Cabot Micro-Cap Insider Issue: September 14, 2022

Growth at a Value Price

Seems like a lot has happened since my last issue.

Market pulled back as I suggested it might.

And then it ripped higher.

And now it’s dropping precipitously again!

Typically, the end of September is a volatile part of the calendar, and I wouldn’t be surprised if we saw another leg down over the next couple of weeks.

This month, I pulled the plug on Dorchester Minerals (DMLP). I still love the business model and hope to be able to buy it at another time, but it didn’t seem like an obvious opportunity (like it did in 2020).

For now, I prefer to play the energy markets through Epsilon Energy (EPSN) and Kistos PLC (KIST:GB), which seem more attractive.

My favorite part about micro-caps is that you can invest in growth companies at value prices.

This opportunity simply doesn’t exist in the large-cap stocks.

My newest recommendation fits that description to a T.

It also checks a lot of other boxes:

1. Strong fundamentals
2. Illiquid
3. Strong momentum
4. Not over-extended.

Without further ado, let’s dive into my latest recommendation, Richardson Electronics.

New Recommendation:vRichardson Electronics: Growth at a Value Price

Company: Richardson Electronics
NASDAQ: RELL
Price: 16.00
Market Cap: $221 million
Price Target: 28.00
Total Return Potential: 75%
Recommendation: Buy under 17.00
Recommendation Type: Rocket

Executive Summary
Richardson Electronics (RELL) is a rapidly growing micro-cap that is benefiting from many “green” initiatives (electric trains, wind turbines, etc.). Despite strong growth expectations and a pristine balance sheet ($40MM of net cash), the stock trades at just 10x next year’s earnings. Insider ownership is high, and I see ~75% upside over the next couple of years.

Company Overview

Background
Richardson is an electrical components manufacturer and distributor based in La Fox, Illinois.

Arthur Richardson (father of current CEO, Edwin Richardson) founded the company in 1947.

Mr. Richardson owns 15% of the common stock and controls the company as he owns almost all of the Class B stock.

One differentiating factor for Richardson Electronics is it has an unusually diverse (for a micro-cap) revenue mix. Its largest customer represents just 10% of sales. It’s not unusual in the micro-cap world for a single customer to represent 50% or more of revenue.

Further, Richardson is quite diversified by geography.

From 2009 to 2020, revenue bumped around (some years up, some years down) in the $150MM range.

Revenue growth started to accelerate in 2021.

The big driver of the growth was the company’s PMT division. PMT is short for Power and Microwave Technologies.

Richardson has three business units.

PMT
Richardson’s PMT business (79% of sales) combines its core engineered solutions capabilities, power grid and microwave tube business with new disruptive RF, Wireless and Power technologies.

PMT’s growth outlook is very strong. More details below.

Canvys
Canvys (16% of sales) provides customized display solutions (basically touch screens) serving the corporate enterprise, financial, healthcare, industrial and medical original equipment manufacturers markets.

Canvys’ growth outlook is also very strong.

Healthcare
Healthcare (5% of sales) manufactures, repairs, refurbishes, and distributes high value replacement parts and equipment for the healthcare market including hospitals, medical centers, asset management companies, independent service organizations and multi-vendor service providers. Products include diagnostic imaging replacement parts for CT and MRI systems, replacement CT and MRI tubes, and other parts.

Healthcare’s growth outlook is more mixed. And at the moment, it is losing money.

Outlook
The company’s PMT division (79% of revenue) is on fire.

It’s being driven mainly by ESG (Economic, Social and Governance), or “green” initiatives.

For example, Richardson recently released a new product: wind turbine ultracapacitors.

The product is known as ULTRA3000. It helps provide auxiliary power to control the pitch and rotation of wind turbine blades, and lasts much longer than the current market standard.

And sales have ramped up incredibly quickly. The product went from conception to > $10MM in sales and back orders to GE in 14 months.

The market is massive.

Each wind turbine takes 18 ultracapacitors which cost (together) about $10,000.

There are 30,000 GE turbines in the U.S.

And the company is in discussions with Siemens and Vestas as well.

Richardson has a similar opportunity to provide ultracapacitors to cell phone towers. The company is in beta testing but revenues are expected to ramp up in 2023.

Finally, the company has a large opportunity in electric trains, which will need battery units.

Here’s what CEO Edwin Richardson said on the last conference call about the opportunity “green” initiatives are providing:

“And it’s just amazing the opportunities as everybody tries to go green, and we have this niche power management capabilities here at Richardson to take advantage of some of these -- I call them niche applications, they’re quite large for us, but to others, they’re kind of niche.”

Taking it all together, and the outlook is extremely strong. Richardson’s backlog at the end of Q4FY22 was $206 MM, +17.4% sequentially and +87.5% y/y.

Regarding future growth potential, the company doesn’t issue guidance, but here’s what CEO Richardson said on the last conference call:

“I think in our 75-year history, this is our 75th year and I’ve been around 60 years, this is the most profitable year and quarter that we’ve ever had and with (a) $206 million backlog, it looks like we’ll do $250 million or $255 million next year without any problem. So I think we’re on track to be a $500 million company here in the next five years and extremely profitable.”

$500MM of sales in five years implies a CAGR of 17.3%. Pretty good!

Insider Ownership
As Cabot Micro-Cap Insider subscribers know, insider ownership is high on my check list and is critical when investing in micro-caps.

Insiders own 2.7MM shares of Richardson Electronics, or 19% of shares outstanding.

Edwin Richardson owns ~15% of shares outstanding. As such, we are well aligned.

Valuation and Price TargetIn FY 2022, Richardson generated $1.02 in EPS. Thus, it’s trading at ~16x current earnings.

While this multiple doesn’t look very cheap at face value, I think it is.

First, the company is benefitting from secular tailwinds and is growing strongly.

As discussed above, management believes $260MM in revenue is easily achievable this year (+13% growth).

Thus, a 16x P/E is relatively cheap for a secular grower.

Second, the company has been operating its CT replacement tube business as an annual loss of ~$5MM for years. Backing out that loss and annual EPS is closer to $1.35 per share and Richardson’s P/E is ~12x.

Furthermore, the healthcare division could become a positive contributor or be sold or spun off.

As such, its negative contribution will eventually go away, one way or another.

What is fair value?

I believe Richardson can grow revenue 15% for the next two years. This would result in revenue of $298MM in FY 2024. Assuming flat gross margins (32%) and 10% SG&A growth (SG&A grew only 3% in FY 2022), the company can generate $1.88 in FY 2024 EPS.

Applying a 15x P/E yields a price target of 28, significantly above Richardson’s current stock price.

As always is the case, micro-caps are illiquid. Be sure to use limits.

My official rating is Buy under 17.00

Risks
Weak cash flow generation

• Operating cash flow has lagged net income which is sometimes a red flag. In this case, it is understandable as Richardson is growing rapidly and buying all inventory that it can (given supply chain headwinds) to meet demand from its customers.

Corporate Governance

• CEO Edwin Richardson controls the company given his voting shares. Nonetheless, I believe we are well aligned as he owns 15% of shares outstanding and has every incentive to think long term and increase shareholder value.

Insider Selling

• There has been a bunch of selling from insiders recently. I’m going to follow Peter Lynch’s advice and not pay too much attention to it. Part of the reason they could be selling is the stock is close to an all-time high (not a great reason to sell).

Recommendation Updates

Changes This Week: None

Updates

Aptevo (APVO) had no news this week. The company reported quarterly results on August 11. The company continues to report positive results from its key drug, APVO436. Further, it has additional drugs that are progressing well. Aptevo renegotiated its royalty agreement with Pfizer which allows Aptevo to recognize a gain and regain compliance with Nasdaq’s shareholder equity listing requirement. This is a positive. Currently Aptevo has $25MM of net cash on its balance sheet and projects that it has enough liquidity to continue to operate for 12 more months without raising capital. This biotech bear market is no fun, but Aptevo continues to be an asymmetric bet. Original Write-up. Buy under 7.50

Atento S.A. (ATTO) announced on September 7 that it has reached an extension on its lockup agreement with its largest shareholders (who represent 71% of shares outstanding) for 12 months. This is meaningful as it shows the largest shareholders of the company have conviction in the stock and believe it’s undervalued. On August 3, Atento reported another weak quarter. Management lowered revenue guidance to flat versus consensus of +4% growth and previous guidance of “mid-single-digit” growth. EBITDA margin guidance has been reduced to 12% (at the midpoint) from 13.5%. While this quarter and guidance cut were disappointing, the stock is incredibly cheap and is not at risk of defaulting on its debt (no maturities until 2025). Thus, it makes sense to stick with the stock. Original Write-up. Buy under 10.00

Cipher Pharma (CPHRF) reported strong results on August 11. Revenue declined 8% driven primarily by lower Absorica sales (as expected); however, adjusted EBITDA grew sequentially to $3.6MM. The company’s cash balance stands at $24.2MM, ~50% of its market cap. This limits downside risk. Further, the company continues to generate significant free cash flow and buy back shares. Finally, the company had positive pipeline developments with two compounds (MOB-015 for nail fungus and Piclidenoson for psoriasis). Both drugs are progressing in phase III trials. Original Write-up. Buy under 2.00

Cogstate Ltd (COGZF) provided guidance for its fiscal year on August 29. It expects 1H23 revenue to be in line with 2H22 revenue ($19.5MM). At this point, the company decided against providing revenue guidance for the second half of fiscal year 2023. Ultimately, Cogstate’s revenue potential this year and beyond will be determined by key Alzheimer’s drug read-outs which are expected this year and next year: 1) Lecanemab from Eisai (phase 3 data expected in September 2022), 2) Gantenerumab from Roche (Phase 3 data expected in Q4 2022), and 3) Donanemab from Eli Lilly (phase 3 data in mid-2023). All things considered, the thesis remains on track. Original Write-up. Buy under 1.80

Copper Property Trust (CPPTL) announced on September 12 that it has sold 7 of its properties for $65MM. The blended cap rate of the transactions was 7.3%. The trust on an aggregate basis is trading at a ~10% cap rate (the higher the cheaper). Proceeds will be paid out next month as well as net rental income. The trust remains attractive. The current yield is 10%. And the trust has no debt so our downside is protected. Original Write-up. Buy under 14.00

Crossroads Impact Corp. (CRSS) had no news this week. On July 11, the company announced that P10 Holdings (PX), another CMCI recommendation, is investing $180MM of equity capital (through one of its investment funds) at $10.76 a share with the ability to commit an additional $310MM of equity capital at the same price. This will enable Crossroads to really ramp up its ESG lending ability and grow earnings. It will also enable Crossroads to scale up and eventually explore an uplisting to a major exchange. Original Write-up. Buy under 15.00

Currency Exchange International (CURN) reported earnings last night. They looked great! Revenue increased 139% to $21MM, beating consensus expectations by $5MM. This was truly a massive beat. Revenue in the fiscal third quarter was 67% higher than 2019 FQ3 (pre-pandemic). The company’s Payments business grew revenue 65% to $3.6MM. Year to date, Currency Exchange has generated EPS of $1.15 or $1.53 on an annualized basis. As such, the stock is trading at just 9x earnings. The investment case remains on track. Original Write-up. Buy under 16.00

Epsilon Energy (EPSN) announced strong results on August 11. The company continues to benefit from high natural gas prices. Revenue increased 46% sequentially driven by 68% higher natural gas prices. Revenue should continue to soar as long as natural gas prices remain elevated and Epsilon is mostly unhedged. During the quarter, the company generated $5.9MM of free cash flow, or $23.4MM on an annualized basis. The stock looks attractive given its $31MM of net cash and strong earnings power. Original Write-up. Buy under 8.00

Esquire Financial Holdings (ESQ) reported earnings in July. Results were excellent. Revenue grew 23% y/y while EPS grew 37%. Credit metrics look very strong as the company has an allowance-to-loans ratio of 1.2%. The company has a long runway for growth, as articulated by CEO Andrew Sagliocca: “There is tremendous growth potential in both our national platforms due to the limited number of participants and the fragmented approach to finance and technology in both markets.” Despite its strong outlook, the stock trades at just 14x earnings. Original Write-up. Buy under 35.00

IDT Corporation (IDT) had no news this week. The company last reported quarterly results on June 2. At a high level, the quarter didn’t look great. Revenue decreased 12% y/y which was driven by a 17% decline in traditional communications revenue. This segment benefitted from the boom in paid calling during the pandemic, but that surge is normalizing. Most importantly, IDT’s high-growth segments continue to grow well. National Retail Solutions (NRS), IDT’s payment terminal business, grew 102% y/y. Net2phone, IDT’s other highly valuable subsidiary, grew recurring revenue by 42%. Further, IDT expects subsidiary growth to contribute to consolidated profitability in the second half of this year. While the spin-off of net2phone has been temporarily delayed, we know that it and NRS will ultimately be monetized. The investment case remains on track and my price target is 55 based on an updated sum-of-the-parts analysis. Original Write-up. Buy under 45.00

Kistos PLC (KIST: GB) reported first-half 2022 results. They looked great. The company reported revenue growth of 745% and EBITDA growth of 768%. It generated free cash flow of £93MM or $186MM annualized. As such, Kistos is currently trading at 1x current EBITDA and 2.5x current free cash flow. The only downside is that the EU is considering instituting a windfall profit tax on energy companies. While this would be a negative, I think it’s partially reflected in Kistos’ valuation. Further, Kistos generated $89MM of EBITDA in 2021. Thus, it’s trading at just 5.1x “normalized” EBITDA, not a demanding valuation. I continue to see at least 100% upside ahead. Original Write-up Buy under 7.50

Liberated Syndication (LSYN) has had no news recently. I had a chance to speak to the CEO in June. He said the team is working through re-filing its financials, and he expects to “go public” again by the end of September (this might be optimistic given the volatility in the market). Instead of just “turning on” trading, he would like to raise a little capital and also pick up coverage from some sell-side analysts. He noted the advertising business is growing very well and that the podcast hosting business is growing again. It had experienced limited growth last year given free hosting competition, but business has picked back up. While Libsyn has been a frustrating stock, I think (and hope!) our patience will be rewarded by the end of September. Since you can’t actually buy the stock until then, I rate it a Hold for those who already own it. Original Write-up. Hold

Medexus Pharma (MEDXF) reported earnings on August 9. They were excellent. Revenue in the quarter increased 33% y/y to $23MM. Sales drivers were IXINITY and Gleolan sales in the U.S. Adjusted EBITDA was $1.9MM. A huge positive was Medexus announced that it has amended its agreement with Medac to extend the payment date for regulatory milestones triggered by an FDA approval to October 2023, which therefore allows Medexus to launch and begin commercialization well before these license payments must be paid. This is a major positive. Recently, Medac provided the FDA with the information that it requested for its Treosulfan review. We will find out within a month whether the FDA deems the re-submission complete. If it does, the FDA will decide on Treosulfan’s approval within six months. Approval would be a huge catalyst for Medexus as its revenue potential would double. I continue to think the risk/reward profile of Medexus is asymmetric to the upside. Original Write-up. Buy under 3.50

NexPoint (NXDT) finally had its shareholder update call on August 10, during which they provided significant detail into the assets that make up NAV. Management spent a lot of time discussing how they are confident that they can close the gap to NAV. Unfortunately, no comments were made on an increase to the dividend or whether the company will start buying back stock. Both of these would be significant catalysts for NXDT shares. Last month, we saw more insider buying by CEO James Dondero. The thesis remains on track, and I see ~50% upside in the next 12 months. Original Write-Up. Buy under 17.00

P10 Holdings (PX) announced a meaningful acquisition in August. The company is acquiring Western Technology Investment, a market leader in venture debt. The acquisition will add $12.5MM of additional EBITDA to P10. It appears that P10 is paying ~12x EBITDA for the acquisition, a cheap but not dirt-cheap price. This acquisition will add to P10’s growth potential. P10 is currently trading at 15x 2022 adjusted EBITDA which is a very reasonable valuation for such a stable business with strong organic growth potential. The investment case remains on track. Original Write-up. Buy under 15.00

RediShred (RDCPD) completed a reverse stock split on August 18. For every 5 shares that you previously owned, you now own 1 share. The stock price adjusted up to account for the reverse split. The reverse split has no economic impact on RediShred. You still own the same percentage of the company. Other than the reverse split, RediShred has had no recent news. It’s a Canada-based, leading document destruction services company. Insiders own more than 30% of the company. It has grown revenue at a 31% CAGR and EBITDA at an 80% CAGR over the past 10 years through organic and inorganic growth. Future growth is poised to continue, yet the stock trades at just 5x forward EBITDA. I see 100% upside over the next 12 months and significantly more upside looking out a few years. Original Write-up. Buy under 3.50

Truxton (TRUX) reported a great quarter in July. Despite a volatile market, pre-provision net revenue grew 9% sequentially 30% y/y. EPS grew 16% y/y. Credit metrics remain strong. The bank has $0 in non-performing loans and $0 in net charge-offs. During the quarter, the company repurchased 22,000 shares for an average price of $70.05. The Truxton investment case remains on track. The bank will continue to grow loans and earnings prudently while returning excess cash to shareholders through dividends and share buybacks. The stock is trading at just 14x annualized earnings. This isn’t the most exciting stock, but it’s a slow and steady winner. Original Write-up. Buy under 75.00

Zedge, Inc. (ZDGE) announced on August 16 that it has authorized a 1.5MM share repurchase (10% of shares outstanding). This is a positive as it conveys management’s conviction in Zedge’s fundamental and cheap valuation. The stock remains very cheap, trading at 3.4x EBITDA. Original Write-up. Buy under 6.00

Watch List

Catalyst Biosciences (CBIO) is a new name on my watch list. It’s a biotech company that is trading at a negative enterprise value, and is in the process of liquidating. It announced a $1.43 dividend that will be paid out on September 20. I have more work to do on this one, but it looks very interesting.

Harbor Diversified (HRBR) remains on my watch list. It is the holding company for Wisconsin Airlines, which has a capacity agreement with United. HRBR trades at a negative enterprise value (net cash balance is higher than its market cap) and is profitable. It trades at such a cheap valuation because there is uncertainty on whether its agreement with United will be renewed beyond 2023. Nonetheless, the stock looks very cheap.

Societal CDMO (SCTL) is a new name on my watch list. But you may remember it. I recommended it in 2020, and closed out the recommendation for a loss. However, I’ve kept an eye on it, and it’s starting to look interesting again. The catalyst is the company is monetizing its real estate properties which will reduce its debt load. It also made an attractive acquisition and is aggressively pursuing business development. This is important because it accelerates growth and diversifies revenue. From a valuation perspective, the stock looks attractive (~10x EBITDA) but not so much on an absolute basis. I think there will be a time to buy the stock, but I’m not sure we are there yet.

Recommendation Ratings

**Original Price Bought adjusted for reverse split.
* Return calculation includes dividends

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Rich Howe owns shares in PX, MEDXF, LSYN, IDT, DMLP, NXDT, KIST, and RDCPD. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.

The next Cabot Micro-Cap Insider issue will be published on October 12, 2022.