Finding longs and shorts in Canadian junior market
After bottoming nearly two years ago in January 2016, Canada’s junior market has staged a dramatic recovery, but it’s not the usual suspects driving gains for the S&P/ TSX Venture Composite Index.
The massive bull run that followed the financial crisis saw the index surge more than 200 per cent between late 2008 and early 2011 — a rally that was primarily due to strength in commodities. This time around, the unfolding bull market is much more broadbased.
“We’re talking about cannabis, blockchain, artificial intelligence and the internet of things,” said Steven Palmer, chief executive officer at Toronto-based AlphaNorth Asset Management.
The portfolio manager of the AlphaNorth Partners Fund (hedge fund), and the AlphaNorth Growth Fund and AlphaNorth Resource Fund (mutual funds), noted that while short positions are a relatively small part of the firm’s strategy, they are being used more these days.
“We haven’t done much shorting in the hedge fund for several years, but retail investors have been handing us short opportunities on a silver platter,” Palmer said. “For some of this stuff, picking these things off is pretty easy.”
He highlighted a recent short position in Aurora Cannabis Inc. (ACB/TSX), which was established around its recent high, and covered a few days later.
“Some people are buying the stock and really have no clue, other than thinking the company is going to be a market leader, this is a new space, and the government is going to do something,” Palmer said. “It’s all very vague, and they don’t have any specific data on industry capacity or market size. Nobody really knows, it’s just guesswork.”
The portfolio manager doesn’t like the Canadian marijuana sector for several reasons, so when related stocks soar to market caps that represent very high multiples relative to their current revenue — often on little or no news — he takes the opportunity to go short.
“Many of the companies are run by Vancouver-based promoters or other people that know very little, and are trying to make a quick buck on the back of retail euphoria in the space,” Palmer said, warning that the federal government’s legalization of recreational marijuana use may be delayed.
One of AlphaNorth’s criteria for investing in a business is that it has something proprietary. In the case of marijuana companies, Palmer thinks that’s rare. He’s also critical of the industry’s claims about the health benefits of cannabis, stating that “there is no scientific basis for the vast majority of it.”
That hasn’t stopped Palmer from investing in Tinley Beverage Co. Inc. (TNY/CNSX), which makes cannabis-infused and hemp beverages that are sold in California. He added to this existing position after alcoholic beverage giant Constellation Brands Inc.’s recent investment in Canopy Growth Corp.
“Constellation wants to get into cannabis beverages, but Tinley is already there,” Palmer said. “It’s not necessarily an easy thing to throw CBDs and THC into a drink and have it taste good, so there is a proprietary angle there as Tinley partnered with former executives of Cott Corp. It isn’t just a ‘me too’ marijuana producer.”
Another hot sector that AlphaNorth has capitalized on is blockchain, specifically through a recent short position in HIVE Blockchain Technologies Ltd. (HIVE/TSX-V). While HIVE is the first publicly traded cryptocurrency miner in Canada, Palmer noted that there is nothing proprietary about this business either.
“It checks a lot of the boxes you want to be negative,” he said. “The founders have three cent stock, millions of dollars have been spent on promotion, and the EBITDA forecast for next year is minimal.”
Stocks like this typically have high trading volumes, so it’s easy to get in and out, and they’re volatile. That produces a good combination if investors are on the right side of a trade.
“When a stock goes up by multiples in just a few months, the riskreward is usually not to further upside, but more to the downside,” Palmer said.
An example of a big winner on the long side for AlphaNorth is LeoNovus Inc. (LTV/TSX-V), a provider of blockchain-enabled storage software. The firm has been supporting LeoNovus for several years, currently has a more than 10-per-cent stake (including warrants), and participated in a five cent per share private placement in September. The stock is currently trading around 50 cents per share.
The company’s technology allows data to be stored on a dispersed network. So rather than a bank, for example, storing its data in one place that requires expensive security and cooling, LeoNovus can essentially chop up the data and store it in many different places, such as thousands of computers or even hotel cable TV boxes.
“They’ve been getting major companies, including a Canadian bank, health-care company, and marketing firm, to sign pilots for the technology,” Palmer said. “I expect them to announce further pilots with other companies before the end of the year.”