| | Smallcap Discoveries: 2020 Top Ten Discoveries Part One |
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In both 2016 and 2019, we shared with our subscribers the best ideas from our watchlist. We call it the "SCD 10 under 10" list. That is, 10 quality stocks under a $10 million market cap.
The concept is simple. By following a simple formula, searching for value in the most overlooked part of the market, we can find market-beating opportunities. The simple criteria are:
- Growth - Quarterly revenue growth >25%
- Profitability - Two consecutive quarters of positive net income
- Size - Under <$50M market cap and the smaller the better. A tight share structure is also a bonus - Ideally, the best situations are <30M shares outstanding
Our bold claim was that even if you didn't read a single thing about these companies, you had a good chance of outperforming the market with a basket of these stocks.
Since numbers don’t lie, let’s see how well these 20 companies have performed (* based on closing price Dec 31, 2019): - 70% of the companies share prices are higher today
- 744% return was the biggest winner (Sangoma Technologies Corp)
- 115% is the average return for the basket of stocks
- The biggest loser was 90% (Good Life Networks)
As investors, we recognize that not every stock we own is going to be a winner, it’s part of investing. However, by sticking to a simple criterion we have routinely demonstrated we have a proven formula for finding companies that can create huge rewards for those investors.
It’s like putting a quarter into a slot machine that always spits out more cash over time. This is why we love microcaps and try to stick to our formula.
Earlier this year, we published an article outlining the bull-market we are witnessing in microcaps and some of the market dynamics (Click here for the article). On that note, we thought it makes sense to highlight some of the cheapest companies we’ve seen.
After reviewing all SEDAR filings, we’ve compiled a list of around 50 companies that we’ve whittled down to 10. And so today, we’re presenting the Top 10 companies on our watchlist. Well, just the first 5 – you’ll have to wait until next week for the Top 5 in Part II of our special.
Before we share this list, we need to remind our subscribers that not all these companies are SCD picks, but rather just ideas and companies we are following. Moreover, we’ve done some early research on each company, but for some, we haven’t completed our full analysis.
For each company, we’ll provide some key facts and a list of pros and cons. Thereafter, we’ll provide the bottom line on if we are buying or passing and what we’d need to see to invest. There’s no order to the stocks, other than we own them or are following closely.
Spectra Products Inc. Ticker: SSA.V Price: $0.05 Market cap: $3.86M Shares outstanding: 77.11M Revenue (TTM): $2.1M Net Income (TTM): $543,000 Revenue growth last nine month (Y/Y): 3.3% P/E (annualized): 7x |
| | If you recall, this is a company that we’ve profiled in a previous Top 10 at $0.03 and financed at $0.05. It continues to remain as one of our top picks as it’s just too cheap. What it does: Spectra makes safety and maintenance products for the transportation industry. Their flagship product, Brake Safe, allows truck drivers to visually determine the brake adjustment condition of their brakes. Out of adjustment brakes are the number one service violation in North America.
Spectra’s other key product is Termin-8r. This is an anti-corrosion lubricant that extends truck parts’ life and reliability.
Pros: - Untapped market. Spectra has a strong franchise in Canada but has only begun penetrating a lucrative US market that is 10X the opportunity in Canada. Per the MD&A, sales are accelerating in the US.
- Regulatory tailwinds. Out of adjustment brakes are a BIG risk to drivers and as a result, they are the #1 service violation in North America. Spectra’s products have now become mandatory and as regulators crack down, Spectra’s brake business should continue to grow organically.
Cons: - Dependent on new business. Spectra’s flagship BrakeSafe product is made to last – once you buy it, you’re set. This is great for customers – but means Spectra doesn’t have recurring revenues to count on and must find new customers to grow.
- Cyclical. The trucking industry is cyclical and tied to overall economic conditions. In a downturn, fleet operators will be less likely to invest in the aftermarket accessories Spectra offers.
Bottom Line: Spectra has a proven business model that is now accelerating into the US market. With a clean balance sheet and valuation in the mid-single digits, we own and continue to like Spectra.
FP Newspapers Inc. Ticker: FP.V Price: $0.38 Market cap: $2.62M Shares outstanding: 6.9M Revenue (TTM): $1.88M Net Income (TTM): $174,000 Revenue growth last quarter (year-over-year - y/y): 175% P/E (annualized): 9.3x |
| | What it does: FP Newspapers Inc owns securities entitling it to 49% of the distributable cash of FP Canadian Newspapers Limited Partnership ("FPLP"). FPLP owns the Winnipeg Free Press, the Brandon Sun, and their related businesses, as well as the Canstar Community News division, the publisher of six community newspapers in the Winnipeg region, and The Carillon in Steinbach with its related commercial printing operations. The businesses employ 364 full-time equivalent people in Winnipeg, Brandon, and Steinbach Manitoba.
Pros: - Strong free cash flow. FPI is generating strong free cash flow and we anticipate them continuing to do so for the foreseeable future.
- Overlooked business. FPI has a confusing and complex structure, that likely turns a lot of investors away. While others view this as a bad or boring business, we view it as a potential opportunity. However, it’s not a business we think has a 10x upside, so the most optimistic case is a 2-3x over the next couple of years.
Cons: - Royalty business. The Company generates its free cash flow based on the royalties collected on the bottom line from the various newspapers. Moreover, it’s not a business that is growth-oriented and the basis of revenues for FPLP is from print advertising, which likely continues to get worse, meaning the royalties to FPI may diminish over time.
- Reliant on the partner, FPLP. Given that FPI owns 49% of the distributable cash of FPLP, they are solely reliant on their success. As FPI is not managing or operating this entity, there are structural issues and risks since there’s no control from FPI on the distributed cash from FPLP.
Bottom Line: FP Newspapers own assets that are returning a high level of cash flow with almost no overhead, just public market expenses. It’s a complex structure that the market is likely overlooking, in a declining industry. We like the cash flows and recognize the value of the business will increase as long the cash keeps compounding. While we don’t own any shares, if the market sold off, we may revisit the idea for a deep value trade.
Inventronics Ltd. Ticker: IVX.V Price: $0.21 Market cap: $925K Shares outstanding: 4.41M Revenue (TTM): $6.42MM Net Income (TTM): $536K Revenue growth last quarter (year-over-year - y/y): 48% P/E (annualized): 1.2x |
| | What it does: Inventronics Limited designs and manufactures custom enclosures and other products for an array of customers in the telecommunications, electric utility, cable television, oil, and gas, electronics and computer services industries in North America. The Corporation owns its ISO 9001-registered production facility in Brandon, Manitoba.
Pros: - No dilution: Inventronics has not financed since 2002 and completed a 5/1 consolidation in 2006. Since then the issued and outstanding have not changed.
- High inside ownership. Insiders own approximately 70% of the issued and outstanding. This means the insiders have a vested interest in creating some type of value for the Company, as they are the majority shareholders. We feel confident some value will eventually be created but recognize it may take a lot longer than we are willing to wait. In addition, the current structure leaves only 1,330,145 shares left for public shareholders. It creates a situation where there’s virtually zero liquidity, and if there’s any buying or selling it will likely be with large spreads.
Cons: - Declining business. Inventronics was founded in 1970 and has been a public Company since 1997. Historically, the Company had peak sales in 2007 and has been declining ever since. For the past decade, sales have ranged consistently between $4-$5M per annum. Inventronics is having another strong year compared to its previous year, and hence why it showed up when reviewing SEDAR filings, but can the Company return to a multi-year growth period? This remains to be seen.
- Nuts and bolts business. Inventronics manufacturers custom enclosures. Think of a large steel enclosure that house telecommunications equipment that sits in your neighbourhood, or a traffic control enclosure near a busy intersection. These products are industrial-grade lockers applicable to a variety of industries. However, that means there’s no software, no recurring revenues and likely never going to have a high multiple. It’s a nuts and bolts business where material increases in sales will likely require a comparable increase in expenses.
Bottom Line: Inventronics is cheap, and arguably one of the cheapest companies we’ve seen. It’s trading at less than $1M market cap, with a stable profitable business. Given that controlling a public vehicle can fetch a $1M in value, we think there’s a relatively limited downside to owning Inventronics. The challenge is that buying a position won’t be easy, and without growth, the shares likely won’t attract any new investor interest. It’s a situation where aging management has a vested interest to create value, and likely sell the Company or take it private at some point. The question remains, do we think the upside is worth the opportunity cost of waiting for this value triggering event?
NexgenRx Inc. Ticker: NXG.V Price: $0.20 Market cap: $14M Shares outstanding: 69.92M Revenue (TTM): $9.48MM Net Income (TTM): $38K Revenue growth last quarter (year-over-year - y/y): 35% P/E (annualized): Negative |
| | What it does: NexgenRx is an Independent Canadian provider of ASO (Self-Funded) Drug, Dental, and Extended Health benefit plans supported by technology. NexgenRx is Canada's only independent full-service technology solutions provider, offering proprietary full front-end enrolment, hour bank and mobile access capabilities, combined with state-of-the-art claims adjudication and full provider network coverage. These combined capabilities allow NexgenRx to provide complete proprietary solutions to plan sponsors that need sophisticated front-end administration and health benefit technology applications, all in a cost-effective manner. NexgenRx is committed to building partnerships with organizations looking to exceed the expectations of their clients and plan members and deliver superior administration and claims processing solutions at a competitive cost.
Pros:- Trending in the right direction: NexgenRx IPO’d in 2006 with a $0.35 offering. At that time, the Company had $27K in sales and $6.2M in losses. Today, the Company is doing roughly $2.4M in sales per quarter and roughly $9.3M in annual sales. Representing a 25% CAGR since 2005. While the Company posted its first profitable year in 2012, the earnings have gyrated since. In fiscal 2019, the Company is setting record revenues, has positive operating cash flow and generated $750K in EBITDA for the first nine months.
- Consistent insider buying. Management owns approximately 18% of the issued and outstanding. But there’s a non-management shareholder, Paul Crossett who’s been steadily accumulating shares in Nexgen. Paul started buying in 2015, at which point he owned 1M shares, which has now grown to almost 12M. When combined, the total insider ownership is at roughly 35%. Given Mr. Crossett’s consistent buying pattern, we expect it to continue.
Cons:- Normalized numbers. In 2018, Nexgen acquired two benefit administration companies for an aggregate amount of $4M. These two acquisitions have started to reflect on the financials, which has caused the revenues to spike roughly 30% higher Y/Y. Therefore, while the recent revenue growth may be exciting, we don’t believe it accurately reflects the long-term growth trajectory. While we expect Nexgen to keep growing, we recognize that the growth will slow down as the comparable financial metrics will begin to include these latest acquisitions.
- Lacking net profits. Nexgen has had periods of profitability, and when it happens, it has been quite profitable, but it has not sustained. For the past two years, Nexgen has continued to post net losses and haven’t demonstrated consistent and predictable profits. We are tracking the Company closely and monitoring the financial trends for consistent profitability. Two quarters of profitability and we would be taking a serious look at this Company.
Bottom Line: Nexgen is exactly the type of company we like to look for. An established business that provides a high margin SAAS offering, which can potentially garner a larger market multiple. It’s also not that cheap, trading at roughly 16x EV/EBITDA, 370x earnings with around $1.8M book value, which is full of intangibles and goodwill. We continue to monitor the Company closely for any signals that the Company can maintain net profits and while continuing its growth trajectory.
Aurora Solar Technologies Inc.
Ticker: ACU.V
Price: $0.125
Market cap: $11M
Shares outstanding: 88.2M
Revenue (TTM): $2.15M
Net Income (TTM): Negative
Revenue growth last quarter (year-over-year - y/y): 35%
P/E (annualized): 8.5X |
| | If you recall, this is a company that we recently profiled and are participating in the pending private placement offering of $0.10 common shares with a full warrant at $0.15 What it does: Aurora Solar Technologies is a leader in the development and delivery of inline process measurement, analysis, and control systems for solar cell manufacturers. We believe that solar power will dominate the renewable energy field and our mission is to bring quality and profitability to every customer through superior control of critical processes during solar cell manufacturing.
Aurora's products are used by some of the world's most advanced and respected solar cell manufacturers. With headquarters near Vancouver, Canada, Aurora has operations in Shanghai, China, and partners in all major solar manufacturing markets.
Pros: - Recently profitable: Historically, Aurora has only delivered two-quarters of profitability. Once in Q2, 2017 and their most recent quarter Q2, 2019. While the Company has not delivered a full year of profits, or consecutive profits on a quarterly basis, we recognize that throughout 2019 the Company announced a record number of new contracts with both new and existing customers. In the coming quarters, we anticipate these orders will start to be recognized in the financial statements.
- New software. Currently, all the sales for Aurora are from hardware products. However, the Company has spent a considerable amount of R&D dollars, developing software that addresses the growing challenges facing cell manufacturers in characterizing and controlling production variation. InsightTM, Aurora’s novel “data science” product is now being beta-tested by multiple clients as a SAAS offering. Management believes this software could save its clients $10-$30 million annually per manufacturing facility and if successful would change the company’s valuation overnight.
Cons: - History of dilution. Aurora has financed its operations off financing activity and has already completed 7 financings since becoming public in 2011. The largest destruction of value for any microcap company comes from dilution and Aurora has certainly had its fair share. As a result, the issued and outstanding shares are quite high.
- Low inside ownership. The co-founder and CEO is the largest shareholder with 2,341,770 shares and the total insider ownership is less than 5%. Having a board of directors and management team that owns shares and has a vested interest in the success of the Company is of paramount importance, especially for microcaps. We recognize the potential risk that the board and management might not always be thinking as if they are a shareholder given the lower ownership. It should also be noted however that Pathfinder Asset Management owns roughly 17%.
Bottom Line: Aurora is a Company we own and continue to like. We believe the company is in a sweet spot, operating in a high growth market, providing critical solutions for the clients’ cell manufacturing operations. We felt the Company was relatively cheap for a hardware company, but recognize the market is providing no value for the new software products. If the software products are successful, we think the Company could have a large re-rating as Aurora’s story will have fundamentally changed and so should the perception of the market.
Wrap-up So, there you have it, 5 undiscovered companies that meet our criteria. We can’t promise all – or even some of these – will be winners. But our experience shows owning tiny, cash flowing micro-caps is one of the fastest routes to big profits.
Tune in next week for Part II of our list, where we’ll reveal another Top 5 of the cheapest, most undiscovered companies we know.
Paul, Trevor, and Brandon |
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