Black Diamond Group – A Recovering Pick and Shovel Play

Black Diamond (TSX:BDI) came to my attention when it was recommended by Benj Gallander at the GuruFocus Value Investing live seminar earlier this week. Gallander is the co-editor of the “Contra the Heard” Investment Letter, which reports 18.1% annualized over the past 20 years.

A pick and shovel play

Black Diamond is a cyclical “pick and shovel” play on the recovery of the oil and gas industry. A pick and shovel play is an investment strategy that invests in the supporting supplies and services needed to produce a commodity instead of in the final output. It is a way to invest in an industry without having to endure the risks of the market for the final product.

The investment strategy is named after the tools needed to take part in the California Gold Rush. In the gold rush, most of the money was made by the merchants selling supplies to the miners rather than the miners themselves.

Gallander also cited substantial insider ownership of the company as a buy signal.

More about Black Diamond

Black Diamond rents and sells modular space and workforce accommodation solutions on oil and gas work sites. It operates through two segments, Modular Space Solutions and Workforce Solutions. It’s in the business of providing temporary modular rentals and accommodation for workforces in remote locations for oil and gas exploration and construction sites as well as related services like power. It operates in Canada, the U.S. and Australia. Activity in this area had slumped in the last few years, but now with the increase in oil prices, activity is coming back.

The company was founded in 2003 and is headquartered in Calgary, Canada. Note that all figures listed below are in Canadian Dollars. The company trades on the Toronto Stock Exchange.

As can be seen from the chart below, the company is highly cyclical. It now appears to be emerging from the deep trough it went through in the past six years.

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Cash Flow is coming back

Revenues in both segments of the company are bouncing back, as show in the below chart from the company:

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Cash flow is increasing rapidly from the bottom it hit last year. Operating cash flow per share has risen 22% over the last 12 months.

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Balance sheet

The balance sheet is reasonably good, as can be seen from the snapshot below. Assets of 508 million Canadian dollars ($420 million) are balanced by liabilities of C$280 million and equity of C$228 million. The company does not pay dividends.

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Valuation

Valuation is difficult to determine for deeply cyclical company such as Black Diamond, especially when they are just coming out of a slump. However, looking at the speed of recovery in the last year, I am expecting the stock price to double in the next 12 to 18 months.

The GuruFocus projected free cash flow (FCF) calculator is indicating a fair valuation of $8.12. Looking at the history of the stock, this appears reasonable to me.

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Insider ownership

Trevor Haynes, the CEO of the company, owns 6.67% of the stock, which is a substantial ownership stake and aligns his interests with the shareholders. I like to see strong insider ownership. Insider trading of the stock over the last 12 months is very favourable. It looks like insiders have loaded up to play the recovery.

Conclusion

Oil and Gas prices are recovering and so are capital projects supporting the industry. Business for companies like Black Diamond is bouncing back.

The company has a lot of operating leverage, but as utilization of assets increase, the company gains pricing power and cash flow increases dramatically. This can be seen in chart below, which shows operating cash flow (OCF) divided by tangible book value.

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This seems like a good time to get on board the train as it catches speed. The trick to investing in cyclical stock like Black Diamond is timing. Get on early in the cycle and get off before the cycle peaks. It’s impossible to time it perfectly, but if we can be approximately right, we can make a lot of money.

Disclosure: The author does not own shares of Black Diamond Group but is considering buying.

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