McRae Industries (OTCMKTS: MCRAA): If cash on the b/s is unlikely to be paid out, does it still exist?

Those of you who have read my previous posts know that I have not had a whole lot of luck looking at stocks in the Canadian market as of late. I decided to expand my search into the USA. My first write up is on McRae Industries (McRae). McRae Industries has a market cap of US$84M.

I will note right off the bat that McRae trades on the pink sheets in the USA under the ticker MCRAA, which means it does not file financial statements with the SEC. The company has not filed with the SEC since 2005 when it ceased doing so in an effort to reduce costs. McRae still posts audited financial statements with Grant Thornton being its auditor for the past 10+ years.

Mcae Industries imports and sells western and work boots, as well as manufactures and sells military combat boots. The key point of distinction being that McRae manufactures military boots, while the company designs and imports western and work boots leaving the manufacturing to a third party. McRae was founded in 1959 and is most well known for its Dan Post brand of boots. McRae is headquartered in Mt Gilead North Carolina which is about a 1.5 hr drive from Charlotte.

Previous blogosphere write-ups on McRae include one at OTC adventures and another at Oddball Stocks. I think this post will add to the conversation by providing more detail around potential growth and valuation.

Let’s put McRae through my screen of: 1) Capable management teams and board, 2) Strong balance sheet, 3) Profitable growth, and 4) An attractive valuation.

1)      Management and Board

McRae has two classes of shares. Class A shares elect two directors as a separate class while Class B shares elect 5 directors. On all other matter, Class A shares get 1 vote and class B shares get 10 votes.

As mentioned above, McRae no longer files with the SEC meaning we no longer get share ownership data. As of McRae’s last filing date in 2005, the McRae family owned 40% of Class A shares and 60% of class B shares and controlled 53% of all votes.

For the same reason (ie. McRae not filing with the SEC), we do not currently have data on executive pay. In 2005, Gary McRae (President) was paid ~$250K while the four named executives were paid a cumulative ~$800K.

I assume that the McRae’s have maintained their ownership, while it is likely that pay has increased as net income has increased.

My view is that the McRae family communicates with shareholders in an open and candid manner. This boosts my confidence in the quality of the management team. One example is how Gary McRae has communicated about trends related to Western boot sales. The excerpt below is from the 2014 annual letter which came before Western boot sales peaked in 2015:

“We see our western/lifestyle segment in a state of change. The women fashion consumers who have driven the market in this business over the past few years are becoming more price conscious. Because of this, we see more of these consumers moving from the Dan Post brand to the popular priced Laredo brand boots. We will be introducing our new line of men’s, women’s and children boots at the Denver WESA show in January 2015 and are excited about the designs we have to offer. To some extent, we expect the revenues in this segment to be down from previous years as the market adjusts to these changing boot preferences.”

Gary McRae literally warned shareholders of an upcoming challenging environment. This is unheard of in today’s era of fast-talking, free-wheeling management teams. Most management teams keep problems hidden until they get so ugly they can no longer be disguised. This is similar to a teenager with an enormous pimple. When the pimple first appears and is small, the teen has no shame in using a bit of cover-up to hide it. But at some point the pimple get so friggin’ huge, that the teen admits defeat and exposes it to the world as any more cover-up would make their face more orange than Donald Trump’s.

In short, McRae communicates with their shareholders like they are partners. For this reason, they have gained my trust and a vote of confidence.

2)      Balance Sheet

Some may call it “overcapitalized” or “lazy”, but to me, McRae’s balance sheet is pristine. Similar to a ski mountain early in the morning before first tracks have been made, McRae’s balance sheet has not been disturbed by anyone. No banker or anyone even acquainted with a banker has made their way near this balance sheet.

McRae has a relatively small market capitalization having grown from ~$30M 10 years ago to ~$84M today. Despite this small market cap of $84M, McRae has nearly always maintained a double digit net cash balance.

Astute readers will notice the large ramp in cash between 2016 and 2017. A natural question is what caused the cash increase and will it be permanent.

The chart above makes it clear the surge in cash was due to a large reduction in working capital. Cash flow before changes in working capital (blue line) has remained relatively stable, while cash flow after changes in working capital (red line) has surged. In the case of McRae, the specific reason is a reduction in inventory. A large portion is due to a reduction in military inventories. I expect this to be sustained as military sales are now on the decline. This could change if McRae wins new military contracts.

3)      Profitable Growth

In the chart below, you can see the top line (purple) has flattened out over the past four years. This is largely due to sales in the Western category (blue line). An offset has been military (green line).

Although it does not show up in the chart below, Military sales are currently rolling over hard as the company has yet to fill lapses in old contracts with new contracts. Military is on pace in to be down ~45% y/y in FY18 (y/e August). To put this in context, Military sales could fall from their level of $46M in FY17 to ~$25M in FY18 if McRae does not announce new contract wins.

My expectation would be that McRae will continue to win new military contracts, although overall levels could continue to be lumpy as we are currently seeing. I say this because of the nature of government contracting. The government has legislated that 23% of all government contracting dollars should be awarded to small businesses. McRae qualifies as a small business as it has less than 500 employees. Further, McRae has an even further advantage as some of its manufacturing capacity is located in a ‘HUB’ zone (historically underutilized business zone).

On Western, the trend in segment sales looks bad. However, numbers need to be viewed in the context of a broader narrative. I would be concerned if McRae sales were down while the rest of the industry were flat or gaining (ie. McRae was losing market share). In order to find out if this is the case, the next step is to figure out who McRae’s competitors are and their respective sales trends.

McRae’s largest competitor is the company that owns Justin and Tony Lama boots. This company happens to be Berkshire Hathaway. Given the boots are a very small part of the much larger conglomerate, disclosure is non-existent.

McRae has another competitor that is a public company named Rocky Brands (NASDAQ:RCKY). Rocky is a much better comparison because similar to McRae, it only produces boots. There is a slight difference in that the majority of Rocky’s sales come from work boots ($110M) and Western Footwear is a secondary category ($39M of sales). Rocky also has a significant military business $38M of sales).

As mentioned above, I would be concerned about McRae’s competitive position if they were shrinking in their sales while their competitors gained. The chart bellows show McRae’s Western sales (Blue line), relative to Rocky’s (red line).

McRae rose faster than Rocky’s, but it has also shrunk quicker. I attribute this to McRae, or more accurately Dan Post, having a stronger brand in the marketplace than Rocky’s Durango brand.

One reason I say this is due to the trend of Durango’s high and low price points over time (available in 10-K).

In the chart, you can see that Durango experimented with a high price product line (red), but it failed and prices were quickly restored back to near previous levels. On the other hand, the low end of Durango’s product line (Blue) has continually seen price reductions.

Western Boots went through a boom between 2012 and 2014. During a boom, consumers are less price sensitive and more sensitive to brand and style. When consumers placed a higher weight on brand and style, McRae won relative to Rocky (as averaged in McRae’s higher level of sales between 2012 and 2014). However, as the fashion trend has subsided, consumers have become more price sensitive and have weighted cost as a higher factor in their purchase decision. Since McRae gained more during these boom times, they have lost more as consumers’ tighten their purse strings.

In summary, I do not think McRae has any structural impairment around their Western segment. I also think Military sales will eventually rebound with new contract wins. Overall, McRae is in a mature category, and I expect this to be the major determinant of their growth in the future. Sales will likely stop declining, but it is unlikely they exceed the low-single digit (LSD) to mid-single digit (MSD) range.

One last thing to note is Boot Barn (a major retailer of Western boots) recently reported a quarter with MSD same-store sales growth for the first time since mid-2015 (note the fiscal year is ended April 1). Boot Barn had been struggling to overcome the impact of the oil price collapse in late 2014. This reversal could bode well for McRae’s future Western sales trends. Given McRae is the manufacturer and Boot Barn is the retailer, it is logical that Boot Barn’s sales would turn up before McRae’s as Boot Barn is closer to the final customer. In McRae’s most recently reported quarter (Q1/FY18), Western boot sales were down 8%.

4)      Valuation

The judgement of valuation is often in the eyes of the beholder. Some will say timing the market is impossible, so why bother? Stocks return the most of any asset class over the very long-term, so you should always own them. If you believe this, then it follows that in picking individual stocks, it should only matter if one stock is “cheaper” relative to other similar stocks. Valuation in an absolute sense is not important. Or in other words, stock selection becomes a relative valuation game.

On the other hand, you may think that we are 10 years into a bull market so a stock’s valuation relative to its history is important. For the most part, all stocks are expensive relative to history, so why be invested? Valuations revert to the mean over long periods of time so there will be a better time to buy. You are willing to participate in the market but only in exceptional circumstances when you find shares that are both undervalued relative to peers, but also undervalued to where they have traded historically.

I do not wish to delve further into this argument and pass judgement as to which side is right in this post. However, I do help to provide perspective on both sides of the argument.

First let’s look at McRae’s valuation relative to history. The way to read the charts is that each year has a line with a dot. The top of each line represents the high in valuation for the year, the bottom of the line represents the low and the dot is the average valuation for the year. The green dot is where McRae currently stands based on my estimates for FY18. I have looked at this analysis for P/E ratio, EV/EBIT, and P/B. In short, each metric suggests McRae is near the high end of its valuation range relative to where it has traded historically.

So in an absolute sense, McRae looks expensive. The other way to think about valuation is how McRae trades relative to other public companies. As mentioned above, Rocky Brands is a close competitor so we can look at how the market is valuing McRae relative to Rocky.

On both a P/E and P/B basis, McRae looks to be priced at a similar level to Rocky. However, on an EV/EBIT basis, McRae is at a significant discount to Rocky. This is very interesting in my opinion. Both P/E and P/B ratios have share price in the numerator. This means that McRae does not get any credit for its large cash balance when using these ratios. On the other hand, EV/EBIT does give credit to McRae for its cash balance (see Appendix 1 if you need an explanation why).

This divergence in valuation metrics suggests to me that the market is taking the view that the cash within McRae is “trapped” because of the family ownership, and therefore should not have any value attached to it. This to me is short sighted. Cash has strategic value during recessions when financing is hard to come by and there are forced sellers in the market place.

Summary

The McRae family appears to be honest and competent operators; I am happy to be their partner. McRae has a very strong balance sheet; a point the market appears to be overlooking in its valuation of McRae relative to Rocky. While McRae’s Western business has been weak and Military business is expected to be weak over the coming year, I do not think either business is structurally impaired. McRae should be able to grow with the market at a minimum over the long-term.

Appendix 1: Industry Analysis

When first becoming acquainted with an industry I find it helpful to draw out a value chain of the different players involved in getting the final product to the end-consumer.

Some value chains do not have any excess profits associated with them. Others see the excess profits migrate to the single step in the chain that has the most power. In terms of Western boots, my opinion is that the designers and brand owners (ie. McRae, Rocky, Justin, Tony Lama) have the strongest position. An outline of strengths/weaknesses in each step follows:

Raw materials: Historically a very tough business. Most profits are earned during periods of short supply, but these do not last long as new capacity comes along and excess profits get competed away. Major raw materials are leather and rubber.

Contract Manufacturer: While reputation and reliability count for something, the premium that a contract manufacturer can earn will always be limited. McRae can do product tear-downs and will be able to know what a product should cost to manufacture. McRae’s business will be put out to bid with multiple contractors competing. McRae will always experiment with new sources of supply so that it can never be held captive by a single contract manufacturer.

Designer and Brand owner: This step of the value chain is relatively light on capital as the major investment is inventory. In order for the brand to remain relevant, the company must keep styles current and support the brand with marketing spend.

Retailers: According to Boot Barn (NYSE:BOOT), there are thousands of independent specialty stores across the United States that sell Western boots. Boot Barn is relatively small with 219 stores, yet they think they are 3x larger than their nearest competitor. This high level of fragmentation is advantageous to McRae and other manufacturers. Most of the manufacturers’ customers lack the scale necessary to backward integrate into brand ownership and manufacturing. This limits their ability to demand volume discounts and advertising support when bargaining.

A conversation about industry would not be complete without discussing the impact of technology. As consumers change their purchasing habits from on premise to online, there is risk that a dominant internet retailer of Western boots could emerge, develop its own brands and cut out brand owners by going direct to the contract manufacturers. In this case the new value chain would have one less step and look like this:

To some extent, Boot Barn is trying to do this with its growth strategy which includes both 1) increasing private label penetration from the current 11% of sales level, and 2) increasing sales done via e-commerce (demonstrated by their acquisition of Sheplers). There is not an immediate threat to McRae because Boot Barn still relies heavily on brand owners for logistics capabilities. Most of Boot Barn’s merchandise is delivered directly to their stores and they need brand owners for this capability. I’d also note McRae is positioned to benefit from private label as they exclusively supply Boot Barn with their El Dorado brand. More recently, Boot Barn announced “exotic” extensions to their El Dorado brand:

Given the importance of proper footwear fit, I view it as unlikely that a new brand will be able to emerge out of an online retailer. I view online purchases to be more likely from a brand that the customer is already very familiar with. For example, if they have a favorite boot and the sole has worn out, it will be easier to reorder the exact same boot at the exact same size online.

I’d also note that ‘authenticity’ is an especially important trait of Western boot brands. Dan Post for example is “Cowboy Certified”. Boot Barn’s motto is “Be True”. It is difficult for an upstart to have the same authenticity as a brand that has successfully appealed to American outback values for several years. This can be seen by the simple fact that there are not many new Western boot brands. The last major brand to emerge was Ariat in the early 1990s. They did so by competing at the high end, and focusing on first appealing to athletes competing in horse riding. Other Western brands and their inception date are listed below:

Dan Post – Mid-1960s

Durango – 1968

Tony Lama – 1911

Lucchese – 1883

Justin Boots – 1879

Stetson – 1865

The support for McRae having a strong position in the value chain comes from McRae having better return on capital than Boot Barn (their customer).

McRae also has better numbers than Rocky, its closest publicly traded comparable. A higher ROIC versus a competitor generally implies the company with a higher ROIC has a competitive advantage. They are able to do something that their competitor cannot. If their competitor could replicate their efforts, they would earn similar returns on capital. In McRae’s case, I think the higher ROIC is a result of a stronger brand.

While it looks like McRae has a lower gross margin, it is being weighed down by military having a very low gross margin of only ~15% and McRae having a higher mix of military sales than Rocky. McRae’s Western boots carry a gross margin of 34% and work boots have a gross margin of 35%. This is relative to the gross margin in Rocky’s whole sale segment of 32%. McRae having a larger gross margin than Rocky is consistent with McRae having higher prices points implying a larger brand premium. This difference in gross margin largely falls down through to a difference in EBIT margin. I’d also note McRae’s pre-tax ROIC number is helped by carrying less inventory on its balance sheet than Rocky.

Out of interest, I took a look at the numbers for a similar, but adjacent value chain. The numbers for Nike (NKE), Foot Locker (FL) and Finish Line (FINL) are below. My main takeaway is that one of the reasons the numbers for the athletic shoe value chain are so much higher is that the chain turns inventory much quicker than the Western boot chain. Players in the athletic shoe chain turn inventory 4x a year versus 2x a year for the Western boot chain. Nike has also done a good job at building its brand and extracts a price premium from the consumer which shows up in the gross margin line.

Appendix 2: Enterprise Value (EV)

 Enterprise value (EV) is defined as market capitalization (share price * shares o/s) plus net debt (total debt less total cash). Let’s use an example to illustrate. The company has: 1) 10 million shares, 2) a share price of $10, 3) Debt of $20M, and 4) cash of $10M. In this case, the company’s market capitalization is $100 million (10 million shares o/s * share price of $10). Net debt is calculated as $10 million (total debt of $20 million less $10 million of cash). So enterprise value is $110 million (market capitalization of $100 million + net debt of $10 million).

In McRae’s case, there is no debt and a large cash position, so the calculation becomes market capitalization minus net cash (rather than plus net debt). In the example above, let’s now assume $20 million of cash and $10 million of debt. So net debt would be -$10 million and EV would be $90 million (100 million market capitalization less the $10 million net cash position).

The Company’s website: www.mcraeindustries.com/

Author Ownership: YES OTCMKTS: MCRAA

Read Disclaimer:

This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.

Qualitysmallcaps.com is not engaged in an investor relations agreement with McRae Industries, Incnor has it received any compensation from McRae Industries, Incfor the preparation or distribution of this article.

The author may trade shares of McRae Industries, Incthrough open market transactions and for investment purposes only.

Titan Logix (TSXV: TLA): Market Cap = Net Cash. But sometime’s a bad company, is just a bad company

Let’s start by running Titan Logix (“TLA”) through my initial screen of: 1) Capable management teams and board, 2) Strong balance sheet, 3) Profitable growth, and 4) An attractive valuation.

1) Management and Board

TLA appointed a new CEO in Feb 2016 named Douglas Carruthers. In Dec 2017, TLA announced Carruthers employment agreement will not be renewed and Carruthers will cease to be CEO as of 31 January 2018.

This quick change in CEO is usually a cause for concern and warrants deeper investigation. My conclusion is that Carruthers has been pushed out by the Board. Shortly after Carruthers was appointed CEO, The Jerry Zucker Revocable Trust (“Zucker Trust”) announced it was looking to appoint three directors. In April 2016, the Zucker Trust announced an agreement with Titan in which the Zucker Trust was able to appoint two directors and acquire 2.3 million shares.

The current Board of Directors consists of 4 people at TLA; two of which have been appointed by the Zucker Trust (Helen Cornett and Grant Reeves). Warren White (the third of four directors) also looks connected as both Warren White and Grant Reeves sit on the board of Circa Enterprises (TSXV: CTO). I believe the Trust did not want to renew Carruthers’ employment agreement for cost reasons. The current Chief Technology Officer, Greg McGillis, previously served as CEO at Titan and continues to be employed at Titan. My expectation is that there will not be a new CEO appointed. While the executives are not earning excessive compensation, my impression of the Zucker Trust based on this article is that they are very frugal and will not leave any stone unturned in search of cost savings.

The Zucker trust currently owns 25% of shares outstanding. There are no other 10% owners.

Given their track record, I would deem the Zucker Trust as capable. However, there is a question as to whether the Zucker Trust is aligned with the interests of minority shareholders. In a previous transaction, the trust came under scrutiny for paying $1.70 a share to take Galvanic Applied Sciences private. Prior to the offer for Galvanic, the shares were trading at $1.60 on the open market, meaning the premium was very small.

It is also worth noting that the two Board Members that the Zucker Trust appointed to the Titan Board were involved in the Galvanic Transaction (Grant Reeves and Helen Cornett).

2) Balance Sheet

TLA’s balance sheet is very strong. As at 30 Nov 2017, Titan had $6.5 million of cash, $2.0 million of marketable securities, and an additional $4.9 million owed to TLA by an energy services company in the form of a secured loan. TLA does not have any debt outstanding.

3) Profitable Growth

Recently, TLA has neither grown, nor been profitable. The company sells a single product which is heavily exposed to fracc’ing and shale oil. As such, they have seen revenue collapse from $17 million to the current level of ONLY ~$3.5 million; down a whopping 80%. The table below shows sales, earnings before taxes and EPS for the past 10 years.

4) Valuation

As at 30 November 2017, Titan Logix has a 28.5 million shares outstanding. Shares most recently traded hands at $0.50, putting TLA’s market cap at $14.3 million.

Titan has lost money in each of the past two fiscal years (TLA reports on an August year end) making earnings-based valuation measures difficult. Peak EPS was $0.15 in FY12 which is roughly 3.3x the current share price. It is highly unlikely that TLA will earn this amount again in the near future as the company benefitted from the massive build out of the shale oil industry, which is unlikely to repeat.

Another way to think about valuation is to look at assets. The total of TLA’s cash, marketable securities and secured loan is $13.4 million. This almost fully supports TLA’s current market capitalization of $14.3 million. If TLA can ever earn money again, then the current share price could be an attractive entry point.

TLA’s trajectory looks promising in terms of returning to profitability. After reporting a gross margin of 22% in FY16 and 33% in FY17, TLA reported a 47% gross margin in its most recent quarter (Q1/FY18). On a cash operating basis, TLA spent about $150K more than it earned in Q1/FY18. In FY17, TLA spent $809K more than it earned on a cash basis and in FY16 the same number was $2.4 million (excluding asset sales but including interest income).

When valuing companies on an asset basis, the rate of burning cash is important because the asset value deteriorates by the rate at which the company burns cash each quarter. Given the trajectory, TLA should return to profitability and start increasing asset value each quarter by the end of FY18 or early FY19.

Summary

Balance sheet is very strong. Based on the strong balance sheet, TLA also looks attractively valued given it is trading nearly at the same value of its cash, marketable securities, and secured loan. The Zucker Trust likely does not have the interest of minority shareholders’ in mind, but this may limit upside rather than increase downside risk which I am okay with. The big question to answer is whether or not TLA can become profitable. If it does not, the company will continue to burn cash, and the balance sheet will slowly weaken, and for lack of a better term TLA will likely be a “value trap”.

Return to profitability?

In order to determine if Titan Logix can become profitable again, we need some more information:

End-markets: Titan focuses predominantly on the upstream and midstream oil and gas industry. This market demands rugged and reliable equipment because the drill sites are often accessed via rough industrial roads.

Product: Titan’s core product is known as the TD80. Its use is in mobile tankers (ie. large trucks that carry fluid). The TD80 is one part fluid level gauge and one part overfill prevention device. The TD80 has no moving parts making it more durable than float-based mechanisms. In the year ended Aug 2017, the TD80 and the associated display generated 83% of TLA’s revenue. The key takeaway is TLA is a single product company.

Sales Channel: Titan sells to both the manufacturers of mobile tanks and the dealers who sell mobile tanks. Examples of tank manufacturers are: Mac LLT, Heil Trailer, Beall / Walker (owned by Wabash National; a public company), and Vantage Trailers. An example of Dealer is Shipley Motor Equipment in Arizona or Bruckner’s Truck sales in Texas. It is worth nothing that Wabash (owner of Beall/Walker) thinks its tank trailer sales will be up 10-15% in 2018, but this is after being down 35% in 2016 and down another ~10% in 2017. I’d also note that Beall/Walker has significant exposure to dairy, food and beverage end-markets that TLA does not.

End-user: The end buyer of Titan’s TD80 product is often oil companies themselves. Unlike in over-the-road truck transport, the end-user (ie. oil company) is often the owner of the truck rather than a third party logistics/transportation company.

Intellectual Property: It is unclear how much intellectual property is proprietary to TLA. TLA notes in its annual report that it has a license agreement with Lawrence Livermore National Laboratory and pays a royalty of 3% of TD80 sales. The license agreement remains in force until Feb 2018 when the last patent expires. TLA talked about filing its own patents in FY14 and FY15 but it is unclear if these have been incorporated into any product. Titan paid royalties of $79,199 in FY17.

Rig count: Given TLA’s focus on upstream/midstream oil and gas end-markets, the Rig Count in the United States is a very important indicator. As can be seen, while the number of rigs has increased from the lows, it is still materially below 2015 levels. In my view, this means there is still a significant amount of equipment or “kit” that is sitting idle. This is likely to depress sales in the near to medium term.

Retrofit:  Given depressed new tanker sales due to idle equipment, TD80 has turned attention to gaining sales in the retrofit market. The table below is from Wabash National. It shows that the life of an Aluminum Tank is ~10 years while the life of a Stainless Steel tank is 15-30 years. Given that the TD80 is a solution meant for “rugged” applications with no moving parts, I would expect it also has a relatively long life. This limits the amount of retrofit opportunity available to Titan.

Competitors: TLA has a number of competitors that also offer tank monitoring solutions. TLA is unique because of the technology used in its product called Guided Wave Radar (“GWR”). The only other company to offer GWR is Vega (www.vega.com). I do not view Vega as a competitive threat because TLA actually sells some of Vega’s product within its “stationary tank gauging” assortment listed on TLA’s website. It is unlikely TLA would sell product of a company that it views as a competitor.

Other TLA competitors include:

Scully Signal (www.scully.com): Scully offers a overfill protection system which relies on an optical sensor. The optical sensor has a binary output. It is either wet or dry meaning the tank is either full or still has room. Optical sensors do not offer level gauging like GWR does. GWR can tell you whether a tank is 33% full of 55% full.

Garnet Instruments (https://www.garnetinstruments.com/): Garnet sells a product known as the SeeLevel tank gauge which is based on a “Float” system. GWR has advantages relative to float-based systems. Fluid movement in the tank during transport can set off an overfill warning in a float-based system. Floats can also get stuck and do not measure properly if tank is not cleaned/maintained properly.

There are a number of other competitors also using some combination of floats and optical sensors for overfill protection including: Micro-design (http://www.micro-design.com), Civacon (http://www.opwglobal.com/; Owned by Dover NYSE : DOV), and Dixon Bayco (www.dixonvalve.com).

There are also a few competitors who specialize in underground tanks and leak detection: Tanknology (https://tanknology.com/) and Tank Tech (https://www.tanktech.com/).

Last, there are a number of company using sensors on stationary tanks or bins to send data up to the cloud which is then used to optimize transport routes: eCube, SmartBin, Atek Access Technologies, Enevo, SMARTLogix, Numerex (owned by Sierra Wireless; TSX: SW).

Growth Strategy

TLA is trying to return to growth by 1) Focusing efforts on adjacent end-markets (ie. outside of crude oil such as food, chemicals, etc.), 2) Emphasizing retrofit sales, and 3) Software allowing monitoring of driver performance, fluid level and weight inventories, alarm conditions and GPS location data.

I do not have a high confidence around any of these growth strategies.

In terms of adjacent markets, I think TLA had a great “product-market fit” with shale oil because of shale oil’s need for a rugged instrument and the high sensitivity around spills (TD80/GWR allows for multiple warnings at different fill levels). It will be difficult to expand into other applications as there are already entrenched competitors that know the needs of the specific application better than TLA.

In terms of retrofit, I think the opportunity is limited given TD80 has a relatively long product life.

In terms of software, I am not sure there is a valid value proposition that customers will be willing to pay for. I would like to see more “reference” customers before making this bet.

Summary

Titan has a single product that is dependent on the crude oil market. It is likely that Titan’s end-market in 2018 will be better than 2017. However, any improvements will likely only be marginal as there is still a lot of idle equipment that needs to be worked through. Titan has a unique technology, but it is coming off license in 2018. It is unknown if Titan has enough other patents to prevent competitors from entering Guided Wave Radar. I do not have confidence around Titan’s growth efforts outside of the TD80 and the crude oil end-market.

Titan is not a “quality company”. The fact that nearly all of Titan’s sales are from single product is bad. The fact that the product is coming off license and could be exposed to new competition is even worse. Not to mention that the product is dependent on a very cyclical end-market prone to boom-bust cycles. However, as I have said in other posts, a quality investment does not necessarily need to be a quality company.

Titan does not fit with my investment strategy.

Where I could Be Wrong

There is a possibility of an asymmetric risk/return payoff. It is hard to see things getting much worse for Titan. At the same time, TLA should return to profitability over the next 1-2 years. TLA’s market capitalization is almost entirely backed by cash, marketable securities, and a secured loan that Titan owns. In other words, Titan is being priced near liquidation value. If oil were to spike back up to US$100+, I would expect there to be another capex frenzy in shale oil as companies rush to prove out reserves. I do not think Titan is getting any credit for this “optionality” in its share price.

The Company’s website: www.titanlogix.com

Author Ownership: No TSXV: TLA

Read Disclaimer:

This article is for informational purposes only. This article is based on the author’s independent analysis and judgment and does not guarantee the information’s accuracy or completeness. The information contained in this article is subject to change without notice, and the author assumes no responsibility to update the information contained in this article. The information contained within this article should not be construed as offering of investment advice. Those seeking direct investment advice, should consult a qualified, registered, investment professional. This is not a direct or implied solicitation to buy or sell securities. Readers are advised to conduct their own due diligence prior to considering buying or selling any stock.

Qualitysmallcaps.com is not engaged in an investor relations agreement with Titan Logix Corp. nor has it received any compensation from Titan Logix Corp. for the preparation or distribution of this article.

The author may trade shares of Titan Logix Corp. through open market transactions and for investment purposes only.