Value Investors Club / TMX GROUP LTD (TMXXF)

Description

How I do Things

My firm uses a methodology patterned after the books of Peter Lynch which involves populating a

portfolio containing an array of stock chocies, including fast growers, stalwarts, asset plays, and to a lesser extent cyclicals and turnarounds and slow growers.

The resulting portfolio composition is entirely decision based involving lots of lots of stock picks along with a monthly

rotating assssment to add/subtract based on story and price changes involving a wide range of selections,

thereby ensuring that no single decision determines my results.

This means that my holding periods can range from very short (month or two) to very long (my style is often buy and hold and sell and buy the same ideas again), with the underlying idea expressed by John Train that if I am an above average investor, my decision making will invariably pull me higher. Lastly, as a one person firm I have to deal with both client reporting, pedestrian requests, and a whole host of things to serve my clients and earn a living, so my style has

always embraced the idea that scratch and sniff pattern based research based on critical factors was inherently more effective – for me – than detailed research on any specific company, which means that I typically look at

hundreds and hundreds of companies in any single year (Value Line is a primary source). Course, I also get bored easily so this fits my personality (esp. since I must be 100% self-sufficient beyond email buddies or discussions on bulletin boards; I am 100% self taught), and want to achieve good results on a consistent basis, but there is a limit to how much I know, how long I will spend on any single idea before moving on, and how l many filings I read. I try to protect myself by favoring the obvious business model, one that generates a lot of cash.

I believe this style also benefits from a common man effect, where if I recognize an obvious value then odds

are that it won’t be long before someone else finds it too. Consequently, I define "value" far more limited than most: I major avoid restructurings, value based on future assumptions that radically differ from current performance, and value

based on usually anything other than free cash flow, and I don't short. With FCF, I look for companies with a CFFO to CapEx ratio of 4x or better (not dogmatic) but really like those 10x and above. I like seeing BS that get better over time, and I think the use of debt is inherently a bad move unless paid down quickly (a lesson learned from following hundreds of capital killing moves by retailers).

I also believe the market is efficient but it usually doesn’t know any more than I do about the future in

companies I follow. I also like stories where dollar cost averaging is an effective strategy (and thus the story can be followed a LONG time) but spent little time forecasting beyond the next few years. Thus, I don't build models like many do and don't make intrisic value calculations of EBITDA determinations beyond keep track of a 100 to 200 companies on a custom spreeadsheet along with screening techniques that history has shown add value (e.g., a stalwart screening list based on PE ratios - see my Lowe's writeup earlier this year).

That said, I offer up X-T as my latest investment idea though admittedly this was a much better setup at

the begin of 2016 but it is still a stock I find attractive.

Thesis

X-t is a good business trading at a reasonable price and is an attractive business for the long-term. This

company features the usual exchange operator attractions including 1) a solid BS with minimal debt

levels, 2) generating a ton of FCF, with 3) margins and earnings tied to volatile volume changes, currently

4) paying down debt and likely a rising dividend, with 5) restructuring charges set to tail down in a few

quarters. Negatives include total dependence on Canadian securities (esp. oil, gas, and minerals) and

currency, inherent tie-in with volume changes which are inherently unpredictable, and competition

which so far has made little inroads.

Business

X-T is the TMX exchange up in Canada. From the Annual Information Form on Sedar:

TMX Group is an integrated, multi-asset class exchange group. TMX Group's businesses operate cash and

derivative markets for multiple asset classes including equities, fixed income and energy. We also provide

clearing facilities, data products and other services to the international financial community.

Here is why I like the biz:

*BS has negligible debt levels. Cash was 384m as of 9-30-16 with debt of 1018 or -634. Net debt was -

771 on 12-31-15 and -882 in 12-31-14. Management has stated that debt paydown is one of its primary

goals. Interest expense ytd was 25.8m vs. 30.6 ly.

*Biz generates huge FCF. CapEx was 27.8m in 2014, 23.7m in 2015, and ytd 9m for 2016 at 8.9m vs 18.2

ytd 2015. Cumulative CFFO from 2014 to 9m 2016 was 540m vs 60m, a ratio of 9 x 1.

*Company is tightly controlling expenses. Company has been involved with a restructuring plan for a

few quarters (see any EPS release or annual information form) but it still seeing higher margins before

strategic expenses. Q3 sales ytd was up 2.3% with expenses down 4.5%. Even with 21m in alignment

expenses income from operations was up 11% ytd.

*capital allocation. Other than a small 14.7m acquisition in 2014 free cash flow has been devoted to

debt paydown and now paying a dividend.

*valuation. Not as interesting as it was, but the stock trades for 17.9x trailing earnings with an EV of

4432 with TTM CFFO of 285m. Restructuring costs are expected to tail down in future years (I am not computing any future numbers here cause nobody can predict volume trends), but admittedly these expenses have been persistent so we’ll see about the future.

Comparisons are always hard given the variable nature of the exchanges, their reliance on volumes and non-volume related activity, diversification, and varying debt levels and acquisition policies and dividend payments and buyback plans but ICE, CME, NASDAQ, and several other exhanges trade for what look to me to be higher valuations (though some like CME are inherently better business models given the exclusivity of their product lines) . BATS was recently scooped up at higher levels. In general, I have never found an exchange stock that I didn't want to invest in.

Here are concerns:

*Canada is heavily resourced based. I haven’t looked to see how much but in my years investing there the resource

and banks seem to be all they talk about, and this stock got killed late in 2015 when oil fell. Even if not

a long-term problem, this can create short-term trading opportunities.

*Earnings tied to volumes which are unpredictable. This one doesn’t bother me – people never seem to

stop trading for long, but there are monthly volume reports that at least give you a feel for what’s

happening and the current compares. Again, monthly results sometimes lead to opportunities.

*Incoming competition. There has been a lot of chatter about NASDAQ entry into the market and other

competitors and litigation and lots of other stuff you can read about in the filings but so far none of it

has mattered. Admittedly I have not spent a lot of time with this because in every single exchange

stock I’ve ever looked at over 15 years+ regulatory and competition pressures never seem to stop the

cash flow from coming in and volume reports will show the impact if things do change.

*the stock is no longer cheap. As noted, last year was a much better setup – competition news was

newer, oil was dragging, and the stock fell hard on small volume – but I still think the valuation is good

for a long-term investor. At the very least, the FCF they generate gives the company a lot of options.

http://business.financialpost.com/news/fp-street/tmx-ceo-waves-off-competitive-threats-as-rivals-

gather-at-the-gates (from Dec 2015)

*for US investors, the CAD is at 76c right now. Since I've been investing down under this has varied from about $1.05 when oil was booming to 68c or so last year. I have no opinion about the CAD currency but figure that since I plan to invest there for many years I can DCA any fx impact out.

*trading volume isn't the greatest. I am a small investor so this is less of a problem for me but trading here can move the stock.

As far as management, they seem to know what they are doing (it is very hard to tell otherwise). Eccleston has been interviewed a few times but it hard to tell at this point but his capital allocation has been pedestrian and pedestrian seems

good to me.

On catalysts, it is hard to come up with specific ones, but the stock recently jumped 6 to 7% earlier this year and was now down 2 to 3% ytd yesterday so it does provide opportunties to trade on specific non-business related news. As I type this, the stock is up 1% today.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Continued FCF growth

show sort by

			2017	2018
Price:	69.41	EPS	3.87	0
Shares Out. (in M):	55	P/E	17.9	0
Market Cap (in $M):	3,797	P/FCF	16.3	0
Net Debt (in $M):	635	EBIT	0	0
TEV (in $M):	4,432	TEV/EBIT	0	0