The Portfolio as at 22/03/2016

Latest portfolio position. I haven't had time to write about my recent purchase of Adacel Technologies (ASX:ADA) yet, but I bought on March 17. Once the cricket season is over I will have a lot more spare time! 

It should be noted my cost basis is only around NZD12,500 currently. The strengthening Aussie dollar has positively impacted my portfolio, but Google finance reports the cost basis at spot rates annoyingly. I'm currently in the green around NZD1,900. I need to put the remaining capital to work!

 

Closed Position in TFS Corporation

Today I sold down my position in TFS Corporation (ASX:TFC). 

My main reason for buying the company was for a company with very good long term prospects the share price had been hammered, and there were a lot of near term catalysts. I still believe in the long term prospects of the company (and continue to hold in my main portfolio), but the near term catalysts I listed when buying the company have largely played out.

New end market agreements have been announced, financial results have been announced, and all this years harvest has been forward sold meaning no substantial news post harvest.

The business has its risks which mainly relate to cashflow and debt now. In the long term I am happy with this. However, weighing up the near term catalysts and risks I have decided to lock in my 30% profit and look elsewhere. I held for a couple of weeks hoping for a short squeeze to play out, but have decided I've given it enough time.

All in all I look at this as a successful purchase and prudent sale given my one year horizon. 

I have a number of options I'm looking into and I'm close to purchasing a new company. I will write about these in due course. 

The Portfolio as at 01/03/2016

Latest portfolio summary. A bit of green this time - but that could be taken away just as quickly...

See previous posts for my thoughts on what has caused the price movements.

Prophecy International and TFS Corporation Limited release Half Year Report

Last week two companies I hold in the 20k portfolio released their half year reports. Both company's reports were very pleasing. The market's reaction however has been polar opposite.

TFS Corporation (ASX:TFC)

TFC's results were largely as expected, but there were a few crucial pieces of information that I think the market had flagged as key risks. Plantation sales are up 50%, cash EBITDA is up and royalties from Benzac sales has tripled. The market rewarded it with a 24% increase in the stock price.

The main highlight for me was that both this years and next years anticipated harvest volumes have been forward sold. This included new agreements with Chinese and Indian buyers for heartwood at comparable prices to USD4,500/kg of oil. I think this has reduced a key risk - the significant increase in sandalwood volume over the coming years will actually lead to cash generation. I have always thought this was a concern for the market, because otherwise the forward earnings can be relatively easily estimated and discounted (this isn't the only risk however).

Another thing I had mentioned previously was the amount of shorting of the stock that has been going on recently. This had reached almost 10% of the float. This equates to just over 30 million shares. That is a significant number of shares that need to be bought back at some stage. I think the rise on Friday was largely attributed to these shorters covering their position, leading to a potential short squeeze. There are still approximately 30m shares that need to be covered. I think this could lead to a significant rerate over coming weeks as shorters scramble to buy back shares. Very exciting times for the long shareholder after what has been some pain at the hands of these shorters.

Unfortunately, I decided not to complete my position in TFC for the 20k portfolio, but the 1,700 I picked up could produce a very good return. Especially if the short squeeze continues.

Prophecy International (ASX:PRO)

Prophecy's results were also relatively as expected, however, there was a key piece of information regarding already booked revenue that I assumed the market would reward. This was not the case though!

PRO's guidance for the year is $20m revenue. The half year produced 8m revenue. This was announced previously and some may have been concerned that this indicated they weren't on track to meet guidance. It should be noted guidance is 67% revenue increase for SNARE and eMite products, which even if missed will still represent very impressive growth.

The profit for the half year was subdued, but this was expected and management reiterated previous guidance. Guidance is for 8.8cps. At the current SP this is a forward PE of 16. That is for a company that will double earnings this year and likely continue at a significant growth rate going forward. PRO has the ability to leverage earnings without increasing the cost base. More sales staff have increased the cost base recently, but for a company growing at such a rate it is obvious why they went to do this. Growth funds more growth!

Interestingly, the commentary indicated that 3.8m of sales is already booked regardless of new sales in the half. That puts the revenue for the half at 11.8m. On top of this, a significant amount of existing revenue is reoccurring. Therefore, the new sales required to meet guidance aren't overly onerous. Remember when this report came out we were already two months into the second half. Management obviously like what they see from recent sales.

Management also updated the market on various initiatives such as product development and different sales avenues. This is positive and shows the company isn't resting on its laurels even with their tremendous recent success. To add to that a director has bought in the last few days (albeit a small amount relative to their 7.5m existing shares)!

Moving to the SP, the market has continued to hammer PRO. I put this down to a combination of profit taking (the SP was up around 600% in the past year) and PE contraction due to the global doom and gloom (I am of the opinion the world will not end and good companies will keep making money). PRO's trailing PE will all of a sudden be 16 come the end of June, and it has tremendous growth prospects ahead. I can't see the SP staying low for very long and one positive update could send it back up.

The long term investor in me unfortunately won out and I bought more during the sell off after the report came out. I figured the market would study up and realise it was a buy. This was not to be unfortunately! I will endure some short term pain, but the long term prospects have me licking my lips. I've missed out on this additional upside for the 20k portfolio (I don't want to be too overweight in any company), but I will add more to my personal portfolio if it keeps dropping. I should have used TA here, but the opportunity was too good to resist. I'd rather be in and not miss out on a significant rise given I am a happy purchaser at these levels.

All in all, a good report from both companies, and I'm confident there is significant upside to be had for my 20k portfolio timeframe and well into the future.

Update

I haven't done a post in a while so here is a quick update:

Research

I have been filtering through a list of about 30 (and growing by the day) companies I have come across. These are companies I've encountered in the news, on forums, word of mouth and any other medium. That obviously means there are no gaurentees about their quality and each company needs to be looked at from scratch. I simply use it as a method to discover a company I don't know about.

A few I've come across justify further research. This usually means they are reasonably valued, have a decent balance sheet, have an interesting business and make money. I'll post about them if I consider they are worth pursuing further.

I'm considering investing in a gold miner as a possible turnaround in the industry is apparent. However, I may decide to keep this out of my 20k portfolio as it's likely going to be a lot more volatile and therefore a longer term view may be necessary. 

There's been a good rally this week in the US. A sustained consolidation may bring some money back into riskier assets. As I already predicted, the world doesn't seem as though it will end. Investing in companies growing their earnings is a good place to have your hard earned. Short term pain is tolerable provided you understand a company's risks and take a long term view (more than a year!!). Let others capitulate and sell around you and buy when things are cheap. 

Portfolio Plan

I've reconsidered my original plan of buying shares in 4 companies with 5k in each. I may end up limiting total purchases to 2.5k in some companies and holding another one or two companies. It all depends how my buy list looks. Having said that, PRO released their half year which was a good one (largely as expected but with good commentary around future growth). The market sold down which means I will probably complete this position.

Global Health Limited (ASX:GLH) is a company that lost a big contract and had an eps drop a year ago. Since then they've resumed winning contracts and growing the business. There was recently an independent research report written about them. Rather than rewriting about them please see the link: http://risingstarresearch.com.au/resources/Global%20Health%20.pdf

I've held shares through the rough times and topped up just before Christmas as the forward PE multiple was around 7. Since then it's rerated considerably and warrants further consideration. I will be watching their half year results and commentary closely. Any upgrade will likely see another rerate. If I can get in early enough I would happily add it to the 20k portfolio.

Update on my TFC Position

A quick update on my TFC position:

I continue to bide my time for purchasing my second parcel. The market continues to be very volatile, and given it dropped through support around $1.30 I will wait until a turnaround of momentum looks to be happening before adding to the position. I am still extremely bullish about the company and look forward to buying more!

TFC Keeps dropping and MBE has significant close

Today was an all round bad day on the markets. It proved no different for my two 20k challenge stocks.

TFC broke below the 129-130 mark which it had been flirting with for a while. There are a few old support points around the low 120s so will be interesting to see where it stops. Sentiment may start changing when results come out which has happened in the past. I will hold off buying my second parcel for now.

MBE closed on the technically important 29c mark. This marks old resistance and recent support. A bounce from here would almost confirm the near term support point. Whereas if we break below then we are searching for new support. Earnings are coming up, the market already has guidance, but expect a beat as usual from management. I expect even though the market knows what's coming we wil get a good bounce.

As all good investors know - short term price fluctuations mean nothing. The quality will rise to the top.

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.

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/