The market continues to rally despite a global recession, surging unemployment and now riots across the country. As legendary 1900s trader Jesse Livermore would put it, “The path of least resistance is up. Don’t fight the tape.”
Nonetheless, I am cautious and believe this bear market rally is getting a bit long in the tooth. First consider the “Buffett Indicator”. Warren Buffett likes to view global market cap versus global GDP. In the financial crisis, it got as low as 42. Today, it stands at 90.8, at the high end of its historical range.
It’s hard to pinpoint what is driving the stock surge. On the one hand, markets are clearly forward looking and are signaling the economy is likely to bounce back in the second half of 2020.
On the other hand, there are some troubling signs related to retail investors jumping into the market and even using their stimulus checks to buy stocks. Online brokers are reporting a record number of new sign-ups. Robinhood, a free online trading start up that is popular with millennials, has reported surging demand for its app since the start of the lockdown, as shown in the chart below.
I even received a text out of the blue from a friend who said, “I’m on Robinhood. Give me some stock tips.”
This friend has never asked me for investment advice before even though I’ve known him since high school.
Usually, when I get random people and friends asking me for “stock tips,” the market is due for a pullback.
However, my focus will continue to be on identifying attractive micro caps with strong balance sheets that can grow regardless of the economic outlook. I’m looking forward to sharing my next recommendation with you next week.
Until then, let me provide some quick thoughts on my current recommendations (more detailed updates further below):
HopTo (HPTO): HopTo continues to bounce back and forth between 0.45 and 0.52. If it were to fall below 0.45, I would upgrade it to BUY. The most recent quarter was mediocre, but the company is well positioned in the current environment and attractively valued.
Medexus Pharma (PDDPF): Medexus was up slightly last week but continues to be largely ignored my most investors. The company will report quarterly earnings in June. I’m optimistic as it will be the first time that management will provide an outlook that includes recently acquired XINITY (hemophilia drug).
P10 Holdings (PIOE): Last week, PIOE continued to gradually grind higher. No big news. The investment case remains on track.
Recro Pharma (REPH): REPH has bounced back from disappointing a quarterly report but will remain in purgatory for the next couple of quarters, unfortunately.
Riviera Resources (RVRA): The stock was flat on the week with no news. The next catalyst for the stock would be the announcement of a sale of one of RVRA’s assets. This would likely result in another distribution for investors.
U.S. Neurological Holdings (USNU): The stock was up 18% last week on no news. Large moves (both up and down) often happen with tiny micro caps. Don’t get too excited or too down based on these moves.
The next Micro-Cap Insider issue will be published on June 10, 2020. Our June webinar will take place on June 11, 2020 at 2 p.m. ET, and we will review open recommendations and answer member questions.
If you have any questions that you want me to address, feel free to send me an email at rich@cabotwealth.com.
Changes This Week
None
Updates
HopTo Inc (HPTO) continues to bounce back and forth between 0.45 and 0.52. There was no news or SEC filings this week. HopTo reported first-quarter results on May 20. Sales declined 21%, which appears very bad at first glance. However, sales for hopTo are typically lumpy on a quarter-by-quarter basis. The 10-Q discloses that the decline was due to timing of revenue recognition and a larger order in Q1 2019 that did not renew. Most importantly, management noted that it expects “sales in 2020 to be similar to sales” in 2019. In other words, management doesn’t expect a decline in sales in 2020 despite the Q1 drop. This is the same language that hopTo used in 2019 (sales grew 13% in 2019). As such, I’m not concerned with the headline drop in sales in Q1.
One issue that I will continue to watch relates to the rights offering that hopTo closed in March. As part of that agreement, there was a backstop agreement whereby management and a consortium of accredited investors agreed to purchase at $0.30 per share up to $2.4 million of hopTo stock. Essentially, the backstop agreement is a massive insider buy and bodes very well for the outlook of the stock. That transaction was expected to close in April but the 10-Q indicated that it was not expected to close in May. If the backstop agreement doesn’t close, it will be a negative signal for the stock. Since I issued my BUY under 0.45 rating, the stock has appreciated above my 0.45 limit. As such, my current rating is HOLD. If the stock drops back to 0.44 or lower, my recommendation will change back to BUY. HOLD
Medexus Pharma (PDDPF) was up slightly this week but continues to fly under the radar. On May 22, Medexus issued a press release stating: “We continue to generate steady growth across our key product lines and, despite the disruption from the COVID-19 pandemic, our sales teams have continued to be remarkably productive by finding new ways to connect creatively and productively with clinicians and patients.”
Medexus will release full quarterly results in June, and I expect investors to be impressed with progress to date. Pro forma for the recent acquisition of XINITY (hemophilia drug), it is trading at an EV/revenue multiple of 0.8x while peers trade at 3.0x. My rating for PDDPF is Buy under 2.32.
Earnings Date: Expected in June.
P10 Holdings (PIOE) continued to gradually grind higher this week on no news. PIOE reported earnings on Thursday, April 30. Revenue grew 8% y/y due to additional fundraising by RCP Advisors. Cash earnings stayed flat y/y at $0.04 although that was due to costs related to acquiring Five Points and almost acquiring another private equity manager. RCP Advisors noted it has already raised $165 million of additional capital commitments for its private equity funds. It will launch two more funds this year and Five Points will also begin a new fundraise. Excluding one-time costs, PIOE will generate $0.27 in cash earnings in 2020. As such, PIOE is trading at 7.9x 2020 free cash flow. This is too cheap a valuation for a company that has sticky revenue, high margins, and strong growth potential. The investment case is on track. BUY Under 2.25
Recro Pharma (REPH) has bounced back from a disappointing quarterly earnings report but will remain in purgatory for the next couple of quarters, unfortunately. As a reminder, management decreased annual revenue guidance due to 1) increased competition from Mylan, a competitor to Recro customer, Teva; 2) slower-than-expected new business growth, which REPH believes is primarily attributable to COVID-19; and 3) notifications by two customers of discontinuations for two commercial product lines, which resulted in a decrease of approximately $4 million on previous 2020 revenue guidance and is estimated to have an annual impact to 2021 revenue of approximately $7 million to $8 million. Given COVID-19 headwinds, I recently took my price target down to 13.00, which corresponds to a 15.0x EV/2020 EBITDA multiple, a 25% discount to public peer Catalent. While my price target still implies significant upside longer term, I continue to believe REPH will be in “purgatory” for at least the next couple of quarters given COVID-19 headwinds. As such, my current rating is HOLD.
Riviera Resources (RVRA) was flat on the week with no news. The next catalyst for the stock is likely to be the announcement of a sale of one of RVRA’s assets. This would likely result in another distribution for investors. RVRA continues to be an attractive long-term holding. It has minimal debt and is generating positive free cash flow. Further, it has a very valuable asset in its Blue Mountain midstream business. Once the energy market turns (and it always eventually does), Riviera will be well positioned to benefit. BUY Under 2.25
U.S. Neurological Holdings (USNU) was up 18% last week on no news. Large moves (both up and down) often happen with tiny micro caps. Don’t get too excited or too down based on these moves. USNU operates as a holding company in the United States. It is engaged in providing medical treatment and diagnostic services that include stereotactic radiosurgery centers, utilizing gamma knife technology, and holds interests in radiological treatment facilities. USNU reported Q1 2020 earnings on May 15. The company generated $0.02 of earnings and $399,000 of free cash flow in the first quarter, and as a result net cash on the company’s balance sheet increased to $1.7 million or $0.22 per share. USNU did note that revenue declined 12% in the quarter driven by fewer procedures being performed due to the outbreak of COVID-19. Eventually, I expect deferred procedures to resume. Since I issued my BUY under 0.20 rating, the stock has appreciated above my 0.20 limit. As such, my current rating is HOLD. If the stock drops back to 0.19 or lower, my recommendation will change back to BUY under 0.20. HOLD
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 HPTO, PDDPF, REPH, and RVRA. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.