Robert McWhirter, President and Portfolio Manager at Selective Asset Management, explains why his four past stock selections have done so well and provides details on how he determines when to sell a particular stock. He also talks about how there could be a price war brewing in the marijuana space and mentions three new stocks that he likes, including one with 39% year over year recurring revenue growth.
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Male Voice: Looking for more expert investing advice? You should check out the Experts and Analysts page on SmallCapPower.com. And, while you’re there, be sure to check the Experts and Analysts Top 20 picks. It’s under the premium research tab. Happy investing from your friends at SmallCapPower.
Female Voice: The SmallCapPower expert interview.
Interviewer: Bob McWhirter has more than 30 years of experience in the securities industry and is a top ranked money manager in Canada. He uses a 12-factor stock selection methodology that has both growth and value characteristics, including return on equity, earnings surprise, earnings estimate revision, price to book, and price to earnings ratio. We asked Bob back to the studio for an update on the four stock picks he shared with viewers during his last visit in 2013.
Bob McWhirter: We were very pleased with the performance of the four picks since December 19. On average, they were up 38% since December 19 through to April 22. And, from the purchase price on December 19 through to the actual peak prices that occurred between the period, the stocks were up 71%. It’s also important to note that we owned all four of the stocks from December 19 onwards. Alter NRG is up about 20% during the period. We still have positions although we’ve reduced our position in the stock because it’s moved up. This is the waste to energy firm. During the period, they announced a new contract with a Chinese partner for an incinerator enhancement product and also a 650-ton per day waste to energy project with Barbados as well. Avigilon is the company that basically has high definition cameras used for surveillance. They reported their earnings on March 4. Sales were up a crisp 56% year over year. Earnings were up 105%.
But, there was no earnings surprise that went with it, which then begs the question as to when to sell or reduce the stock. In spite of Avigilon’s strong results, the actual stock rose a little bit after they reported, then drifted back. And in part because they have a 48 PE on a trailing basis, they also end up having a PE multiple of 35 times 2014 estimates. But, you shouldn’t look at the PE by itself. You need to look at what are you paying versus what are you getting. In this case, with a 35 PE you’ve also got 35% earnings growth. That gives you a PE to growth rate of just under one times, which most people view as attractive. The big question, since earnings estimates have been shaved by 5% over the last 90 days, becomes one of will the earnings estimates growth of 64% for 2015 hold true? That’s really the kind of main question. So, technically, this stock had declined, and you should always have a stop loss of about 10% for a company.
If it does decline by 10%, you should look at the stock seriously and figure out whether something changed with the stock or whether the market backdrop has changed. In this case, shares of Avigilon had declined, and we’ve sold the position. At the moment, there is a fair number of tech analysis kind of sell signals on the stock. We think it’s a great company, but we think we can buy it back closer to $21 to $22. Shares of Burcon NutraScience were up 93% since December 19 because Archer Daniels Midland has announced an intention to end up expanding the commercial production of the CLARISOY product. This is a product that uses soy, extracts the protein from it, and produces a clear, odorless, colorless, tasteless protein that could be added to products like Gatorade. So, ADM has announced again they’re going to go ahead with that. We believe this announcement also further increases the likelihood of a new partner for doing the same thing but extracting protein from peas, which also should provide a good opportunity for Burcon.
FLYHT Aerospace, we sold the stock at 60 cents, which was up 38% from the December 19 price. At that point, it was trading at an estimated 15 times enterprise value/EBITDA based on 2015 estimates. Subsequently, the stock moved up a further 30% because of the Air Malaysia crash or disappearance of flight MH370. So, in part, valuation appeared to be rich in comparison to other opportunities. We felt it was time to sell the stock and look at something that was less expensive.
Interviewer: During our last interview, you said you thought Canadian equity markets would struggle in 2014 compared to those in the U.S. Do you still believe this?
Bob McWhirter: Well, since December 19, the S& P has underperformed the TSX. by about just under 5% in part because of the strong performance of energy stocks on the TSX. That’s because oil’s been above $100 for a fair while and also the decline in the Canadian dollar has also translated into more earnings for Canadian-based companies. We think the TSX will likely be entering a period of outperformance versus the U.S. markets as a result of energy stock performances, and we have an energy stock included in one of our new picks.
Interviewer: Some U.S. biotech and tech stocks have shown signs of weakness lately. Do you think this could be the start of a broader market correction south of the border?
Bob McWhirter: We don’t think so. If you look at the advance/decline line in a lot of the U.S. indices, you’ll see in spite of the overall indexes struggling the advance/decline lines are moving out to new heights. We think that signifies pretty good breadth in the market, and as a result, we expect the market will move higher and particularly in stocks that have strong fundamentals. With good growth, we think they will continue to do well.
Interviewer: There’s been a lot of talk about marijuana stocks recently. So, what’s your take? Is this a bubble in the making, or should investors take these stocks seriously?
Bob McWhirter: Well, the market at the moment is about 37,000 Canadians have medical marijuana licenses. That’s expected to grow by about a factor of 12 over the next 10 years.
However, there are over 600 applicants for new applications to be able to grow and produce medical marijuana. Unfortunately, in contrast to the beer industry where there’s a minimum selling price for beer, there’s no minimum selling price for marijuana. So, we’re expecting that there will be a huge price war. In addition, almost like the mid-1980s where there were over 100 different snowmobile manufacturers and there are currently three of them left in the business, we think it will be tough sledding for a lot of these companies to make money over time.
Interviewer: Do you have any new stock ideas that you can share with our audience?
Bob McWhirter: Sure. We’ve got three picks. The first one, in alphabetical order, is Cortex Business Solutions. This is a small cap company, $21 million, and they provide an electronic network that basically is used for business invoicing. It reduces costs and the days sales outstanding, which is a formal way of saying how long does it take a company to get paid. It’s cheaper and faster. They reported record results on March 27. Their Q2 sales, their sales were up over 32% year over year. Their recurring revenue was up 39% year over year. On a quarter over quarter basis, the sales were up 11%, which is an increase of over 52% on an annualized basis. The company recently did a financing of $10 million, which we participated in. We think that’ll be enough to carry them through until their cash flow breaks even in the second quarter of 2015. Husky and Finning are two customers who basically are having all their suppliers go on the Cortex network to take advantage of the savings that are offered by Cortex’s solution.
We own the stock personally. Okay, Delphi Energy. Delphi Energy, symbol DEE, is a Calgary-based company that explores for oil and gas. You’re going to ask yourself why is McWhirter recommending an oil and gas stock. Well, the key is what they call ‘slick-water’ fracking. They take five times the water and two times the amount of sand compared to conventional fracking, put it down the same size hole, have much bigger fracturing if you wish. That leads to three times the production out of the wells, and it also means that the wells themselves produce reliably over a much longer time period. Delphi’s management believes that they can grow cash flow at a 36% compound rate over the next five years as they drill out 70 different properties. So, when you look at the kind of enterprise value/EBITDA at a seven times premium for 2014 with the opportunity of 36% compounded cash flow growth over the next five years, we think that Delphi is very attractive.
The stock’s at roughly $3.23, near term target is $4. That implies about a 24% upside. Again, we think this is one that you can buy, throw in a box, and wake up happy three years from now. Still minding stop losses in case something goes wrong, but we think there’s still good long term potential for the stock. Questor Technology, the symbol is QST, is a market cap of $73 million. They have incinerators that are used for the flaring of natural gas. Typically, when you see natural gas being flared in an oil and gas field it doesn’t get hot enough to be able to burn off benzene, which is a known cancer causing agent or hydrogen sulfide, which is the classic rotten egg smell that you have from some wells in western Canada. The advantage of their system is it does not need extra natural gas to be able to get the natural gas hot enough to burn off the nasty stuff. So, as a result it’s a much less expensive process, very reliable, and the payback on their system is less than a year compared to the competitors’ product.
Jennings, Clarus, and Cormark cover Questor, and Cormark is of the view that their sales will grow and double in 2014 compared to last year, and double again in 2015. Questor appears cheap at about a 5.2 times 2015 times enterprise value/EBITDA basis. Capitalcube.com ranks it 97 out of 100 on a fundamental basis. We believe the stock is very attractive. We own a significant six-figure position personally as well.
Interviewer: Thank you for taking the time for the interview, Bob.
Male Voice: Looking for more expert investing advice? You should check out the Experts and Analysts page on SmallCapPower.com. And, while you’re there, be sure to check the Experts and Analysts Top 20 picks. It’s under the premium research tab. Happy investing from your friends at SmallCapPower.
