Dollarama: why I’m ignoring the nepotism and related party transactions

While I don’t think that Dollarama is extremely compelling at the current P/E of 26.5, I do own the stock because I am trying to diversify.  The company’s earnings growth is impressive and I like the new CEO, even though his father passed on the family business in 2016.  And while the related party transactions continue under Neil Rossy, they haven’t meaningfully impacted shareholder returns in the past two decades.

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US healthcare is worse than a free market system

Americans would like to think that their healthcare system resembles a free market system.  Canadians would like to think that theirs resembles a single payor system.  In reality, the reverse is true when it comes to prescription drugs.  In Canada, most Canadians pay for their drugs directly (out of pocket).  You could think of many Canadians as being uninsured when it comes to buying drugs.  In the US, most Americans receive prescription drug benefits from their employer, with the administration of those benefits being handled by a private company.  This is essentially private health insurance that employers are legally forced to pay for.  I would argue that this is the main reason why Americans pay dramatically more for an EpiPen than Canadians do (the listed price is roughly $600 for a pair while Canadians pay around $200 for a pair).  Private health insurance leads to higher costs.  When for-profit companies are compensated on a fee-for-service basis, they are incentivized to spend very little money on lowering drug prices for their clients.  In turn, drug makers take advantage of the situation by charging higher prices in the US than the rest of the world.  The drug makers exploit the payor.  Meanwhile, the insurance companies and PBMs spend very little money on protecting their clients.

This makes me more confident that the American government and states will continue to enact laws that benefit pharma companies, health insurers, and PBMs.  American citizens have the mistaken belief that their system resembles a free market.  On top of that, many people have difficulty understanding the US healthcare system.  Explaining healthcare shenanigans (here and here) is like trying to explain options: many college-educated people have great difficulty in grasping the concepts.  Change is unlikely to happen when American voters don’t understand the problem and its solution.  While the morality of US health insurers is questionable, their favorable economic dynamics may persist for a long time.

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The danger of our own beliefs and ideologies

Human beings are wired to hold self-serving beliefs about the world regardless of the accuracy of those views.  While it is easy to see these tendencies in other people (e.g. flat earthers, Donald Trump’s anti-vaccination views, conspiracy theories), all human beings are wired to have blindspots when it comes to the inaccuracy of their own views.  Why?  Ideologies are often arbitrary but they serve social and political purposes.  Nelson Mandela was once on US terrorism watchlists; nowadays, he is celebrated as a freedom fighter and human rights activist.  Clearly, it’s not possible for Nelson Mandela to be both a terrorist and a hero.  Yet, society conveniently ignores conflicting evidence when it distorts history to fit a particular political agenda.  My theory is this: human beings participate in the mainstream ideology when it benefits them.  When it doesn’t, social outcasts and misfits band together to form their own alternative ideology that benefits them.  In both scenarios, the ability to ignore, downplay, and dismiss conflicting evidence lessens the mental burden of upholding a particular ideology.

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Pretium was mining ore at only 2520tpd in H2 2017 + Why Viceroy’s research is nonsense

I must admit that there is a somewhat useful tidbit of information in Pretium’s environmental filings that I discovered through Viceroy’s hit piece: Pretium was mining ore at a rate of only 2520tpd (tonnes per day) in the second half of 2017.  I would note that management has repeatedly talked about expanding the mill to 3800tpd, possibly because institutional investors don’t understand why Net Present Value matters more than growth.  Unfortunately, the mill expansion plan looks crazy when the underground mining was 2520tpd versus milling being done at 2895tpd; this indicates that underground mining has been the bottleneck.  Management has not been forthcoming about this bottleneck.  Nonetheless, I don’t think that this changes the short thesis much as it is overshadowed by the litany of Pretium’s other disclosure issues (e.g. the Ivor Jones resource model has the ultra-high-grade Cleo vein in a zero-grade domain).

This blog post will also discuss why I covered most of my Pretium short and has a section on why Viceroy’s research is nonsense. Continue reading

Viceroy’s research on Pretium is terrible

Viceroy’s research can be found on archive.org or Viceroy’s website.

First off, there is the issue of plagiarism.  It’s so strange that Viceroy also happened to stumble across Simon Dominy’s paper on the Brucejack deposit.  (To be fair, Viceroy did generate original research of very low quality.)

Secondly, the Viceroy report contains major inaccuracies.  It insinuates that Strategic Minerals LLC improperly inflated the bulk sample results.

The facts surrounding Strategic Minerals LLC are as follows: […]

Grade results for the Brucejack mine from Strategic Minerals LLC were far higher than those reported by Strathcona’s tower sample.

In reality, grade results were very similar between Strategic Minerals and Strathcona.  Table 9 of Dominy’s paper (draft version with working imagesfinal version) shows that the difference was -10%… well within the expected error coming from a high-nugget deposit.  Despite referencing Dominy’s paper, Viceroy seems to have reached some strange conclusions.

In the past, I have criticized Viceroy because they have not been transparent about their relationship with CTS Labs.  Now, my problem with Viceroy is that they didn’t read up on mining or hire a fact checker before publishing their report.  Viceroy’s reckless and irresponsible behaviour gives short selling a bad reputation and may make life more difficult for other short sellers.

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What I’ve learned about short selling

The most disappointing thing that I’ve learned about short selling is that identifying frauds and scams is not as consistently profitable as it “should” be.  Identifying frauds actually isn’t the hard part.  The real issue is that fraud isn’t symmetrical.  While fraud reduces returns on the long side, actually making money by betting against fraud is much harder than it seems.  Here are some reasons:

  1. The wealth isn’t exactly transferred from the longs to the shorts.  Short sellers have to pay money to borrow shares.   Much of the profit from short selling ends up in the hands of brokers, who earn large fees from lending shares to short sellers.
  2. Short positions tend to be correlated because of the way they are marketed.  The parties lending out shares tend to be institutional investors who fall prey to the marketing tactics of small investment banks.  Being unable to ride out market conditions can cause short sellers to lose money.
  3. Worthless companies often get taken over.  There is always some rich person or misguided CEO that will throw money at a fraud.

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Pretium Q2 2018 update

According to Pretium’s financials published on SEDAR on Thursday evening, the Brucejack mine is generating very strong cash flow.

Cash and cash equivalents increased by $72.5M.  This is largely inconsistent with fraud.  If Pretium were engaged in Worldcom-style fraudulent accounting where expenses were improperly capitalized into capex, then the capex number would be dramatically higher than $5.771M while the increase in cash would be closer to 0.  Given how low capex is (even lower than what the feasibility study anticipated, which is $76.8M over the first four quarters of production)… I think that we can safely conclude that Pretium didn’t engage in Worldcom-style accounting for Q2.  The market seems confident that the cash generation is real, sending the stock up 19% following the filing of financials on SEDAR.  Needless to say, this development is not good for my short position.

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