If you are a value investor with a focus on balance-sheet items in your search for bargains, this is an important time of the year for you. Most companies operate on a December financial-year end, so quarterly reports issued during the year are based primarily on management's best judgment of the value of assets such as accounts receivable, inventories and intangibles. Needless to say, an optimistic bias tends to creep in during this process and asset values reflect this.
When the auditors show up for the year-end review, however, the analysis often becomes more rigorous and assets can be written down quite dramatically. As a result, a stock purchased at a discount-to-book value, or net-net working capital, suddenly is trading at a premium to those values. Not because the stock price has gone up, but because the asset value has cratered. That is why it is important to check the audited financial statements, typically released in March.
With that as background, I was prompt to review the audited financials of McCoy Global Inc., which were released last week. This Edmonton-based company is in the oil-service sector and its threaded-connection products are used predominantly in the well construction phase for both land and offshore wells. The stock came to my attention in December, 2015, when I wrote an article for Report on Business about TSX-listed stocks trading below net-net working capital per share (i.e., current assets minus all liabilities). McCoy was one of only eight stocks that passed that deep-value screen, and since I eat my own cooking, I added it to my portfolio.
Last year was a tough one for oil service companies and McCoy Global saw revenues collapse from $82-million to $27-million. Cost of sales actually exceeded revenues, so the income statement showed a $6-million operating loss even before restructuring charges, impairment charges and other losses drove the final comprehensive loss to $38-million, or $1.30 a share.
None of this was good news, but the balance sheet paints a more robust picture because many of these charges were non-cash in nature. On the balance sheet, there remains $60-million of shareholder equity ($2.16 a share), cash per share of 80 cents, net-net working capital per share of $1.85, negligible intangible assets and no debt. With 27.7 million shares outstanding and a stock price of $1.70, McCoy Global still represents a bargain below net-net working capital, although the market capitalization of $48-million keeps it off the radar screen of institutional investors.
The company cannot sustain too many years like 2016, but the emphasis on a strong balance sheet in the selection process increases the odds it will be a survivor and well-placed for the recovery phase. When this recovery will take place remains uncertain, but management struck a positive note in comments which accompanied the financials: "During the fourth quarter of 2016, an improvement in customer sentiment was noticed as industry fundamentals showed signs of beginning to stabilize and in certain regions improve. This increase in activity has carried into the beginning of 2017."
Their optimism is supported by the backlog that was up fractionally from September to December and the book-to-bill ratio (incoming orders divided by current sales) was positive for only the second time in eight quarters. With almost 50 per cent of fixed assets located in Canada and over 90 per cent of revenue generated outside of the country, McCoy Global should also benefit from a weak Canadian dollar.
With 2016 receding in the rear view mirror, I am hopeful that 2017 will see a return to growth, especially as the company felt confident enough to make a small acquisition in the first quarter. Deep-value microcap stocks are only appropriate for investors who do their own research and own a diversified portfolio, but they present an opportunity to invest in what is certainly the most inefficiently priced sector of the market.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.