Edelheit Agonistes

From the comment thread last month on his pick Hemisphere GPS (TSX: HEM.TO) on the Value Investors Club:

issambres839 (Aaron Edelheit):

How does a company that has no debt go from having a $250 million market cap to a $15 million market cap excluding net working capital?

While clearly $5 per share last May was too high in hindsight, is US$0.75 a little ridiculous?

Judging from the price action since then, apparently $0.75 was a "little ridiculous", but this one of the responses Edelheit got last month to his question:

oogum858:

Hi Issambres. . .I don't know anything about this company, but to your question of:

"How does a company that has no debt go from having a $250 million market cap to a $15 million market cap excluding net working capital?"

Obviously one potential answer is "Because the company is worth $15mm"

Given the desperate nature of your question I wanted to at least write down the most obvious response. I do this not to be a jerk, but because you seem to be insanely frustrated and at the very least it's good to try to think clearly about such things. Mr. Market revalues companies all the time and it can be really exasperating when you think he/it/whatever is totally wrong. But you have to make allowances for the divergent opinion. I'm sure you're thinking about this question all the time, so sorry if this seems condescending. . but i dunno... how else could an uninformed VIC member answer your question?

Some other interesting comments there, and some thoughtful responses from Edelheit. Worth reading.

An Unprecedented Investment in Food Security

Yesterday, the Financial Times reported that South Korea's Daewoo Logistics had leased half the arable land on Madagascar ("Daewoo to cultivate Madagascar land for free"). From the article:

Daewoo Logistics of South Korea said it expected to pay nothing to farm maize and palm oil in an area of Madagascar half the size of Belgium, increasing concerns about the largest farmland investment of this kind.

The Indian Ocean island will simply gain employment opportunities from Daewoo’s 99-year lease of 1.3m hectares, officials at the company said. They emphasised that the aim of the investment was to boost Seoul’s food security.

“We want to plant corn there to ensure our food security. Food can be a weapon in this world,” said Hong Jong-wan, a manager at Daewoo. “We can either export the harvests to other countries or ship them back to Korea in case of a food crisis.”

The editors of the paper criticized the terms of the deal as "neocolonial" in a related editorial, "Food security deal should not stand".

Hopefully, someone from the precision agriculture company Hemisphere GPS (TSX: HEM.TO) has arranged a sales call with Daewoo.

The graphic above is from the FT article.

Hemisphere GPS Reports

In its press release, Hemisphere GPS (TSX: HEM.TO) reports that its Q3 revenue grew 46% year-over-year, and its gross margins increased to 52%. Expenses increased 46% year-over-year as well (partly due to the acquisition of Beeline), and the company posted a loss of about $233,000 for the quarter (the loss would have been about twice that if it weren't for Hemisphere's foreign exchange gains).

On the Value Investors Club, Edelheit quotes these bullet points from Canaccord,

1) Revenues USD$13.2M up 46% yr/yr, Gross profit margins 51.6% and EPS (0.00) was better than consensus 12.6M GPM 48% EPS -0.01 (our forecasts 13.2M, GPM 50% /-0.01)
2) Company maintained FY guidance of revenue growth of greater than 45% (we believe mgnt will likely increase its FY guidance to better than 50% on the 11:00am CC)
3) Gross profit margins big positive surprise at 51.6% (slowest qtr of the yr) up 500 bps yr/yr, this should support current forward estimates if not cause some EPS estimates to increase in 2009 (street is 0.25-0.30 USD in FY2009)
4) FX trend of weakening cdn$ is positive for HEM margins (substantial cdn based operating costs), these margins were realized against a cdn$/USD$ spot of 1.06 (obviously we are at 1.18 now)
5) No signs of AG related slowdown
6) At C$1.70 share stock HEM has 20.5M in cash or 0.37/share, is trading at 4.4X 2009 EPS , growth rates in excess of 50% (and company now benefiting from favourably FX trends)
7) Company bought back 181,00 shares in Q3 @ 2.46/share

Edelheit then comments,

Why the heck is this at $1.70? Seriously, this is one of the most ridiculous malfunctions of the market that I`ve ever seen. 46% revenue growth, much better than expected margins and the stock is at 4.4X earnings?

Of course, Hemisphere isn't trading at 4.4x trailing earnings, but at 4.4x estimated 2009 earnings. If Hemisphere actually meets those earnings estimates, I'd expect it will trade at a higher multiple.

The photo above comes from the Hemisphere GPS website.

Will the Credit Crisis lead to a Food Crisis?

In a recent post ("Jim Rogers on CNBC Europe Early This Morning") we mentioned that Rogers continues to be bullish on agricultural commodities. Another investor who remains bullish on agriculture is Aaron Edelheit. Today on his blog, Aaron Edelheit writes that low global inventories, continuing demand growth from China, and the credit crisis together are setting the table for food shortages next year ("Looming Food Catastrophe in 2009"). Regarding Chinese demand, Edelheit quotes an article by Jim Lane, editor of Biofuels Digest¹ ("It's not food, it's not fuel, it's China: Expanded study of impact of China on global corn market") that argues that demand for corn has been driven primarily by the growing consumption of meat in China (since corn is used to feed livestock):

“Even with all the growth, Chinese meat consumption is still 45 percent less than the average consumption in the US,” Lane warned. “An additional 277 million tonnes of grain would be needed to support China at parity with the US. That would take 68 million acres to grow. There isn’t that kind of arable land available anywhere is the world, whether we grow grains for renewable energy or not.”

Regarding the impact of the credit crisis, Edelheit writes,

The credit crisis is hammering South American farmers, to the extent that they cannot get fertilizer². No fertilizer, no planting of crops.

Further, suppliers are asking farmers in the U.S. for more upfront money to make sure they aren’t holding delinquent debts, causing farming to be a bit more uncertain this year.

Edelheit bases this on an article by Carlos Caminada, Shruti Singh and Jeff Wilson on Bloomberg yesterday ("Farm-Credit Squeeze May Cut Crops, Spur Food Crisis").³ This raises two questions related to one of Edelheit's holdings, Hemisphere GPS (TSX: HEM.TO): if farmers can't get credit to buy fertilizer, can they get credit to buy Hemisphere's precision agriculture equipment? Do they need credit to buy Hemisphere's equipment? Edelheit doesn't say, as he doesn't discuss his stock positions on his blog.


¹I find this sort of primary research -- the kind often done by industry-specific analysts, but occasionally done by money managers such as Edelheit -- impressive. Partly as a result of doing this sort of research, occasional commenter Daniel Wahl (his blog) invested early in some winners in the agricultural space, as I noted in a post last June ("Stress Fractures in Titanium"). Daniel has taken his blog in something of a new direction recently, as he prepares to launch a new blog, and he no longer writes about his trades, but he did note in a recent comment thread on his blog that he is still holds Hemisphere GPS, and calls on the fertilizer company Potash Corp. of Saskatchewan (NYSE: POT).

²This may have been a factor in the recent correction in the prices of fertilizer company stocks.

³Jim Rogers similarly linked the credit crisis and commodities in his CNBC Europe interview last week, noting the difficulty anyone would have in borrowing money to dig a mine today.

Aaron Edelheit on Hemisphere GPS's Q2

In response to a question in his Hemisphere GPS (TSX: HEM.TO) thread on the Value Investors Club, Edelheit wrote:

q2 was a good quarter, that was slightly disappointing on earnings, but nothing earth shattering. Again, I think investors are starting to miss out on how good the next year could be.

Consider the following:

1) I believe that the company will sign a big contract with Agco by year end. This will cause sales to really jump next year.

2) The company is making in-roads into Russia/East Europe. That should show up next year

3)The company has a slew of new products coming out in q4, including a drive by wire autosteer product that has no competitive alternative.

4)The company has started working with their products for sugar cane harvesting. Penetration for GPS is negligible.

Those are just some of the reasons 2009 should be a blow out year. With the performance of this company and the management, and the competitive position they are in, who cares about any one quarter? They continue to move in the right direction and I think one day they will be bought out.

I continue to think this is a $6-$8 at the end of next year barring a major NA drought.

Although we've learned that Edelheit doesn't respond to questions about his stocks on his blog, it's good to know he still responds to questions on the VIC.

Edelheit originally recommended Hemisphere in July of 2006 when it was called CSI Wireless and was trading at C$1.50 per share. HEM.TO closed today at C$3.81 per share.

Hemisphere GPS Reports

Press release from Hemisphere GPS (TSX: HEM.TO): "Hemisphere GPS Reports Record Q2 Revenues, Earns $0.06 per Share as Gross Margins Reach 52.5%". Those earnings were below the more optimistic consensus estimates. 2Q revenues were up 59% year-over-year, but total operating costs were up 63% year-over-year, partly due to the additional costs added with the acquisition of Beeline Technologies. Hemisphere's stock was down about 9% today. I haven't had a chance to listen to the conference call replay yet, but if I hear anything noteworthy when I do, I'll post it here.

Precision Ag Update

Hat tip to Daniel Wahl ("Quick Notes") for noting Trimble Navigation's (Nasdaq: TRMB) earnings release last week. Trimble has a division that competes with Hemisphere GPS (HEM.TO) in the precision ag space. Daniel quoted this excerpt from Trimble's conference call:

"Second quarter 2008 Field Solutions revenue was $90.1 million, up approximately 63 percent compared to revenue of $55.3 million in the second quarter of 2007. Revenue growth was driven primarily by strong demand for agricultural products."

Daniel sees this as bullish for Hemisphere, and I agree. This space seems big enough for more than one firm to do well.

Hemisphere's 2Q conference call is scheduled for Tuesday morning.

Hemisphere GPS in the Mainstream Business Press

Hemisphere GPS (HEM.TO) was recommended by Lisa Hess in her column in the July 21st issue of Forbes, as company to invest in to benefit from the commodity boom. She also recommended Titan International (TWI) in this space. Titan manufactures the giant tires used by mining and agricultural vehicles.

HEM.TO Update: Four New Patents for Hemisphere GPS

See this press release ("Hemisphere GPS Awarded Four New Patents for Positioning and Automated Steering") for the Physics 903.

Hemisphere GPS (HEM.TO) is one of three positions I currently have that are Aaron Edelheit picks. Again, it's worth signing up for guest access to the Value Investors Club to read Edelheit's initial write-up, under his pseudonym "Issambres839". Hemisphere is also a holding of Daniel Wahl and Ravinsu (who doesn't have a blog yet, as far as I know, but occasionally graces us with his comments here). I've mentioned Hemisphere here before a few times, but I don't think I've explained what the company's business is. Here is a layman's description, in a nutshell:

If you've ever mowed a lawn or spread fertilizer or seeds on a lawn, you've probably overlapped your rows slightly, to make sure you covered the whole area of your lawn. Commercial farmers have long done essentially the same thing. When a commercial farmer is working with tens of thousands of acres, all that overlap can lead to the waste of a lot of (increasingly expensive) fuel, fertilizer, and seeds. Hemisphere is a "precision agriculture" company. By using satellite guidance systems, Hemisphere's equipment precisely steers tractors and other agricultural equipment, obviating the need for overlap, and saving farmers a lot fuel, fertilizer, and seeds -- and, consequently, a lot of money.

In a sense, Hemisphere GPS is to the agriculture industry what Alloy Steel International is to the mining industry. Both companies' products enable operators in their respective industries to operate more efficiently.

New Position: Destiny Media Technologies, Inc. (DSNY.OB)

Today I picked up some shares in Destiny Media Technologies, Inc. DSNY.OB at $.40 per share on margin. I plan to pay off the margin loan next month, when I sell the wreckage of some of the stocks I bought from the Magic Formula Investing list last August. Destiny Media is a pick of "issambres839" on the Value Investors Club. Thanks to Daniel Wahl, I've learned that issambress839 is the professional value investor Aaron Edelheit, of Sabre Value Management in Santa Barbara, CA. Edelheit may be one of the best investors I had never heard of up until last month.

In contrast with many value investors who use trailing metrics such as P/S and P/E to screen for stocks (recall rules-based investor Marc Gerstein's frustration with this approach in "What's Wrong with Today's Value Investing?"), Edelheit often researches small stocks without current earnings that are nevertheless trading at a low multiple to his estimates of their future earnings. When he recommended DSNY.OB on the Value Investors Club in January (when it was trading at $.68 cents per share), Edelheit wrote that it was trading at 7x his estimate for fiscal '09 earnings (at the current quote, it's trading at about 4x his estimate; insiders have been buying on the way down). Destiny Media is the second stock I bought based mainly on Edelheit's write up (and subsequent news that confirmed his thesis); the first was the precision agriculture company Hemisphere GPS (HEM.TO), which I bought around $4.34 per share (Edelheit originally recommended it last summer when it was trading at $2.74 per share). Like Hemisphere, Destiny Media is a Canadian company. Edelheit is willing to consider obscure Canadian companies (including those such as DSNY that trade on the OTC Bulletin Board) in search of undiscovered values.

I recommend signing up for guest access to the Value Investors Club so you can read issambress839/Edelheit's write-up for Destiny Media in detail, but here's my summary in a nutshell. Destiny offers a service (its Play MPE network) that enables record labels to digitally (and securely) transfer songs to radio stations. The service includes security features such as a (recently patented) digital watermarking technology to prevent unauthorized redistribution of the songs. The value proposition here is that Destiny Media can save the record labels a lot of money: Destiny's service costs about 90% less than the old method of sending songs in CD format via courier. Destiny had been offering its service to some labels at no charge last year, but has been signing contracts with them to pay to continue the service this year. As Edelheit pointed out in his write-up, since Destiny's stock is obscure, foreign, and has no analyst coverage, few are aware of the paying customers it is lining up for its Play MPE network.

According to Edelheit, Destiny also offers a product called Clipstream, which is similar to Adobe Flash but uses 90% less bandwith. This product could a source of additional future earnings, but his multiple estimate above was based solely on Destiny's Play MPE service.

One note about risk: Destiny has a collection of conventional wisdom red flags for risk -- it's a microcap, it's foreign, and it trades on the OTC Bulletin Board. So it's not exactly a widows & orphans stock. Then again, in the last year we've seen stocks that some would have considered suitable for widows and orphans -- e.g., Citigroup, Fannie Mae, etc. -- suffer stomach-churning drops. This subject is a subject worthy of its own post, but the conventional wisdom about potential risk versus reward with respect to stocks may be worth revisiting.