Tuesday, February 10, 2015

Is the market crazy?

In the right hand corner I give you the Grill Cheese Truck Inc (OTCMKTS:GRLD)  they listed about a week ago, raising some dough (US$ 10 million) to buy some stuff (mostly trucks I guess).  This company is a common type of product: they sell lunches to office workers in a few cities (off the back of a truck). There have been a number of comments from people I respect here and here and people I respect less here.  

So far so good.  The company operates 9 to 11 trucks -- its not entirely clear from the 10Q that were recently issued -- its seems that they've franchised the concept with two trucks (yes a truck that sells home made grill cheese sandwich).  So these guys have total revenues of $1,000,000 and operating losses of $2 million.  They've never made money (well at least not since 2013).  They've got a total of $12 million in retained losses.  

However, they recently sold some shares on the OTC market (about $10 million), and the reward has been to give then a market capitalisation of $100,000,000.  Yep, I am not joking.

This company has never made any money.  Its COGS + SG&A are equal to about 200% of its total revenues.  How you do reconcile the "no profit in sight" with a $100 million valuation.  Well, one way is to look at total market size ("Merica 300 million population!") for grill cheese sandwich.  You say to yourself, with their brand they will franchise their trucks all over the place and within 12-24 months they will have 300 truck selling their sandwich.  Plus, aside from the truck the operator pays no rent (they park on the street and pay modest municipal licenses). So they are worth a bundle.

On the other side, lets look at operations:  Generating an 8% gross return is not huge, that doesn't include depreciation, and overheads -- once a truck is working you can assume that those trucks are generating as much cash as is reasonable from the very start.  So we have to assume that even in a franchise environment, there is limited cash flow potential (the franchise user will need revenues too!).  finally, and this is the killer, although I like grill cheese sandwich, I don't like them all the time.  In fact, its a bit of a fade.  Once it passes -- then what?  

There are additional issues; first off its hard to trademark a grill cheese.  Its is after-all bread and cheese -- there's nothing special in the ingredients, Second there are no barriers to entry.  You can go out in any chosen city and buy a truck, paint it kind of orange, call it the "Grill cheese Wagon" or the "Grill Cheese Chef"and voila, your in business, and you got the benefit of GRLD's free advertising. You see with a market cap of $100 million everybody had heard of these guys, since imitation may be the most sincere form of flattery, but it remains that orange trucks selling grill cheese is not exactly an earth-shattering concept!  It's hard to justify that $100 million valuation.  

I'm not saying the Grill Cheese Truck is a bad business (actually it doesn't sound that great), but there are no (literally NO) barriers to entry into this business.  We had the same thing in 2000 with the doctcom bubble where guys would market "un-pattenable" or "un-trademarkable" business that had great value added but no way of protecting their efforts.

Now Barry Ritholtz is a very interesting guy so is Kid Dynamite (they guys I respect at the top of the page), yet the come to this problem from very different perspectives; BR is a private equity guy and KD is "mostly" an ex-trader (very successful at that).  Now BR was a little sloppy in his analysis of GRLD but his overall point is correct (which is also my point), but KD is also not wrong on a macro level, where he goes off the rail is to talk about total market for grill cheese sandwich -- which is irrelevant when you have 9 to 11 truck in two or three towns.  Sure you can expand, but the truth is despite all the publicity GRLD got from this $100 million valuation, anyone can paint a truck orange and sell Grill Cheese -- the average punter will not know the difference.  Plus, and this is important, there's not much magic in making a grill cheese (we're back talking about barriers to entry).  

I agree with Ritholtz that this valuation (on a company) that's generating operating losses on such a simple product is not the best investment ever.  In fact, looking at the 10Q the've never made money. Their SG&A expenses are nearly equal to total revenues (these figures don't include COGS expenses).  At a gross level the business generates an 8% return, and SG&A are equal to 900% of Gross revenues.  That's not a winning formula in my book.

The market is irrational, the value of GRLD is based on the same metrics as a Picasso -- its what the other guy is ready to pay, and has little relations to the fundamental value of the painting (yeah yeah I know this is a stupid analogy).  Bottom line the market has gone crazy -- its not clear whether is across the bord.  

Take oil companies -- if oil price are going down to $20 /bbl (that's Morgan Stanley's prediction) then Exon, Shell and the other big players are not worth a lot right now (don't get me started about the oil sands companies).  There is something wrong in the markets;  If 35% of Canada TSX is driven by raw material and energy -- these have got kicked in the face over the past 12 months -- their valuations don't seem to reflect this massive commodities price collapse.

The baltic dry index -- a real sign of what's going on in the commodity complex just hit its lowest level EVER. We are talking about 30 years of index here.  Something is afoot, but its not clear that the market is buying the new dynamic of lower energy and raw material prices.  This despite the market telling the market (ok ok I know) that demand for raw material (e.g. the Baltic Index) are in the sub-basement.  

So, if you are looking to invest money, maybe right now I would steer clear of the entire debt capital market (equities and bonds) and also away from Canadian(or Australian) real estate.  I would look at real assets (land etc).  I think that cash is a wonderful commodity, and think that gold is not too bad (not great -- I'm no gold bug) as a store of value.  In a nutshell, I think the markets are way too hot, that the current European/Greece games are not only interesting but may prove to be defining in terms of the whole Euro/ECB will be there for ever.  

I think that if oil price do go down any further, that the high yield market (junk bonds to everyone) is going to implode, because nearly 25% of all issuers were oil and natural ressource companies.  I think that the odds of a correction are greater than the odds of a boom.  

Anyway, just as a final note -- I have no position in GRLD, nor oil nor Morgan Stanley

I hope you enjoyed, BTW I tend to be a pessimist -- so grain of salt and all that...

Post-Script:  Well a week later the price of price of GRLD has moved from $6.00 all the way down to $3.00 and now back around  $4.00 -- looks rather volatile!


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