Jan 24th, 2015 by aboveaverageodds
Editors Note: This is the first of a four part series on Input Capital, where the first three posts will be published today with the finale heading your way towards the end of next week. Note that the original thesis outlined below was purchased at C$1.59 in October of last year, with the second posted shortly thereafter at ~C$1.80.
That in mind, naturally certain aspects covered in parts 1 and 2 such as the stated stock price, f/d share count, implied valuation, cash on the balance sheet, and so on are all somewhat dated, and thus will need to be reworked for anyone that’s new to the story here. At least for those of you who’d rather not wait until next week. Even so, one thing remains the same – Input remains a grossly mis-priced and under appreciated high quality business on the cusp of a multi year period of sustained super compounding. So while the stock has run up quite a bit since I took a position, the reality is that Input offers a far better risk/reward today than at perhaps any other point within its relatively short life as a publicly traded company.
In fact, earlier this month the company announced a number of details that taken together, have not only brightened Input’s longer-term prospects but materially de-risked the business in the process. And yet the market barely noticed, sending the stock up some 15% on roughly 10x normal volume – only to give back about half of those gains since. At any rate, while I’ll dive into these latest developments in detail in a bit, for now let’s keep “first things first” and start at the very beginning to get a better feel for the business and it’s ultimate potential.
So, readers meet Input Capital. Input Capital, meet readers. My hunch is some of you will become fast friends – not to mention make an enormous amount of money together over the next 2-3 years and even then, that’s just the beginning. Indeed, this owner operated snowball is just getting started.
You can mark my words on that!
****Part 1 – A Field of Streams
If you build it, they will come . . .
In the constant hunt to bring you recommendations worthy of your hard-earned investment dollars, your editors couldn’t be more pleased to bring you this month’s recommendation: Input Capital Corporation (INP.V, INPCF).
Input Capital is the world’s first agricultural commodity streaming company. Think of it as the Silver Wheaton (SLW) of farming. If you’ve never heard of it, don’t worry. Input’s initial public offering was only two months ago. Most investors don’t even know it exists.
What does Input do, exactly?
Simple: It offers money to farmers to help them finance their farms and become more productive, and in return, Input gets a “stream” on these farmers’ future crop production. Input buys the canola after the harvest at a predetermined and heavily discounted price. Input’s profit is the difference between the price it pays the farmer and the price canola trades at in the market.
This is a great deal for farmers, as it not only provides them with some much needed flexibility and upfront cash, but productivity-improving expertise critical to optimizing the profitability of their farms. The end result is a much more productive farmer. Which is just a fancy way of saying a farmer with a lot more money than he or she would have had absent partnering with Input. Of course, Input makes out like a bandit too. After all, its average return on invested capital for these “streams” should clock in at ~30% + over a full cycle, but let’s not get ahead of ourselves here. Better to start with a high level walk on the mechanics of these deals for illustrative purposes and we can go from there.
That in mind, let’s start with the following example, we’ll call it exhibit A. In this case, Input will provide a farmer with an upfront $1 million payment. Input will then receive a “stream” of 770 tons of canola at a fixed price of $100 per ton annually for 6 years. But what’s that worth you ask? Well, if assume a reasonable mid cycle canola price of about $500 per ton (note canola was trading north of $600 earlier this year), quite a bit actually, as Input would stand to generate annual cash flows of ~$308,000 a year, which of course equates to a yield of about a 30% on invested capital every year over the life of the six year contract. Of course the fact that the unit economics of a streamer are as good as they are is certainly no surprise to this crowd but then again, it wouldn’t be right if we didn’t lay out a simple walk like this to hammer home the point.
But it gets better! First you need to keep in mind that these steaming contracts entitle Input to receive additional “bonus” tons that offer extra upside if productivity is particularly good in any given year (typically this amounts to 15% of the crop yield over 30 bushels/acre). Yet these bonus tons are more of a side show in my mind given what really starts to make the numbers get crazy is when you start to factor in Input’s ability to reinvest each year’s cash flows into even more high-yield streams!
As an aside, if you don’t know by now, Above Average Odd’s has a special place in its heart for exponential compounding machines and Input may be one of the best natural compounders we’ve ever seen. Of course time will tell but assuming the model works as well as it has to date and management can execute on a level commensurate with their capabilities, we don’t think it’s a stretch to say we may be on the ground floor of what we think will be a truly magnificent five year period of exponential growth in per share.
Think that’s hyperbole? Take a look at what the company’s done in the last year. With 10 streams in place and a balance sheet that will fund an additional 20-30 streams this year, the snowball has already started rolling. And this is the type of snowball that the bigger it gets, the faster it should grow (here’s to hitting escape velocity sooner than later!).
You see Input’s “breakthrough” value proposition is very much at the heart of why we are so excited about this undiscovered franchise’s future. For the farmer, gaining access to critical working capital is just the beginning. Input also provides access to bargaining power with grain handlers and input providers like fertilizer. For example having the cash to buy fertilizer during the fall off-season saves the farmer as much as 20-40%. Having the cash to pay also means the farmer gets a 3% discount and doesn’t have to carry interest costs, which frees up more cash. And of course, the more excess cash a farmer has at his disposal the more they’ll be able to invest in profit maximizing inputs that should enable their farm to become more materially more productive than it would have been possible otherwise.
Think about it like this: instead of traditionally spending $200 per acre to generate crop revenue of $150-250 per acre, the farmer can now invest $300 on inputs which should allow him to generate ~$300-450 per acre. And that’s to say nothing of all the ancillary benefits that come from Input providing these farmers with a consulting agrologist to help him or her maximize productivity in other ways. You see by implementing best practices such as: soil testing, seed treatments, precision seeding, weed control, timing and application of operations, and crop residue management, the efficiency gains start to pile up fast.
Or consider for a moment that the average canola crop yield in Canada is about 25 to 30 bushels per acre. Yet the true potential of this farmland when combined with best practices and proper investment in farming inputs could produce as much 60 to 70 bushels per acre. Now I don’t know about you but that’s a stunning delta, one I didn’t expect to find and my US farming contacts told me shouldn’t exist. But then I verified it for myself and studied it to the point where it actually started to make 100% sense – that is given how radically fragmented the CA market is relative to say the US.
Anyhow, in light of the above reality, clearly the difference in overall productivity between the least productive farmers and those who have the financial and intellectual capital to implement best practices in Canada is tremendous. Better yet, it’s the win/win exploitation of this massive gap for the benefit of poorest and least productive that is at the heart of how Input adds value. And trust us, given our analysis of the plight of your average Canadian small farmer and structural factors ongoing in the industry it’s hard to imagine any shortage of willing takers for the services INP’s offerings, at least at any point over the next decade, but who knows.
Another key point to think about here is the clever way these deals were struck in terms of incentive alignment. For example, the structure of the streaming contract guarantees Input Capital with receive a fixed number of tonnes, which by definition allows for substantial upside to the company’s partners if they can make their farm maximally productive across the other 2/3rd’s their crops, not just canola. Simultaneously, this also incentivizes Input to help make the farmer as successful as possible given the company is entitled to a piece of the upside as well, which again, is typically 15% of the crop yield over a 30 bushel per acre hurdle rate.
One Streamer to Rule Them All
Let’s take a moment to savor how beautiful of a business this is. After all, Input retains basically all of the great qualitative attributes that I love about the stream finance business model and practically none of the negatives. Indeed, as a guy that’s deeply familiar with both, I’d be lying if I said I didn’t wholeheartedly believe that Input possessed far and away the best iteration of an already superior business.
Bold words, but before you rush to judgment, consider a few distinguishing characteristics that are singularly unique in the stream finance world.
1. No production delays.
With Input, there is no extended period of time waiting for a mine to be developed. Crops are planted year after year generating production immediately. For example, every single one of Input Capital’s existing streams will generate high margin revenue and cash flows by the end of the year.
2. No exposure to capex overruns or to the fragility of the capital markets.
As I witnessed with Sandstorm Metals, hard rock streaming companies will always be indirectly exposed to the mining sector’s ongoing immolation of capital. But this will not happen on farms – i.e. there will not be any crop input overruns (pun intended).
Additionally, with Input one doesn’t need to worry about external factors such as the health of the general economy/capital markets or the negative reflexivity that turmoil there can wreak on metal streaming company’s future prospects. So unlike with precious and base metal streamers, Input isn’t dependent on mines getting up and running on time and on budget, the capital markets playing ball or any of the other issues that can kickstart a dreaded “death spiral” or other issues that can end the life of your average mining company in six seconds flat.
3. Fortress-Like Downside Protection.
Another critical difference separating Input’s model is the presence of Canadian government backed crop insurance. This is absolutely critical to understand because it makes the odds of a bad crop bankrupting Input’s streaming partner(s) essentially nil, as this insurance covers ~70% of the farmers historical total crop production, which we should note is substantially in excess of the tonnage owed to Input.
In other words, every stream Input purchases they receive not only comes with an asymmetric call option on canola pricing along with a hedge fund like performance fee, but what amounts to a government funded put option that protects the downside. And did we mention that this crop insurance is paid for by the farmer? Yes, read that twice.
Taken together these idiosyncratic nuances make the odd’s that the company ever experiences a severe/permanent loss of capital extremely unlikely. That, and to marry the best elements of the streaming model with an unheard of measure of downside protection like this was really a stroke of genius. We’ve been attempting to pick apart this puzzle for nearly three months now and our respect for what these guys have done has only deepened every step of the way.
As a quick aside, a big reason the market seems to be missing all of this is because the nature of these seemingly small differences is just not well understood. The fact that Inputs ag model is dramatically less risky escapes the market because most participants are not yet familiar with the unique differences at play here. Honestly, the market is hardly aware the company even exists (more on this in part 2).
Eventually this wont be the case, as the market will realize it’s mistake and come to appreciate the under appreciated virtues of these idiosyncratic differences. Our guess is sooner rather than later given the data from this years harvest is almost in. Early reports are indicating that 2013 is going to be a very productive year.
Canada + Oil = ?
All that said, let’s take a step back and ask what kind of crop these farmers are growing for Input? Why, rapeseed plants, of course! Never heard of it? Yeah, neither had we. Safe to say selling an agricultural commodity with a name like rapeseed is a non-starter but we digress.
Here’s an interesting story. In the 1960’s, Canadian scientists were looking for a way to grow and process cooking oil. They succeeded with the rapeseed plant, but quickly realized that no one was going to buy something called rape oil. So instead, their marketing department took Canada + oil, and came up with Canola! Which explains why you’ve never seen nor heard of a canola plant.
Now, you are probably scratching your heads like we were when we first heard about this. Canola? Seriously? But did you know that canola is the most profitable crop for Canadian farmers, constituting 25% of all farm revenues? In fact over 25% of all the world’s canola is produced in Canada, and 70% of the world’s canola exports are from Canada (can you say cartel?). Regardless, Canola is processed into oil and meal, which is used for cooking oil, animal feed, biofuels, and lubricants. More importantly, canola is required for long-term food production. In an age where the world’s population is quickly approaching 8 billion and citizens all over the emerging world are introducing more protein into their diets, the fundamental secular tailwinds for Canola are substantial and unrelenting.
What makes this story even more fascinating is that there are over 50,000 canola farmers in Western Canada alone. Talk about a high margin, borderline absurdly long runway of growth potential (remember we are starting from a base of 10, not 100 or 1000, but 10). Furthermore, this streaming model could easily be translated to farmers in the upper United States, and farmers of other crops such as grains and pulses (lentils, beans).
Even more compelling is the demographics of Canadian farmers who will soon be undergoing a massive generational transfer of farm assets (over $30 billion) in the next several years. This is one of the reasons why so many of Canada’s skilled farmers will soon be faced with the expansion opportunities of a lifetime. The rub is that these farmers cannot afford to take advantage of it on their own.
Which leads us to the fact that there is a critical shortage of flexible financing solutions for Canadian Canola farmers. This is especially true with financing farmers with the requisite working capital to operate and grow their farming assets in the most productive manner possible. The key to Input’s value proposition to the farmer is that it offers them flexibility and control. This cannot be overstated enough. Sure, the traditional bank’s loan may come with what appears to be a lower fixed interest rate, but if you’re starting to run low on cash, the bank is going to come in and force the farmer to liquidate one of his tractors – at the very worst possible time. Input generates a lot of goodwill with its farmer partners because they will not force the farmer into a corner like this.
In addition, as we stated before, Input will not only give them this flexible capital, but is also committed to help them potentially double their crop yields! It’s safe to say that no bank loan officer will help the farmer achieve the yields of his dreams. And this is one of the reasons why farmers are so enthusiastic to partner with Input. When Input can demonstrate to them how their farm can generate double the amount of crops, it almost does not matter what the cost of this capital is to the farmer.
That in mind, the ideal farmer partners for Input Capital are young capable farmers with the right skill sets but who need capital after purchasing the intergenerational transfer of a farm, or older farmers who foresee a large expansion opportunity, or good farmers who simply need more working capital. The farms typically range in size from 3,000 to 12,000 acres and are located in the black/dark brown soil zones of Western Canada.
Before we move on then, a couple of things seem clear. One being that canola is a major player in the Canadian economy. And two, despite this fact, canola inexplicably remains largely overlooked by the investment community.
Especially when we juxtapose it with Potash, one of the investment community’s perennial favorites. The point here is to use Potash merely to illustrate the multitude of meaningful similarities between these two uniquely “moaty” commodities with a bevy of structural similarities that make the comparison far from specious.
Consider some of the data points below:
- Canola is a bigger global market than potash
- Canola is a bigger export business for Canada than potash
- Canadian canola exports have been growing at a CAGR of 18.3% over the last 10 years (compared to 13.6% for potash)
- Canola is Canada’s #7 export to the world (potash is #10)
- Canadian canola exports have double the market share in global export markets than potash
- Canadian canola exports to China are 8.5x the value of Canadian potash exports to China
- As already noted, Canadian canola exports to China have been growing at a CAGR of 36.4% over the last 10 years (compared to only 4.1% with potash)
- Canola currently represents 16.0% of all Canadian exports to China (compared to only 1.9% for potash)
- Canola is Canada’s #1 export to China (potash is #12)
- Canola employs 228,000 Canadians. Potash employs 5,041 Canadians.
Once all that is internalized, consider for a moment that there is only one publicly company providing investment exposure to Canadian canola production: and that’s Input Capital Corp. (TSX.V: INP). It has a market cap of only $90 million.
Yet remarkably there are three companies providing investment exposure to Canadian potash production: POT, AGU, MOS. Now these are indisputably inferior businesses on pretty much every meaningful level and yet bafflingly, these companies have a combined market cap of essentially $60 billion.
Think about that…
Input’s Owner-Operators: Outsiders in the Making?
The management team behind Input Capital has a history of value creation. They previously founded Assiniboia Farmland Partnerships in 2005, which was one of the very first private equity farmland partnerships in Canada., Starting with $53 million in equity capital, they eventually amassed over 117,000 acres of farmland in Saskatchewan worth over $125 million with over 136 farmer tenants. The Partnerships produced 20% IRR net of all fees since 2005, returning over 200% to its shareholders.
Through Assiniboia, management was able to form strong farming relationships with their tenants, over 75 of who are canola farmers. Unsurprisingly it was the trust built through these relationships that helped Input Capital create what your editors view as an amazingly innovative streaming contract on an already innovative business model. Nonetheless, it was this goodwill that provided Input with the customer beachhead necessary to prove out the concept in all its cash generating glory.
Turning to the question of incentive alignment, note that Input’s directors and executives own ~20% of the common stock and are therefore strong aligned with shareholders to create long-term value. As one of Inputs key executives put it, “make no mistake, we’ve got it all on the line.”
Taken together, the above factors point to the fact that we have something special in Input’s executive suite – and by special, we mean owner operators that appear to possess the requisite skill sets and character to build an enduring multi billion dollar business. As you’ll see, these guys are flat out good and their presence at the helm of this undiscovered emerging franchise truly fires us up.
Our calls with CFO Brad Farquhar illustrate this point nicely. For example, Brad has exhibited contrarian, second order thinking on a level that one would think would make Howard Marks proud. Case in point, was the borderline glee in his voice while he explained to us that in his estimation Canola prices were poised to come down in the near term off the back of what has been a record breaking year for Canola farming across Canada. Like a value investor happy to average down on a position in the name of long-term profit, Brad was palpably excited about the opportunity for Inputs terms of trade with farmers to widen in their favor, especially given the ~$45m in dry powder the company is looking to deploy this year. This might not sound like much, but let’s just say that in our experience, its incredibly rare for an executive to openly root for price declines in way that simply screamed “long-term greedy”. We’d be lying if we said we didn’t love it.
Another illustrative example was when Brad was responding to a myriad of our questions on capital allocation and the paramount importance of preserving/growing per share value.
In particular, while discussing his thoughts on utilizing equity for growth, Brad was emphatic that any future raise would only be considered if it was done at favorable prices (read in a manner that materially augmented per share value). He pointed out that Input had attempted to go public earlier this year. When their bankers informed them that they had the money but that the pricing would come in lower than what they wanted, they turned it down without blinking an eye. He told us essentially that the decision to walk away wasn’t much of a decision at all and that they would have held out for better terms indefinitely rather than go public merely for going public’s sake.
Another little gem concerning our conversation with Brad, was our discussion of his personal thoughts regarding buybacks. Given the model is one that typically uses serial equity raises (ideally at elevated valuations) in the service of rapidly compounding per share value – and hence is uniquely vulnerable to the empire building CEO – we wanted to know whether he plans on buying back stock in the event of a significant selloff.
This was important in our mind because we wanted to know that whether we find ourselves in a recession – or really any environment that is marked by a steep drop in equity prices – we can count on them to shrink the share count heavily. Remember that the idiosyncratic differences that define Inputs unique model put the company in a unique position to prudently buy back stock in a way that other early stage streamers like SND cannot, a fact that Brad was quick to point out. You see with Input, cash flows are not only highly certain, they are received relatively immediately and therefore can be reinvested immediately. Also given the present valuation, by our math a buyback at half today’s price would allow Input to put that capital to work at higher returns with a fraction of the risk – at least relative to the alternatives uses of that capital (i.e. investing in additional streams). Clearly buying back stock at a low single digit multiple to pre tax earnings when the equity is worth 10-15x (conservatively) is a very good use of Inputs internally generated cash flow. As they say, the math doesn’t lie. Brad would agree.
And while he prefaced his response by saying that Input was still an early stage (newly public) company, and hence had not “officially” had board level discussions on the topic, he did say that he personally “would be a huge buyer” if the stock were to decline. And better yet, that as CFO and co-founder of the world’s first agricultural streaming company, he understands the “cash-generating power of the business better than anyone else alive.” He emphasized that in this scenario “buying back our own stock is the best thing we could do”.
Input’s Breakthrough Value Proposition Quantified
Editors note: Part of our due diligence process consists of designating various members of the team and trusted colleagues with the task of devils advocacy with every idea under consideration. Below is a few questions that we felt were particularly thoughtful in this regard. Our hope here is that by answering these questions they will provide members with not only some hard won insights, but also a springboard of sorts for readers to write us with their own questions and concerns. So, with that lets dig in…
Q: If these deals are so lucrative, why then doesn’t everyone do it? What’s behind this, is the issue capital constraints, awareness, or belief in the efficacy of methods / fertilizer etc.?
A: Everybody isn’t doing it for the same reasons that most investors invest like idiots, they don’t know any better and even if they did, it would take a substantial sum of money and many years to ramp the learning curve. Input is a business that was created and fine tuned over many years. It is not something that can be replicated with a big pile of cash. And it relied heavily on their pre-existing relationships with the farmers that lease out their farmland from their farmland partnerships.
Sometimes, a great idea can be staring at you in the face, but if it’s difficult to implement, then it won’t get done. For example, a lot of investors in the last decade believed that farmland prices were going to skyrocket. We even thought so too. But did we buy any farmland? No . . . because it’s really hard! There’s no farmland equities traded on a liquid financial exchange. There’s no futures on farmland. Even if we went out and bought some land personally, we’d then have to grow the crops ourselves or lease it to some farmers and manage it. Farmland had not been “financialized,” and therefore very little institutional money went into it.
But Brad and the Input Capital management team did. They had the thesis right, and then walked the walk by creating a series of private equity farmland investments. And that’s what they are doing here with Input Capital. It’s not just a matter of coming up with the capital. They had to have the right relationships – with the farmers, with the agrologists, with the grain elevators, etc. And these relationships were earned through trust developed over many years.
What Input does is so powerful because they give a farmer the financial tools he needs, the agrologists give him the information, the science and the coaching he needs – so that the farmer just needs to go out and execute. And assuming average weather, he’ll do better than he has before. All because the marginal return on the next dollar of inputs is astronomical, and he’s not “going at it alone” – and hence likely to make a fatal mistake in an area where he may be a little out of his depth.
That, and it takes money to make money. If you don’t have money, you might succeed by pulling yourself up by your own bootstraps over time. But wouldn’t it be easier to take on a financial partner who will put in equity-like capital and take it out on a predictable schedule over six years? Of course it would be, and that is what Input does. It brings the best of everything together.
Q: From a secular perspective, the AG industry in the U.S. has gone industrial with a sophistication and scale that is dramatically higher than just 10 years ago. Is this not the case in Canada? In other words, why isn’t the canola market as sophisticated as say corn in the U.S? The reason we ask this is that one would imagine a large, sophisticated farmer would figure this out and keep all the incremental margin for himself. What’s the deal here?
A: Our understanding is that things have gotten way more sophisticated. A typical grain farm needs 5,000 acres to get scale. Some of Inputs clients are much larger than that. But these new technologies – variable rate tech, GPS, precision agriculture, etc. etc. – are just coming into maturity for what Canadian’s grow and how they grow it across Western Canada.
For these reasons, we believe the next 10 years should be an unbelievable time for Canadian farmers as tech and soil and seed science converge, but it is indisputably more capital intensive than it’s been in the past. Those with the capital will succeed, and those who don’t will be hobby farmers.
Even large, sophisticated farmers are struggling with the capital requirements of farming today. Land is way more expensive than 10 years ago, equipment is bigger and more expensive, labor is more expensive, inputs are more expensive, and the scale is way more massive. The improvements in potential results outweigh all of this, that is if you have the capital to unlock the productivity potential.
As we understand it then, everyone would love to do it if they could, but again, the tools available to the vast majority of farmers today in Western Canada are limited and inflexible. What Input Capital offers is much more material to a farmer than what their banker has to offer, and much more flexible than what their trade credit supplier has to offer.
So again, Input’s main benefit is that their financing of working capital is non-constraining, flexible, and therefore gives farmers control which allows them to be very opportunistic and provides them with the requisite freedom to make the right decisions economically long-term.
Sadly, often times farmers make decisions not based on best economic long-term outcome, but according to their opportunities as they become available, which is often when they are most starved for capital and hence maximally vulnerable. And even in flush times when they do have money they will invest, but then in an ironic twist of fate, that will only leave them tightly constrained and in a poor position the following year, especially if things get worse. For example, if it’s a great year this year, a farmer may take the cash and purchase the farm next door to expand, but then this leaves them tightly constrained with a lot more land but essentially no working capital to make that land productive in a maximally efficiently manner.
Another example of how truly priceless a relationship with Input can be gleamed by looking at what happens to a farmer if sometime in the future he has a horrendous year for whatever reason. In this case, Input can allow the farmer to roll over the promised base tonnage into the next year, so that the farmer isn’t put out of business. Obviously Input’s flexibility generates a lot of goodwill compared to other kinds of bank financing.
In sum, Input helps farmers drive down their cost of capital through productivity improvements and various cost savings, all of which is quantified below:
1. Buying inputs off season (~20-40%)
2. Discount for Paying Cash (~3%)
3. Interest Costs (~10%)
4. Flexible Crop Marketing Program (~6-12%)
And these are just a few of the ways Input is able to help farmers unlock their productive potential. The fact is, this isn’t just some clever slogan, as Input is able to reduce a farmer’s inherent cost of capital on average by a whopping ~39 – 65%!!
What’s Input Capital Worth?
Current Price: $1.60
Shares Outstanding: 59.0m
Market Cap: $94.4m
Fully Diluted Shares: 62.6m
To get an idea of what Input is worth, let’s crunch some numbers to get a feel for the cash generating power of the business assuming the company deploys its existing war chest at similar returns of some of the company’s more recent deals. Lets also assume no further equity financing between now and year-end 2014.
We use YE 2014 only because the company should begin to receive the high margin cash flows derived by putting to work the tens of millions presently sitting in cash on Input’s balance sheet.
At any rate, a great way to accomplish this (we think) is to use the last deal Input inked in Alberta for guidance. With that deal we saw Input pay $1mm upfront for a 6 year deal in which the farmer will sell the company 888 tonnes of canola per year, for six years, at a predetermined and heavily discounted price of $100 per tonne.
So, if we take the $35m from Input’s most recent capital raise plus the $5 to $6 million in FCF the company should generate both this year and next, that gives us a range of something between $45 & $50m in available capital for reinvestment before we account for any bonus tonnage.
So 45 x 888 equals 39,960 tonnes on the low end. If we user the higher end of the above range, we get 50 x 888 or 44,400 tonnes. Add the mid point or ~41,880 to the tonnage Input is already set to receive this year from its streams already in place – which is another 17,152 tonnes (give or take), and we are looking at a total of approximately 56,032 base tonnes as a reasonable basis for projecting the company’s earnings capacity come year end 2014.
Also, according to management, it’s reasonable to assume that these new tonnes will have a $100 delivery payment just like the 888 tonne deal noted above. Given that, we should be able to forecast Input’s “normalized” earnings power in future years in a manner that is at least approximately correct. In other words, we have all the secret ingredients necessary to derive our estimate.
So, assuming a net profit of $400 per ton (a number we derived simply by taking our $500 “mid-cycle” or “normalized” estimate for the price of canola minus Inputs $100 purchase price/bushel), the company would generate ~$22.4m in cash by year end 2014.
Being a small company with a model characterized by low fixed costs, Input’s expenses are very low – currently only about $1.2m per year. Let’s assume that this will double to ~$2.4m as they will likely be hiring a couple of sales/marketing people and be spreading the word about Input to more farmers. In that case, Input’s pre-tax cash flow will approximate ~$20m.
Now if that number doesn’t make you want to “rub your eyes and check again” something is seriously wrong. After all, that means investors are getting a chance to purchase Input today at a mere 5x pre-tax cash flow.
Remember as well that this is BEFORE we’ve taken into account the value that will likely accrue to Input based on the value of its bonus tonnes related to it’s own forecasted yield improvements. The funny thing is, based on early indications this number is looking to be very significant but of course we will have to see.
Ok, well, what about if we include “performance fees” in our assessment? What’s our implied YE ’14 multiple to pre tax cash flow?
Great question! If we want to try and back into what we’re paying if Input delivers on its claims as it relates to its ability to dramatically improve the productivity of its partner’s farms, shareholders will be very happy campers. The thing is, to do that investors need to realize that for every 10 bushel per acre yield increase over the 30 bushels per acre hurdle, Input stands to benefit to the tune of about an 8% increase in total tonnage received.
What’s interesting is that our understanding is that Input’s farmers could quite possibly hit 50 to 60 bushels/acre, or at least something close to it without too much trouble. Indeed, one can look at a variety of examples from this years harvest (according to management) and conclude that is a number that is very possible. Of course until the imminent release of the data from this years harvest we can’t say for sure, but all indications lead us to believe that such an estimate isn’t aggressive.
Regardless, according to the anecdotal evidence from this years harvest it appears shareholders have multiple reasons to believe Inputs average streaming partner will manage to improve his bushels per acre metric to something close to the 60 mark hypothesized above. If that proves true, Input would earn additional bonus tonnes of ~13k tonnes or approximately $5.3m for the year. And again, if the data proves this out, it’s not unreasonable to assume these performance fees will repeat over the life of the streaming contract. Sure, 2013 was the best year on record but these yield improvements have presumably been driven by Input specific initiatives and hence, are more likely than not to be sustainable.
If that’ the case, an upside estimate of Input’s “true” annual pre-tax cash flow come year end 2014 should clock in at ~$25m. This would obviously make the base case owner earnings multiple we derived above even lower. In other words, by our math investors who get in at the current trading price could be paying an implied 4x YE ’14 pre tax cash flow.
Now that’s the type of valuation on an undiscovered emerging franchise that gets your editor out of bed every morning!!! And with that, we’ll leave the rest for part 2 coming later this month.
In the meantime, feel free to email me with any questions and rest assured we’re just scratching the surface of this remarkable opportunity.