The Rational Cloning: Weekly Ideas #18
Upslope Capital & Alluvial's Q4 2021 Update, Kuppy on Oil, Pete Panda on Tin
Welcome to the 18th edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) Upslope Q4 2021 Update
With an increasingly treacherous investing environment, defensive strategies, which have been out of favor since the March 2020 bottom, should see a resurgence. We’ll see.
a. MarketAxess (MKTX) – Reinitiated Long
MarketAxess is the leading platform for electronic trading of corporate fixed income securities (mostly HighGrade, High Yield, Eurobonds, Emerging Markets). The stock was a Core long of Upslope’s – until early 2021, when it became apparent the company was coming under significant competitive pressure from Tradeweb, a smaller but formative competitor. After being short for most of 2021, we covered in December and reinitiated a modest long position. Why now?
(1) Fundamental outlook has stabilized and may have troughed; evolving revenue mix bodes well for future growth. MKTX faced two key issues in 2021: increasing competitive intensity from Tradeweb and a generally tough environment (low volatility and incredibly tough comps vs. 2020). On this latter point, we know 2021 will be a far easier comp for MKTX. And, as previously noted, higher volatility ahead seems a reasonable bet.
(2) Shares have massively de-rated from about 50x EBITDA to 30x. This is still not “cheap” – especially considering the environment for high-multiple stocks – and we are sized somewhat cautiously to reflect this. But, one can’t ignore that MKTX continues to be a highly attractive business (nearly 60% EBITDA margins, double-digit top line growth, a fortress balance sheet, and genuine strategic value). Additionally, if fundamentals do, in fact, turn up, valuation will quickly appear reasonable. (
3) Takeout optionality becoming a consideration as enterprise value approaches $13 billion. The math surrounding a potential MKTX take-out is still somewhat challenging, given the relatively high multiple on the stock. However, given the strategic value of the business, it’s awfully hard to see shares go much lower without serious interest from large, diversified exchanges. And again, should fundamentals turn up, the takeout math will also quickly improve.
b. Casey’s General Store (CASY) – New Long
Casey’s is the 3rd largest operator of convenience stores in the United States and effectively the 5th largest pizza chain in the country. Geographically, Casey’s is focused exclusively on the Midwest and South, with locations primarily in small towns (almost half with populations <5,000; three-quarters with <20,000). Gross profit is split across Grocery & General Merchandise (37%), Fuel (32%) and Prepared Food & Dispensed Beverage (28%).
Generally, Upslope’s thesis is that Casey’s is an attractive, defensive, and growing value-oriented stock – perfect for the environment today (and years ahead), which for some time has been enamored with sexy, speculative growth stories. The company has a unique and concentrated geographic footprint (see above), which could eventually make it an M&A target. At <11x EBITDA the stock is not expensive on either a relative or absolute basis and the balance sheet is reasonable (<2x net leverage).
(2) Alluvial Fund Q4 2021 Update
a. P10
P10, Inc. remains the fund’s largest holding. The company’s latest achievement is successfully refinancing its debt, lowering the interest rate from 7.00% to 2.25% and extending the term. This new agreement provides P10 with plenty of available capital to pursue its acquisitions strategy and build its stable of alternative investment managers. Assets under management should soon exceed $17 billion, with a clear path to $20 billion and higher.
P10’s only disappointing aspect has been its lackluster share price movement since its IPO. Despite its peerless cash flow profile and predictability, growth options, and management skill and alignment, shares continue to change hands at just 17x my estimate of current free cash flow. I remind myself that though P10 is now an NYSE-listed company, the value of its free-floating stock is just $260 million. For trading purposes, P10 is still just a micro-cap. It should be no surprise that it acts like one.
b. Crawford United
For the second year running, Crawford United celebrated the new year with acquisitions. This time around, Crawford spent $4 million to acquire Florida-based Reverso Pumps and Separ of the Americas. Assuming a purchase multiple of 6x EBIT, the acquisitions will increase Crawford’s earnings by 15 cents per share. While individually they may seem small, the continued acquisition of quality niche industrial companies adds up to major growth in Crawford United’s earnings power.
I expect the company’s results to feel some short-term pressure from supply chain troubles and inflation, but I like what the company is building. I am confident that Crawford’s earnings will exceed $10 per share at some point in the next decade and its shares will rise accordingly.
c. Garrett Motion
Garrett Motion is also feeling the effects of the troubles with global supply chains. Difficulties in sourcing semiconductors have led many large automotive manufacturers to slow production, which in turn delays orders for Garrett Motion’s turbochargers. Still, the environment has not prevented Garrett Motion from making progress on improving its balance sheet and beginning to return capital. In November, the company announced a plan to repurchase $100 million in common and preferred stock. Then in December, Garrett Motion announced it would accelerate the planned redemption of its Series B preferred stock held by Honeywell.
By this time next year, Garrett Motion will have meaningfully reduced its liabilities and bought in quite a bit of stock at a very attractive price. As supply chains normalize, the company’s earnings and cash flow will benefit, giving the company the ability to return more capital to shareholders and invest in the transition to products for electric vehicles.
d. LICT Corporation
We are still awaiting the results of LICT Corporation’s strategic review. The announcement of any decision on strategic alternatives was likely delayed by the company’s participation in FCC Auction 110, in which LICT successfully bid on $7.7 million in mid-band spectrum to support its wireless offerings. With the auction over, I look forward to news from the company. Even if the result of the process is a decision to maintain the status quo, LICT’s status as a provider of essential communications infrastructure and its commitment to returning capital make its shares attractive in the mid-$20,000s.
e. Unidata
On the topic of essential communications infrastructure, I could not be more excited about Unidata! For the first time, Unidata has laid out its 2022-2024 strategic plan, projecting 2024 revenues of EUR 64-79 million and EBITDA of EUR 19.1-23.3 million. At the mid-point of these projections, Unidata currently trades for just 6 times 2024 EBITDA, a gigantic discount to competitor valuations and to fair value using a common-sense free cash flow-based approach.
These are ambitious targets, but they are achievable. Unidata’s strong, recurring cash flow will enable it to invest $40 million in its fiber network from 2022 to 2024 without taking on debt. This extended network will allow Unidata to offer its broadband services to thousands upon thousands of new customers, both residential and enterprise. Doubling revenues from 2021 to 2024 will require Unidata to expand its offerings to adjacent products and services like data centers and internet of things applications, but the demand is there. Unidata richly deserves its position as Alluvial Fund’s second-largest holding.
f. TIM SA (Poland)
TIM SA is a distributor of electrical components with a fast-growing third-party logistics (“3PL”) business. TIM has grown revenues at a 14% annual pace since 2016, accelerating recently as e-commerce takes off in Poland. The company worked hard to transition its business model to online sales over the last several years and wound up creating the 3PL segment almost unintentionally. As its online business grew, TIM found it could use excess warehouse space to fulfill online orders on behalf of other Polish companies. Today, more than half of TIM SA’s 3PL revenues come from external clients, including blue chips like IKEA. TIM SA is taking steps to accelerate the growth of the 3PL business and highlight its value by preparing to offer a portion of the business on the stock exchange. In my view, the fast-growing, highly profitable 3PL business is worth more than 70% of TIM SA’s current market capitalization.
(3) Kuppy: Oil Traders Will “Break The Fed” And “Make Jerome Powell Cry Uncle”
Q; What one sector of the equities market would you dive into now if you had to pick only one - and why?
It’s not an equity, but if there was one asset to focus on, it would be long-dated OTM oil futures options. They’re the purest way to get long inflation and they’re mispriced compared to the potential upside. All sorts of right-tail assets seem mispriced, but the IV on oil futures options seem particularly mispriced as it is so cheap compared to the parabolic upside potential.
In terms of equities themselves, I think offshore oil services are about to really inflect.
With Brent at $86, demand for offshore production will come back in a major way. Especially because many Western governments are making it so painful to explore and produce oil domestically. As a result, the incremental supply will come from places that need the oil revenue—much of this will be offshore.
Meanwhile, much of this offshore equipment trades at tiny fractions of replacement cost. At the top of the cycle, these companies often trade for a few times replacement cost. I think we’re about to a surprising move in the price of oil, and these equities are the fulcrum security in the oil sector—but since most have restructured in bankruptcy, they have clean balance sheets and minimal risk if I’m wrong and the sector doesn’t inflect.
Oil is about to surprise people—offshore hasn’t moved yet. That’s where I’d be focusing my time, but buying the 2025, $100 strike oil call just seems like a more elegant way to play this with a lot less operational risk and a whole lot greater upside potential.
(4) Pete Panda: The Case for Tin
Tin prices have been climbing from sub $15k/t to +$40k/t in the last two years. Enough of a reason to have a look under the hood.
Rio Tinto, through research by Boston’s Massachusetts Institute of Technology (MIT), has detailed the metals that are expected to be the most impacted by new technology… tin is predicted by MIT to be the metal that will be most affected by technology.
Tin is used in many forms. It takes a high polish and is used to coat other metals to prevent corrosion, such as in tin cans, which are made of tin-coated steel. Alloys of tin are important, such as soft solder, pewter, bronze, and phosphor bronze. A niobium-tin alloy is used for superconducting magnets. Most window glass is made by floating molten glass on molten tin to produce a flat surface. Tin salts sprayed onto glass are used to produce electrically conductive coatings. The most important tin salt used is tin(II) chloride, which is used as a reducing agent and as a mordant for dyeing calico and silk. Tin(IV) oxide is used for ceramics and gas sensors. Zinc stannate (Zn2SnO4) is a fire-retardant used in plastics.
Solder consumption has grown rapidly over the past decade and has replaced tinplate as the largest area of tin consumption. Tin welding is mainly used in the electronic semiconductor industry, although the global electronic components show the characteristics of miniaturization (smaller chips = less solder usage), yet the increase of single equipment components does not significantly reduce the total consumption of electronic solder.
“Electrification of the world will need microchips. Lots of them. Period.”
Inventories: Simply put: These exchanges hold stock of different metals in their warehouses to smoothen out the global flow of metals, ease of transactions, keep supply on the shelves, etc. What we are seeing today, is that just a few days of supply is available (count 1000t/day). History has shown us anything below 10 days is worrisome & cause for attention. This has become painfully visible in the backwardation* we recently saw in the market.
Tweets That Make You Go… Hmm 🤔
Some humorous tweets/memes:
