Soda, Brazil, and Royalties

by Travis Johnson, Stock Gumshoe | June 20, 2014 11:25 pm

One buy and a few quick thoughts that come to mind this week for the Friday File

Happy Friday, all — Irregulars have already seen a few “members only” articles this week, from Dr. KSS’ new posting[1] to my update on goings-on with Ligand[2], so I think we’ll probably be a bit on the brief side with the Friday File today… let’s see if I can stick with that prediction.

Things are fairly slow in my portfolio this week, but I’ve been considering adding to a few positions where pricing seems reasonable and the future’s looking a bit brighter — chief among those is probably SodaStream (SODA), which I did a small chunk to today as it dipped under $36.50 (they’ve been showing signs of life in their US growth again, including a big promotion at Walmart[3], though we won’t really know details for another six weeks as we await another quarterly report), and I’ve also been looking at Softbank some more (haven’t bought any yet).

SODA, for those new to the group, is the maker of home carbonation machines and — perhaps more importantly — they boast a huge global network of locations where the CO2 cartridges used to fuel these machines can be recharged and recycled (buying a new cartridge costs about $30, if you bring back the old one for recycling you get a new one — a “refill” — for $15). They also sell the flavors that folks add to their carbonated water to create regular or diet sodas in a hundred or so different varieties, most are a bit better for you than conventional soda, having fewer calories and actual sugar, though they are different from the Cokes and Pepsis you’re used to and if it wasn’t for the kids we probably wouldn’t get any of the flavors — I just like the bubbly water.

As an investment, the company is basically a “mini blue chip” with a large and established brand and recurring revenue business in Europe… but they’ve used the cash from that “blue chip” business to expand, pouring cash into building up their distribution networks in other countries in an effort to grow. The most notable market is the US, though they’re growing quickly in parts of Asia as well, and their big investment in building a US business up to meaningful scale has used up the free cash flow from their steady, slow-growth European operation. The stock fell from its heights of about a year ago in a few steps down as they failed to meet growth expectations, and the impact was heightened earlier this Spring because SODA had a weak holiday season, with heavy discounting and lots of unsold inventory of their carbonation machines.

I suggested SODA and wrote it up in more detail a couple month ago[4], and the story continues to play out more or less as it was then — the quarterly results were weak but more or less in line with expectations, but they did sell a lot of machines (at worse margins) over the last six months, and those people should need some nice high-margin refills… and they have some decent summer promotions going on, so I think we’re likely to see the stock rebound as earnings improve in the next few quarters. We’ll see, it’s still a small position for me but the business is long-established, difficult to replace, and profitable even when they’re trying to break into a big, expensive market in the US… that makes me want to own a piece and see how it plays out. The folks at the Fool had a similarly optimistic take this week here[5] and last week here (on the Walmart promotion news)[6], so I might certainly be wrong but I’m not alone.

In other quarters, I’ve also been watching with some interest as Altius (ALS.TO ATUSF) dwindles in price a bit thanks largely (I think) to the delays in securing financing Alderon’s (AXX) Kami mine. Alderon needs to borrow well over a billion dollars to construct the mine, and with pretty much all the permitting done and the employment and equipment deals pretty much in place, it’s just that money keeping them from moving forward. (If you’re new to this story, Alderon was created by Altius to develop this mine, which Altius discovered, and Altius owns a portion of Alderon equity and a fat 3% royalty on any eventual mine production).

They’ve been saying for close to a year that it’s very close, and they should be getting help from their partner Hebei in getting some Chinese banks on board, but so far no dice. Kami is not currently negotiating from a strong position with iron ore prices staying weak, and I suspect that at these prices the only really interested parties are Chinese steelmakers and any banks that want to cooperate with those firms, so there could easily be yet more delay. But once the money comes through, which I expect it eventually will unless iron prices collapse more thoroughly, they’ll get moving again.

Altius has no particular expectations of their equity stake in Alderon, which should continue to be diluted as Alderon raises money, but they are (and I am) counting on the Kami royalties to start flowing in a few years. Their need for this cash flow is is not urgent at the moment, since Altius will be profitable starting with their next quarter (thanks to their huge deal for the Sherritt royalties that we’ve talked about many times[7]), but growth depends on Kami and on some of their other early stage projects paying off over time. On the plus side, gold’s sprightliness of late has meant their Virginia Mines position (small in the grand scheme of things) is looking perkier again. When it comes to commodities in general (save energy) I’m hard pressed to want to add to anything given my portfolio’s overweighting, so I haven’t nibbled any more on these shares but Altius would still be my first stop when adding to that sector. Iron ore at $90 means there’s no real rush — those prices are enough for Alderon’s mine to be built and to make a little money, they say their break-even will be around $70, but prices at these levels aren’t going to light a fire under their feet.

Last time I dug through the numbers of Altius’ expected royalties and the value of their outside investments (mostly stakes in Alderon and Virginia Mines, but there are a couple others), I determined that Altius was reasonably valued but not dirt cheap — I thought the equity, given a 10% discount rate on the expected royalty stream, should be worth about $330 million for fairly conservative investors. Those metrics are still roughly the same (we’ve not yet seen the first quarter of Altius results after the royalty deals closed), so Altius is getting closer now with a market cap of about $340 million. I still think that the steady royalty income they’re about to start booking will have investors re-rating the shares and give them a good chance of reaching $20 by the end of the year, but if iron prices collapse that’s not going to happen… I’m holding and will be patient about adding more, I think this will build into a tremendous company over time but it’s a bit holding and I don’t really want to add more to this position unless it becomes irresistibly cheap.

What else is happening? Well, I’m watching a lot of the World Cup and hoping that we’ll see the shares of Arcos Dorados (ARCO) dip again after the Brazil enthusiasm fades, because I’d like to start nibbling on that one if it gets a bit cheaper again…. though I’m continually pleased by the steady performance of Cielo (CIOXY), our Brazilian credit card processor that is doing very well operationally and seems to be getting a bit of a boost from the Brazil attention as well, but in the short term it’s tough to get excited about buying that one at all-time highs and 20X current-year earnings and with the expected dividend yield down to about 2.5-3%.

I look around at the consumer-oriented stocks that I’d like to own in Central and South America, but there’s just not a lot of cheap out there that gives you enough confidence to buy into challenging political situations or unpredictable currencies — even the breweries are expensive with all the takeover action putting a bid under the beer and liquor firms. So when it comes to Latin America my larder is a bit bare these days after selling Brazil Fast Food (BOBS) a few weeks ago, but I’ll wait to do any more buying until things look a bit cheaper. Or, you know, until my opinion changes. (And as you may have noticed, I was tempted into buying a few of those Brazil Resources warrants[8] a few weeks ago when they started trading — though that’s more of a speculation on a gold stock that has feverish fans with big megaphones than it is a real Brazil play)

So beyond the kerfuffle over Ligand (also a big holding for me) that’s what has come to mind this week — I still feel like I want to hold some cash for what seems like the inevitability of bargain prices hitting us in a surprise market shock at some point, because record highs in the indices and months of low volatility and market complacency and low interest rates make me think that there’s another shoe to drop somewhere out there… but, well, I’m not going to sell stocks that I like just because I’m a little worried. The market keeps hitting new highs, and it doesn’t care that I’m worried.

Have a great weekend! Fingers crossed for the US taking on Portugal on Sunday… and for a bargain or two to be sniffed out in the week to come.

  1. Dr. KSS’ new posting:
  2. update on goings-on with Ligand:
  3. big promotion at Walmart:
  4. a couple month ago:
  5. optimistic take this week here:
  6. last week here (on the Walmart promotion news):
  7. talked about many times:
  8. buying a few of those Brazil Resources warrants:

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