Introducing The Double Dog Index

Telling the Story as it Unfolds in 2022

A net-debt free Metallurgical Coal name that will earn its market cap is cash in 6 quarters. Two Steel producers in the same neighborhood. Two Lumber Producers that would generate in the 80% of EV neighborhood at $1000 CME. A shipping company that seems to be trading at 1x ‘22 EPS. You get the drift. “This is stupid” is not unique to one or two little niches, it is spread across a variety of industries and companies. “Ok, but WHY”?

• It’s because there have been massive supply responses in each of these industries and capacity is going to be a huge problem, right?

• It’s because there are structural demand issues with each commodity, right?

• It’s because ESG is going to lead to lower commodity prices in said sector, right?

• It’s because these companies have no terminal value after 3-5 years, right?

• It’s because realizations are far different than what you see on the screen, and these companies can’t really lock in any future profits, right?

• It’s because we are at the end of a very long economic cycle with Consumer Balance Sheets in really bad shape, right?

An interesting thread that runs through all the questions above is that there is a real continuum of answers across industries on each point.

Supply response? I don’t love what’s coming by the end of ‘22 and into ‘23 for Met Coal. Thermal? Pretty non-existent. Canadian Lumber? Crickets. Steel? Somewhere in the middle.

Demand? Yes, Thermal Coal is on a predictable downward trend. The same can’t be said for Steel, or Fertilizer or Wood.

ESG? If anything, this could be a tremendous boost to pricing in various industries. For Thermal Coal, if there is no capital available and no regulatory certainty, who in their right mind will build? This dynamic looks set to almost ensure a higher price deck as the reality of global demand in the next five years is met by the fantasy thinking of those who primarily address supply from the nose of their Gulfstream.

Terminal Value? Once again, a lot of the Terminal Value concerns are steeped in fantasy rather than physics, and physics seems to be entering the equation. You actually want to buy, not sell this inflection.

Realizations? On this question, there is a range. I would argue that Lumber producers are basically price takers at spot, and there is no real liquidity in the Futures contracts so you might as well ignore them. Met Coal? Several of the producers have already locked in insane margins on their domestic production, which can represent a meaningful amount of volume. Steel has some similar dynamics.

Finally, on the Macro. Maybe this is a mini cycle that will last three years. From a US lens, it sure feels like this cycle could have either duration or magnitude. The Consumer is as healthy as ever, there is still a bit of slack in the Labor market, there will be a Roaring 20s spending impulse once Covid is truly in the rear-view mirror, housing demographics are very favorable for the next 3-5 years and I’m not giving up on Infrastructure. Maybe I am wrong and maybe we are heading into a 2022 recession, but this feels a lot more like the calls for Armageddon in every hiccup from 2010-2018 as opposed to the real thing.

“Ok, so what DO all of these companies have in common? They’re all Double Dogs! I won’t link to my least viewed Substack article of all-time¹, where I had the audacity to write a market allegory. So let’s use some more common language. You are NOT SUPPOSED TO pay a low-multiple for a cyclical. “Everybody knows this”. When you pay a low multiple, the company is likely on peak earnings and thus what looks like 3x EV/EBITDA is really 6x-8x mid-cycle. All makes sense, and this is why the market maxim exists. But what if that 3x is 1x?

If Vegas made you lay 14 points to take the Chiefs over the Jags tomorrow, the line would be set pretty fairly, and this is essentially a 50/50 bet. But what if that line for some reason went to 30. All of the sudden maybe it’s not so bad to take the Dogs. This is where we stand right now.

Without further ado, I present the Double Dog Index. After seeing so many trades that look quite similar in various industries, I am equal parts excited (I love the risk/reward in many of these even though I only own a handful), fascinated (I want to tell this story as it unfolds) and perplexed (I get why $ARCH might be a sucker trade at 4x 2022 EBITDA, but at 1x and change?!).

I had a general list I considered for inclusion and while not every name will perfectly clear the bar on all points, I tried to get as close as possible. The point is, I am trying to isolate Double Dog and not expropriation risk, egregious corporate governance or something similar.

1. Will earn the majority of its mkt cap in FCF in next 4-6 quarters

2. Has a relatively clean capital structure (i.e., not over-levered or w/ debtholder vs stockholder conflicts)

3. Has reasonable management (i.e., not a stock that 'nobody will touch' due to past mgt transgressions)

4. Is not publicly opposed to capital return.

5. Is not a special situation (i.e., $AMPY w/ the Oil Spill overhang)

I am trying to link some sort of background on each name. I have written about a few of them, but there are also many great resources on #fintwit which I’ve tried to curate.

1. ARCH - This is my favorite Double Dog because I view downside risk as incredibly contained (low on cost curve, you are VERY likely to get capital return) yet the upside convexity is very much there. I am linking my last article but there are two others in my Substack archives.

   $ARCH Spaces Prep

2. AMR - Could earn nearly 1/3 of its market cap in the first quarter! Come on. Some who are smarter than me prefer AMR as they view it as higher upside convexity capture.

   Aggressive Value @aggresivevalue

   @doctorslernon @acosgrove003 @twebs $AMR avg price of current mix is ~ 325 per Mton port. Take off 10% to short tons is 292. 50-60 freight (guesstimate could be high) is 232-242. This is 140-150 margin on high range of cost of 92. They already sold 28% at q3 report for 105 margin so avg is 130-140 with crnt price

3. X - Dirt cheap and they don’t even have a pension overhang!

   Aggressive Value @aggresivevalue

   1/ $X. while coal is dirt cheap this is cheaper. Steel companies will be here long after coal has been phased out deserves higher terminal value. X lets you have it both ways on the BF/EAF debate. Also a hidden call on oil/gas with tubular division (major octg shortage at moment)

4. STLC - Could this be the unicorn? The aggressive repurchase is already very much in motion, and this management team seems to be very aligned with shareholders. How can you not love buying back 13% of the company in one transaction at a 26% discount?

5. ZIM - My favorite part of Shipping Twitter right now is the many posts about the amount of free cash flow ZIM makes PER WEEK :). Once again, shipping is not without its flaws, but the market is absolutely daring you to bet that rates don’t implode tomorrow.

   Alpaca Capital @Alpaca_Capital

   @viggy_krishnan @BuffaloBillCo $ZIM has a chance of hitting $50 in EPS for 2022 with a 30-50% earnings payout ratio against a current share price of $53.66… Have to turn some rocks to find management who won’t incinerate capital, but some really mispriced opportunities remain.

6. UAN - Plum expects $38 of distribution on an $82 stock in the next three quarters and this is a company that can forward sell up to 6 months of production.

   $UAN - Plum's Best Commodities Play

7. LXU - Similar to $UAN, with a good primer thread below

   STOCKtori @satorimind

   Long $LXU LSB Industries via shares and calls. LXU is a small to mid cap Ammonia/UAN/ Nirtic Acid fertilizer producer based in the US. 89M O/S for a $845M MC. Currently trading for less than a 2pe at current fertilizer prices.

8. RFP - $1000 Lumber Prices would lead to a sub-1.5x EBITDA multiple and the company has already started small buybacks and paid a $1 special dividend during the Lumber run in May. I wrestled with including Lumber companies as they do have very little ability to lock in the curve, but who knows, maybe the fact that this commodity has spiked back to $1100 means we might see a yearly average in the $800-$1000 range. There is a confluence of supply and demand issues causing these price spikes, and it’s not just Covid-related supply disruption.

9. GFP.V- I wrote this one up a few months back and my key conclusion was that if you just build a two-step model with 1 year of strong prices and then revert back to either $500 or $600 Lumber long-term, the risk/reward looks quite favorable. Interestingly, you really get paid much more on the normalized assumption (as opposed to the 1-year super-spike) and I am becoming increasingly confident that something like $550 could be a new floor.

   $GFP.V: A Rivetting Opportunity

10. CEIX - Consol has optionality to hit a lot of different markets with its Thermal coal production, so there are many ways to win here. @KNLCBD did a great episode of Single Stock Spaces and posted this thread in advance

    KNLCBD @KNLCBD

    A $CEIX primer in advance of the @twebs spaces tomorrow. First, I am long $CEIX. I like to start these discussions about why I think you should care. See my view of $CEIX below. Essentially think they'll cashflow their EV in the next 2 years. Debt free 2H 2022.

    

    

    twebs @twebs

    Episode 8 in the books. @KNLCBD has a compelling thesis on $CEIX, with eps estimates a country mile > consensus. Could we be on the verge of rapidly improving sentiment for Coal as a critical part of a functioning grid? What would that do to multiples? https://t.co/Onx8iJREOh

11. WHC - A bit controversial as there are some who really don’t like management here, but stronger for longer Newcastle and this stock is severely under-valued.

    Twain's Mustache @TwainsMustache

    @puppyeh1 at spot -50% WHC is currently trading at ~ 43% FCF yield at strip for next 27 months FCFF ~ 150% of current market cap

    

12. ARG.TO - Sure it’s nichey and there is some idiosyncratic risk but it’s also levered to copper prices and makes zero sense if Copper over $4 has duration…. and we aren’t having an energy transition without a boatload of copper demand.

    Jeremy Raper @puppyeh1

    Friendly reminder that even ref much lower copper prices (ie before last few days) $ARG.TO is at <2.5x EV/EBITDA w no debt and about to return to substantial capital returns...

    

    Jeremy Raper @puppyeh1

    $ARG.TO had rallied ~35% since this In a couple of weeks but given the rally in copper and the extremely positive earnings report (and signaling on capital returns) I continue to believe this is wildly mispriced. Still at ~3x fcf at spot Copper with net cash... https://t.co/1cUAerTtIW

1. Don’t read it, it’s terrible. The market voted with its collective lack of feet (traffic)

The Double Dogs