Medley
#3
By Manuel Maurício
July 31, 2020
Introduction
It’s earnings season so here’s another medley. On this medley you will find my thoughts on Aercap, Cameco, Facebook, MTY Food Group and Riwi.
Taking in consideration that we’re right in the middle of the biggest crisis ever for the aviation industry, Aercap had a great second quarter. Let’s start by looking at the revenue breakdown:
Basic lease rents were down -12%. I’m actually surprised. I was expecting much worse.
Maintenance rents were up 106%. This happened because whenever an airplane comes off lease the company recognizes this revenue that was owed to the airline, but it isn’t anymore. This leaves a bittersweet taste in my mouth.
Net gain on sale of assets was down -87%. Although this is a big decrease, I wasn’t expecting the company to be able to sell any airplanes in this environment, let alone do it with a profit. Aercap has sold 9 airplanes in the second quarter for $188 Million comparing to 22 airplanes in Q2 2019 for $502 Million.
All summed up, revenue went down by -7%. Let me remind you that, although Aercap has been through numerous challenges before, this is the most global and uniform crisis in its history.
BALANCE SHEET AND LIQUIDITY
As I’ve mentioned on previous posts/emails, the company has been able to both raise unsecured debt in the markets during the quarter as well as pay down debt that was maturing in 2020 and 2021. This is called refinancing and it’s the normal procedure of a company like Aercap. The other good thing about this is that the company is paying down debt that has a higher interest rate compared to the debt it is currently raising, so in the meantime, the cost of debt is going down.
This goes to show that the debt markets are telling a different story from the stock market. Investors are willing to lend money to the company at attractive rates (4,2%) while pricing the stock as if it were to go bankrupt. *Note: I should be finding the prices of those bonds in real time.
This next slide is even more important than the revenue slide. It shows the sources of funds and the uses for those funds. The company estimates an excess coverage of $6,4 Billion which in turn means that the company has 2,2x the liquidity it needs for the next twelve months.
It’s worthy noting that the “Estimated Operating Cash Flow” which is the upper blue bar on the right, has been decreasing for the past several quarters. This means that the company has been adjusting to what it’s seeing happening in the industry and it expects to be collecting less than in the past. This should be monitored closely.
MANAGING LIQUIDITY
AerCap has rescheduled the delivery of over 100 aircraft that were originally expected to deliver in 2020, 2021 and 2022. This rescheduling served to reduce the cash Capital Expenditures in 2020 and 2021 by a total of $5.3 billion.
SALE AND LEASEBACK
So there’s this thing in the aviation industry called sale-and-leaseback agreements. This is when the airlines sell their own airplanes to the lessors and lease them back. It gives the airlines an immediate injection of cash. Gus Kelly, the CEO, said that he’s not looking to make any sale-and-leaseback agreements right now, but he’s willing to consider them in 2021 when he expects there will be a significant increase in supply in new-technology airplanes as Boeing and Airbus start delivering airplanes.
DEFAULTS
There are several airlines that are going through bankruptcy processes, thus not paying, but in most cases Aercap is not taking the airplanes back because usually the companies will continue to pay once they get out of the bankruptcy process.
So far Aercap has been helping its customers by letting them defer some of their lease payments to a later date (the same happened with MTY Food Group. We’ll get to that in a minute). In March the “notes receivable” were around $140 Million and they are now $430 Million. The management team is expecting this to go up to $800 Million in the next couple of quarters. This is something I will keep my eye on in the future because it tells us if the company is being able to collect payments from its customers.
IMPAIRMENT
There is still a chance for so much impairment charges to the assets that the equity (also-known-as-shareholders) gets wiped out, so this is something we must pay close attention to. I’ve talked about it HERE.
So far in 2020, 950 airplanes were retired around the world. Most of them have been 747s, 757s, A340’s, that make up less than 1% of Aercap’s fleet. So far so good. The problem is that there have also been some announcements of early retirements of 777’s and A330’s that make up 10% of the fleet. That’s a risk.
In the second quarter, the company had asset impairment charges of $73 million, which primarily related to lease terminations, not so much to long term devaluation of the assets. Either way, I’ll keep a close eye on this.
CONCLUSION
The reported earnings per share were $4,09 in the first half of the year. Taking the second quarter earnings-per-share and saying that that’s what the company will earn going forward, we have EPS for 2020 of $7,9. The stock is trading at around $27. That’s a PE ratio of 3,4x. For those of you who are new to valuation, that’s cheap. These companies usually trade for 10x earnings which would be $79.
Another way to do it is through the book value. Aercap’s book value per share is $75,5.
Given the circumstances, the company is hanging in quite well. I’ve had one subscriber ask me about the decline in the share price going into this earnings season. He was counting on a quick rebound for Aercap. I’m not expecting it to be neither quick nor easy. There is a lot of uncertainty in the world right now, especially when it comes to air traffic. We’re going to be seeing more bankruptcies, more production cuts from Boeing and Airbus so there will probably be high volatility for Aercap along the way. Investors should be prepared for that.
During this lockdown I’ve been wondering if Altria’s shipment volumes were going up or down. It seems that after an amazing first quarter where shipments grew 6%, they’ve gone down again. But not too much, -9% to be exact. During the Great Financial Crisis the shipment volumes went down by -12%. I don’t see why we can’t see a similar drop this time.
In general terms, the results were “meh” with little to no surprises. The $27 Billion in debt are still there, the stake in Ab Inbev (the greatest beer company in the world) took a big hit due to the lower share price, but what I’m interested in the most is the iQos.
The company has never reported the terms of its profit share agreement with Philip Morris International, but it’s now starting to shed some light on it by revealing that it needs to maintain a 5% dollar share in the geographies where it sells the iQos so it can keep being the sole distributor. This isn’t much, but it goes to show that if Altria isn’t able to gain a certain market share, Philip Morris International could switch distributors. I wonder what other company could do it?
All in all, no surprises here. I’ll keep following it just because I believe the iQos can be a game changer.
Altria revises its 2020 estimated full-year domestic cigarette industry adjusted decline rate to be in a range of 2% to 3.5% from a range of 4% to 6% based on better year-to-date industry performance and expectations for continued category resilience.
Have I mentioned that you need to be a Zen master if you are to reap profits investing in uranium? I believe so, but I’m saying it again. Everyone in the Uranium world was eagerly awaiting for Cameco’s earnings. Not so much for the numbers themselves, but for what the company would be saying about the current environment. I could resume it all in one sentence: Everything is pretty much the same as it was last quarter. For those who want some more colour on this, keep reading.
The basis of the uranium thesis is that the utilities must come to the negotiations table and contract future uranium supply. For this to happen they will have to feel that there isn’t enough uranium to go around. When this happens, they will have to pay what the producers ask.
Now with the coronavirus around, utilities’ main focus is to keep supplying electricity to everyone without any disruptions. They’re not focused on buying uranium right now. Although this is a bummer and I would like to see the uranium price go up quickly, if one is convinced that some day utilities will buy uranium, this delay is actually important to reduce supply, leading to higher future prices. That’s why I chose to buy Yellow Cake and UPC instead of the miners (for now). They don’t suffer much given that their costs are minimal (they bought uranium and they only have to pay to store it).
CIGAR LAKE IS RESTARTING
Cigar Lake mine was idled a few months ago due to health concerns, but Cameco is bringing it back online in the beginning of September with an expected production of 5,3 Mlbs in total for 2020. The company is bringing it back online because it’s cheaper to mine it than to have it in care & maintenance while buying uranium on the spot market. I would love to see this mine closed indefinitely so Cameco could just clean the inventory that’s out there, but hey, it is what it is.
COMPETITORS ARE RAMPING UP PRODUCTION
Olympic Dam, the largest copper mine in the world is planning to increase its Copper production output. Why should we care? Because although BPH is mining copper, it also mines uranium as a byproduct. That’s also why it’s one of the lower cost uranium producers in the world. And if they increase copper production, this will result in increased uranium production too. But Cameco isn’t worried because BHP will still need to compile an Environmental Impact Study and these things take time.
YELLOW CAKE IS SELLING URANIUM
As we we know, Yellow Cake is selling uranium to buy back shares. This is both good and bad. It’s good because it will lead to a higher Net Asset Value per share, and it’s bad because it doesn’t transmit an image of low uranium inventories which would lead the utilities back to the negotiations table.
BALANCE SHEET
The company has a strong balance sheet. It has $863 Million in the bank and $1 Billion in debt maturing in 2022, 24 and 42. It still has a $1 Billion undrawn credit facility, so there aren’t liquidity issues for the time being.
CONCLUSION
Everything is still much the same. For those of you who are uranium investors, go out to the beach, drink some caipirinhas, and enjoy the summer.
This week the CEOs of Amazon, Apple, Facebook and Google were called to testify before the Congress of the USA. This seemed more like a roast to me. I’m not sure what congressmen and congresswomen intended to get out of such session.
FINANCIALS
Revenue is up 10%. Even in the midst of the greatest pandemic of modern times, and with the big brands boycotting the platform, Facebook is growing.
And yes, its growth rate has been decreasing.
That was to be expected. Trees don’t grow to the skies. And Mark knows this. That’s why he has plenty of irons in the fire to keep Facebook a successful story.
Important milestones were the increased rollout of Facebook shops across Instagram and Facebook and the future launch of Facebook Pay. Users won’t need to leave the apps in order to buy a product.
INVESTMENT IN JIO AND WHATSAPP PAYMENTS
Facebook has recently bought a 10% stake in JIO, the mobile telecommunications giant in India. India is where Facebook has the largest whatsapp user base. Everyone’s using whatsapp over there and the economy is very informal. Mark understand this so he decided India (and Brasil) was the best place to test Whatsapp payments.
JIO is one of the – if not THE – largest mobile phone retailers in India. With its stake in the company, Facebook is guaranteeing that all of these phones will come out with Whatsapp fully integrated. Why Whatsapp? Because everyone is using it. And Facebook wants people to buy and sell things through Whatsapp. The first building block to get to there is launching Whatsapp payments.
Facebook has been experimenting Whatsapp Payments with 1 Million users in India and now the company wants to ramp it up to the whole population. But these things take time and the bureaucracy and regulatory hurdles aren’t always easy to overcome.
THE HARDWARE COMPANIES HAVE A LOT OF POWER
Here’s something I didn’t like. The new Apple iOS 14, launching in the fall, will force Facebook to show an opt-in message for tracking users in order to deliver targeted advertising. Apple will let people chose between “Allow tracking” and “Ask app not to track”.
This obviously isn’t good for Facebook because its whole business is based on highly targeted advertising which is achieved by tracking its users. This is something to keep an eye on. It will definitely affect the business. By how much is anyone’s guess.
One last thing that caught my eye was Mark Zuckerberg “asking” for more regulation. He knows that more regulation benefits him because he has the $$$ to do whatever the regulators require while other platforms might not be able to do that.
The right path, I believe, is regulation that keeps people’s data safe while allowing the benefits of this kind of personalized and relevant advertising.
To conclude, Facebook isn’t as cheap as when I bought it for the Portfolio. In fact, I’m not really sure we could say it’s cheap.
Let’s say it keeps growing at 10% per year. It would reach around $11 in Earnings-per-Share in 2024. Slap a 20x multiple to that and you get a $220 share price. Add back the cash that will be generated until then and you get $277. The stock is trading at $250 right now so the upside isn’t huge (based on the previous assumptions).
There is one school of thought that says that I should be trimming my position here. There’s another one that says that you should hold on the compounders even when they seem overvalued. I’ll be thinking about it over the holidays. (I’m going on holidays, but I’ll keep working, if that’s what you were thinking).
MTY Food Group is one of those businesses that I like to follow. It’s a hundred-bagger so what’s there not to like? As a Quick-Service-Restaurant franchisor, it’s obviously suffering right now. I’ve read its Conference Call Transcript and instead of writing a detailed analysis like I did for Aercap, I’m just going to layout the topics that stuck with me:
Second half of March and April was when the restaurants were hit the hardest.
Gradual recovery in the US. Much lower recovery in Canada given their exposure to malls and office towers.
Great job from the management team in cutting costs, managing working capital, delaying payment to suppliers, negotiating new debt covenants with the banks and negotiating with landlords. These measures yielded a Free-Cash-Flow of $10 Million, but they are not sustainable.
RESTAURANTS
There were 1470 closed restaurants at the end of the quarter, but now only 600 of them are closed.
The management team knows that without franchisees, there’s no MTY. About half of the network participated in the 40% abatement the company had offered in exchange for early payment of royalties (the company had previously paused the collection of royalties).
There are now $7,3 Million in deferred royalties in accounts receivable which will start being paid in the fall and “will be staged over enough time to make the repayment possible for the franchisees”.
SALES AND PROFITS
Revenue decreased by -22,1% from 126M to 97,8 Million.
In an incredible plot twist, the recent acquisition of Papa Murphy’s was what saved the company. EBITDA declined from 34,1M to 18,2M. Papa Murphy’s accounted for 50% of the total EBITDA.
The net loss of -$99,1 Million is mostly due to the non-cash impairment charge of $120,3 Million. If we back out this charge, the company was cash generative. The Cash from Operations was $16 Million. And on top of that it was able to refranchise some Papa Murphy’s for $10 Million. This goes to show the level of cost cutting and the ability of its management team in a time where a lot of its restaurants were closed.
DEBT
The debt covenants were renegotiated with the banks and loosened up. The company is still able to make small and medium sized acquisitions, but it’s restricted from paying dividends or buying back shares until the Debt/Ebitda ratio comes down to 3,5x.
CONCLUSION
There is still no clarity on the health of the restaurants. On an email, the CEO told me that if there was the need for it, the company would take over the most badly-hit restaurants and operate them (only to refranchise them later on).
If things “go well”, at these prices, MTY Food is super cheap. But again, it all depends on how many restaurants there will be open at the end of this and the adhesion to them, especially in Canada where most of them are located in malls or office towers. But the issue with this is that not even the management team has granular data on the financial health of its franchisees or whether if the restaurants are Free-Cash-Flow positive or not, so it doesn’t really know if they will endure this crisis.
Riwi is that company that I haven’t bought for the Portfolio, but that I can’t stop following. If you’re new to All in Stocks, I recommend you to read my previous write-ups on Riwi HERE.
As you know, I’ve recently talked to Daniel Im, the CFO. I was more interested in understanding how the business works than focusing on the financials. I wanted to understand how the company sells the product, how the users use it (if they can create any survey they’d like. It seems that it isn’t that easy) and how Riwi prices it. One thing that stuck with me was the difficulty to sell the product. This isn’t like other products that people are aware of and are calling the company to buy them. The management understands this is an issue they have to overcome so they are aggressively hiring sales rep’s to sell the product.
I must confess, I have mixed feelings about this one. On the one side, I believe that if it takes off, the company can be an “overnight success”. Neil Seeman, the CEO, owns 37% of the company and there are only 18 million shares outstanding. This is important because when institutions start to buy it, there will be so few shares out there that they will force the price up and that’s when a microcap goes from relatively overvalued to stratospherically overvalued.
INSIDERS SELLING
On the other hand, the company has to constantly be educating its clients about its technology. I like products that sell themselves. On top of this, several insiders have been selling stock recently. Rob Pirooz is one of them and although I haven’t met him yet, he is a respected microcap investor. I’ve talked to several important Canadian investors and no one really knows why he is selling, but it’s not a good sign.
SNEAKY MANAGEMENT TEAM
Now off to the financials. On their latest press release, they’ve stated that the revenue went up by 53% and net income by 617%. This seamed all nice and good until I noticed that they were talking about the last six months, not the last three months, as they should. Sequentially, the revenue went down -25% from the first quarter. The management was sneaky on this one. I don’t like sneaky people.
I’ll be keeping an eye on Riwi, but my confidence has taken a serious hit.
CONCLUSION
Now, if this was cheap, I would consider buying it, but it isn’t. With $1,2 Million in estimated profits for the full year, we’re talking about a PE ratio of 54x.
Neil is guiding for $30 Million in sales in 2024. Will the company achieve this? Well, they’ve missed all the prior guidance so I wouldn’t be surprised if they’d do it again.
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