Cabot Micro-Cap Insider Issue: July 13, 2022

My Ideal Set-Up

My ideal stock set-up has the following factors:

1. Growth
2. Cheap (absolute and relative)
3. Not over-extended (near 50-day moving avg.)
4. Illiquid
5. Positive momentum

In the micro-cap world, it’s usually not hard to find a stock that checks all these boxes. After all, I have thousands of stocks to choose from!

But it gets a little harder in a bear market.

Factors #1 through #4 are easy (especially #2!).

But #5 is the doozy.

Currently only 17% of stocks in the S&P 500 are trading above their 200-day moving averages. We have momentum, but in the wrong direction.

When I started my career, I only cared about my valuation estimate and the current market price. If I saw a dollar trading for 50 cents I backed up the truck. If a stock was trending down, even better! It gave me an opportunity to dollar cost average down.

But there is one potential problem with this approach. You can be wrong, and the market can be right.

After some painful lessons, I’ve learned to appreciate momentum. Stocks that are trending down tend to continue trending down, and stocks that are trending up also continue in that direction.

This month, I’m recommending a stock that checks all five of my boxes (including momentum!).

The only caveat is you have to go overseas to buy it. It doesn’t have an ADR so our only option is to buy the local shares which trade in London (any questions, just let me know!).

Nonetheless, its pretty easy to buy shares through Charles Schwab and Fidelity, the two brokers that I use.

I think it’s going to be worth the hassle.

Alright, let’s get into this month’s new idea: Kistos PLC.

New Recommendation: U.K. Gas Company Trading at 1x Free Cash Flow

Company: Kistos PLC
AIM: KIST
Price: 4.87
Market Cap: £384 million
Price Target: 10.00
Upside: 100%
Recommendation: Buy under 5.50
Recommendation Type: Rocket

Executive Summary
This U.K. natural gas provider is run by an experienced oil and gas operator that created a 40x return on his last public energy company. Kistos is taking advantage of a booming natural gas market in Europe yet only trades at 1x current free cash flow. It has very little debt. The management team is excellent, and they own ~20% of the company, ensuring that we are well aligned. I see at least 100% upside ahead.

How to Buy The Stock
I generally focus on U.S. and Canadian-listed stocks. In this case, Kistos PLC doesn’t have shares that you can buy on a U.S. exchange. However, it’s possible to buy shares on Fidelity and Schwab. On Fidelity, Kistos PLC trades under the symbol “KIST:GB”. On Schwab, it’s possible to buy the stock although you will have to call a representation. Any questions, reach out to me at rich@cabotwealth.com.

Here are a few outside resources about Kistos to supplement what I’ve written below:

Good Write-up

Good article on Management

Good VIC Write-up

Company Overview

Background
Kistos plc is an independent U.K.-based company focused on European energy, specifically with low carbon intensity credentials.

The company was established in October 2020, with the aim to build a balanced long-life portfolio with high quality production and development assets, energy storage, infrastructure and energy generation projects with industry-leading carbon footprint credentials.

Interestingly, Kistos was establish specifically to create shareholder value. You don’t see that mentioned by many companies, especially companies in the oil and gas industry.

Before we get into Kistos’ strategy, it’s important to spend some time on the management team.

The chairman, CEO and CFO all previously worked at a U.K. oil and gas company named Rockrose Energy PLC.

Rockrose Energy PLC was a smashing success. It generated a 42x return for investors from 2016 to 2020.

What is notable is that this fabulous return was generated when the oil and gas industry was in the doldrums. Remember: West Texas Crude oil hit negative-$40/bbl in 2020!

After the management team sold the Rockrose Energy business, they decided to get the band back together and try to replicate their success.

Kistos IPO’d at 100p/share following a successful public equity raise of £31.8mm.

Kistos’ stated strategy was to create value for its investors through the acquisition and management of companies or businesses in the energy sector.

This is the same strategy that Rockrose Energy had.

One other point worth mentioning is that Kistos’ goal is to be part of the energy transition. Natural gas will be critical to Europe’s transition to a low carbon economy, which is demonstrated by the European Commission’s decision to categorize investments in natural gas production as “transitional economic activities.”

Business Outlook
After raising capital, in 2020 Kistos began evaluating several acquisition opportunities.

In May 2021, Kistos completed its first acquisition: Tulip Oil.

Kistos acquired Tulip Oil Netherlands and Tulip Oil Netherlands Offshore for €223mm. The company completed a £52.5mm public equity raise at 155p/share and issued €150mm of Nordic bonds.

At the time of the acquisition, the asset was generating $30MM in EBITDA. The very next year, the asset generated ~$100MM of EBITDA. Talk about value creation!

Recently, the company closed another acquisition.

As part of the acquisition, the company acquired a 20% interest in the Greater Laggan Area (North Sea).

Kistos paid $125MM with cash on hand and cash generated by the asset. The asset generates significant cash flow and has additional upside potential through development and infill drilling opportunities.

From these two acquisitions, Kistos is on track to generate $520MM of EBITDA and $345MM of free cash flow.

And Kistos isn’t done yet. They are actively pursuing additional accretive acquisitions include a potential deal for Serica Energy.

If Kistos can land Serica Energy (see my watch list section), it would be a home run.

Insider Ownership
As Cabot Micro-Cap Insider subscribers know, insider ownership is high on my check list and is critical when investing in micro-caps.

Importantly, the management team owns 20% of shares outstanding and so we are directly aligned.

Further, the compensation progress (salary and bonus) appears very modest compared to most other public companies that I’ve analyzed.

Valuation and Price Target
My valuation analysis for Kistos is a case of, “I don’t know what it’s worth, but I’m sure it’s worth a lot more than its current price.”

Let’s start with the company’s enterprise value.

Using 2021 cash and debt balance (conservative given high natural gas prices), Kistos currently has an enterprise value of £463MM.

In 2021, the company generated EBITDA of £87MM. So it’s trading at a 5.3x EBITDA multiple. That seems reasonable and not particularly cheap for a commodity company.

However, results in 2022 and beyond are going to look unrecognizable versus 2021.

First, Kistos’ production has doubled due to the recently completed Greater Lagan Area acquisition.

Second, natural gas prices in Europe have gone crazy since the beginning of the war between Ukraine and Russia.

Currently, the stock is trading at an EV/2022 EBITDA multiple of 1.0x and a price to 2022 free cash flow multiple of 1.3x. However, these multiples are likely low as analysts are generally conservative with their commodity price forecasts and don’t use spot prices.

Again, I don’t know exactly what the right valuation for Kistos is but I’m confident it’s significantly higher than its current price.

I’m going to start my initial price target on KIST:GB at 10.00, which would imply a price to free cash flow multiple of 2.5x. This implies more than 100% upside from its current 4.87 share price.

My official rating is Buy under 5.50.

As is always the case with micro-caps, use limits as volume is quite low.

Risks
Commodity risk

• Natural gas and oil are notoriously volatile and difficult to predict. Natural gas prices are elevated, and while I don’t think they are going to settle down anytime soon, given the Russia/Ukraine war, I don’t have much confidence in my ability to forecast geopolitical events or commodity prices. Nonetheless, I’m comfortable with Kistos as the management team has proven its ability to navigate challenging environments. Further, the company is generating a massive amount of cash today and has very little debt. Therefore, downside should be manageable if commodity prices plummet.

Concentrated Portfolio

• While Kistos is actively looking to diversify its portfolio, right now it only owns two major assets. As such, its portfolio is rather concentrated and operational issues would drive the stock down. Still, I’m comfortable with this risk given the massive upside potential.

Recommendation Updates

Changes This Week: None

UpdatesAptevo (APVO) announced positive data during the week of June 9 from its phase 1b trial in MDS patients treated with APVO436. Thirty-six percent of patients achieved a remission. As of March 31, 2022, Aptevo has $30MM of net cash and expects to receive an additional $22.5MM over the next few years. Aptevo’s cash burn over the past year was $22MM. As such, it can probably make it another two years without raising cash. However, the company probably does want to raise capital at some point. From a fundamental perspective, Aptevo continues to report good data for its lead compound APVO436 in patients with acute myeloid leukemia (AML). This biotech bear market is no fun, but Aptevo continues to be an asymmetric bet. Original Write-up. Buy under 7.50

Atento S.A. (ATTO) had no news this week. The company reached a settlement with an activist investor, Kyma Capital, in early June. Kyma owns 8.5% of the company. Under the terms of the agreement, Kyma will get a board seat and will work with the Board of Directors to evaluate all options to increase shareholder value. Kyma also has permission to increase its position to 19.9%. While the most recent quarter was weak, the stock looks very cheap. And the agreement is a positive. Atento is trading at just 3x EBITDA while peers trade at closer to 12x EBITDA. Original Write-up. Buy under 20.00

Cipher Pharma (CPHRF) had no news this week. The company reported earnings in May. They were great. Revenue was flat year over year, but EPS increased from $0.05 last year to $0.08 this year. The EPS increase was driven by cost cutting (operating expenses decreased 25%). Meanwhile, ~2% of shares were repurchased during the quarter. Cipher currently has $22MM of net cash on its balance sheet, representing 48% of the company’s market cap. Cash flow should be stable for at least the next 4-5 years which will provide time for the pipeline to emerge. The company continues to move its pipeline forward and evaluate accretive acquisition opportunities. Original Write-up. Buy under 2.00

Cogstate Ltd (COGZF) has had no recent news, but we will get a financial update in July. Cogstate is a profitable, rapidly growing Australian company that is the market leader in computerized cognition testing. The biggest use case is Alzheimer’s Disease, which is a massive and growing market. Cogstate is benefiting from a boom in Alzheimer’s R&D spending which is driving 20%+ revenue growth. Longer term, Cogstate’s direct-to-consumer Alzheimer’s test could accelerate growth even further. Despite a terrific outlook, Cogstate trades at just 24x current earnings. Looking out a few years, this stock could easily double or more. Original Write-up. Buy under 1.80

Crossroads Impact Corp. (CRSS) announced that P10 Holdings (PX), another CMCI recommendation, is investing $180MM of equity capital at $10.76 with the ability to commit an additional $310MM of equity capital at the same price. This will enable Crossroads to really ramp up its ESG lending ability and grow earnings. It will also enable Crossroads to scale up and eventually explore an uplisting to a major exchange. Original Write-up. Buy under 15.00

Currency Exchange International (CURN) reported earnings on June 14. Results were strong, but not strong enough as the stock has sold off since. Revenue increased 109% y/y to $13.3MM. Net operating income increased to $2.9MM up from a loss of $0.6MM last year. Both Banknotes (+103%) and Payments (+127%) grew very strongly. Importantly, management noted that it expects a strong summer travel season which should drive (my opinion) record results. The stock continues to look very cheap. Original Write-up. Buy under 16.00

Dorchester Minerals LP (DMLP) has pulled back a bit with oil prices, but I think it continues to look compelling. Dorchester’s latest distribution was $0.75, which annualizes to an 11.3% yield. The company is benefiting from high commodity prices. While commodity prices will continue to be volatile, I expect them to remain elevated for the foreseeable future. Dorchester will pay out all windfall profits to shareholders. Original Write-up. Buy under 25.00

Epsilon Energy (EPSN) announced in June that its CEO and CFO have retired. I’ve gotten more color on this announcement and understand that it was part of a planned transition and that the CEO and CFO will both stay on as consultants for some time. While natural gas prices have pulled back, they remain quite elevated. Last year, the company produced tremendous free cash flow and will likely do so again this year. The company currently has $30MM of cash (20% of its market cap) and no debt. Epsilon recently committed to paying a quarterly dividend of $0.0625 per share starting on March 31. This works out to a 5.0% dividend yield. In addition, the company is actively buying back shares (1.1MM share repurchase authorization). Original Write-up. Buy under 8.00

Esquire Financial Holdings (ESQ) had no news this week. It initiated a nine-cent quarterly dividend in April. This works out to a 1% yield. The company reported earnings in late March (the next quarterly results are due out later this month). Results were excellent, and the investment case remains on track. The company reported Q2 EPS of $0.66, a penny ahead of consensus. Return on equity increased y/y from 13.3% to 15.0%. Esquire remains well capitalized with excellent credit metrics. The company has a long runway for growth, as articulated by CEO Andrew Sagliocca: “There is tremendous potential in both the litigation and payment markets primarily due to the limited number of players and fragmented and inefficient approach to coupling financing, payment processing, and technology. We believe Esquire will be a leader in all three categories in both industries.” Despite its strong outlook, the stock trades at just 12x earnings. Original Write-up. Buy under 35.00

IDT Corporation (IDT) announced quarterly results in early June, and the stock sold off. At a high level, the quarter didn’t look great. Revenue decreased 12% y/y which was driven by a 17% decline in traditional communications revenue. This segment benefitted from the boom in paid calling during the pandemic, but that surge is normalizing. Most importantly, IDT’s high-growth segments continue to grow well. National Retail Solutions (NRS), IDT’s payment terminal business, grew 102% y/y. Net2phone, IDT’s other highly valuable subsidiary, grew recurring revenue by 42%. Further, IDT expects subsidiary growth to contribute to consolidated profitability in the second half of this year. While the spin-off of net2phone has been temporarily delayed, we know that it and NRS will ultimately be monetized. The investment case remains on track and my price target is 55 based on an updated sum-of-the-parts analysis. Original Write-up. Buy under 45.00

Liberated Syndication (LSYN) has had no news recently. However, I had a chance to speak to the CEO on June 20. He said the team is working through re-filing its financials, and he expects to “go public” again by the end of September. Instead of just “turning on” trading, he would like to raise a little capital and also pick up some coverage from some sell-side analysts. He noted the advertising business is growing very well and that the podcast hosting business is growing again. It had experienced limited growth last year given free hosting competition, but business has picked back up. While Libsyn has been a frustrating stock, I think (and hope!) our patience will be rewarded by the end of September. Since you can’t actually buy the stock until then, I rate it a Hold for those who already own it. Original Write-up. Hold

Medexus Pharma (MEDXF) reported a strong quarter on June 22. Revenue increased 15% y/y to $20.4MM and EBITDA in the quarter was $1.1MM, up from -$1.6MM last year. IXINITY has returned to normal sales patterns which closely align with underlying patient demand. The company also benefited from its launch of Gleolan in the United States. If/when treosulfan is approved, Medexus will have to pay Medac milestone payments of $15MM to $45MM depending on the label. Medexus is evaluating financing options to pay the milestone payments with a number of interested parties. Medexus continues to be optimistic that Medac will provide the FDA with all the data that it needs by July 2022 and that treosulfan will ultimately be approved. Liquidity remains strong as the company has $10MM of cash on hand and the business is growing again. I continue to think the risk/reward profile of Medexus is asymmetric to the upside. Original Write-up. Buy under 3.50

NexPoint’s (NXDT) announced last week that its long-awaited transition to a REIT is complete. This week, the company announced that it will hold an update call on August 3, 2022. This is exciting news, and I’m eager to hear more about the strategy going forward. The thesis remains on track, and I see ~50% upside in the next 12 months. Original Write-Up. Buy under 17.00

P10 Holdings (PX) reported another great quarter in May. Revenue increased 32% to $43.3MM while adjusted EBITDA increased 31% to $22.5MM. Assets under management increased 34% to $17.6BN. Higher assets under management will drive continued revenue and earnings growth. The company also announced a $20MM share repurchase. P10 is currently trading at 15x 2022 adjusted EBITDA which is a very reasonable valuation for such a stable business with strong organic growth potential. Original Write-up. Buy under 15.00

RediShred (RDCPF) had no news this week. It’s a Canada-based, leading document destruction services company. Insiders own more than 30% of the company. It has grown revenue at a 31% CAGR and EBITDA at an 80% CAGR over the past 10 years through organic and inorganic growth. Future growth is poised to continue, yet the stock trades at just 5x forward EBITDA. I see 100% upside over the next 12 months and significantly more upside looking out a few years. Original Write-up. Buy under 0.70

Truxton (TRUX) reported another great quarter in April, with the company reporting its best quarterly earnings ever. The private banking team continues to grow assets in the Nashville area and rising rates are benefiting the portfolio’s net interest margin. Asset quality remains sound with $0 in non-performing loans and $0 in net charge-offs (that’s pretty good!). The Truxton investment case remains on track. The bank will continue to grow loans and earnings prudently while returning excess cash to shareholders through dividends and share buybacks. The stock is trading at just 12.3x annualized earnings. This isn’t the most exciting stock, but it’s a slow and steady winner. Original Write-up. Buy under 75.00

Zedge, Inc. (ZDGE) reported earnings on June 13. The stock fell as revenue grew by 18% but declined sequentially. Monthly active users (MAUs) in both developing and developed countries also fell sequentially. However, management noted that MAUs are growing again and that they are cautiously optimistic that these trends will continue. Further, the recent quarter included no contribution from the recent acquisition of GuruShots. Given strong recent insider buying, I’m expecting positive news when we hear more details about the integration of GuruShots. The stock remains very cheap trading at 3.4x EBITDA. Original Write-up. Buy under 6.00

Watch List

I’ve added two new names to our watch list this month. As you can tell, I’m mainly focused on U.K. energy stocks right now as they look very attractive.

Bisichi PLC trades in the United Kingdom but owns coal mines in South Africa. It is very small, with a market cap of only £29MM. As such, it has no sell-side coverage. However, coal prices continue to boom and Bisichi will generate gobs of cash for the foreseeable future. I estimate that it’s trading at a price to free cash flow multiple of 1.5x. Liquidity is very low as insider ownership is high.

Serica Energy is a U.K. natural gas company. Like Kistos, it’s benefiting from a booming natural gas market and trades way too cheaply (0.8x EBITDA and 1.7x free cash flow). The reason why I prefer Kistos to Serica is that Kistos management has more “skin in the game” and are proven operators. Nonetheless, I wouldn’t be surprised if both stocks did well. In fact, both companies are trying to buy each other!

Recommendation Ratings

**Original Price Bought adjusted for reverse split.
* Return calculation includes dividends

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Rich Howe owns shares in BBXIA, PX, MEDXF, LSYN, IDT, DMLP, and NXDT. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.

The next Cabot Micro-Cap Insider issue will be published on August 10, 2022.