INP.CVE - Input Capital

[Guest Schwab711]

Nice post sculpin.

 

The other two failed for failure to deliver, generally by choice.  We do not understand why.  There are likely some integrity issues here, and there were episodes last week that convinced us we could go no further.

 

This scares me because it sounds like the farmers may be incentivized to voluntarily default at times.

[winjitsu]

Can I get a model check?

 

I'm going off this document (http://s1.q4cdn.com/584800959/files/doc_downloads/Input-Capital-FAQ.pdf), where Input takes 2/6 of crop delivery in payments, pays 80% of the remaining amount upfront, and the rest of the 20% over the 6 year period.  I'm not sure how AAOI (http://www.aboveaverageodds.com/2015/01/24/input-capital-inp-v-if-you-build-it-farmers-will-come/) is getting 20% IRR on just base deliveries assuming no change in commodity prices, which is about 4% off from my number.

 

So from my gross number, I feel like I am missing delivery costs, call risk (farmer canceling), agricultural risks (less insurance), and default risk (less asset collateral). On the upside, I am missing bonus tonnes. Canola price variance I'll consider neutral. Anything else?

 

Nice post sculpin.

 

The other two failed for failure to deliver, generally by choice.  We do not understand why.  There are likely some integrity issues here, and there were episodes last week that convinced us we could go no further.

 

This scares me because it sounds like the farmers may be incentive to voluntarily default at times.

 

But for an asset backed investment, this is fine as long as LTV is sufficient -- I don't see a problem. Mortgage payers walk away all the time. The only time this would be a problem would be a asset bubble crash, like the property crash in 07/08.

 

Regarding Cormack's take, posted by Sculpin ... while I do think he is right in analyzing the stock similar to a bank, I disagree with his valuation based on current EPS/ROE, since the cost structure is  inevitably bloated since it is a new and growing company. Growth for a widget manufacturer requires expansion capex, and there isn't a huge impact on operating profits. But for a companies like this, growth requires hiring more people, which increases operating costs.

 

At the end of the day, the idea is fixed operating costs will stabilized/grow slower than revenue, and eventually the company will turn a profit as it matures. This works well for companies that have figured out a superior business model, but the story breaks down for companies that have not. Facebook and Google are in the former, companies like Yelp, Linkedin, Twitter (honestly, take your pick of like 99% of tech IPOs), fall in the latter. If Input is making 15% IRR on each deal, with crop insurance and asset collateral, I believe it belongs in the former.

 

Saying that the company should trade similar to banks on EPS/ROE/BVPS is a terrible comparison. Growth in revenue was 281% (2015 yoy), 262% LTM, with fixed costs trending down as a % of revenue. How many banks can claim that?

 

[Guest Schwab711]

Nice post sculpin.

 

The other two failed for failure to deliver, generally by choice.  We do not understand why.  There are likely some integrity issues here, and there were episodes last week that convinced us we could go no further.

 

This scares me because it sounds like the farmers may be incentive to voluntarily default at times.

 

But for an asset backed investment, this is fine as long as LTV is sufficient -- I don't see a problem. Mortgage payers walk away all the time. The only time this would be a problem would be a asset bubble crash, like the property crash in 07/08.

 

I don't think it's like mortgages at all. Input would be left with a perishable good that needs to be sold for a loss (if they have anything at all). That's part of the reason they expect high returns.

[winjitsu]

 

I don't think it's like mortgages at all. Input would be left with a perishable good that needs to be sold for a loss (if they have anything at all). That's part of the reason they expect high returns.

 

It's secured against farmland and farm equipment.

 

From: http://s1.q4cdn.com/584800959/files/doc_downloads/Input-Capital-FAQ.pdf

 

What are the security requirements for a streaming contract?

A streaming contract does require a higher level of security than a deferred delivery contract. The upfront payment requires security to prevent non-delivery of the canola. Typically, a mortgage registration against farm real estate is required.

 

From: http://s1.q4cdn.com/784243260/files/doc_news/Input-Capital-Corp-Publishes-Q4-Operations-Update.pdf

 

Update on Terminated Streaming Contracts

On November 12, 2015, Input announced the termination of three streaming contracts and which are now classified as inactive contracts. Input immediately began legal proceedings to begin the process of recovering its investment in these three contracts. Management is pleased to report that the recovery process is proceeding smoothly and is either on track or ahead

of previously expected timeframes. On the largest of the contracts, Input has now taken titled possession of 12.3 quarters of farmland (approximately 2,000 acres), and the foreclosure process on the balance of the land associated with the security package for this contract is proceeding ahead of schedule. Input is in the process of finalizing rental arrangements with local farmers for the upcoming growing season to ensure that the land is maintained in good condition in preparation for a sale of the entire property once the foreclosure process is fully complete. In the interim, the farmers will pay a market rental rate to the benefit of Input for the use of the land this year.

 

In addition, Input has consigned a significant number of pieces of farm equipment to a regularly scheduled auction to be held on May 1. An additional batch of equipment associated with this contract will be auctioned this summer. The recovery efforts associated with the two smaller terminated contracts are progressing and are on track with previous expectations. Management continues to expect to fully recover all of the capital associated with the three terminated contracts.

[Guest Schwab711]

I got that. Maybe poor word selection. Either way, small farms can experience volatile output and costs. If it becomes unprofitable to farm in a small region that the farmland may lose a lot of value. Is it really farmland if it's no longer profitable to utilize it? Unless the population or wealth of a location declines drastically, most types of housing generally hold their value (+/- 10-20%). You have capped upside and a large downside, so underwriting seems to be key. At what prof cap rate did Input value the land?  believe farmland has declined in the last 6-9 months (cap rates were around 2-3% a year or two ago). I also think mortgage prepayment has slightly different dynamics because it's someones personal homestead.

[winjitsu]

Valuable perspective. I'll be first to admit I don't know too much about farmland and reading the headlines, things do appear frothy (but forecasts are for continued appreciation in 2016 -- taken with a grain of salt).

 

I absolutely agree -- at the end of the day, this is a financial stock and they key is underwriting standard and management's attitude towards risk.

 

I do believe there are risks. We haven't seen the business model  go through a full cycle yet, be it in canola, farmland, or even the full term of the contract. We're 3 years into the first 6 year contract cycle, and already we've had farmers delaying delivery, pre-payment, and defaults. Others tout the 10 years of management experience, and while valuable, truth is management has only ever known a bull market. I know some real estate guys who made a killer IRRs 2000 - 2006, but that is not hard in a rising market, and it did not prevent them from being slaughtered in the downturn. In my opinion (and in reading the sell-side note posted), this is the current market view.

 

But such is the flavor of financial investments. If you had to invest in a financial company in the agricultural space, what would you like to see? Personally, I like to see diversification (check), prudent use of leverage (none -- so check), and rock solid underwriting, even to withstand collateral write-downs (I don't know yet on this one, will have to see the outcome of the current defaults and personally reach out to management).

 

On the positive side, the company has a huge untapped market both within Canola and in other agricultural commodities. And according to my calculations for LTM, it is operating profit positive to the tune of ~$5M, so it can be self-sustaining from here. My rough calculations are $5M EBIT, growing 180% y/y, $100M EV -- definitely attractive enough to spend more time researching.

 

The main question will be if management can continue to improve and refine underwriting standards (can they be disciplined not to chase growth) while growing the portfolio.

 

Two quick comments to some points brought up previously in this thread (now that I've had time to read through it all):

[*]I don't think its financial engineering at all. It's just lending where the company is paid back in crop instead of cash. In that sense, it is hardly innovative and has been around for thousands of years.

[*]When thinking of competitive advantages, the only one I can think of is economies of scale, which is nice since Input has the first-mover advantage. Other than that, I really think it depends on quality of management, especially their stance on risk and can they make prudent investment decisions (i.e. can they walk away from deals or sit on their capital for several years waiting for better investment opportunities).

 

edit: some numbers were off

[Otsog]

[*]I don't think its financial engineering at all. It's just lending where the company is paid back in crop instead of cash. In that sense, it is hardly innovative and has been around for thousands of years.

 

Agreed, it is hardly innovative.  But, their website and all their disclosures prominently sell "WORLD'S FIRST AGRICULTURAL STREAMING COMPANY".  Their metrics focusing on cash flow on the first pages of every MD&A and Investors Presentation are without a doubt unscrupulous. Q32016 MD&A: "Cash operating margin from streaming contracts of $13.613 million, or $427 per MT (87.0% cash operating margin)".  That is a completely engineered metric that misrepresents the actual operations of the company for the sole purpose of misleading investors. 

 

 

 

 

[winjitsu]

 

Agreed, it is hardly innovative.  But, their website and all their disclosures prominently sell "WORLD'S FIRST AGRICULTURAL STREAMING COMPANY".  Their metrics focusing on cash flow on the first pages of every MD&A and Investors Presentation are without a doubt unscrupulous. Q32016 MD&A: "Cash operating margin from streaming contracts of $13.613 million, or $427 per MT (87.0% cash operating margin)".  That is a completely engineered metric that misrepresents the actual operations of the company for the sole purpose of misleading investors. 

 

 

 

We both agree that the business model is simple and not innovative: you give some money at the start and a little money each year to get the farmer going, and in return you get some crop back over the next 6 years. This is very simple on a cash basis: I lend out $60, get back net $15 over the next 6 years, I make an 1.5x cash on cash return and 16% IRR. But how do you show this in an accrual-based accounting system?

 

When I first glanced at the financials, I found it incredibly difficult to follow. But now that I understand the business better on a deal-by-deal basis, I understand why things have to be they way they are (and also why GAAP/IFRS revenue and net income are absolutely the wrong way to think about this investment). On the net income statement for example, revenue and costs from trading are irrelevant and negligible, interest income/expense is irrelevant, and market value adjustments are material but don't tell you anything about the underlying business (not to mention they'll show up in revenue & cogs when realized anyways).

 

Cash-based accounting is hands down the easier way to think about this business. The $427 number is basically the ~$480 cash they made from selling canola in harvest less the ~$50 they paid for the seeding. From there, you subtract out cash costs from operating (SG&A, lawyers, taxes), and you are left with a number to replenish your capital base and make money. If I owned this business outright, that is how I would think about it.

 

The company's business model lies somewhere between a traditional bank and streaming company (as others know them), with some agricultural spice thrown in. That's a little clunky and hard to convey. I think "Agricultural Streaming" is about the best approximation you can get (but if you think of something better -- please share!). 

 

I work with a lot of new companies so my inclination (perhaps weakness?) is to not get too caught up in the accrual accounting representations of the underlying business.  There is a great comment on a blog post by Fred Wilson, a top VC,  on this topic (http://avc.com/2016/04/generally-accepted-accounting-standards-gaap/):

 

"I hear ya man. It's accrual world."  :)

 

edit: grammar and some more thoughts for clarity

[rpadebet]

This is more like receivable financing, isn't it?

You are letting the farmers sell their future receivables to you at a discount to today's price...but you take on the collection risk and risk of future canola price.(there are some more payments later, but u can adjust for those).

 

I am definitely not an expert in accrual GAAP accounting or Cash accounting, but I agree with winjitsu that the financial statements put out by the company do their best to complicate a simple model. Its best to think of this as an owner of one such contract.

 

 

[Otsog]

4.5. Common classification errors in practice

 

(iii) Failure to classify cash flows arising from an entity’s principal operating activities as operating

 

An entity in the financial services sector typically derives operating income from advancing loans to customers in

return for future payments of principal and interest. Although IAS 7.31 permits an entity to classify interest cash flows

as operating, investing or financing, the requirements of IAS 7.6 (which includes the definition of operating activities)

override this option.

 

Consequently, cash flows relating to loans advanced to customers by a financial institution are required to be classified

as operating activities.

 

http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20in%20Practice/Documents/IFRS_IAS7_print.pdf

 

 

 

[Patmo]

4.5. Common classification errors in practice

 

(iii) Failure to classify cash flows arising from an entity’s principal operating activities as operating

 

An entity in the financial services sector typically derives operating income from advancing loans to customers in

return for future payments of principal and interest. Although IAS 7.31 permits an entity to classify interest cash flows

as operating, investing or financing, the requirements of IAS 7.6 (which includes the definition of operating activities)

override this option.

 

Consequently, cash flows relating to loans advanced to customers by a financial institution are required to be classified

as operating activities.

 

http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20in%20Practice/Documents/IFRS_IAS7_print.pdf

 

Sure, I could just flip over to the cash flow statement, but then how would I show others how much of a Sophisticated Investor I am if I don't go about it in a super convoluted way? Dem accounting rules be all wrong, I tell ya.

[winjitsu]

4.5. Common classification errors in practice

 

(iii) Failure to classify cash flows arising from an entity’s principal operating activities as operating

 

An entity in the financial services sector typically derives operating income from advancing loans to customers in

return for future payments of principal and interest. Although IAS 7.31 permits an entity to classify interest cash flows

as operating, investing or financing, the requirements of IAS 7.6 (which includes the definition of operating activities)

override this option.

 

Consequently, cash flows relating to loans advanced to customers by a financial institution are required to be classified

as operating activities.

 

http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20in%20Practice/Documents/IFRS_IAS7_print.pdf

 

I have a hard time following -- could you state your point outright?

 

All the money from loan repayment in included in the cost of sales which ends up in CFFO:

[*]Companies makes a loan, classified as CFFI, shows up in Canola Interest in BS

[*]Company Sells Canola. Canola interest goes down on the BS. COGs is calculated based on change of value in Canola Interest (basically principle balance paydown + fees associated with collecting). Revenue and COGs are operating activities, which is in CFFO

[*]Gross Margin then can be though of as your Net Interest Income. Again, as a line item statement in NI, this ends up in CFFO

[tripleoptician]

I just increased my position by 50% on this. Having read the annual reports, I think the security claims they put in place seem rigorous including having potential claim to the farm itself.

The $80 million market cap decline today is out of proportion in my opinion. Total contracts (current and future) is around $92 million and the 3 contracts is ~$18 million and input says the security claim is around $24 million.

The market is pricing this as a fundamental impedance to their business model, but I don't think it is. In fact, if they achieve even a 50% return on the security claim I would make the case it strengthens the business model to show it has withstood one of the risks here. Seems like a good bet to make at this time as management have been at this game a while before in the Assinaboia private group and hopefully have the experience to deal with this.

 

Would be interesting to get AAOI's take as he has done a lot of work here before.

 

Market opinion is finally starting to turn again on this stock. Up about 40% from the lows of the last several months.

Business updates:

1.demonstration of the resilience for the security packages associated with the contracts. They have essentially resolved the largest terminated contract with the ability to rent the foreclosed land and then sell at what remains to be elevated agricultural land prices. Machinery is shown to be reasonably liquid asset and will be sold soon.

It seems safe to assume that a very high percentage of the deployed $18 million will be re-cooperated; a profit may in fact be squeaked out here to as package was estimated at $24 million.

 

2. Total yearly capital deployed FY16 was $35 million with smaller deal sizes and more diversified contract portfolio. No material risk of any one contract currently, after the 3 terminated contracts in November.

 

3. Balance sheet will likely show cash on hand in the $27-29 million as of May 30th fiscal with no debt. With opex and potential deployment into "addons"  on existing contracts, we may see cash position decrease into $20 million range around harvest timeframe.

 

4. With the quick canola to cash conversion cycle we experienced in this last fiscal year combined with potential return of capital from foreclosures on the terminated contracts, I think the company could go through this next year of deployment without necessarily doing an equity raise.

 

Overall this business continues to look to have potential solid IRR's and cash compounding cycles with an iron clad balance sheet, huge canola reserves, continued interest from farmers despite of recent terminated contracts, incentivized management with high percentage ownership, and demonstration of solid security packages for loans made.

 

At the previous low, we were paying below adjusted book value. At current price, we are paying above ABV but long term growth prospects are higher than what the current price reflects.

 

[Tim Eriksen]

4.5. Common classification errors in practice

 

(iii) Failure to classify cash flows arising from an entity’s principal operating activities as operating

 

An entity in the financial services sector typically derives operating income from advancing loans to customers in

return for future payments of principal and interest. Although IAS 7.31 permits an entity to classify interest cash flows

as operating, investing or financing, the requirements of IAS 7.6 (which includes the definition of operating activities)

override this option.

 

Consequently, cash flows relating to loans advanced to customers by a financial institution are required to be classified

as operating activities.

 

http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20in%20Practice/Documents/IFRS_IAS7_print.pdf

 

I have a hard time following -- could you state your point outright?

 

All the money from loan repayment in included in the cost of sales which ends up in CFFO:

[*]Companies makes a loan, classified as CFFI, shows up in Canola Interest in BS

[*]Company Sells Canola. Canola interest goes down on the BS. COGs is calculated based on change of value in Canola Interest (basically principle balance paydown + fees associated with collecting). Revenue and COGs are operating activities, which is in CFFO

[*]Gross Margin then can be though of as your Net Interest Income. Again, as a line item statement in NI, this ends up in CFFO

 

I think his point is that cash flows from operations is a terrible way to value the company based on how it treats the cash flows on its loans.  If that isn't his point, it should be  :)

Cash flows from operations are grossly over stated since it includes repayment of principal, while the issuance of loans is in cash flow from financing activities. 

[winjitsu]

 

I think his point is that cash flows from operations is a terrible way to value the company based on how it treats the cash flows on its loans.  If that isn't his point, it should be  :)

Cash flows from operations are grossly over stated since it includes repayment of principal, while the issuance of loans is in cash flow from financing activities. 

 

Ahh -- makes sense though I don't think anyone on this thread mentioned valuing the company on the basis of CFFO at any point. I thought it was in some weird reference to cash operating margin he referenced earlier.

 

Eagerly waiting for their annual report -- is it me or is this taking longer than usual? Also, any idea if they have any exposures to the Alberta fires?

[Otsog]

INP management places a lot of emphasis on CFFO and cash operating margin.  Do they not understand their business or are they trying to mislead people? 

[tripleoptician]

INP management places a lot of emphasis on CFFO and cash operating margin.  Do they not understand their business or are they trying to mislead people?

 

A somewhat facetious statement, but I will bite.

Let's assume that IFRS is followed as per accounting principles. Then it is the non IFRS measures that you are referring to and questioning if management is trying to mislead investors here.

 

1. Adjusted Operating Cash flow (total and per share)

I find this fairly useful because it truly represents the available cash available I that quarter for re-deployment of capital into new contracts. IT helps me determine when the company can be self generating in re-deployment cycles vs relying on equity financing or debt.

 

2. Adjusted Ebitda (total and per share)

I care about this less but the net income/EPS is widely affected by financial derivative and mark to market accounting related to the swings in canola prices.

Therefore this measure gives a closer static look at EBITDA growth over time.

 

3. Adjusted Net Income (total and per share) essentially same as above removing market adjustments and taxes. I personally wouldn't remove taxes from this if I was management.

 

4. Crop Payment per tonne - I find this particularly useful a it helps us predict future operating cash flow for re-deployment. We can estimate realized canola sale prices after harvest and subtract this crop payment which will tell us the amount available.

 

5. Cash Operating Margin (total and per tonne)

Same as above statement

 

6. Canola Replacement Cycle

As noted above, this helps to tell us when the company can grow solely with internally generated cash flows. Given that contracts cycle on average of 6 years, if they can't re-deploy they may go from internally funded to requiring outside capital to start back up again. This is again helpful for me to evaluate.

 

The one measure I think is pointless for them to state is when they say they have 87-90% cash operating margins on the $ per tonne they sold. Real margin is trying trying figure out total sale - upfront payment - crop payment. But if an investor doesn't get this point and thinks the company is making 90% margins than they are out to lunch t begin with.

 

I think AAOI addressed your concerns well earlier in thi thread and would refer to that for more detailed explanation.

[tripleoptician]

 

I think his point is that cash flows from operations is a terrible way to value the company based on how it treats the cash flows on its loans.  If that isn't his point, it should be  :)

Cash flows from operations are grossly over stated since it includes repayment of principal, while the issuance of loans is in cash flow from financing activities. 

 

Ahh -- makes sense though I don't think anyone on this thread mentioned valuing the company on the basis of CFFO at any point. I thought it was in some weird reference to cash operating margin he referenced earlier.

 

Eagerly waiting for their annual report -- is it me or is this taking longer than usual? Also, any idea if they have any exposures to the Alberta fires?

 

Unlikely any effect from fires as it is Northern Alberta while most of the farmland is in the Southern part

[Tim Eriksen]

INP management places a lot of emphasis on CFFO and cash operating margin.  Do they not understand their business or are they trying to mislead people?

 

Exactly.  CFFO is heavily emphasized by management and it is misleading to investors. Is it intentional?  You would have to think so.  If it isn't intentional it means management is ignorant on how to value the business, which would be a concern.   

 

Net income (and ROE) is a more accurate reflection of the quality of the business, and it is low.  In fact earnings are mostly from market value adjustment on the contracts.  Market value adjustments are not of the same quality as normal operating earnings.  There is a risk that none will be earned in a given year, as well as the possibility of a downward revision.  Input has a short term "streaming" business, which is the worst kind.  It would be like being a lender that has to replace its loan book more frequently.  That inherently means higher operating costs.  The company is more of a lending company than a royalty company.  Based on ROE, I would value it at cash plus no more than 8-10 times earnings.  To be buyer I would want a discount from that due to the nature of earnings being heavily tilted to market value adjustments.         

[Guest Schwab711]

INP management places a lot of emphasis on CFFO and cash operating margin.  Do they not understand their business or are they trying to mislead people?

 

Exactly.  CFFO is heavily emphasized by management and it is misleading to investors. Is it intentional?  You would have to think so.  If it isn't intentional it means management is ignorant on how to value the business, which would be a concern.   

 

Net income (and ROE) is a more accurate reflection of the quality of the business, and it is low.  In fact earnings are mostly from market value adjustment on the contracts.  Market value adjustments are not of the same quality as normal operating earnings.  There is a risk that none will be earned in a given year, as well as the possibility of a downward revision.  Input has a short term "streaming" business, which is the worst kind.  It would be like being a lender that has to replace its loan book more frequently.  That inherently means higher operating costs.  The company is more of a lending company than a royalty company.  Based on ROE, I would value it at cash plus no more than 8-10 times earnings.  To be buyer I would want a discount from that due to the nature of earnings being heavily tilted to market value adjustments.       

 

Does this assume that some portion of the company's value is due to their expertise, reinvestment opportunities, ect? How should I determine when to switch from a BV/NAV method to a multiple-based method for companies like this?

 

I'm not interested in Input so much as I'm interested in what the "critical point" is.

[Tim Eriksen]

INP management places a lot of emphasis on CFFO and cash operating margin.  Do they not understand their business or are they trying to mislead people?

 

Exactly.  CFFO is heavily emphasized by management and it is misleading to investors. Is it intentional?  You would have to think so.  If it isn't intentional it means management is ignorant on how to value the business, which would be a concern.   

 

Net income (and ROE) is a more accurate reflection of the quality of the business, and it is low.  In fact earnings are mostly from market value adjustment on the contracts.  Market value adjustments are not of the same quality as normal operating earnings.  There is a risk that none will be earned in a given year, as well as the possibility of a downward revision.  Input has a short term "streaming" business, which is the worst kind.  It would be like being a lender that has to replace its loan book more frequently.  That inherently means higher operating costs.  The company is more of a lending company than a royalty company.  Based on ROE, I would value it at cash plus no more than 8-10 times earnings.  To be buyer I would want a discount from that due to the nature of earnings being heavily tilted to market value adjustments.       

 

Does this assume that some portion of the company's value is due to their expertise, reinvestment opportunities, ect? How should I determine when to switch from a BV/NAV method to a multiple-based method for companies like this?

 

I'm not interested in Input so much as I'm interested in what the "critical point" is.

 

I am actually assuming the opposite.  That there is no value attributable to expertise or reinvestment opportunities.  Returns on equity are low and it has a fair amount of cash so I am valuing it based on the cash plus the value of the present earnings.  There may be some expertise but it is not reflected in the numbers so it seems a stretch to assume there is.  There are reinvestment opportunities but since the current returns are low, how valuable is it?  I would also note that if reinvestment opportunities are so great, why is cash so high?  Shouldn't they have already made additional deals?

 

While it is an oversimplification, I would say that only when a company shows a consistent ability to earn a greater than 10% ROE should someone switch from a book value / liquidation approach of valuation to a cash flow/earnings approach.  A second factor to look for that leads to the switch is when the earnings are not required to be plowed back into the business in order to maintain current earnings levels.  In reality both valuation approaches are always being considered it is just that one is more heavily weighted or emphasized.   

[winjitsu]

I'm actually shocked how different my understanding of the accounting is versus other people... who is right? I have no idea haha but open to criticism...

 

From 12/31/15 Financials:

 

Canola Interests

Canola interests are agreements for which settlements are called for in tonnes of canola, the amount of which is

determined based on terms in the canola purchase agreements which are capitalized on a contract-by-contract basis

and are recorded at fair value. As the contracts contain an embedded derivative relating to the market value of

canola, at each reporting date the fair value of each contract is calculated using internal discounted cash flow models

that rely on forward canola and other correlated commodity pricing provided by independent sources. Subsequent

changes in fair value of these derivative financial instruments are recognized in profit or loss in Market value

adjustments.

 

Included in contracts are pledges of general and specific security made by the farmer as collateral against delivery of

canola tonnes. From time to time, in normal course, the Company may take steps to terminate streaming contracts

that are in default. Contracts that are in the process of being terminated are fair valued at each reporting date based

on the expected amount of capital to be recovered net of legal and other costs. Legal and other costs relating to the

enforcement of security are included in canola interests until the contact termination is complete (see Note 6).

 

Cost of Sales

The initial upfront payment allocated to canola interests is capitalized. Upfront payments allocated to canola interests

are realized as cost of sales on a proportionate contractual tonne basis as sales are realized for each specific

contract. Crop payments are recognized as cost of sales on a tonne basis as sales are realized for each specific

contract

 

As I mentioned earlier in my post, you really need to sit down and get your hands dirty with these financials and think of yourself as a owner of these contracts. There's loads of things on NI that don't really tell you how the business is doing. Total revenue is vastly overstated based on trading revenues, a true owner would only think about growth in streaming revenue, for example. I think most people on this board that are invested have made the necessary adjustments, such as ignoring trading revenues + cogs and market value adjustments at the bottom of NI. There's only like 3-4 annual reports and the accounting/financials are pretty straightforward, so there's really no excuse for not doing the work.

 

Your gripe with NI is market value adjustments. Well that makes it simple, just add it back and you'll see on a LTM basis, the company is still EBIT positive (~$5.5mm CAD when you take out ~$500k gain in "other"). This is the number I've been using to derive my valuations, and I suggest you do too.  The reason is market value adjustments make their way back into COGs when canola is finally received and sold, so in the end it works out and gross margin is a clean number (though you can make a point that the derivative models are unknown and can be subject to fraud -- I couldn't agree more and this ultimately comes down to if you trust management and I'll point out you have no idea how GS/BAC/C value their derivative books either).

 

Its unfair to value the company based on ROE and similar metrics, since operating costs are elevated for a growing company. You need to think of this company on an ongoing basis. Two points:

[*]Based on the definition of Canola Interest above, I think of Gross Margins as effectively Net Interest Income, since principle repayment is recognized in COGs. FYE 3/31/15, Gross Margins was $3,374,162 and SG&A was ~$3.7mm -- EBIT negative. LTM 12/31/15, Gross Margins was $10,513,928, SG&A was ~$4.7mm, EBIT positive. SG&A as a percent of gross margins will only trend downward as revenues increase

[*]Capital deployed by year is $6mm, $25mm, $49mm, and $35mm for FYE 2012 - 2016. Current revenue is going to be understated relative to a company at maturity at a steady state making $35mm in loans a year since loans at the onset were much smaller than they are today. Assuming no growth capital deployed by year, you'll see peak revenue in like 2019

 

I will add in a negative point: I don't like how non-performing streams are included in canola interests. I think it should be broken out into a different line item.

Note: I used COGS and cost of sales interchangeably... hope you get my point

 

[tripleoptician]

I'm actually shocked how different my understanding of the accounting is versus other people... who is right? I have no idea haha but open to criticism...

 

From 12/31/15 Financials:

 

Canola Interests

Canola interests are agreements for which settlements are called for in tonnes of canola, the amount of which is

determined based on terms in the canola purchase agreements which are capitalized on a contract-by-contract basis

and are recorded at fair value. As the contracts contain an embedded derivative relating to the market value of

canola, at each reporting date the fair value of each contract is calculated using internal discounted cash flow models

that rely on forward canola and other correlated commodity pricing provided by independent sources. Subsequent

changes in fair value of these derivative financial instruments are recognized in profit or loss in Market value

adjustments.

 

Included in contracts are pledges of general and specific security made by the farmer as collateral against delivery of

canola tonnes. From time to time, in normal course, the Company may take steps to terminate streaming contracts

that are in default. Contracts that are in the process of being terminated are fair valued at each reporting date based

on the expected amount of capital to be recovered net of legal and other costs. Legal and other costs relating to the

enforcement of security are included in canola interests until the contact termination is complete (see Note 6).

 

Cost of Sales

The initial upfront payment allocated to canola interests is capitalized. Upfront payments allocated to canola interests

are realized as cost of sales on a proportionate contractual tonne basis as sales are realized for each specific

contract. Crop payments are recognized as cost of sales on a tonne basis as sales are realized for each specific

contract

 

As I mentioned earlier in my post, you really need to sit down and get your hands dirty with these financials and think of yourself as a owner of these contracts. There's loads of things on NI that don't really tell you how the business is doing. Total revenue is vastly overstated based on trading revenues, a true owner would only think about growth in streaming revenue, for example. I think most people on this board that are invested have made the necessary adjustments, such as ignoring trading revenues + cogs and market value adjustments at the bottom of NI. There's only like 3-4 annual reports and the accounting/financials are pretty straightforward, so there's really no excuse for not doing the work.

 

Your gripe with NI is market value adjustments. Well that makes it simple, just add it back and you'll see on a LTM basis, the company is still EBIT positive (~$5.5mm CAD when you take out ~$500k gain in "other"). This is the number I've been using to derive my valuations, and I suggest you do too.  The reason is market value adjustments make their way back into COGs when canola is finally received and sold, so in the end it works out and gross margin is a clean number (though you can make a point that the derivative models are unknown and can be subject to fraud -- I couldn't agree more and this ultimately comes down to if you trust management and I'll point out you have no idea how GS/BAC/C value their derivative books either).

 

Its unfair to value the company based on ROE and similar metrics, since operating costs are elevated for a growing company. You need to think of this company on an ongoing basis. Two points:

[*]Based on the definition of Canola Interest above, I think of Gross Margins as effectively Net Interest Income, since principle repayment is recognized in COGs. FYE 3/31/15, Gross Margins was $3,374,162 and SG&A was ~$3.7mm -- EBIT negative. LTM 12/31/15, Gross Margins was $10,513,928, SG&A was ~$4.7mm, EBIT positive. SG&A as a percent of gross margins will only trend downward as revenues increase

[*]Capital deployed by year is $6mm, $25mm, $49mm, and $35mm for FYE 2012 - 2016. Current revenue is going to be understated relative to a company at maturity at a steady state making $35mm in loans a year since loans at the onset were much smaller than they are today. Assuming no growth capital deployed by year, you'll see peak revenue in like 2019

 

I will add in a negative point: I don't like how non-performing streams are included in canola interests. I think it should be broken out into a different line item.

Note: I used COGS and cost of sales interchangeably... hope you get my point

 

I agree winjitsu with your general thought process. I think evaluating the business on its book value vs. earnings multiple is a better, choice because it isn't a true royalty streamer given its shorter life cycle of the contracts relative to traditional streamers. Like Tim Eriksen suggested, this business is required to re-invest on short durations otherwise it will be in run-off and eventually build up excess cash. This is especially true, because I believe the company is participating in more "add on" deals which are essentially very short duration, but still reasonable IRR. So attaching earnings multiples of 16-20x (traditional streamers) seems far too aggressive in my opinion for this company.

 

I have my own math for how this book value grows with time, but it is similar to the attached presentation. I think book value growth at this rate should be priced higher then a 1x multiple. A key consideration is when the business is self propelling with internal cash flow combined with a consistent ability to churn $30-$40 million of annual deals. If deal flow drops off, then the multiple drops. Luckily, the business capex and opex ($4-5 million/year) is more or less static moving forward without affecting the business as it expands. So even in a "total run-off" scenario , owners aren't penalized too severely while awaiting capital return from contracts. As stated before, we are getting a live demonstration of how the security package holds up and it appears total loan loss seems unlikely. There is also no debt to bankrupt the company in the scenario of loss of deal flow.

 

I think this is an "alternative lender" business not really a "royalty streamer". I think it is unique with its ability to charge enough interest via its received tonnage to generate high IRR's, but the borrower has an asymmetric risk profile given the degree to which they can benefit, as well as the company's downside is more robust then typical high interest alternative lenders. Bonus tonnage and improved agronomic yields was the equivalent of a performance fee or bonus structure, but it has not shown enough consistency to rely on it for valuation purposes. 

 

I'm trying to understand if those critical of the business are worried this is a promotional management attempting to pump and dump with their heavy insider ownership? Or is it being skeptical of a new business model that at one point was being given an absurd book value multiple ( I think 2-2.5x BV in the first 1-2 years)? Or in other words, this may just be a mediocre/ okay business and not a good/great business?

 

Thanks for any critical thoughts

GrizzlyRock_Input_Capital_Deck_Final.pdf

[Guest Schwab711]

In the GrizzleyRock presentation:

*Why would the hypothetical farmer's revenue increase by 15% with a stream contract?

 

Without this increase in revenue, the hypothetical farmer is appears to be worse off with Input's financing, even with the assumption of 20% savings on fertilizer and 15% on seeds.

[tripleoptician]

In the GrizzleyRock presentation:

*Why would the hypothetical farmer's revenue increase by 15% with a stream contract?

 

Without this increase in revenue, the hypothetical farmer is appears to be worse off with Input's financing, even with the assumption of 20% savings on fertilizer and 15% on seeds.

 

It has to do with the farmer's timing of sale for their leftover canola tonnes after giving Input their share. Traditional farmers that aren't flush with capital all have to sell their canola at the same time to finance portions of their ongoing capital expenditures. Peak supply is September/October right after harvest and the farmer will need to sell at a lower price during this time secondary to typical supply/demand curves. If they can wait to sell into Dec/Jan and onwards then they can achieve superior prices for their canola.

 

The savings on fertilizer and seed are not hypothetical and are borne out in objective data. It is the same supply/demand issues at play and off-season purchases go a long way.

 

An additional variable that appears to have the potential for some customer stickiness to Input is their superior grain marketing results. They have consistently achieved better than average yearly canola pricing in the 7-15% range. This is not a hedging program, but an in-year locking-in of prices at opportune times. They have an employee that worked at the Winnipeg Commodities future Market who has this as his primary task. This superior pricing will only grow with time as Input have effectively become the biggest mover of canola in the Canadian market. Keep in mind that canola farming in Canada is essentially all private farmers with no institutional involvement. So by selling far more then anyone else, Input is getting superior pricing discounts and this will grow with time. In conference calls, they have alluded to allowing the farmer partners to also market their canola portions along side the company, thereby achieving far better canola market strategies and pricing then the farmers could ever do by themselves.

 

This business is not meant for the experienced, cash rich farmer who would hate to give up the High IRR's for capital that doesn't significantly change their business profitability. Yet for expanding or newer farmers, this business can equate to a win-win for lender/borrower which puts the growth potential and risk profile in a different category then alternative lenders.