A ‘Picks and Shovels’ Play for a Changing Global Economy
‘Picks and shovels’ is an adage that rose to prominence during the days of the gold rush.
At the time, speculators quickly learned that bets on the manufacturers of picks and shovels was more financially prudent than risky guesses as to which prospector might strike it rich.
Over the years this principle has proven applicable to a wide variety of industries. The common factor of these industries has been high risk and substantial rewards potential.
One of most well-known examples of this principle at play in modern markets is Cisco Systems (NASDAQ: CSCO).
While the dotcom bubble saw many companies come and go, Cisco not only thrived but sustained its success by providing the “plumbing” for the Internet. The modern-day equivalent of picks and shovels.
Since hitting the market in 1992, Cisco has gained more than 85,000%.
Astute RedChip Nation members that watched our most recent interview with Royce Funds’ Bill Hench may have picked up on his application of the picks and shovels strategy as well.
In the interview, Hench talks about the boom in artificial intelligence, cloud-based platforms, and other technologies, all of which are driving significant demand for chips. Rather than looking directly at the chip makers, Hench talked about looking at the makers of the equipment used to make the chips. Another modern-day version of picks and shovels.
Another variation on this theme is Knot Offshore Partners (NYSE MKT: KNOP). KNOP owns and operates a fleet of ships that are used to shuttle oil and gas from offshore drilling platforms to onshore processing facilities.
This unique position in the booming oil market allows KNOP to thrive independent of the volatility of oil prices or the risks inherent in exploring for oil and gas. Another low-risk way to play a booming market.
We first featured KNOP on our show in February 2016. It has since doubled in value.
One of the newest members of the RedChip Nation, Xerium Technologies (NYSE: XRM), offers yet another variation on the picks and shovels principle.
200+ Year Operating History
For more than 200 years, XRM has provided consumable products used by major manufacturers to protect and stretch the life of their machines. While the technology has changed over the years, the need remains as vital as ever.
Today, XRM is leading global supplier of machine clothing and roll covers for machines that produce containerboard, tissue, consumer packaging, pulp, and paper.
The Company employs a broad portfolio of patented and proprietary product and manufacturing technologies, as well as extensive industry experience, to provide customers with tailored solutions designed to optimize the performance of their equipment and reduce the costs of their operations.
XRM is a global enterprise selling to customers in 63 countries, with 28 manufacturing facilities in 13 countries and approximately 2,950 employees.
Repositioned to Capitalize on Changing Global Economics
According to data from eMarketer, worldwide ecommerce sales hit nearly $2 trillion in 2016. And with double-digit growth forecasted over the next several years, experts anticipate sales to top $4 trillion by 2020.
This continued explosive growth of online sales is driving a boom in the need for packaging, one of several target areas for XRM products and services.
While it’s anyone’s guess as to which retailers win or which products become blockbusters, we can safely bet this exponential rise in online sales will result in lots of products getting shipped in lots of boxes.
In 2012, XRM began a large one-time repositioning effort to address these and other market changes. According to CEO Harold Bevis on the Company’s latest earnings call, this repositioning effort was completed in 2016.
XRM already secured $94 million in new wins over the last three years due in large part to its repositioning efforts. And $45 million of those new wins came last year alone, a company record.
Timing is Important in Investing
Much like our call on KNOP last year, the timing with XRM couldn’t be better.
For those that followed KNOP, they may recall their industry had just stabilized from a downturn, a downturn which had placed the shares at a steep discount to their real value.
XRM is in a similar position. A spate of machine closures impacted the industry and XRM’s results over the past few years. But the rate of closures dramatically slowed in 2016 and is expected to balance out with the rate of new machine startups moving forward.
Currently XRM shares are trading much closer to their 52-week low than their 52-week high.
We believe this is a steep discount to the real value of XRM shares, which creates a compelling opportunity for investors. And we’re not alone in our thinking.
Macquarie, a leading investment bank, named XRM its top industrials small-cap pick with a buy rating and $13 price target. With shares at just over $5 today, that’s significant upside for investors buying at these levels.
Cost Reductions and Strong Free Cash Flow
In XRM’s 4Q16 earnings release it was noted that they achieved their cost-takeout objectives for year and that a similar program to reduce costs was already underway for 2017. Combined with the implementation of its Lean Six Sigma program, this bodes well for the Company’s future financial performance.
XRM generated $22.8 million in free cash flow in 2016, which it used to reduce leverage. We expect we’ll continue to see free-cash flow used to pay down debt moving forward.
Despite Potential, Relatively Unknown to Retail Investors
With a long track record and proven ability to execute, XRM has attracted a stable base of institutional ownership, but the stock remains under the radar of most retail investors – and that’s about to change.
We’ll be featuring an exclusive interview with XRM’s Harold Bevis later this month on RedChip TV. This will be the first major exposure of the company to the retail investor community. Much like KNOP last February, this type of exposure could lead to solid upside for the shares.
While you’re out looking for the next big homerun stock, do yourself and your portfolio a favor and hedge that bet with a true picks and shovel play – XRM.
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Xerium (XRM) is a client of RedChip Companies, Inc. XRM agreed to pay RedChip Companies, Inc. a monthly cash fee for 12 months of RedChip investor awareness services.
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