Ryan Irvine writes:
I'd like to start this month's installment with a couple of quotes from a man who really needs no introduction in investment circles, Mr. Warren Buffett (Trades, Portfolio). Our clients often ask us how we achieve a level of success in the investing arena. The simple points Buffett makes in these quotes impacted me immensely as a young investor and helped form the foundation for KeyStone's research success today.
The first couple of quotes come from an interview he gave to Adam Smith in 1993, coincidentally the year I graduated from high school.
Smith posted an excellent question: "If a younger Warren Buffett (Trades, Portfolio) were coming into the investment field today, what areas would you tell him to point himself in?"
Buffett answered: "Well, if he were coming in and working with small sums of capital I'd tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time."
The interviewer Smith chuckled, half surprised at this notion and replied: "But there's 27,000 public companies."
And with a wry smile, Buffett replied: "Well, start with the As."
At first this may sound a bit shocking, but Buffett was dead serious. The man today continues to practice what he preached then, reading hundreds of annual reports weekly at the age of 83. Perhaps most importantly, he continues to crush the market.
We take exactly the same approach to the Canadian market, pouring over 3,000 Canadian stocks on a quarterly basis. While it's tedious work, it's actually rather simple in the application.
It's a bit like in the movie "The Shawshank Redemption" where old Andy Dufrense uses a tiny rock hammer to tunnel out of Shawshank prison. If you have enough time and pressure, he proved you can tunnel out of anything. In our case, if we read enough reports over enough time, we can find a few select gems.
Fortunately, after we tunnel through to find our small cap stocks, we don't have to do as Andy Dufrense did and then crawl through a 300-foot river of crap to finally find freedom. We just email it off to clients and post it on our website - it's so much cleaner. Although I must admit that after going through 3,000 annual reports, you definitely feel like tunneling out of the office once and a while.
Basically, what I am telling you is that reading has made Buffett a very wealthy man and he candidly admits it saying: "Reading has made me rich over time."
For Buffett and for KeyStone (I humbly use the two in the same sentence) it is literally a question of turning more pages and looking under more rocks than the other guy. In investing there are no short cuts. Hard work pays off - it is that simple.
Parex Resources Inc. (TSX:PXT)
Originally recommended on July 29/13 (#21328) at C$5.38, US$5.23. Closed Friday at C$7.45, US$6.74.
We recommended Parex Resources in July 2013 at $5.38. With the stock currently at $7.45, here is where we stand following the company's recent operational update.
Parex, through its direct and indirect subsidiaries, is engaged in oil and natural gas exploration, development, and production in South America and the Caribbean region. Parex is conducting exploration activities on its 1,349,000 gross acre holdings primarily in the Llanos Basin of Colombia and 219,000 gross acre holdings onshore Trinidad. Parex is a Canadian firm, headquartered in Calgary.
In mid-January Parex, our top international light oil producer, reported an operational update including a solid production increase. We view the overall impact as positive for the company.
Within the update, Parex also reported positive well testing results from multiple wells, including Tigana & Tigana-Sur (working interest 45%).
Fourth-quarter production was reported as 17,285 barrels of oil per day (bbl/d), which was above consensus estimates. December production was 18,000 bbl/d, excluding minor gas sales volumes that have recently started up.
If we factor in the high success rate that Parex has reported in its two most recent updates and even a moderate level of success going forward, we continue to believe that the company is likely to beat its 2014 production guidance of 17,500 to 18,500 bbl/d.
We believe Parex has a solid management team with extensive Latin America experience. The team has previously shown the ability to operate, grow, and monetize assets similar to those that they are putting together in Parex by growing, developing, and later selling Petro Andina Resources - and generating significant returns for shareholders. With an 8% ownership ($50 million) stake in Parex, management is aligned with shareholders. Valuations continue to be attractive relative to its peers with the company trading at three times expected 2014 cash flow.
As such, and despite the 38% jump since our recommendation seven months ago, we are maintaining our Speculative Buy rating on Parex for investors with above average risk tolerance. The speculative nature of the rating relates to the company's above average geopolitical risk plus the higher level of risk we normally assign to resource companies as they are dependent largely on the prices of the commodities they produce and on the continued risk of successful exploration. At present, the risk to reward ratio appears favourable.
Action now: Parex remains a Buy for investors who can handle the risk.
Mart Resources Inc. (TSXV:MMT)
Originally recommended on July 23/12 (#21226) at C$1.47, US$1.46. Closed Friday at C$1.24, US$1.13.
Next, we take a look at another international oil producer, Mart Resources, which was introduced in July 2012 as a Speculative Buy for those with an above average level of risk tolerance. With the stock at $1.60 at the end of 2012 and following the delay of a much-needed second pipeline, we downgraded the company. For investors with a short-term outlook of three to six months we recommended a full Sell. For those with a one-year or greater outlook, we recommended a Sell Half strategy to reduce exposure at that time. We continued to hold half of our original positions as Mart still provided value based on its first half 2012 results (combined first quarter, which was very strong, and second quarter, which was weak).
At present, the stock is trading at the $1.24 level and for those holding half positions, it has paid approximately $0.30 in dividends over the holding period.
Negotiations have concluded with the local communities for right of way for the last five kilometres of the first section of the Umugini pipeline. The pipeline contractor re-mobilized and restarted construction operations in December 2013. Major road crossing boring has been completed on the remaining five kilometres, and it is expected that pipeline construction will be completed in the first half of 2014.
The news on the pipeline is promising but there remains no guarantee it will be completed on schedule as it has been delayed in the past a number of times. The company has experienced solid drill bit success but with pipeline and export facility losses reported at above 28% in the last period, the company now holds a level of risk we are not comfortable with for the average investor. Given the fact we gain solid exposure to international Brent Crude oil pricing through Parex with less risk, we see no further need to hold our half position in Mart and recommend closing out existing positions.
Action now: Sell.
Athabasca Minerals Inc. (TSXV:ABM)
Originally recommended on Jan. 30/12 (#21204) at $0.485. Closed Friday at $1.59.
Next, we update Athabasca Minerals , which was originally recommended in the IWB in January 2012 at $0.485. When the stock surged to the $2.40 range in the early fall of 2012, up over 370%, driven by two sets of record quarterly earnings, we recommended investors sell half their positions. We recommended holding remaining positions to continue to participate in the solid long-term potential that Athabasca possesses. With the stock closing this week at $1.59, we provide our updated rating.
Athabasca is a resource company involved in the management, exploration, and development of aggregate projects. These activities include contract work, aggregate pit management (Susan Lake), new aggregate development, and acquisitions of sand and gravel deposits. The company also has industrial mineral land holdings in Northeast Alberta for the purpose of locating and developing sources of industrial minerals and aggregates essential to high growth development of the energy and infrastructure sectors.
For the third quarter, Athabasca reported earned aggregate management fees of $3.62 million compared with $3.58 million in the same period of 2012. Earnings per share were $0.038 compared to $0.074 per share in the same period of 2012.
While maintaining management activities at the Susan Lake aggregate operation, Athabasca continued its transition to supplying sand and gravel from what should be higher margin corporate-owned aggregate operations.
Two important and positive developments have recently occurred at the Kearl pit (wholly-owned) that are expected to contribute to future improved productivity and reduced costs of production. First, Athabasca has implemented an improved dewatering method, which has substantially increased operating access for aggregate extraction. Second, the company is currently mining at a depth in the pit where a significantly richer proportion of gravel to sand ratio is being extracted. Previously, a higher sand content with typically less product value was encountered nearer to surface. As a combined result, increased extraction and processing of higher value aggregate is now being realized. Over 63% of the approximate total 248,000 tonnes of aggregate processed at the Kearl pit during the third quarter occurred during the month of August alone.
Athabasca recently reported a $5.75 million financing priced at the $1.45 level. The net proceeds raised from the offering are expected to be used for upcoming capital expenditures on new and existing assets, as well as potential growth initiatives and general working capital purposes. Growth initiatives include future drilling and resource development at the company's Richardson Project as well as the development of the Firebag Silica Project.
On a valuations basis, with Athabasca trading in at just under 16 times its trailing 12-month earnings per share, the stock appears neither expensive nor cheap. If it can grow going forward in 2014, the multiple is reasonable, but if the company does not grow in 2014, it is not. We think the company can grow, but do continue to expect quarterly fluctuations in the growth. As such, we are not compelled to open new positions in the stock at this time. We maintain our Hold on the stock at present.
Action now: Hold.
Sangoma Technologies Corporation (TSX-V: STC)
Originally recommended on Dec. 7/09 (#2943) at $0.82. Closed Friday at $0.28.
The final company we will update today is Sangoma Technologies. This is a true micro-cap situation that we originally recommended in the IWB in December 2009 when its shares traded at $0.82 range. At the time, we considered the outlook on Sangoma to be positive and the potential for growth was present, but we suggested a relatively long-term horizon should be taken (one to three years).
Our near-term rating on the stock was shifted to Hold at the end of 2011 due to challenging business conditions. With the stock currently trading at $0.28 range, we update our rating on the company.
Sangoma is a leading provider of hardware and software components that enable or enhance IP communications systems for both telecommunications and data communications applications.
With $0.15 per share in cash (no debt), or more than half of its market cap, the stock continues to possess a strong balance sheet. But the company's new management team has faced a tough market for its primary products and the company's performance (erosion of capital) has been less than impressive. The company is once again in restructuring mode and may be on the right track in this regard, but the ongoing economic climate and the transition away from its core hardware products make this challenging. As such, the company produced a modest operating loss in the last quarter.
While Sangoma currently trades at less than its working capital per share, we have not seen the consistent free cash flow generation that we witnessed previously. Given the fact we continue to see growth as a challenge going forward, we recommend investors sell Sangoma and employ capital in a business with more mid-term growth potential.
Action now: Sell.
- end Ryan Irvine