No view? You’re expressing a strong view
6 min read

No view? You’re expressing a strong view

Most of the time it’s entirely reasonable to have no view on a stock. Most stocks are priced accurately enough most of the time, and usually the right call is to not bother to figure out whether something is on the cheap or expensive side of ‘about right’.

But sometimes prices are so extreme that I believe that passing or putting something in the too hard basket is actually unreasonable. At a low enough price, to pass on a stock is actually expressing a very strong view.

Here are three such stocks that I own which I believe fall into this category.

Pax Global (HKEX 327)

The first is Pax Global, a USD$1bn Hong Kong based payment terminal manufacturer, which in October 2021 was the subject of an FBI raid in its United States office. The stock fell 50% on the news and at the time that seemed about right.

Various news articles spoke of evidence of its devices sending data home to the Chinese government. It’s a plausible story and, given Pax earn most of their revenue internationally, one which should indeed have hammered its stock price, despite the US accounting for only a small proportion of revenue.

In the ensuing weeks and months though, things just fizzled out.

  • The company provided a plausible explanation as to why non-payment data was being transferred (the basis for the raid); that a geolocator feature dials home to service providers in China.
  • Last I checked, Pax disclosed that only one customer accounting for 0.25% of revenue had pulled the plug on their terminals.
  • Even the US Treasury, in explaining the worst case, said it’s probably not a big deal.
  • A large and reputable US firm, Palo Alto Networks, analysed their devices and signed off on them being clean. Imagine being the US tech firm which accidentally gives the green light to CCP trojan horse payment terminals. They are highly motivated to not get this wrong.
  • The FBI has now had 6 months since the raid to do something. Presumably if there was a smoking gun something would have happened. I don’t see a scenario in which the FBI publicly raids the company, confirms that it is acting illegally, and leaves it to continue such data collection for months afterwards. The longer nothing happens, the more likely it appears that the FBI simply got it wrong and didn’t find anything.

Pax was already cheap before the raid, trading on 10x rapidly growing and high quality earnings, or 5x EV/EBIT given its large cash balance. At half that, it was ridiculously cheap if the raid wasn't extremely serious.

The ‘right’ price in the absence of the FBI raid is in my view somewhere between HKD$10-20. Post raid it traded down to $5.

At $5, given the cash balance, earnings needed to be impacted by something approaching 75% for this price to be right. For that to be the case, you’d need high certainty that both 1) Pax were surveilling US citizens and 2) that it would be made public and would permanently damage revenues and earnings.

For the reasons I laid out above I don’t think that kind of certainty can be ascertained and as such, and without knowing a ton else about Pax, I bought it in February at an average of $5.84. It's since moved up to $7.10 despite Chinese tech stocks performing terribly over the past few months, and still looks very cheap.

McColl’s Retail (MCLS)

McColl’s is a convenience store operator in the UK. They turn over around £1bn per year and back in 2016-2017 they made about £15m of NPAT. During those heady years their market cap was in the £100-300m range but they came undone when they acquired a chain of 300 stores (taking them to roughly 1,000 POS) with copious amounts of debt.

Shortly thereafter their main distributor went broke causing stock outs and sales were impacted. They went into distribution hell and their negative working capital, which had gushed so much cash during the good years as revenues grew, unwound and sucked away their liquidity. I get the impression that their stores were simultaneously becoming dated because underlying profitability remains seriously below prior years and they’ve embarked on a large store conversion drive.

Covid was the death knell and it culminated in a big capital raise in August 2021, with shares on issue more than doubling and the share price halving from around £0.40 to £0.20. Results didn’t live up to expectations post raise, and the price is down another 90% to £0.02 (from a 2017 high of nearly £3).

With the current market cap of £7m* against £1bn in sales and a peak market cap of £300m, we again see a very strong claim being made by the market; that this business is going broke. I don’t disagree, it’s the most likely outcome for sure. But it’s not a certainty and there are a few reasons to think they could be given the breathing room to stay alive.

McColl’s balance sheet equity is approximately zero and it’s worth much less than that dead. It has liabilities of £530m, and we need to subtract £160m of intangibles, £75m of inventory and £230m of fixed assets (mostly fitouts) from zero equity to get a better estimate of liquidation value.

They’ll get some back from what competitors would pay to pick up the better stores, but we can agree that creditors are taking a haircut of hundreds of millions of pounds if it doesn’t survive in its current form.

The major creditors are McColl’s banks, who are owed £140m, and their key supplier Morrisson’s who is owed most of the nearly £200m of receivables.

Faced with the prospect of an enormous haircut, the credits might chance it and see if McColls can muddle through. There are some small rays of hope:

  • McColl’s are still EBITDA positive to the tune of roughly £20m per year so the creditors should not suffer from waiting absent further deterioration of fundamentals.
  • LFL sales are suffering due to Covid-driven supply interruptions which is acutely impacting their working capital position. Merely waiting for better supply will meaningfully improve their cash position.
  • McColl’s are refreshing their larger stores to more profitable and higher turnover formats which will benefit earnings and further improve working capital.
  • Lower performing stores continue to be closed.
  • Margins in almost all businesses are mean reverting, and often not for any reason that you can put your finger on. Margins have swung hard in the wrong direction and there’s every chance that they swing back for long enough to get them through the valley of death to profitability.

These are all fairly weak excuses for optimism. But the business is trading at 0.007x sales and 0.5x peak earnings. It is dealing with what I believe are motivated counterparties who have let it live this long, and if things turn around the potential return is in the order of 5-20x.

As I mentioned, I do expect the business to go bust as the most likely outcome, but the risk/reward makes it a worthwhile bet. While the flop and the river have come out poorly, the price expresses what I think is too high a level of certainty of the river being a dud too.

(*I wrote this piece on April 7 2022 Sydney time. Overnight, before posting the article, the stock was up 60% on no news, I’m assuming on takeover rumours.)

Altus SA (GPW: ALI)

Last is Altus, a Polish fund manager with a USD$15m market cap and a troubled history. In 2018 Altus was embroiled in a scandal which sent the share price from zł17 to around zł1.50. It’s complicated and only reported in Polish, but as far as I can gather an Altus fund sold a business to an outfit named GetBack which subsequently went bad. GetBack sued them and as a result Altus lost their reputation, all their funds and their licence to operate. They hung onto a pile of cash and a subsidiary which was able to continue operating under its own license.

The CEO and major shareholder was thrice thrown in prison and each time released because the prosecutors couldn’t bring a case against him. Altus have disputed the claims against them by both GetBack and the regulator, though the regulator appears not to be responding to them any more. For a long time they also disputed the case brought against them by GetBack, though they have in the past six months recognised a provision against the litigation.

The reason the stock is interesting though, is that today's zł1.42 share price buys you around zł2.10 of bonds plus a funds management business making around zł0.20 per year.

In the absence of the scandal, this business should be worth at least zł3.50. The 60% discount to this figure, like in the other cases, puts far too high a certainty on the eventuality of a terrible outcome.

I can’t claim to properly understand the Polish legal documents (even after engaging a Polish legal translator to help). But based on what I’ve read I don’t see a scenario in which both the cash and the subsidiary could be lost. There are no encumbrances over the bonds that I am aware of, only on the FUM of the subsidiary. I believe the worst future outcome is that GetBack is awarded 2% of the FUM of Altus’s subsidiary.

Again, I don’t know how this will shake out. But the expectations implied in Altus’s price very precisely enunciate a high probability of an extremely bad outcome which I just cannot find any evidence for.

So that’s the framework. The prices of these stocks are so low as to suggest a certainty which I believe can’t be justified by the evidence. The individual outcomes are of course very uncertain, but I expect as a basket that they should do pretty well.

Disclosure: Long all three stocks, with small positions (especially McColl’s).