Note: Purchasing is possible in U.S. dollars on OTC Markets, or on the Toronto Stock Exchange (TSE) in Canadian dollars. For liquidity purposes, I will be buying in Canadian dollars on the TSE, so all figures listed are in Canadian dollars, unless otherwise noted. Current U.S. dollar price is $3.52, and Canadian dollar price is $4.58 as of March 18. This article was written on March 18. Any dates or facts in this article refer to that day.
|Purchase Price: $4.60 (March 18)||Market Capitalization: $188 million|
|Price Target: $13.80 (200% Upside)||Enterprise Value: $345 million|
|TTM EV/EBITDA: 4.10||Time Frame: 24 months|
Black Diamond Group Ltd. (BDI) rents and sells modular workforce accommodation and space rental solutions to customers in Canada, the U.S. and Australia. In addition to providing turnkey lodging and other support services related to remote workforce accommodation and space rentals, the company also provides specialized field rentals to the oil and gas industries of Canada and the U.S. The company is headquartered in Calgary, Alberta, Canada, and operates four segments:
- Structures: Provides modular structures designed for remote site accommodation and space rentals. The remote site accommodations, when assembled together, form large dormitories, kitchen/dining facilities and recreation complexes. Space rental modular structures provide high-quality, cost-effective modular space solutions to a diverse customer base in Canada and the U.S. The space rentals fleet includes office units, storage units, office complexes, training facilities, lavatories and custom manufactured structures.
Structure Black Diamond Group (BDI) created for Mount Milligan Project in British Columbia.
- Logistics: Operates remote lodging facilities for itself and other third parties. The primary revenue sources consist of turnkey lodging services for camps operated by Black Diamond, remote facility management and supply chain solutions. The majority of the business activity within this segment occurs in western Canada.
- Energy Services: Provides accommodations fleets for drill camps, geologist/engineer quarters and staff quarters. Energy Services also provides a complement of surface rental assets that would typically support a drilling or completions operation such as solid and liquids containment, rig matting, and support equipment. The primary revenue sources consist of rental revenue for this equipment, and non-rental revenue consisting primarily of catering, transportation and servicing of equipment revenues.
- International and Corporate: Provides modular structures for remote workforce housing and modular workspace solutions and provides associated services in Australia and other areas outside of North America. The primary revenue sources consist of rental revenue for this equipment, and non-rental revenue consisting primarily of catering, transportation and installation revenues. Corporate includes the costs of head office administration, interest costs, taxes, other corporate costs and residual assets and liabilities.
Black Diamond Group Ltd. five-year price chart
The stock peaked in May 2014 at $35.70 and trades at $4.58, or 87% lower. This was driven by two factors:
1. China's real estate bubble and iron ore
Iron ore 20-year price chart (source: Index Mundi)
Iron ore accounts for 26% of Australia's exports. Iron ore is used to make steel, which is used in real estate construction around the world. The Iron ore price run-up from 2005 to 2011 was driven by the Chinese real estate bubble, which also occurred during the same period. China produces just over 40% of the world's iron ore supply, but consumes more than that. By default, the second largest producer, Australia, is the world's largest exporter. Since China consumes more than it produces and it is the world's largest producer, it consumes 64% of the world's iron ore exports. China is Australia's largest trading partner for this very reason. Three Chinese cities, Shanghai, Shenzhen, and Beijing have property price to income ratios of over 30. Beijing's property prices rose 800% from 2003 to 2011! To put this into perspective, New York and San Francisco's red-hot bubble real estate market have ratios of 14 and 22. It puts Vancouver and Toronto's bubble to shame.
In 2010 and 2011, Chinese authorities became weary of a real estate bubble and required any family purchasing a second home to put down 60%. This, along with the number growing unoccupied real estate in China brought iron ore demand to a halt. Most producers, expecting stable demand, had no plans to curb production. This led to the oversupply, and thus, the falling iron ore prices. The market is still in a deleveraging phase that will likely need a few more years to stabilize.
BDI's International and Corporate segment provides services in the resource rich states of Queensland and Western Australia. It was hit by the falling commodity prices when demand for its workspace and work force housing services fell along with the commodities.
2. U.S. shale oil bubble
WTI crude oil spot price (source: Index Mundi)
In 2009, energy companies began using improved drilling techniques to extract oil from shale rocks. This process is costly, but was justified because of high crude oil prices. U.S. based oil production slowly gained market share at the expense of other oil producing countries. This led to a supply/demand imbalance, hence the level of crude oil prices today.
BDI provides services to the oil and gas sector primarily in Canada, but also in the U.S. Depressed crude oil prices led E&P companies to curl capex spending, which hurts BDI.
The company carries $159 million of debt today, but paid $37.4 million toward the debt load last year. The capex and dividend cut should propel the debt reduction. The company also holds hard assets with a book value of $547 million. The company has historically been able to fetch above book for its used assets. The workforce accommodation fleet assets ($339 million BV) can be liquidated if it does come to that, though I don't believe it will.
WHY BUY NOW?
Like Gamehost Inc., maintenance capex ranges from about 1% to 2% of the asset values. This means that the company is able to curl those expenditures at will. Capex spending over the past few years have been more on growth than maintenance.
The company is vertically integrated, meaning that the segments depend on each other. For example, the logistics segment provides catering, waste management and security services to the structures and Energy Services segment. As capex gets cut for the Structures, the Logistics segment automatically slows the necessity to spend. This is beneficial as the company has the foresight to curb expenses for all other segments automatically. Capex has dropped from $120 million in 2014 to $50 million in 2015 to an expected $10 million in 2016. The company depreciates about $55 million a year, but won't need to purchase anymore equipment or structures until the coast clears. While net income may turn red, cash flow will remain green.
The company recently cut its dividend and will be paying, even after the cut, a robust 6% forward dividend yield at these prices. The cut is necessary at this time due to the depressed oil prices and the necessity to divert the cash flows to its debt load.
Crude oil recovery
Iron ore recovery
This will likely come after the crude recovery since the deleveraging phase is so much larger. A significant risk to this is China's slowing economy. But as the world works off the excess inventory, we should hopefully see a bottom within a few years or so.
Asset utilization peaked in 2012 because of the iron ore slowdown. Assuming that the company resumes back to peak revenue levels with 15% profit margins as it was before the slump, we'd be paying approximately 3.25x peak earnings. This is a company that recorded revenues of $5 million in 2006 and then $386 million in 2014, or a CAGR of 72%. It's one of those hyper growth stocks that kept reinvesting profits. The growth will likely resume and even run higher once crude oil stabilizes because of the increased capacity before and during the oil slow down. I believe a 200% run from these levels is reasonable.
I bought this on March 18 for C$4.60, and it's my largest position at 11% of the portfolio. This is not for the faint-hearted as it's likely going to be volatile. As some of you know, unlike most hedge fund managers and virtually all of academia, I do not equate volatility or beta to risk. My belief is that risk comes from whatever distorts the future cash flows of a company and not the volatility of its stock price or stock prices in general. The depressed price of crude oil is a clear risk, but will likely subside as the market corrects itself. U.S. crude inventories are still rising, so this might take at least few months before we see a real bottom. My next trigger buy will be at $4.00, and then $3.50. I'll increase my position by 25% each time the stock price drops below the trigger levels.