What a crazy market.
The U.S markets continue to do well as they shrug off news that COVID-19 cases are spiking in Florida, Arizona, California, and other states.
In fact, US markets are trading at significant premiums versus international markets according to Bloomberg.
I personally don’t think the forward returns for U.S. large cap stocks look very attractive due to several reasons:
1) Valuations are elevated on an absolute and relative basis.
2) A Democrat could win the U.S. presidential election, which may result in higher corporate taxes.
3) We could see a significant spike in COVID-19 cases this fall.
Nonetheless, I see many opportunities in the micro-cap space!
That’s the beautiful thing about micro-caps; there are many small hidden gems that can grow even in a challenging macro environment. Better yet, many are trading at inexpensive valuations.
This week, we have a couple of changes that I want to highlight. First, as we expected, Medexus Pharmaceuticals (PDDPF) reported an excellent fiscal 4th quarter. While the stock has run up, it is still trading at a bargain valuation. As such, I raised my buy limit to Buy under 2.50.
Second, I’m recommending selling half of Hopto Inc (HPTO) above 0.49. This is an illiquid stock so be sure to use limits. Given that we haven’t received an update on the backstop agreement (see additional details below) closing, I think it makes sense take some profit at 0.50 or above. At the same time, if the stock falls back to 0.44 or lower, I would likely upgrade to Buy.
We recently hosted our monthly webinar, and you can watch a replay here. As a reminder, the next issue of Cabot Micro-cap Insider will be published on Wednesday, July 8, 2020.
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
Increasing PDDPF buy limit to Buy Below 2.50
Move HPTO to Sell Half Above 0.49
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. As a reminder, Hopto reported first quarter results on May 20, 2020. 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 the 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 until May. If the backstop agreement doesn’t close, it will be a negative signal for the stock.
We haven’t gotten any news related to the backstock agreement closing. As such, I think it’s prudent to sell half our position above 0.49. At the same time, if the stock falls back to 0.44 or lower, I would likely upgrade to Buy. Sell Half Above 0.49
Liberated Syndication (LSYN), my most recent recommendation, was down slightly on the week with no news. LSYN is a profitable podcast and website hosting company with $10MM of net cash on its balance sheet growing at a double-digit clip. As the business does not require much capex, it generates significant free cash flow. Despite its high business quality, sticky revenue and secular growth trajectory, LSYN trades at just 8.7x 2019 EBITDA. An activist recently won a proxy fight with management and has undertaken a strategic review for the company. The conclusion is expected to be announced soon. My 6.00 target implies significant upside. Buy under 3.35
Medexus Pharma (PDDPF) reported excellent fiscal 4th quarter results yesterday. As a result of the transformative XINITY acquisition, Medexus generated adjusted EBITDA of $4.2 million in the quarter or $16.8 million on an annualized basis. Better yet, revenue grew organically 27%. So clearly there is significant growth ahead. One other positive is that Medexus bought back 919,000 shares (~9% of shares outstanding) in the past fiscal year including 139,400 in the most recent quarter. Based on Medexus’ run rate EBITDA of $16.8 million, the stock is currently trading at an EV/EBITDA multiple of 5.9x and an EV/Revenue multiple of 0.9x. It’s even cheaper on forward estimates. Specialty pharma companies trade at an average EV/EBITDA multiple of 16.5x and an EV/Revenue multiple of 3.4x. Previously, I recommended buying under 2.32, but given the excellent execution by the company and its clear undervaluation, I’m raising my buy under target to Buy under 2.50. When buying PDDPF or any other micro cap, be sure to use limits and try to buy the stock as close to its current market price as possible. Buy under 2.50
P10 Holdings (PIOE) was down slightly this week after appreciating by ~10% last week on no news. PIOE reported earnings on Thursday, April 30th. Revenue grew 8% y/y due to additional fund raising 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 8.4x 2020 free cash flow. While PIOE still looks fundamentally attractive, I have it rated as Hold as it has appreciated significantly since my initial recommendation. I may raise my Buy limit in the future, but I’m comfortable with a hold rating for now. Hold
Riviera Resources (RVRA) 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. 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 flat on the week. 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, 2020. 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 would 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, LSYN, PDDPF, PIOE, 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.