·         Results of harvesting and subsequent sale of wood/oil

·         High establishment fees for managed plantation investors than prior years

·         Positive results from the pharmaceutical trials and Benzac sales. The reverse applies obviously

·         All the above will continue to prove the business model which will allow build investor confidence.

I will consider closing my position if there is a significant rerate. Normally I wouldn’t do this. I see significant long-term upside for the company, but given the one-year timeframe of this portfolio it will be important to lock in profits for what is otherwise a relatively long-term investment thesis.

The Portfolio

Here is the portfolio:

It's been a turbulent time, but that was expected when I started the challenge. The volatile start will hopefully equate to bigger gains after a year.

MBE position established 22-25 January 2016

TFC position established 27- January 2016

PRO position established 16- February 2016

Not sure why the image quality is so bad.

Empired - Has the Recent Sell-off Offered an Opportunity?

Empired (ASX:EPD) have been on my radar for a while. I have never committed too much time to researching them because they have appeared to be fully valued.

After the recent drop I decided it could be time to invest. The reported PE ratio is 6-7 and revenue is expected to grow. I read through the reasons for the lower guidance and they say it is all one-off in nature. These are situations that sometimes offer investors a cheap entry due to one bad year and then it's business as usual and the SP recovers.

They indicate H2FY16 will be back to normal. This is always something to be careful about as sometimes management overlook reasons for these events. I am always very sceptical until there is sufficient evidence to prove a one-off is in fact a one-off.

In this situation I don't think I will invest just yet. The reasons for the lower guidance include integration of an acquisition and what appears to be poor contract execution. This may not be the case, but I want to see evidence of their EBITDA margins returning back to their reported target of around 8-10%. Once they prove that it was a one-off hiccup I will look further into the company and consider investing. Until then I will watch with interest.

First Position Complete

I wasn't necessarily expecting to complete my position in Mobile Embrace (as discussed in a previous post) one day on from the first parcel, but I have. I put in an order at 30.5c after it opened at 32.5c. There was good support at 30c so I thought I'd jump in the queue. Anyway - just before the end of day auction my order had been filled. 

7,350 shares at 30.5. My position in MBE is now complete. I will add a post to track my positions and performance.

TFS Corporation Enters My Thinking

TFS Corporation (ASX:TFC) has been a company I have watched (and owned) for a while. I won't go into detail, I will quickly outline the company and the reason it has come onto the radar.

TFC grows Indian sandalwood plantations and sells oil and wood to high value end markets (they have a deal with Galderma for $4500/kg of oil).

It has recently dropped from $1.90 to $1.30 on no news. The company has reaffirmed guidance a number of times during this drop. Four directors purchased shares in October 2015.

In my opinion 2016 is a big year for the company. 

This year marks the first meaningful harvest of which they will have a significant volume of oil to sell. They have previously proven their ability to successfully harvest and sell oil, but I am of the belief the market wants to see proof on a larger scale. There is currently no reason to believe they won't be able to achieve this.

Currently they have agreements with 2 companies (one being Galderma) to sell oil for $4,500/kg. There are a number of other end markets currently in the pipeline. I believe the market wants to see more end uses for the oil/wood before investing. There is a potential perceived risk that they won't be able to sell all their harvested wood. The company is confident these agreements will be reached and they are likely to occur in 2016.

The problem with investing in this company in the 2016 challenge portfolio is the long term nature of their cashflow. It is not until 2020 that the harvest size becomes large and has the potential for significant cashflow. Therefore, the market may not catch on for a few years yet.

There are also people who aren't happy with the revaluation of the trees which significantly adds to the companies reported profit. This won't matter once the trees are converted to oil, but it is something to note regarding investor sentiment. The PE based on reported profit is currently very attractive at 3.4.

I really like this company. There are a number of reasons why market sentiment might not work in favour of the company in 2016, but if it keeps dropping I will certainly consider adding it to the portfolio. 2016 has the potential to cause a significant rerate.

For more detailed analysis see this link for a number of reports:

http://www.tfsltd.com.au/investors/shareholders/broker-research/

XPD Soccer Gear - What Gives?

As part of a screen I ran I came across XPD Soccer Gear (ASX:XPD).

On the face of it, this company ticks a lot of boxes. For starters it is growing quickly and has a PE of only 6, and has plenty of cash to cover its debts. This got me excited so I continued with my research.

The company is a Chinese company that listed on the ASX through a holding company in Hong Kong. They are in the business of selling soccer gear to the rapidly growing Chinese market (great, right?).

They listed on the ASX last year to raise $5-15m to fund growth. This is a relatively common thing to do. However, before listing, the company already had around $20m cash on the balance sheet. They are also highly profitable. So why go to all the effort of listing and diluting ownership to raise such a small amount? The short answer is I don't know. I simply cannot come up with a good reason for this. They seem to have plenty of cash to fund their own growth, so why go to the market now?

They reported they were to build another factory to allow for growth, however, this has been pushed back without reasonable explanation.

There is a history of some Chinese companies overstating things to their overseas investors. There's been cases where financial results have been completely fabricated. I'm not saying this is the case here, but we should proceed with caution. Getting money out of China to overseas investors can be difficult. 

Trying to justify what the market is doing is not usually recommended as it will lead to bad investment decisions. However, I ask myself why it has applied a low multiple to the company. I can only assume this is due to the risks I am worried about.

Everything could be OK with XPD, I have no evidence to prove otherwise. There are just a few things that smell a bit to me and that's enough to stop me from investing. I will periodically look up the stock to see how it's tracking. Is it be too good to be true? Only time will tell, and I will find out, either way, from the sidelines.

The First Purchase

The first purchase in the $20K challenge portfolio is......

Mobile Embrace Limited (ASX:MBE)

On Friday 22 January 2016 I purchased 7,275 shares at 31.5c. I intend to spend the remaining $2,500 allocated to the company over the next few days.

Investment Thesis

I won't go into huge detail here, but I will outline the primary reasons for investing in the company.

I have followed this company for a couple of years while they have experienced some good growth.

The business has two main arms: mobile advertising and mobile payments. The worldwide shift towards smartphones is obviously a massive tailwind for the industry and why I am excited about the company. The company is based in Australia where it has built a successful business. It has recently become fully operational in the UK along with some South East Asian countries. Revenue from overseas is expanding at a rapid rate.

Due to increasing business costs profitability has been patchy and hard to predict, however, a lot of the expenses that have caused this are becoming more predictable.

Key financial information

Revenue Growth:

FY13 - $12.2m

FY14 - $19.3m

FY15 - $33m

HY16 forecast - >$27m

The above shows some impressive revenue growth over the past few years, and a good forecast going forward. However, revenue growth means nothing if it doesn't eventually reach the bottom line. The company is close to leveraging good returns from its cost base.

HY16 profit forecast is for >$3.5m EBITDA, and >$7.5m underlying EBITDA. The $4m difference comes from a one-off cost associated with customer acquisition that will be earnings accretive over the next few years.

I expect H2 of FY16 to be considerably better than H1, however for the purpose of conservatism I will assume they will be the same.

Reported EBITDA, assuming further one-offs for FY16~ $7.5m. This will roughly translate to $4.9m NPAT or 1.2cps

Reported EBITDA, assuming no further one-offs (further one-offs are entirely possible) for FY16~ $11m. This will roughly translate to $7.1m NPAT or 1.8cps.

Underlying EBITDA for FY16~ $15m, or approximately $9.7m NPAT or 2.4cps.

Given the rapid growth I will conservatively use a forward PE of 20. This means an SP of between 24c and 48c is justified. However, I am more inclined to lean towards the underlying number as this is more representative of earnings going forward. Given management historically beat their own guidance, and a PE of 20 is potentially conservative, I see significant upside from here to an SP of 50c in the next year (~50% above my purchase price).

Technical Analysis

On Thursday 21 January 2016 a number of important technical indicators occurred. The price bounced off previous resistance of 29c, a gap was closed between 29 and 29.5c, the SP bounced off the 200 day EMA and the RSI hit oversold levels. The next few trading days will be interesting and if it holds above these levels we should see a turnaround in SP direction.

SP Performance

The recent high of 44c a month or so ago has marked the short term peak. Since then the price has been beaten down to current levels. There has been no change to the business fundamentals. The worldwide markets have been very nervous and been selling down higher risk companies. This stock has always been extremely volatile and large SP swings are common. I see the recent SP action as an extremely good buying opportunity. And as always if it drops further I will buy more. 

Conclusion

Mobile Embrace is a company that has proven itself over the past few years. The industry it is in has significant tailwinds, and they are at the beginning of an international growth spurt. The relatively fixed cost base is likely to see margins expand and new revenue will find its way to the bottom line a lot faster. Recent SP action has resulted in a very good buying opportunity.

The $20,000 Stockmarket Project

I've set this blog up to document a challenge I have set myself. The challenge is simple: to see what I can turn $20,000 into in one year on the stock market.

A bit of background about my investing history

I have been investing in the stock market for just over three years. I invest primarily on the ASX and NZX, but also the US markets. I spend a considerable amount of time following the market and researching companies to invest in. My risk tolerance is high, and I primarily invest in small cap growth companies. I avoid investing in speculative companies that have no earnings. I focus on finding profitable companies that have the potential to grow their earnings considerably in the mid to long term and that are undervalued because the market has missed them. I live by a lot of Peter Lynch's investing principals. I have had no formal education in the stock market. I am an engineer by training. I believe this places me in good stead because I have no industry biases and use my background in analysing problems to uncover good opportunities.

The Plan

One year is not long for a long term investor. Therefore, I have to be very careful with the companies I choose. I will be choosing companies that have strong potential to increase their earnings in the next year and beyond. Picking companies that are undervalued is also crucial. I will need to be invested before the hype begins.

The combination of undervalued and good short term earnings growth potential (as well as long term) gives me the best chance of the market rerating the stock over the next year. Good earnings reports will awaken the market and most likely increase the stock price.

This obviously isn't as easy as it sounds. Companies with good growth potential are often overvalued. Therefore, finding these companies is not easy and takes a lot of time.

How I will break down the $20,000

In order to achieve a level of diversification, remove timing risk and not be too time consuming, I have decided to apply the following rules:

-the portfolio will consist of 4 companies

-I will buy 2 parcels of stock of each company separated by a week.

These two rules are baby steps in terms of diversification and eliminating timing risk. A diversified portfolio should have more than 4 stocks, and timing risk should be eliminated by buying over a number of weeks or months. In this challenge I do not have this luxury!

I hope by following this blog you will learn something. I will log my progress here for my own records and for others to get insight into how I am approaching this. Please feel free to comment!

Nothing on this blog should be taken as investment advice.