When I see a bullish trend in the markets (like rising commodity prices) I go look for the most highly levered (or high “beta”) play to that trend.

Generally, I say the lowest cost intermediate producer in any commodity is the best beta. There are lots of junior gold, copper & oil producers. There is only ONE junior phosphate producer: Itafos (IFOS-TSX/MCNB-NASD)

So early in this year, I bought a position at $1.50. Within three months, I was able to sell half at $3 and now I’m riding for free. I love free–especially in a cyclical industry.

Today, I’m sending you my initial report on Itafos from back then–so it’s dated now. While there is still a lot of upside in Itafos in the coming 12 months–paying down debt, re-negotiating debt, asset sales ($$$$), reducing the 70% shareholder–I’m just watching now.

I have now found a new junior fertilizer producer, with stunning growth and offtake deals with the majors that could see it increase production 500% in the coming 3-4 years and become one of the biggest successes in the history of my newsletter.

I have a report just like this one below–on my new #1 fertilizer stock. Fertilizer prices have skyrocketed as Russia banned exports. Itafos was just a double for me. I think this new pick–which trades under 50 cents a share–will be my biggest win of 2022.

This report gives you a flavour of how I write up my investments for my subscribers. I would urge you quickly download my report on my next fertilizer stock, where I lay out all the information in a similar manner.

COMPANY ANALYSIS

ITAFOS INC.

IFOS-TSX / MBCF-NASD

Itafos is the only junior fertilizer producer I see–and that’s where The Big Beta is. As you will read, the large and expensive debt they carry is a big drag here, but commodity prices and asset sales can remedy that in the next couple quarters.

The 70% controlling shareholder means the stock will never be liquid, but experienced management who also understand finance to me says the business will improve over time. Actually, the business is doing GREAT now, it’s just the finance picture that will improve.

I do own a small bit of stock here—20,000 shares at $1.50. But the lack of liquidity says I can’t really own much more.

I see 4 Big Catalysts in 2022—#1 being asset sales that de-lever the company. And #2 is re-negotiate the debt package. Then #3 is just continued high cash flow from the bull market in phosphate will be a catalyst over time. Number 4 is in Q3 when their Idaho mine should get its permit for Life-Of-Mine extension. But from here, the stock could do nothing until one of these things happens.

This bull market is also happening in grain prices, which is helping farmers pay for higher phosphate prices. 

QUICK FACTS

Trading Symbols:                                     IFOS

Share Price Today:                                   $1.35

Shares Outstanding:                                185 million*

Market Capitalization:                              $250 million

Net Debt:                                                  $225 million

Enterprise Value:                                     $475 million

* fully diluted

POSITIVES

– MANAGEMENT—former Potash Corp exec

– Cheapest valuation of a fertilizer producer in the public markets

– Cash cow right now. Will continue to generate A LOT of free cash if prices hold up (big de-lever)

– Top line is directly tied to the price of phosphate fertilizer

– US asset—located in Idaho

NEGATIVES

– BIG debt and it is not priced cheap

– Need to see permits granted for mine life extension

– Minimal float on stock/Castlelake owns 70% (so this will forever be a retail stock)

– Small fish in big pool competing against Nutrien (NTR-NYSE) and Mosaic (MOS-NYSE)

The Investment Thesis

At less than 3x next year’s EBITDA, Itafos is the cheapest valuation fertilizer play on the market.

At current phosphate prices, FCF (Free Cash Flow) could reach nearly half the market cap next year.

Itafos is so cheap for a couple of reasons.

First, no one has heard of this stock. Limited analyst coverage. No institutional ownership. 

Second, Itafos has no float. Float is what stock is available to trade (usually considered as all the stock NOT owned by management or 10% + shareholders). Itafos trades by appointment; it has no liquidity. And it may never have any because…

70% of the company is held by a private equity fund called Castlelake LP. Castlelake is a not a big player in the Ag business; far from it. And they also don’t appear in a hurry to divest their shares.

Third, Itafos is cheap because fertilizer stocks are cheap

Source: Company Disclosures

None of these companies trade at lofty multiples. In a market where stocks are far from “cheap”, here is a sector where you can say they are.

Investors are playing wait-and-see on the sector. Fertilizer prices have gone through the roof. Phosphate, which is the fertilizer of choice for Itafos, has seen an incredible price rise the last year, with DAP NOLA up 86% ytd 2021 ($400/st to $745/st) (DAP=Di-Ammonium Phosphate/NOLA=New Orleans Louisiana price hub)

Source: BMO Capital Markets

The question is, can prices stay here?

The work I’ve done says yes. Prices may not be going a lot higher, but I also don’t think they are going a lot lower, at least for another year or so.

The phosphate market is being driven by demand from India and reduced exports from China and Russia. This will continue for at least the first half of 2022. Strong US grain markets are keeping farmer affordability in line despite the current increases in the price of phosphate fertilizer.

Itafos is led by veterans. I spoke with their CEO David Delaney and Chief Strategy Officer David Brush a couple weeks ago. Delaney worked for Potash Corp for 30+ years, including 5 as COO. Brush has an equally long history in private equity.

The wind is at their back with fertilizer prices at multi-year highs. There should be plenty of cash to bring down debt. When they do the market should start to notice.

CONDA MINE AND PROCESSING FACILITY

Itafos main asset is Conda, a phosphate mine and processing facility located in Idaho.

Conda can produce up to 600,000 tonnes of fertilizer, or about 7% of production in the United States.

Two mines, Rasmussen Valley and Lanes Creek, deliver phosphate rock into the processing facility. Two additional mines, collectively referred to as H1/NDR, are at the permit stage and are expected to begin mining in 2024.

Source: Itafos Investor Presentation

Reserves at Rasmussen/Lanes Creek are enough to feed the plant until mid-2026. By that time, H1/NDR will be operating with enough ore for another 10+ years of production.

They are in the process of permitting H1/NDR. They submitted an Environmental Impact Statement (EIS) in October. They expect permits to be granted early next year.

Source: Itafos Investor Presentation

The Conda facility produces monoammonium phosphate (MAP), superphosphoric acid (SPA), and ammonium polyphosphate (APP).

MAP is the standard granulated phosphate fertilizer.  It contains about 10% nitrogen and 50% phosphate.

SPA is a very high (~70%) phosphate concentrated liquid. It is an ingredient in APP, which is used in fertilizers, flame retardants and as a food additive.

By tonnage, Conda produces about 70% MAP, 25% SPA and 5% APP.

The MAP is sold to Nutrien through a long-term offtake agreement. This agreement is up for renewal in 2023. 

The selling price is tied to the posted DAP fertilizer price (DAP is just a slightly different mix of phosphate/nitrogen than MAP). As you can see below, Conda’s revenue per ton follows closely to MAP prices.

Source: Itafos Filings

SPA and APP that is produced is sold directly to retail/blenders via an Itafos brand.

The facility requires a combination of phosphate rock, sulfuric acid and ammonia as inputs.

Ammonia is sourced from another long-term agreement with Nutrien. Like the MAP agreement, it comes up for renewal in 2023.

About 40% of the sulfuric acid is produced internally. The other 60% come from the Rio Tinto Kennecott mine, just southwest of Salt Lake City Utah.

Sulfuric acid supply has proven itself to be risk. Twice in the last two years, they have experienced “significant disruption” of the sulfuric acid supply, including Q4 21.

In September the Kennecott smelter was shutdown following the release of “molten copper materials”. Sulfuric acid shipments to Itafos were stopped until mid-November. The disruption will impact Q4 results, but not enough to keep the company from raising guidance when they announced Q3.

FOREIGN ASSETS FOR SALE

A few years ago the strategy was to become a global player in the fertilizer market. As part of that, Itafos purchased assets in South America.

But the debt burden became too much and with fertilizer prices in the dumps for the last decade, Itafos struggled to just keep them up to date. Now they plan to take advantage of the improved landscape and sell the international assets:

Source: Itafos Investor Presentation

Of the four, Arrais and Farim are the most likely near-term sales. Both are an EBITDA drain on the company ($4 million and $2 million respectively) and need larger capital to get back to full operation.

 EXPECT DEBT BURDEN TO COME DOWN

As Itafos builds cash, expect that cash to go towards paying down some very expensive debt they are carrying.

Itafos has $250 million of debt. Most of the debt comes from a $206 million term loan (paying 8%) and a $42 million promissory note that is held by Castlelake.

The $42 million note is killing Itafos with interest. The loan pays 15% interest (increasing to 18% next year) with 4% of that paid in stock.

Sadly, Itafos can’t pay down the promissory note without first paying off the term debt. When I talked with Delaney and Brush, they said that one way around this would be to restructure the entire debt load in one swoop.

That would be ideal, but given that they just refinanced their term loan in August (it has a 3-year term) I’m not sure how easy it will be. Given that uncertainty, I have not modeled in any significant reduction in interest costs over the next year.

STOCK CHART

CONCLUSION

Itafos is a cash cow right now, but the stock in the last year reflects that—up 5x. (Many good commodity producers are up that much in the last 12 months)

Arguably, the stock will not have another Big Move up until that debt comes down, either by re-negotiating the terms or selling assets–or both.

But at current phosphate prices, this stock has big leverage–and a great operational team.  It’s the ONLY junior phosphate producer. It’s in the US. 

Part of it will come with results. Itafos should be able to cut debt by US$100 million next year if phosphate prices stay at this level.

In the last 3-quarters, 65% of EBITDA has translated to free-cash-flow. If that continues and if prices stay at the current level, debt should be under $50 million by YE 2023.

Source: Itafos Disclosures, Our Forecast

Another Big Catalyst–but not likely until Q2/Q3–is the permitting of the mine-life extensions at H1/DNR. That will check another box.

Firming up the mine extension will bring on new lenders, which will lower the cost of their debt. Another check.

Itafos has 185 million shares outstanding. Let’s assume the market gives them no multiple expansion over the next year.

If that happens (eg. A flat Enterprise Value) the debt reduction alone should give you a 50% gain on the stock.

A more bullish case is that the market recognizes Itafos and gives it a market multiple (maybe 4x EBITDA). If that happens, you are looking at more than a double.

The very bullish case is the market starts revaluing the fertilizer stocks overall. Instead of Mosaic trading at 4x EBITDA and a price to earnings of 7x, maybe the market gives them 6x and 12x. The same thing happens to Itafos and it is a triple from here.

You get the picture.

Nowhere am I talking about fertilizer prices moving higher.

Buy Itafos on where fertilizer prices are today. Watch the news and make sure they are staying there. As long as we remain at these levels, the stock has legs to go far higher.

EDITORS NOTE: I HAVE A NEW FERTILIZER STOCK PICK–and it has everything I could ask for

1. a management team who has built and sold one agriculture related company already.
2. They have a unique science, technology, and product–
3. and it’s so good, they have offtake deals for up to 5x their current production.
4. They did over $15 million in revenue last year and are growing quickly.

To get this company’s name and symbol before the institutions rush in, CLICK HERE

The market is flying.  Meme stocks are back.  It is good times again. 

But I have not been a big buyer.

Instead, I have taken the opportunity to reduce my positions – particularly in oil – and regroup.

I am not convinced that what we have here is a sustained bull market run.  So I still have a huge cash position, and have been doing mostly…nothing.

Instead, I think this is a market that has lost its roots.

Here’s my thinking (caveat: after making A LOT of money from late 2019 – mid 2021, I have been wrong a lot lately).  A month ago, I was sure that we were on the road to a much larger move down.  The S&P was headed to a 3-handle.  The micro-cap stocks that I work with would have been that much worse. 

Then the Russian invasion of Ukraine—war–happened.

The war changed everything.   But front and center is that it changed the narrative.

The S&P had been falling for two months.  Most stocks had been dumping since the summer.  The narrative accompanying the fall was a world of rising rates and the demise of a 30-year bond bull market.

But then – BOOM!  An about face: war, shortages, fear of escalation.

It was scary.  It IS scary.

But here’s the thing.   This new narrative – war – it follows a whole new set of rules.

These rules aren’t nearly as bad for stocks as endlessly rising rates, particularly for the stocks that had been going down the most.

BUT – and why I am being cautious–the war narrative will be transitory.  Fundamentals – the economy, inflation, the Fed tightening – they will come into play again.

The economy sure looks like it is rolling over to me.  There are an awful lot of headwinds once we get past any moment of triumph.
 

THE NEW WAR NARRATIVE

 
Do you remember that we had sky-high natural gas prices in Europe as far back as November?  I do.
Doesn’t matter.  Natural gas was now up because of the war.

Same with oil, same with coal, corn, soybeans, steel, metals and rates.  Every move up and down was now because of the war.

That laid the seeds for a rally.  A boomer!   A positive development on the war front, any positive development, is now a reason for the market to rally.

Do you really think that unprofitable tech and meme stocks like Gamestop (GME – NASDAQ) could have rallied as the 10-year note took off to 2.5% absent the war?

Source: CNBC

No way!  Rising rates are the sworn enemy of these stocks.

But if rates are rising because of war?  Especially if we are winning?  Bullish!

It is no surprise that the best performers have been those stocks that were shorted the most – meme stocks and unprofitable tech. 

Check out the biggest winners since March 11^th (only 11 trading days ago!):

• Gamestop (GME – NASDAQ) up 143%
• AMC (AMC – NYSE) up 116%
• Kodak (KODK – NYSE) up 67%
• Virgin Galactic (SPCE – NASDAQ) up 44%
• Tesla (TSLA – NASDAQ) up 43%
• Bed Bath (BBBY – NYSE) up 37%
• Beyond Meat (BYND – NASDAQ) up 36%

See a theme?  Former darlings, beaten down for months, now back with a rocket-ship-like rise.
It’s a war rally – driven by the euphoria of winning the war.  Worrying about rates is for another day.
 

CAN THIS GO ON?

 
Because this is a war rally, it is hard to know how far it will go.  We know how far bear market rallies go – they would normally be ending right about now.  War rallies are more uncertain.

But I doubt this is a new bull market.  We almost never see a new bull market led by the winners of the last one.

What’s more, the craziest moves have been in the most heavily shorted stocks.   Short-selling rallies run out of steam when there are no more shorts to cover.

Given the pain, we may be getting there soon.

Morgan Stanley put out an interesting piece this week.  They pointed out that as of last Tuesday, almost 80% of the shorts established in the first quarter had been covered.

They called last week the biggest week of short covering since they started following the data!

That number has surely only gotten higher as we have continued to grind up since then.

The moves we have seen in the most shorted names have been remarkable.  Stocks up 50% or more in the matter of a couple of weeks.

It is hard to ignore that this is the hallmark of a bear market rally.  They don’t call it a ‘rip-your-face-off’ rally for nothing.
 

COMMODITY STOCKS –
RISKS TO THE LEFT, RISKS TO THE RIGHT

 
Two weeks ago, I told my subscribers I was selling all my oil stocks. The reason? I just didn’t see enough upside left.

“I sold all my oils this morning.  Everything.  All of it… I’m not worried about missing A Big Trade in oil now. “

That turned out to be a good call.  It has been a rollercoaster ride for oil since then.  All commodities rocket up and down on each new promise of or failure to resolve the war.

But if you zoom out a bit further, oil stocks, all commodity stocks, aren’t doing much of anything.
There are good reasons.  Commodity stocks have multiple headwinds.

First, there is the news cycle.  Every indication of some sort of deal means that oil, coal, steel, grains – they all take a hit.

Anyone that has bid up these stocks over the past month has now been thrice burned by the news flow.  Investors are getting more reluctant to hit the ask going forward.

While no one really knows what is in Putin’s mind, what does seem clear is that Russia is not winning this war.  Putin’s only out – to save-face – is through a negotiated settlement.

That will be great for the world – but it would be less great for commodities.

The other headwind to commodities is the economy.

If and when an agreement is signed – what then?

A lot of evidence is pointing to a weakening economy.

A classic sign of a coming recession, the inversion of the yield curve, is already on us.

Source: Bloomberg

Consumer confidence is plunging and at levels typical of recessions.

Source: Federal Reserve

The consensus for first quarter Real GDP estimates has decline from 3.7% in late December to 1.7% now.   

The more-accurate Atlanta Fed data driven model (GDPNow) predicts only 0.9% GDP.   We are getting REAL close to negative numbers.

Source: Bank of America Capital Markets

Maybe most concerning – retail sales is starting to teeter.  Headline retail sales were flat in February (meaning Real or inflation adjusted retail sales fell).

Source: U.S Census Bureau

Restoration Hardware (RH – NYSE) shocked the market this week with the dour outlook CEO Gary Friedman gave on their quarterly call.

Friedman said that RH had seen demand soften in Q1.  But he was even more uncertain going forward – in fact he said he has never been more uncertain about the outlook in his 22 years in the business.

I don’t think anybody really understands what’s coming from an inflation point of view, because either businesses are going to make a lot less money or they’re going to raise their prices. And I don’t think anybody really understands how high prices are going to go everywhere.

Central banks are marching ahead and tightening right into this.

Bank of America is still saying the Fed is behind the curve.  They believe that we will see faster rate hikes and a “higher terminal rate”.  They see 50bp rate hikes in both June and July with 25bp hikes each of the other meetings.

The result – a Fed funds rate over 3% by May of next year.
 

NOT A BEAR MARKET RALLY – A WAR RALLY

 
Yeah, I know, the market is brushing this off like it does not matter.

It could be that the market is telling us we worry too much.  That the economy will be fine.  Don’t ever underestimate Mr. Market!

But it might not be saying that at all.  What if this is a war rally–not be confused for a bear market rally or cyclical upturn.

A war rally doesn’t care about rate-tightening or 3^rd quarter GDP.  It is looking for stocks that outperform, for momentum, for exuberance!  We’re winning!

It is massacring complacent shorts in the process.

To be blunt, while war is not really “good” for anyone, it is not necessarily bad for stocks.  There are plenty of examples of a flat or up market during war-time periods, particularly if things on the front lines are going well.

Yet I’m being extremely careful here.  At some point this war rally will have run its course.  When it does, I think it’s quite possible that the market gives its head a shake and remembers what it was before the war.

I don’t want to be all-in when that happens. So I continue to sit on a huge cash pile.  My only real purchase of size was a tiny but fast growing fertilizer producer just hitting positive EBITDA.  I think it has a chance of being my biggest winner of 2022.

The move down in January and February was not about the fear of invasion.  It was about pricey equities, unprofitable equities, running into a freight train of rising rates.

It was about a slowing economy at a time of rising inflation.

It was about COVID still rearing its head and throwing a wrench in the supply chains again and again.
All those worries?  Still here. Worse now.

Right now, the market doesn’t care.  The post-war victory run is in full force.

But that will end.  All things do.  Reality will set back in.

When it does, I’m not so sure it won’t come crashing down on us.

EDITORS NOTE: To get Keith’s fast growing fertilizer stock CLICK HERE

While the overall market took it on the chin yesterday, there was one big breakout.  No, not oil.  Renewables.  The renewable sector has formed a long bottom and looks about to break out of its range.

Source: Stockwatch.com

Bigger renewable names like Plug Power (PLUG – NASDAQ), Enphase (ENPH – NASDAQ), and Solar Edge (SEDG – NASDAQ) were all up 10% on the day.

What is driving the move?

While one day doesn’t make a rally, if it holds up, I think we can chalk it up to energy security.

I don’t know where the oil top is.  I think these talking heads calling for $200 or $300 oil don’t understand the market.  Oil might go higher, but but I don’t think it goes much higher.

But Europe and the United States are learning a painful lesson of being dependent on energy from foreign, unfriendly sources.

It is abundantly clear that we are going to move to energy imdependence.  BUT… this doesn’t mean we get a flood of new pipelines and LNG infrastructure or see moves that incentivize oil and gas production. 

President Joe Biden laid it out very clearly yesterday.

Source: Twitter

This crisis will be used as a reason to direct more money to renewables and clean energy sources.

With Democrats in control and with Europe already beholden to green policies, the events of the last few weeks have – in all likelihood – actually shrunk the window to renewable dominance.

How so?

We are going to see a mobilization of dollars towards renewables that will dwarf what we’ve seen so far.

This is war.  In war governments have the power to enact extraordinary measures that would be balked at during peace times.  They can justify deficits and spending that they could not otherwise.

This time, instead of spending on tanks, bombs and guns (though in Europe I am sure there will be plenty of that too), the wartime chest is going to be spent on energy independence.

We are already starting to see the announcements, and this is just two-weeks in.  From Reuters:

Germany announced plans to rapidly accelerate solar and wind deployment to reduce reliance on Russian gas and plans to achieve 100% renewables by 2035 (including 200GW of deployed solar), vs 45% renewable demand today and against ~60GW of installed solar in Germany as of December 2021.

Expect more expedited targets, high renewable goals and more dollars allocated.

At the same time, renewable producers are going to be flush with cash.  Renewable power plants are the only electricity producers that aren’t seeing cost inflation.

Names like Transalta Renewables (RNW – TSX) and Altius Renewables (ARR – TSX) – both producers of renewable power – have seen their stocks soar.

Source: Stockwatch.com

Energy independence in this new world is not oil or coal and it probably isn’t even natural gas.  It is wind, solar, batteries and maybe nuclear but that one I’m still not sure about.

Will it work?  For now, it doesn’t matter.  As an investor I mean.

All that matters is that dollars are likely going to pour into the sector.  Subsidies and grants and freebies and you name it.  Just get it done. 

That is what I think the market is sniffing out this week
 
My favourite renewable stock trades at 5o cents a share. They don’t just produce one renewable energy form, they produce THREE–hydrogen, Renewable Natural Gas (RNG) and a biochar that replaces coal in steel plants.

And they have early adopters who have signed contracts in each of them.

This company is funded, and is racing towards revenue on three fronts. I see it as one of TWO potential 10-baggers in my portfolio. Get the report, name and symbol of this company right HERE. 

The disaster unfolding in Europe this week is unearthing a whole host of problems with our energy system.

Not the least of these is that we clearly need more Liquified Natural Gas (LNG) capacity.

Oil has grabbed the headlines this week, but for the last 4 months LNG had taken center stage. The dependence of the EU on Russian gas has limited sanctions and forced Europe to sit idly by as Putin does what he wishes.

It is clear we need alternatives and renewables are not there yet. The only way to fill the gap is with LNG. The world needs LNG even more if 7 million barrels a day of Russian oil gets embargoed!!!

Abaxx Technologies (ABXX – NEO) is looking to create the world’s first LNG contract that gets settled in physical gas; not an accounting ledger. It will be out of Singapore and has high profile backers like Kyle Bass and Robert Friedland.

These commodity exchanges are more profitable than stock exchanges. If CEO Josh Crumb has bet right and LNG is The Next Big Fuel, then Abaxx will be a cash cow for investors.

Think of Abaxx as trying to do for LNG what Brent crude did for oil.

Now, that’s enough upside, but TODAY, their spin-out Base Carbon (BCBN-NEO) has its IPO, and Abaxx owns 19.7% of BCBN. Depending on how that stock trades, it will add a lot of value to Abaxx.

QUICK FACTS

Trading Symbols:                                     ABXX

Share Price Today:                                   $2.50

Shares Outstanding:                                71 million

Market Capitalization:                              $205 million

Net Debt:                                                  -$30 million

Enterprise Value:                                     $175 million

There was a time, not so long ago, when Brent crude was not a thing. There were local benchmarks – WTI was the biggest and most liquid – but if you wanted to peg the value of seaborne crude oil you needed to place a call to the traders on either end.

Those days are long gone and now Brent is by far the bigger contract. Two-thirds of all oil is priced in Brent.

Today, we have a similar set-up in LNG.  

Source: Abaxx November Investor Presentation

We have local prices and benchmarks that are cobbled together from traders. But there is not a true LNG exchange traded market.

Abaxx is looking to change all that.

BUILDING AN LNG EXCHANGE

Building an exchange isn’t easy. Abaxx has spent 3 years and $25 million getting together the regulatory licenses, arranging clients, and building the software.

Abaxx has a system that is ready to trade right now. The last, remaining step is getting integrated with a prime broker. These are the banks that will act as the intermediary in the exchange and facilitate the trades.

It is this final step that has been holding Abaxx back. They need to coordinate multiple global banks to be ready to launch.

That means getting large, monolithic banks to prioritize IT changes, integration of the exchange to their backend, and do the myriad of assurance and acceptance testing. It takes time.

The other time hog has been their vision. Abaxx is building more than an exchange – they are putting together both the front and back end , and that means a clearinghouse too.

Getting a clearinghouse approved means more regulatory and more hoops. Abaxx received notification that their clearinghouse was approved in principle by the Monetary Authority of Singapore in August.

Building the clearinghouse is a barrier to entry and creates a moat for Abaxx.  It means that for every transaction done, Abaxx does not have to defer to a third party for clearing.  They can do that themselves.

What will set Abaxx apart from other exchanges that trade LNG futures is that Abaxx products will be physically settled rather than cash settled contracts.

It is a big difference for an end user or producer. One is an accounting settlement where cash exchanges hand. The other is physical delivery of the gas.

On their update call on February 22^nd, Abaxx was asked in the Q&A when they would be up and running. They didn’t give a date. It tells me there is still work to be done.

COMMODITY EXCHANGES ARE

VERY LUCRATIVE

What we do know is that once the exchange is in operation, it should be a cash cow.

Exchanges make money off volume. Every transaction through the system, Abaxx will take a tiny cut.

The LNG market is BIG.  Abaxx estimates that by 2030 the LNG physical market will be about 320 million tonnes per year (this is an estimate from Morgan Stanley).

At $10 per mmbtu that works out to an addressable market of $150 billion in gross volume.

From that level of trade, Abaxx estimates their addressable market in terms of revenue potential at about $500 million

Source: Abaxx November Investor Presentation

Exchanges typically get nice multiples. Abaxx highlights that the average P/E for exchanges is about 21x 2021 earnings.

Source: Abaxx November Investor Presentation

Taking a closer look at some of the North American exchanges, CME Group (CME – NYSE) trades at 31x P/E, the Intercontinental Exchange (ICE – NYSE) trades at 21 x P/E and Nasdaq (NDAQ – NASDAQ) trades at 20x P/E.

Each of these exchanges is a cash cow – their free-cash-flow yield range from 4-6%.

Of course, these are all established and far, far larger names. The market cap ranges from $25 billion for the Nasdaq to $85 billion for CME Group. Abaxx has a market cap of $200 million.

That difference is telling you that Abaxx still has a long road ahead. But the prize – being the first to market with exchange traded LNG – sure looks attractive.

LNG AS A STEPPING STONE TO CARBON

Getting the exchange and clearinghouse off the ground is really just Step One. The bigger picture here is to introduce new contracts for a wide range of commodities.

On their February 22^nd investor call Abaxx described how much easier it will be to launch subsequent products once they have their own exchange and the clearinghouse operating.

“This [exchange clearinghouse] will allow us to move quickly and control that whole process, the marginal efforts to launching our next products are so much less than getting a whole ecosystem off the ground.”

One of those next-to-market products will almost certainly be carbon.

Abaxx just finished the distribution of 5 million shares of their subsidiary Base Carbon to shareholders. 

Base Carbon is putting together a voluntary carbon market contract.

The idea evolved from Abaxx’s own potential customers. Being involved with LNG, many of them are worried about global warming and (more personally) what it means for their business. 

A time will come, probably not too long from now, where imports of an LNG cargo into Japan or the EU will require an offset to its carbon footprint at the same time.

Hearing these concerns, Abaxx looked at the options and quickly realized they were limited.

They identified the problem – there weren’t enough reforestation projects out there to make a dent.

Abaxx set to work to put together a standardized carbon offset. Basically, it’s a carbon contract that represented a set tonnage of carbon being removed from the atmosphere; a contract that could be used to offset carbon producing assets.

Out of this recognition, Abaxx created their Base Carbon subsidiary.

After the share distribution Abaxx still holds 19.7% ownership in the business.

In addition, Abaxx shareholders will participate in Base Carbon through royalties. Abaxx will get a 2.5% royalty on carbon credits that Base Carbon sells.

WHY SPIN-OUT BASE CARBON

If Base Carbon fits so well with the exchange, why sell it?

There are a few reasons.

First, Abaxx believes that Base Carbon could generate a lot of excitement from investors.  They don’t want that muddled with the mechanics of getting an exchange up and running.

Second, the business is bound to be capital intensive. Abaxx expects that to get to scale Base Carbon will be raising $100’s of millions in capital. They don’t want to dilute the LNG business as they do this.

Third, Abaxx wants to keep their stock a pure play on the exchange. Base Carbon complicates the structure and, once everything is operating, the financials as well.

Base Carbon was cashed up in November when Abaxx did a $50 million offering of shares. Abaxx owns 19.7%.

TIMING FOR LNG EXCHANGE

COULD NOT BE BETTER

Over the last couple of weeks the world has changed – maybe forever.

Abaxx is one of the few companies that are on the right side of it. We need more LNG.

Even before Russia invaded Ukraine, LNG forecasts were being ratcheted up. Shell’s LNG outlook, released late last year, estimated that LNG demand would nearly double by 2040.

Their forecast was mainly based on increasing demand from Asia. You can add Europe to that mix now.

Germany did a 360° just this week, announcing they want 2 LNG import projects built as soon as possible. Other countries will follow the lead.

At the end of the third quarter Abaxx had $30 million of cash and equivalents available. They spend around $1 million a month. Now they will have just under 20% of BCBN’s market cap that they can mark to market each quarter.

It’s a very low burn rate and it gives them enough cash runway to get the exchange up and running.

I like the space and I like the progress Abaxx has shown so far. My only question is when does the exchange start generating cash?

I don’t have an answer for that. It looks like there are still some hurdles to overcome. 

I’ll be watching this one closely to see if they can clear them.

DISCLOSURE—I AM LONG ABAXX AND BASE CARBON

Alberta may not be back to its former self, but it sure looks like it is getting off the mat.

It always starts with jobs, especially in Alberta. Here the news has turned positive for the first time in years. Unemployment in Alberta dropped to 7.2% in February.

Source: economicdashboard.alberta.ca

Unemployment is now below the pre-pandemic level.  It is even below the rate in Ontario.  It may be hard to believe but unemployment in Edmonton is 6.9% – or 0.8% lower than Toronto!

Over 90,000 jobs are now vacant and available in Alberta.  This is 50% more than there was in April last year.

Other measures are showing similar strength.  Retail sales – something that had been stagnant for years – has seen a noticeable uptick in the last 6 months.

Source: economicdashboard.alberta.ca

Finally, the real estate market – again a sector that has been flat for years – is starting to turn up.

The Calgary Real Estate Board (CREB) said in February that “thanks to persistently strong sales, inventory levels in the city eased to the lowest levels seen since 2006”.

January saw 2,009 homes sold.  This compares to end-of-period inventory of 2,620.

That means that inventory in Calgary is only a little over 1 month of supply – and sales always ramp through the spring.

Edmonton real estate is a bit further behind Calgary but there are early signs of strength there as well.  According to the REALTORS Association of Edmonton (RAE), sales in January were up 13% YOY.

It is no secret what is driving the upswing.  As much as Alberta is trying to diversify its economy, the economy still goes as energy prices go.

Today, with WTI over $90 and natural gas over $4, the outlook is looking better than it has in a long time.

I expect the bonuses in Calgary to start hitting bank accounts right about now.  After years with no bonuses, I expect employers to richly reward to their staff.

Put it all together and it is time to look at Alberta again.  Especially companies tied to Alberta real estate.

I’ve come up with 3 names for you – one mid-cap and two small-caps.  Two of these names have direct ties to the real estate business, while the other stands to benefit from a return to normal and a better Alberta economy.

Boardwalk REIT

Living in Vancouver, I am no stranger to a strong real estate market.  House prices and rents in Vancouver seem to only go one direction – up.

That strength, which has traditionally been centered on the lower mainland and the GTA, broadened out last year to cities like Montreal, Ottawa and Guelph.

This year it looks like that will extend to the Prairie provinces, with Alberta being the first in line.

Boardwalk REIT (BEI.UN – TSX) is my mid-cap play on Alberta.   Call this the safe way to play the boom.

Boardwalk was founded as a Calgary-based apartment REIT in 1984.  While they operate rental apartments across Canada, more than half of their footprint lies in Alberta.

Source: Boardwalk December Investor Presentation

Boardwalk operates a simple business.  They own apartments, usually centrally located in medium to large cities, and they rent out the suites.

What I like the most about Boardwalk is that it’s not obvious how cheap it is.

A quick scan of brokerage reports shows that Boardwalk (BEI in the chart below) scans middle of the pack in terms of net-asset-value per unit.

Source: RBC Capital Markets

But this comp misses the point (something RBC to their credit recognizes, giving the stock an Outperform).

NAV is calculated on past sales.  In Alberta, apartment prices have been depressed for years because Alberta’s economy has been in the dumps.

But this is beginning to change. 

Boardwalk showed the following slide in their investor presentation.   You can see the difference between where the stock price is and where the unit NAV would be if their whole portfolio traded at the price of recent real estate transactions.

Source: Boardwalk REIT December Investor Presentation

Sales prices of rental properties are rising for one reason – it is a much tighter rental market than it has been for years. 

When oil prices swooned and unemployment in Alberta shot up to double-digits, Boardwalk was making concessions.  They were offering a free month to new renters.

But now occupancy at Boardwalk is back to 96-97% at the Q3 seasonal low-point.

That means rent concessions are a thing of the past.  Going forward Boardwalk should benefit from gradual rent increases.  In Alberta, unlike much of Ontario and BC, there are no rent-controls.

We are already seeing this happen.  In Q3 incentives declined and new lease spreads, which is the monthly rent of a new lease compared to the rent of the lease it is replacing, turned positive for the first time in years.

Source: Boardwalk Q3 Investor Presentation

Meanwhile prices have plenty of room to rise.  Rental affordability in Alberta is better than anywhere else in Canada.

Source: Boardwalk Q3 Presentation

Maybe most important, Boardwalk is seeing a growing trend of “move-ins”.  These are out of town renters.  Boardwalk described on their call that  they are seeing “more Canadians move back to Alberta and Saskatchewan”.

Source: Boardwalk Q3 Presentation

REITs trade on a metric called capitalization rate, or cap rate for short.  Cap rate is essentially the net operating income of the company divided by its market capitalization.

At $55, Boardwalk is trading at a cap rate of 4.84%.

Source: Boardwalk Q3 Presentation

This is a big discount to their Eastern peers, where the cap rate averages in the mid-3’s.

That made sense when oil was in the dumps and unemployment in Alberta was near double digits.

Not as much now.

Consider that when oil boomed in the early 2010’s cap rates in Alberta were below Ontario and Quebec.

I don’t know if we get all the way back there, but I think it’s a decent bet that the gap narrows.

Big Rock Breweries

My second name and first small-cap gets away from the real estate theme.  Big Rock Breweries (BR – TSX) stands to benefit from western prosperity and a truly “open” summer.

Big Rock operates breweries in Calgary and Vancouver.  The company started in Alberta and it remains the core of its business.

Big Rock has had a tough go of it since 2014. 

Source: Big Rock Breweries Investor Presentation

In 2014 the oil industry was booming.  Big Rock was the premier name for beer and Alberta was just the sort of place that drank a lot of it.

But then came the headwinds.  The oil prices collapsed.  Competition came from newly minted craft brewers.  And then the biggest hit of all – the beer tax.

It wasn’t called a tax.  It was a “mark-up”.  Different sized brewers pay different sized mark-ups to the Provincial Government for each beer they sold.

In March 2015 the NDP announced changes to the mark-up which lumped Big Rock in at the same fee rate as large brewers like Molson Coors and Heineken.

Suddenly Big Rock was uncompetitive.  They were being treated like a big player but they had small player costs.

Retailers passed through the higher rate to consumers.  Big Rock beer was suddenly more expensive.  Sales slipped.

Big Rock tried to maintain their market share by reducing their wholesale price.  But that destroyed their margins.

Big Rock’s EBITDA margins, which had averaged mid-to-high teens from 2010-2013, fell to 4-6% in 2015-2017.  The stock cratered from a high of $19 to under $5.

At the end of 2019, with a Conservative government in place, Big Rock finally got a reprieve.  In October of 2019 the Conservatives announced a reduced and more graduated markup, one that meant a reduction in Big Rock’s fees to the Alberta Gaming, Liquor and Cannabis (AGLC) of close to 50%.

That alone could have started the turnaround.  But of course, we all know what happened shortly after.  COVID hit, restaurants and pubs closed down and oil prices tanked.

While the Alberta economy did poorly in 2020, Big Rock was still able to take advantage of the reduced mark-up and begin to right the ship.

EBITDA margins recovered back to the double-digits (still well below the 2010-2013 level).  Sales began to grow even as keg sales (sales to restaurants and bars) did not.

Flash forward to today and Big Rock has several things going for it.

First among them is that Big Rock is no longer constrained by paying large fees to the AGLC.  A quick look at the numbers shows how those fees hammered the company for nearly 6 years, and how their removal coincides with the start of a recovery

Source: Big Rock Financial Statements

Second, Alberta has been first to rip off the pandemic restriction band-aid.

Big Rock should see on-premise sales ramp again.  Keg sales help both top and the bottom line because packaging costs of kegs are lower than bottling and canning.

A truly “open” summer season would also benefit Big Rock as it would mean a tourism revival and more visitors to big beer drinking events like the Calgary Stampede.

Third, the rising oil price is bound to buoy Alberta sales.  Alberta booms coincide with more corporate events, more lunches out, and more alcohol consumption.  Albertans seem to understand that their booms won’t last.  They do their best to take advantage of them while they can!

Big Rock trades at a discount to their closest peer in the public market Waterloo Brewing (WBR – TSX), a brewery serving the Ontario market.

Source: Company Documents

But really, Big Rock should trade at a discount to Waterloo Brewing.  Waterloo Brewing has been consistently delivered higher margins and better cash flow than Big Rock.

Over the last 5 years it has been the better operating company – hands down.

But there is another way to look at it, and that is the idea I have here.  Big Rock is a classic turnaround.  Big Rock has seen all the headwinds I mentioned above.  And those headwinds are disappearing, one by one.

If Big Rock can take advantage of these tailwinds, the stock has some catching-up to do.

Genesis Land Development

For my final pick I’m heading back into real estate – this time to home building – with Genesis Land Development (GDC – TSX).

Genesis is a home builder in Calgary.  That’s right, they only build in Calgary and its surrounding area. 

I know, its odd.  When I came across this company, I scratched my head and asked – why is this company public at all?

But it is.  Genesis generates revenue from land development and selling homes.  Forward orders of homes drive future growth.

Genesis owns land and lots throughout Calgary and Airdrie.

Source: Genesis Land Development Investor Presentation

They own 681 acres of land in Calgary.  That land has the potential for 4,577 future lots.  In the last year Genesis has been adding more lots, 240 of them, which they purchased from 3^rd party developers.

Genesis is currently building out houses in 5 communities in Calgary in addition to those 3^rd party communities.

Source: Genesis Land Development Investor Presentation

That gives them a big runway of inventory.  Genesis sold 225 lots and homes last year, they will do 250+ this year.  Current inventory is enough for nearly 20 years of home sales at the current build rate.

But I suspect the build rate is going to rise.  We are seeing that already.  In the first 9 months of the year Genesis saw a 22% YOY increase in home orders, from 138 to 168.

That has put the outstanding inventory of home orders well above the levels it has been for the previous couple of years.

Source: Genesis Land Development MD&A’s

Genesis did a rights offering in December, raising $30 million at $2 per share.

Two things about this offering.  First, there was HUGE management participation – 11.3 million shares went to directors and management (they were already big holders of over 65% of the shares).

Second, Genesis doesn’t seem to have needed the money.   They had $29 million of cash at the end of Q3.  That makes me think Genesis is expecting to either ramp their home building or make some large land purchases.

Like my other two picks, the stock is trading on the Alberta of the past few years, not the Alberta of the next few.

If I’m right, returns will accrue via dividends.  Genesis pays out a dividend that has varied a lot over the years depending on the performance of the business.   It has been as high as 46c per share in 2017 and was nil in 2017.

Source: Genesis Land Development AIF

So far this year Genesis has earned 16c EPS in the first 9 months.  That puts the stock at about 12x earnings.

Another way to look at the stock is on the value of their real estate holdings.

Genesis carries their land at the lower of cost or fair value.  At the end of Q3 Genesis held $210 million of real estate on their balance sheet. 

Real estate is the main balance sheet asset.  It is the primary contributor to the book value of $235 million (they also have $21 million of debt and ~$59 million of cash post rights offering).  Genesis has a market capitalization of $146 million. 

That pegs Genesis at ~0.62x book, which seems awful cheap given the tightness of the Calgary housing market.

I have anecdotally heard of other Calgary builders (not Genesis) raising prices on new homes $25k per month the last few of months.

My back-of-the-napkin math suggests every $25,000 of price increase would mean an extra 10c EPS to Genesis on an annual basis.

While there is no guarantee Genesis will realize those kinds of gains, if they did, the stock, which is already reasonable, begins to look extremely cheap.

So there you have it.  Three plays on Alberta.  You put it all together and Genesis, like Big Rock and Boardwalk, look well positioned to take advantage of a recovering economy in Alberta.  It is something to be hopeful for, because right now Canada needs all the good news it can get!