21 Feb Capital 19 Catch-Up

Border Conflict Creates Opportunity

It was another difficult week for stock markets that are struggling to find any good news.

The Australian All Ordinaries was flat, down just 13 points for the week and the US S&P500 fell 1.6%.

The week was driven by news of conflict in Ukraine. So, let’s start there and look at what is happening.

If you believe western media (we take a somewhat skeptical view of all media sources) Putin is amassing troops on the border of Ukraine and ready to invade. Russian media says it is just a training exercise.

Putin’s actions can only be for one of two reasons. Either he wants to take Ukraine for his personal legacy or because he does not want them to join NATO. It is definitely not economic. We will probably never know his exact intentions and it is impossible to predict what will happen anyway.

All we are going to concern ourselves with is how to manage our assets around this event.

And that is very simple.

Stock markets always sell-off in times of uncertainty and then rally back once things are known.

“Buy the rumour, sell the fact” is an old saying and worth remembering here.

Stocks markets are presently volatile and it makes looking at portfolios certainly interesting day-to-day. Trying to play these short-term moves is an impossible task.

But things change when you look at it from a long-term perspective.

Imagine the world six months from now. Russia has either invaded or sent its troops home. But what impact has either of those events had on the profits of Microsoft (MSFT) or Commonwealth Bank (CBA)?

Regardless of what happens, it will have no impact on virtually all US and Australian companies. If anything, it might be positive.

Say it does invade. The West will impose sanctions and that will affect Oil (expect an oil price jump if they do). It might well mean Europe can no longer source oil and gas from Russia. They will still need to heat their homes so Europe will go looking for alternative markets and Australian LNG companies will be very happy to load tankers with product and ship them over there.

Australian oil and gas companies will have found a new market to sell into and bank new profits because of it.

Rather than see these events as a risk and a concern for lower prices, we see them as an opportunity to profit. If Russia invades, it will make no difference to many market segments and an opening of new potential sales for others. If Russia does not invade traders will wonder what they worried about and go back to buying back those stocks they sold in the first place.

Either way, we see higher prices coming.

Sure, in the short-term, we might see a day or two of selling the invasion news. If that happens we will be aggressive buyers of any dip.

The second problem for stocks is inflation or more correctly, the anticipation of central banks increasing interest rates because of it.

This one is a longer-term issue. The good news is higher interest rates are already factored into stock prices.

The US interest rate markets are basically 100% sure the Fed will raise by 25bps in March and they are factoring in a 37% chance the Fed raises by 50bps.

For things to get worse from here, you would need to see the Fed raise rates even more aggressively than the market has already discounted. That is highly unlikely.

Sentiment at present is negative, but there won’t be a lot more downside. Once we have the March fed meeting out of the way, (March 15-16) that uncertainty will be removed and we will be left with equity prices trading at fair value, a more predictable course of Fed action, no more Covid business disruptions and growing company profits. Stock prices will recover.

Between now and then we might well see more volatility. But use these days to buy bargains.

Talking of bargains, here is one we have uncovered recently.

National CineMedia Inc (NCMI)

Current price – $3.17

NCMI is in the advertising business, creating, producing and distributing ads that run before the movie starts in movie theatres.

Unsurprisingly, the share price tanked in February 2020 when the coronavirus pandemic forced the closure of movie theatres. But, now that the world is starting to return to normal, so too are revenues at NCMI.

Their last two quarters have seen increasing revenues. The 3Q result was up a whopping 428% year-on-year. There is still some way to go to get back to pre-pandemic levels and there is no reason the company cannot do so as the world returns to normal.

Back in 2018 and 2019, NCMI paid out a regular $0.17 quarterly dividend. Even though the pandemic effectively closed their business, management had been so prudent with cash that they had built up a war-chest to get them through this difficult time. NCMI has continued to pay quarterly dividends throughout the pandemic of $0.05 per quarter

That gives them a present dividend yield of 6.3%

The company still has $61million cash in the bank to continue with this payment and increasing revenues will add to that.

Eric Wold, of B. Riley Securities, recently published his analysis and wrote “We remain positive on the opportunity for the ‘lights down’ strategy to differentiate NCMI’s offering vs the emerging AVOD networks. We are modeling NCMI’s revenues throughout 2022/2023 to, more or less, mirror box office attendance patterns and would expect to see some positive separation in the coming quarters as NCMI benefits from stronger inventory utilisation and higher CPMs….”

Wold adds, “Not only did NCMI have enough liquidity to push through year-end and into January, the company will start to benefit from incoming cash flow on the stronger 4Q21 seasonality and monetisation of the upfront advertising commitments.”

Wold has a price target of $6 on the stock, an 89% upside to present prices.

Last week NCMI announced a strategic partnership with RAD AI to leverage the power of recommendation and referral with machine learning to drive distribution of advertisers’ messages through targeted social influencer networks. The market liked this announcement and the stock jumped 8% on the news.

What we like with NCMI is the belief revenues should increase significantly in 2022 as people return to movie theatres. Those increasing revenues should drive the stock price higher and we are looking for close to 100% gain.

While we wait for this, we can sit back and receive a 6.3% yield

Risk remains low, if NCMI management can navigate a market that pretty much stopped them earning revenue, they are clearly doing something right. The stock price has started to move with the re-opening of theatres but remains seriously depressed. We recommend using the current global negative sentiment to build a position before it moves higher.

If revenues manage to return to pre-pandemic levels and management goes back to paying $0.17 per quarter, this would represent a yield of 21% on current prices.

At that stage the more difficult question would be – do you sell to lock in the capital gains or hold for the massive yield?

Disclosure

Employees of Capital 19 presently own NCMI stock

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.