A Comment -- General Comments From an Expert (A Commentary)

Company Highlight: Hammond Power Systems (HPS.A)

Prior to HPS.A releasing first quarter earnings, the stock had been a small-cap darling on a strong uptrend. What appears to be a huge earnings miss, was heavily impacted by non-cash expenses through share-based compensation when employees exercise stock options. With the growth of the company, hiring has increased, but with the shares up 242% the value of share-based compensation has increased dramatically and is charged against earnings. While this is not a positive, it is something common that high growth companies can experience. We do not think it should be a big factor driving the stock down, but the big EPS miss and high levels of stock-based compensation were a talking point leading to the stock taking a hit. Sales growth did also slow a bit from prior quarters which the market further did not like. However, HPS.A is increasing prices for Q2, and if demand is inelastic to this price change, then growth could be back up into the teens. Distribution growth was strong in the US, and the backlog rose 11.1% year over year. Margins were still decent despite a less-attractive product mix and start-up costs in Mexico. SG&A costs did rise. While not a great quarter overall and there is some reason for the sell-off, HPS.A still has plenty of potential and recently increased its dividend substantially.
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Complete elimination of any political risk premium that was in the oil price. About 2 months ago, he started getting far too many interview questions about whether oil was going to hit $100. As a contrarian that made him nervous, so he raised quite a bit of cash (about 33%). And he's been actively spending that given the selloff.

Heading into a key OPEC meeting in a few weeks. His best read on the situation is that they'll extend the voluntary cuts through to the end of this year. Still concerns about a weak China, whether the Fed will cut or not, and how is the US consumer holding up. That means sharper than average inventory draws beginning next month. 

Given these headwinds plus seasonal weakness, high $70s is pretty good. Energy is up 20% YTD. As we look to the second half of this year, sees demand seasonally increasing, OPEC continuing cuts. Falling inventories are bullish for oil. Possibility of $90 Brent by end of 2024.

Bullish heading into 2025. LNG Canada starting to ramp up and will start taking nat gas in the next month or so. Outlook remains solid.

Weekly numbers that come out are typically of low quality. Last year, underestimated US demand by 400K barrels a day. So he waits for the monthly numbers and wouldn't be surprised to see an upward revision. 

No tangible evidence that the consumer is faltering. We hear all these stories about trade downs to Walmart and people buying fewer Big Macs, but if you look at miles driven, the consumer seems fine. Demand is not shooting the lights out, but it's fine.

He still sees enduring religion of returning free cashflow to investors, irrespective of tax changes. It's likely that people will do some estate planning by the deadline and take some gains off the table. But he doesn't see the impact occurring on share buybacks.

Right now companies are awash in free cashflow, not meaningfully growing, and paying down debt. There's really nothing to do with that cash except give it back in the form of dividends or buybacks. Investors very clearly want share buybacks.

We've had a bit of a rerating. Stocks aren't trading at 2x cashflow, now more like 10-12x free cashflow yield. Still sees meaningful upside at $80 oil and $4 gas. Real power in the next couple of years is the compounding effect of buying back 10-15% of outstanding shares every year. Three to four years from now, the remaining shares will be so much more valuable.

Personally, he likes to buy when others do not. He likes panic and fear. Be greedy when others are fearful. The best buys are when you're sick to your stomach. That's not the case today.

When there was so much going on geopolitically and there was euphoria in oil, that was not the time to be deploying capital. Huge premium risk to the oil price, and you could wake up one morning with oil down $5.

Where global oil inventories are today, there's no risk premium in the oil price. He's bullish on oil, so that makes him want to deploy capital. He's gone from 33% cash weight to about 10.5%. Now actively spending.

What to buy? You could buy oil names. The valuation gap between large cap and small is the widest in history. The large guys are trading at such a massive premium, and the small guys are at a discount. It's an inefficient market and there's not as much interest in small caps. You'd think that would make you want to buy large caps, but he's a contrarian.

He sees opportunity in small- and mid-cap stocks, as long as you have asset quality and a management team you can trust. Also free cashflow will allow for meaningful share buybacks. There's always a bit of hair to the story, so you need to figure out if it's a mispriced stock (a catalyst will drive the rerating) or a value trap (stays cheap forever).

People are getting increasingly bullish on gas. It's hard to get the timing right, as gas is not at robust levels right now. Because of LNG Canada, next year looks much better. But he feels that now's the time to start accumulating. He has probably a 25% weight in natural gas right now, plus about a 10% weight in services, which is an indirect and cheaper way to play a bullish call on natural gas.

Everyone's chasing NVDA and AI right now. If you're bullish those things, you should be bullish natural gas because it's going to lead to a 7-14% increase in nat gas demand between now and 2030.

Not all names have the same upside potential. It's a stock-picker's market right now.

It was all about the picks and shovels. But now it's spread out to what people are calling the AI grid, so the whole energy grid and how energy is going to be sucked over into the AI ecosystem. Everyone's starting to participate.

If AI revolution started back in the fall of 2022, when OpenAI came out, you'd think that by now the software companies would have been able to get some traction. But the end users are still trying to figure out how to monetize the opportunity.

So the best opportunities for this year remain with picks and shovels, such as chip suppliers, designers, data centres. There aren't that many participants when it comes to the real data centres, the two main ones are EQIX and DLR.

Recent US Federal Reserve minutes seem to be self-fulfilling prophecy. Negative comments reflecting higher inflation being felt by markets. However, important numbers (inflation, job numbers, retail sales) pointing in the right direction. Many areas of the markets performing well including commodities and broader areas the market - not just big tech. Consumers are turning out to be very robust - not showing weakness as expected. If US Fed paid closer attention, would notice that inflation is cooling, and customers are starting to stay home. Strong Walmart & TJX sales indicating customers are starting to search for "value" options. Major news today is NVIDIA - recording earnings continue to power stock performance. However, time will tell how much of share price already had earnings baked into share price. 

Shopify First Quarter Highlights: 

Looking at high level metrics of revenue and EPS, SHOP appears to have had a solid quarter. No one would have guessed just by seeing these numbers that SHOP’s stock would decline by over 20% following the release. Additionally, breaking out total revenue by solution type; merchant solutions and subscription revenue both displayed strong growth of 24% and 34% from the prior year and beat estimates. What the market had issue with was SHOP's outlook. Particularly gross profit margin outlook for Q2, which the company forecasts declining 50 basis points. SHOP also said it expected revenue growth in the 'high-teens,' which was disappointing to some when estimates called for growth just under 20% for Q2. Additionally, the company raised its operating expenditure guidance which further probed cause for concern. A 20% drop in price is definitely a strong reaction to this news, but due to SHOP’s expensive valuation the market will be highly reactionary. We continue to like SHOP and the quarter in itself was good, while the company continues to have a solid growth profile.
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To him, it's a sign that maybe the economy's slowing. We're seeing that in the US when you look at sales and such. And it's showing up on the charts when he looks at the sectors. The defensives can be leading indicators.

If you look at the bottom of a market and the bottom of an economy, it's the growth stuff that'll pick up a little early as smart money starts picking it up. So just maybe smart money is starting to move out of high beta and into defensives.

We just made a new high on the S&P. As a technical guy, he can't ignore that. He's in. But there are signs, such as the VIX, which is hovering around 12, very low. 

Historically, if it stays below 12.5 for too long, you almost always end up with a market correction. Don't worry about a few days, but if you get a cluster it means there's complacency in the market and you ought to be worried. He's a bit concerned, given how fast things are moving these days.

Yes, and that's largely looking at resources like gold and stuff. TSX has a slightly different profile than the S&P 500, which is mostly high-beta tech.

It's interesting. In his blog, he said that he thought the market would pause around 5150. It went right through 5200, the old high, and here we are just over 5300. It doesn't matter what he thinks or says, the market's going to do what it's going to do.

You're not allowed to have a theme. You have to follow what the tape is telling you. The tape's telling us that it's a new high, with more momentum moving into the market. For the time being, we must remain bullish. He's still long the market, but there are signs telling him that things are a bit stretched, and that the party could end in the next month or two. We'll see.

Nothing's absolute. The tape's the tape. If it's over 5200, he has to stay long the market. But he's aware of the signs and, just as in Star Trek, he's prepared to "take evasive action" and move. Keep an eye, but don't argue with the tape.