Smallcap Discoveries: Weekly Update: August 22

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Subject: Smallcap Discoveries: Weekly Update: August 22 - 26

August 22 - 26

Market Commentary

Markets

Thanks to hawkish talk from the head of the US Fed, Jerome Powell, the North American equity markets sold off hard at the end of the week. The DOW finished the week lower by 4.2%, Nasdaq was lower by 4.4% and the TSX was down 1.2%. Nasdaq has now retraced 8.0% from its recent highs (August 16) but still up 14.9% from its year low (June 16). This retracement has me somewhat relieved as the markets were starting to look quite overbought. Nasdaq has gone from a relative strength reading of 74/75 down to below 50, a much more balance situation.

While the Fed appears to be happy to maintain a hawkish and tightening tone the inflation and economic data continues to appear to be going in the direction that should make the Fed happy.

The Fed’s favorite inflation gauge, the PCE index actually fell by 0.1% in July. Stripping out food and energy it rose by 0.1%, both numbers below economists’ estimates. A major drop in gasoline prices is helping reign in inflationary pressures and while the Fed is maintaining a hawkish stance this type of data will likely allow the Fed to ease sooner than many would expect. We believe the Fed needs to continue to talk tough now to prevent needing to act tough later.

Energy

This week Saudi Arabia sent a message to the markets and oil traders. In a market where some are seeing extreme energy shortages and volatile energy prices the Saudis warned that supply cuts may be necessary if prices for oil were to weaken much further. WTI oil started the week below $90 and topped out mid-week over $95 only to close at $92.97 on Friday.

Natural gas futures remain near decade highs above $9 as we begin to exit the summer heating season and move into the fall shoulder season where historically demand drops before the winter heating season. This year looks to be quite different as LNG demand from Europe is strong and gas producers wait for the Freeport LNG shipping facility to get back into full operation.

Then we have gasoline. I believe this is one of the key commodities that the Fed is keeping an eye on as so many products and services have gasoline as an input. It’s also a key part of the consumers spend so a lowering of gasoline prices should help ease inflationary pressures through out the economy. In that regard it continues to head in the right direction.

We saw another uptick in North American drill rig activity this week. The Baker Hughes rig count increased by 3 land rigs this past week. A number of energy service stocks were hitting fresh new 52-week highs as their financial results continue to impress.

Commodities

Most commodities ended the week mostly flat although Friday saw a sharp dip for many commodities on the back of a strong jump in the US dollar due to the hawkish comments from the US Fed.

Gold ended the week at $1750.80. Rising interest rates and a slowing economy is not usually very helpful to gold.

Stocks

A down market doesn’t mean there aren’t great buying opportunities in this market. The overbought conditions that we have been talking about for a few weeks have abated and a bit of healthy fear should be looked at as a good thing. Exuberance is never a long-lasting condition in the markets.

There continues to be a lot of discussion around whether we are in a recession or not. Remember that the economy and the stock market are two different things. The market is a leading indicator and most economic data is lagging. In most cases the market moves well in advance of the economy both on the way down and the way up. In fact, a great article in Forbes this week shows how disconnected the two are.

How Stocks Perform Before, During, And After Recessions May Surprise You @Forbes. “Investors may be surprised to learn that in the last 69 years, on average, stocks did worse in the year before a recession began than during the recession itself.”

"Far more money has been lost by investors trying to anticipate corrections than has been lost in all the corrections combined" - Peter Lynch

I’ve been a bit more active this past week and added 2 more new names to the portfolio, Inventronics (IVX.V) and Ibex Technologies (IBT.V). While not new to our watch list both are now back in my portfolio. This week we had a good chat with the CEO of Inventronics and we were quite pleased with what we heard. The company produces metal cabinets that house sensitive telecom and power equipment for fiber optic networks, other communications networks, and the power grid. We feel there is much more resilience in the business than we originally thought. They are benefitting from the continued build out of telecommunication and electricity infrastructure through out North America, a super cycle that likely will last for at least the next decade. Sounds like a simple product and in a way, it is, but because of the size and weight and significant demand the company benefits from its strategic location in the center of North America (Winnipeg, Manitoba). There is little competition from international sources because shipping costs make foreign manufacturers uncompetitive. This is a great (boring) business, with great margins, a logistics “moat”, rapid growth and in my opinion is criminally undervalued at current prices. At Friday’s closing price ($2.55) the stock trades at only 4.1 times trailing 12-month earnings. Revenues are up 75% on a TTM year over year basis and up 52% over the same quarter last year. This has the potential to be a fantastic compounder over the next few years.

The other company, Ibex Technologies (IBT.V) is a small contract research organization and specialty producer of enzymes for the biomedical industry. We interviewed company management a year ago so for those of you that missed it you can view it here. In June the company announced another strong quarterly result. Quarterly revenues were up 51% over the previous year and trailing 12-month revenues were up 33% from the previous period. At Fridays closing price of $0.50 the stock trades at 8.7 times trailing 12-month earnings but with $7 million in cash and an enterprise value of $6.5 million the stock trades at only 4.2 times EV/earnings. No wonder the company just announced a share buy back as clearly management think the stock is a bit too cheap.

I absolutely love buying shares of companies that are growing above 25% and yet sport a single digit price to earnings ratios.

These 2 companies are not the only 2 opportunities like that right now.

This market seems ripe with opportunities in the microcap and nanocap space. Most retail investors are fearful and most institutional investors continue to play up market in the larger liquid names. Not only are investors moving to the sideline or going upmarket many are just leaving Canada. There is a growing valuation gap between Canadian and US smallcaps.

The long-term microcap investor rarely finds a time that is as ideal as it is right now to be selectively buying, especially in profitable Canadian microcaps. Profitable Canadian microcaps are trading at some of the lowest valuations than I’ve seen in a long time.

There are lots of microcap companies with impressive results and lots of these companies are cheap. You are going to find more bargains in down markets when it’s hard to find the courage to buy them. The opposite is true in up markets.

To get a big winner it helps to start with a cheap stock. These stocks need to be growing fast (compounding) and they need PE ratio expansion. You’re more likely to see PE ratio expansion if you start with a small PE ratio. It’s what I witnessed with Xpel Technologies, Biosyent, Hamilton Thorne, Bowflex, Medifast and so, so many others. These were all single digit PE companies growing revenues well into double digits per year. This is exactly what I’m seeing in our universe of Canadian microcap stocks right now.

Stay tuned as Trevor and I are putting the finishing touches on a new “Cheapies” list. This one will be full of double-digit revenue growers trading at single digit PE ratios.

This Week’s Canslim Contender

Hudson Technologies (HDSN – Nasdaq)

Closing Price: $10.48

Hudson Technologies, Inc. is a leading provider of innovative and sustainable refrigerant products and services to the Heating Ventilation Air Conditioning and Refrigeration industry. For nearly three decades, we have demonstrated our commitment to our customers and the environment by becoming one of the first in the United States and largest refrigerant reclaimers through multimillion dollar investments in the plants and advanced separation technology required to recover a wide variety of refrigerants and restoring them to Air-Conditioning, Heating, and Refrigeration Institute standard for reuse as certified EMERALD Refrigerants(TM). The Company's products and services are primarily used in commercial air conditioning, industrial processing and refrigeration systems, and include refrigerant and industrial gas sales, refrigerant management services consisting primarily of reclamation of refrigerants and RefrigerantSide(TM) Services performed at a customer's site, consisting of system decontamination to remove moisture, oils and other contaminants. The Company's SmartEnergy OPS(TM) service is a web-based real time continuous monitoring service applicable to a facility's refrigeration systems and other energy systems. The Company's Chiller Chemistry(TM) and Chill Smart(TM) services are also predictive and diagnostic service offerings. As a component of the Company's products and services, the Company also generates carbon offset projects.

Website: https://www.hudsontech.com/

Sector: Industrial – Business Support Services

Last quarter revenue growth: 72%

TTM revenue growth: 81.5%

Last quarter EPS growth: $0.89 vs $0.26

Trailing 12-month PE: 5.24

Insider Ownership: 17.26% (per Yahoo Finance)

Institutional Ownership: 77.86% (per Yahoo Finance)

Recommended Reading

100 Baggers by Christopher W. Mayer – Stocks that Return 100-to-1 and How to Find Them

I’m re-reading this super book. It’s a great reminder of what the common characteristics of multi-baggers are and what one of the biggest traits necessary to be able to benefit from a multi bagger…. almost sloth-like patience. And a hat tip to one of our friends Chip who gets a great mention in the book.

Buys and Sells This Week