FIISO - Energy Exposure Uranium's Dry Spells Bullish On SHF Holdings

2023-09-28 08:46:00 ET

Summary

• Chris DeMuth Jr on why the energy sector offers opportunities for underpaying and high returns, particularly in oil and gas equities.
• Uranium is a promising commodity for meeting future energy demand and has the potential for significant growth.
• SHF Holdings is a fintech company serving the cannabis industry and has strong profit potential.

Listen to the podcast below or on the go via Apple Podcasts or Spotify .

Chris DeMuth Jr returns to discuss the energy sector and why it's his biggest sector exposure (1:20), his thoughts on uranium's huge dry spells (15:20) and why he's bullish on SHF Holdings (22:45).

Transcript

Daniel Snyder: Hey, welcome back to the Investing Experts Podcast. I'm Daniel Snyder. And it's great to be back. It's been a moment since I've hosted an episode and I hope you've been enjoying all of the great guests on this show. I'm thrilled to be back because a good friend of mine, great guest, fan favorite of the show, Chris DeMuth Jr. is back with us today.

Chris, thank you for joining us.

Chris DeMuth Jr.: Good to be here. Thank you very much for having me.

DS : So I want to give a little teaser about what we're going to go over through this episode that people can make sure they listen to the end because the end is an individual stock idea that you are holding in your individual account. Is that right?

CD : Correct. It's in fact, it's the only stock I'm holding in my individual personal account.

DS : And this is coming from, you know, we've had conversations over the last two to three years. I can't keep track now. We've talked about Activision ( ATVI ), we've talked about Twitter. You have litigation. You've had so many great calls and you shared it with our audience time and time again. So I can't say I appreciate you enough.

But before we get into the stock idea and what's going on there, I wanted to get your take on what's going on with the oil and gas market lately because we've seen the price of oil just start to ramp up incredibly right now. And I've heard people whisper that this is a new top for oil, gasoline, they're pulling back, things like that. But what are your thoughts on that specific market and how are you handling it?

CD : The energy sector is far and away our biggest sector exposure. We don't really look to make sector bets. We look to underpay. But I keep stumbling into opportunity after opportunity after opportunity to underpay in energy. And I don't seek thematic wisdom. I seek underpaying and I want to buy a dollar of value for $0.50 and then I want to get my dollar back. And I'm happy to do that in boring ways.

I'm happy to do it in ways that I don't understand. I'm happy to do it in ways wherever I can find a counterparty. But what's interesting about oil and gas is the counterparties telling me that they make no sense, or they're telling me in their vernacular that they're trying to do something different.

They're trying to divest oil and gas. They're trying to divest the way that people in the past divested from South Africa or people have had campaigns to divest against Israel. And those are not people who are saying I'm being rational and self-seeking. They're people who are saying that we have a view, an almost religious view, or political view against this thing and we're trying to hurt it.

Now, it’s not clear to me how you hurt it as a public security if they don't need to raise more capital. But the oil and gas sellers, I think are driven by a kind of religious fervor that has led to real world consequences where both government policy and large asset allocators have done something with ESG, that is very light on the G, which is that the G part, I've always been quite a fan of. And pretty heavy on the E, and the E says we need to invest in intermittent energy sources that I think are okay.

Sometimes even good supplements in very specific geographies. Their environmental benefits are massively attenuated if you like cradle to grave at the cost of their inputs, right? It -- like a lot of ideas in politics, they're well served if you focus on the intent and the very kind of narrow aperture of what the fans want you to look at.

If you look at all of the chemicals that go into it and so forth, it's a lot less clear. It's good for the environment. But intermittent energy has -- there's a time and place for it. That time and place is not replacing all hydrocarbons. And it's not a solution that's going to come close to human demonstrable demand for many, many decades.

So I think you have an industry that's been the most cyclical of industries, where the cycle is essentially being broken, where the companies that I like to invest in instead of putting a lot of money in CapEx are just spewing capital back to owners. We're getting big dividends, special dividends M&A, they are just returning capital out of being told by friends and enemies alike, stop increasing supply at the same time, demand.

The same politicians say keep stimulating demand and then they say, why are prices going up? They’ve all – you you’re awake halfway through the first class of Econ 101, you'd say that's just what happens and I think the prices are just starting to rise.

So who knows what crudes does short term, what gas does short term. But there's lot of companies you can set up where you're basically paying for a market cap where they're going to get their market cap back in cash within the next few years. So I think the sector has amazing opportunities.

The sector has been its own worst enemy in terms of management that kind of over invests at the worst possible moment at the top. But they're not doing that this time, they're just not. And if prices are even approximately like what they are today, it's going to be great for a lot of oil and gas equities. And if it improves from here, it could be a bonanza.

DS : So let's dive a little bit deeper into that. It sounds like you're avoiding the CapEx side of the industry. You're not looking for companies that are drilling new infrastructure, but maybe you're looking at midstream, you're talking about the end of the line. So how should investors approach this sector at this time?

CD : So there's undersized upstream. A Unit Corp ( UNTC ) is something that our firm has a significant exposure to. And that's one that they've just been basically distributing money back to shareholders as fast as possible whenever there's excess cash and that, I think that's quite likely that they will sell all of these kind of with under a billion dollar market caps and you look at and think that should be a part of a major.

There's really no reason why, there's no efficiencies at that scale. I would say that we are shareholders of many of the potential and definitive deal targets. We own Denbury, ticker ( DEN ), that's in a fairly mundane, I think, kind of cheap price deal with Exxon Mobil ( XOM ). Now it's an all stock deal. So it's just a modest discount on Exxon. So a fairly conventional setup. But I think Exxon is really underpaying for that and so there's at least a non-zero shot kind of comes with a lottery ticket of a better bid emerging.

I don't think we're going to get one. I think we're going to get a 5% IRR to owning Exxon. And because I like the sector, I'm fine owning Exxon with a lottery like upside of something better emerging. So we like the kind of definitive deal targets. We like some of the upstream. UNTC is I think a good example. We like some of the refiners.

I mean, one thing that we've owned for a while now, Delek, ticker ( DK ), has a public sub. It’s a public sub that's not that convenient or cheap to short, but ex the sub, we bought it for less than free. It's now a little more than free. But you have all of the assets of the whole company basically netted to the public subsidiary for free. Back in the day, I don't know if this was a kind of the early tech bubble, kind of early turn of the century tech bubble.

Palm had a very famous situation and it was the same thing where the sub was actually more expensive than the parent company which is a real paradox. I mean, I think if you were going to a professor preaching the strong version of the efficient market theory and you just wanted to disprove that I think these negative price parent minus subsidiary stubs is pretty much as far as I can tell proof that the market's not perfectly efficient and you can exploit that with a Delek, DK. So those are just kind of examples, but there's a lot of them. I mean, I'm kind of an oil and gas suss at this point. I just love them all.

DS : Yeah, it's interesting because it's a market. As you said, the ESG front, without the standard guidelines is obviously kind of a factor into the decision of investors maybe wanting to stay away or big fund managers just don't want to get into the sector anymore, but the free cash flow is just incredible.

CD : Incredible.

DS : And all the byproducts that come from oil and crude. I mean, you're talking about jet fuel, the plastics manufacturing, the paint for companies like Sherwin-Williams ( SHW ), these ingredients from oil. The product spans across more industries than some investors realize. So going forward, I think if somebody is looking at oil and gas and they're debating if they want to do an individual name or the ETF, like the ( XLE ), would it be better to play the ETF or individual names in this specific sector?

CD : I think they're -- I think you can do better if you don't need the liquidity and if you're not putting together -- if you're investing billions of dollars, it's very different than investing millions. If you are investing millions, I think the Deleks and the Unit Corps are better. If you're investing billions, that's a lot harder.

And you end up owning, Buffett buys ( OXY ) and that's Occidental, and that's perfectly okay. I hope and expect to do quite a bit better than that especially if I'm willing to buy illiquid undersized companies that should get bought. I hope to get both a return of some capital while I wait on getting a return of all of the rest of my capital.

The analogy I really make is, if you look at industry pariahs and my two favorite examples of this are tobacco with the master settlement agreement in the end of the 20th century. And then if you look at UnitedHealth ( UNH ) with Obamacare, these companies were just told they were the devil. And in many cases, investors try to stay away, their prices were beat up.

But what the government did in response to tobacco and then United Health was basically criminalize its competition, create a barrier to entry that they could have been arrested for racketeering if it was private. But they were rhetorically destroying companies that in fact they were destroying the competition.

And 100 years from now, people will be smoking Marlboro Reds and they'll be, United Health, taking users cuts of our healthcare system because of the government. They're basically -- they made the government limited partners of their business. State finance requires money from tobacco.

The government's broke and they've kind of had this kind of almost fascistic relationship with these nominally private companies. And I look at oil and gas right now and I think this is the most hated set of companies and just most rhetorically ravaged companies I've seen since United Health and Altria ( MO ).

If you look at how they've done this, this is spectacularly well for the equity holders because the only thing they were left to do was make money and give it back to their shareholders. And they've made extraordinary amounts of money and it had almost inverse relationship with the kind of pariah status that the regulators put on them because when they settled and when they wrote legislation, the people who were writing the legislation were the people at these companies.

And they did a lot of things that made it very, very hard to compete with them and it kind of permanently enshrined their relationship with the state. I think if you look at oil and gas now, government is doing everything it can to have maybe short term rhetorical slights, but long-term benefit for equity holders here.

DS : So one more question on this industry before we move on to the next commodity we want to get to. And I've got to ask you about, you know, like I mentioned earlier, oil prices have ramped up. We've had $90 per barrel this week. It's kind of hovering around there right now.

The SPR though, the strategic petroleum reserve is something that, of course, the administration has been looking at, they've been draining. We've seen people all over the internet talking about how it's getting to lower and lower levels during the times of the Russia Ukraine war and it's such an international market. So, should investors worry about the SPR being depleted? What are your thoughts on that?

CD : If it's further depleted, I mean, the physical spaces could collapse. It's really from an engineering perspective, it's obscene. From its intent, it's obscene. It’s been drawn down to win a midterm election so far has nothing to do with being strategic or if it's strategic, it's strategic for particular political purposes and we just might need it at some point. If I could have my wealth denominated in US dollars or any foreign currency or gold or Bitcoin or barrels of crude.

Absolutely, I'd prefer to have my wealth just denominated in barrels of crude. I think it's going to store its value better and it's more useful than gold. And so no, it's obscene to be that short-term focused.

But if you look at really on a bipartisan basis, how all of our recent government has acted, it's been a short-term maximalist at really any longer term cost. If you look at our debt and deficits, if you look at how we treat things like this. So, yeah, now we're going to be screwed if we ever need it. And it's really horrible how tawdry our behavior has been towards it.

DS : Great. Let's go ahead and leave that there. Now, moving on to this next topic, I am actually thrilled to talk about, because while I was prepping for this episode, I went over to Seeking Alpha and I went to the top ETF screener and I kid you not, three of the top five names have to deal with this commodity that we're going to talk about right now.

So let's dive into it. We're talking about uranium actually. So just kind of give me the gist. I don't know much about this sector or the commodity. So being an investor that doesn't know anything. How would you guide me with this specific commodity right now?

CD : I told you in oil and gas how much I love the oil and gas equities. We actually have no commodity exposure in oil and gas. We have no exposure to the commodity as a commodity. We have a ton of exposure to oil and gas equities or are very exposed to it. Uranium is sort of the opposite situation for me. There are a lot of rogues and pirates and scoundrels that run uranium companies, especially miners.

They've done very, very well recently. Put a gun to my head I probably see more shorts there than longs. It's an interesting area. I like energy, generally like oil and gas, very, very cyclical but has had these just huge dry spells that are kind of hard for honest men to cope over the long-term. So you turn to other things. There's probably some very nice good, quality people who run uranium companies who are going to hate me for saying that, but I own none.

We have a huge exposure to the commodity itself, the physical commodity itself. I wrote, in the first half of this year, I wrote a piece called the Green Energy Future Glows. And it's basically saying that, if oil and gas is my effort to not take ESG too seriously and kind of be a counterparty for a religion that is not my religion and that I believe has a multi-decade gap between human demand and hypothetical green supply, Uranium's my effort to actually take it seriously and say, okay, well, if we are going to supply demonstrable human demand, and there's something kind of snobbish and obnoxious about a lot of the western first world assumptions on demand, that presupposes that the assumer is warm in winter, cool in the summer, lights on at night, travels includes flies wherever they want to and has full use of energy my view is that that's what everybody wants and that as people in the developing world go from making $1000 a year to $10,000 a year, they're going to want the same. And the fact that they've been suffering historically isn't an indication of what they've wanted. It's what they could have. And once they get a little taste of that they're never going back. Once they get a taste of individual transportation, they're never going to go back and the price elasticity will reflect that.

And so we have this huge increase in demand that's very likely in the years ahead. And supply is being artificially constrained by politicians and asset allocators alike.

But nuclear actually can fill a huge part of that gap. We're going to need hydrocarbons. We can use wind to chop up birds and to provide a little bit of energy from time to time and we can use solar power. There's enough slave labor to pull the needed chemicals out of the ground for solar. We can use that too. I don't stipulate much of the moral or environmental case for either, but I will stipulate that they can produce a little peak energy here and there.

But we're going to need coal, we're going to need oil, we're going to need gas. But uranium is where we can have a huge part of that demand served in ways that are not carbon intensive, not my beat. But listening to other people when I'm not in Connecticut, I'm in Maine. So a little global warming probably at least several months a year sounds pretty good to me.

And it's not my religion, it's not my beat, but it's a lot of people's and I think that uranium is a big part of that solution. It's a much smaller component as a commodity to the energy production than coal, oil and gas, really any of the others. It's kind of almost incidental.

The supply is long-term available, but in the spot market the next few years, I think the chance for it to double several times over, I think is really, really high. I think that the industry is kind of lackadaisical about it. Apathetic. I don't think anybody's going to get fired for under-reserving for uranium and even if it doubles and doubles again, I don't know that people get fired for it within the industry. I think you can just buy it at the price later on.

And it's not going to be seen as a scandal in the way that people who have it is a much bigger component price, a component part of the price of production could get fired for. So I think they're apathetic. And I think that the left's hatred of nuclear has just been collapsing.

You know, you see it in very progressive countries in Europe, really subtly changing the definition from intermittent, they don't like that phrase, but you know, whatever the alternate sources to kind of non-carbon intensive, kind of creeping nuclear back into the definition of what they're for in a lot of countries where if they take their carbon footprint seriously and they want the lights on this is the way out of that conundrum.

DS : So the underlying message there is on the commodity, not the stocks. Right?

CD : Or let me know what's better than that. I would love -- I would phrase it more as a question. I own the commodity, not the stocks. I own the Sprott Physical Uranium Trust units ( SRUUF ). For an American like me, it is my deep and abiding loathing of taxes comes back with a special loathing of PFIX and the tax status of this trust because it's Canadian. But I trust it and I think it is going to do spectacularly well from here and I'm in the market for something better.

So when I say that's what I'm doing, show me something better. It is a literal, sincere plea and not a rhetorical fame in the comments, in responses, please hit me up if you're an honest CEO of uranium company that's undervalued and you're not a pirate and you took umbrage at me saying you guys are a bunch of pirates, then give me a call or send me a note. I'd love to find something more tax efficient and smarter than just owning a pile of physical uranium. But that's the best I got so far.

DS : Slide into Chris DeMuth’s inbox. I love it. Now, let's go ahead and dive into this stock that we kind of teased out at the beginning of the show, the one stock you have in your individual account. I'm kind of intrigued by it because it's a cannabis play, but it's more a bank play instead of just cannabis. So why don't you go ahead and tell everybody what it is and what your thesis is behind it?

CD : Sure, I need two throat clearing caveats, then I'll dive right into it. First throat clearing caveat is, professionally I own a diversified portfolio. We look at a lot of litigation, especially antitrust, IP, nationalization. We do some merger arb, we do event driven, we do various flavors of value investing where we think we can underpay and get our money back.

Personally, I can do whatever I want. I tend to do things that I don't have in the fund. In this case, for strange reasons, we own it in both places. But it's basically a small and a liquid company. But it's the one stock that I own personally in my individual account.

The other caveat I'll give is that I totally reject the concept of sin stocks. There's 8 billion versions of what people consider to be sins. I think the job of capitalism is to provide goods and services that people think they want, not what they should want, the prices they're willing to pay. So I'm willing to invest in anything that's legal. And that is an honest arbiter of what they're doing. In this case, cannabis. I've never smoked cannabis or anything else. But those are my two throats clearing.

But I'm happy to invest in alcohol, cannabis, tobacco, ultra-processed foods, all sorts of things that I wouldn't want in my own body, but I own my own body and you and yours. And so take as much cannabis as you want. SHF Holdings, ticker ( SHFS ). I own the equity. I actually own some of the warrants which are SHFSW, which I can talk about as well. It's small, it's a liquid, it's my one stock I personally own. And it is the only NASDAQ-listed fully compliant fintech that serves the cannabis industry.

So if you are a cannabis provider, I mean something physically dangerous about it has been, people have stacks of hundreds of dollars of bills in safes and are really disconnected from the modern 21st century financial world. And this is a company that has been around for almost a decade and it is kind of the one serious compliant fintech company for cannabis.

DS : So, obviously a huge issue that even our government is trying to figure out here in the United States. And there is this news, I think it was just this morning, we're taping this September 21st, about the SAFER Act that they are working on. Is trying to help out how they're going to regulate the financial side of the industry for cannabis because as you just mentioned, people are holding a ton of cash and that might go to other things like avoiding some tax payments. We don't know, but who knows what's going on behind the scenes? Right. So what is your opinion on this SAFER Act? Do you think it's going to pass? They have a committee markup on the September 27th [which has since passed] . What are your thoughts here?

CD : So the entire life of this company, SHF has been during the hopes and expectations and shattered dreams of full national legalization, rescheduling and regulation of finance. What I love about this investment is it wins either way. It is becoming a profitable business.

We can talk about how they make money, but in the current status, the longer it's in the gray market, the bigger that's going to grow, the longer they're going to be able to take outside profits from an area where they basically don't have competition.

And once it's legalized, the music stops and they get bought the next day or so where a kind of plain vanilla mainstream company is going to want a maybe 6 to 18 month head start and is going to buy them and it's even at 10 times the current market cap, it would be a tiny little acquisition for them.

So, my preferences are mixed, my expectation is that this is not something that's going to happen this year. It's not something that's going to happen next year. The window starts to open in 2025 and that would be fine with me. That would be ideal for SHF.

We have, set in a house that have different problems. It's been held hostage in the past, but I would say a solid majority of legislatures true view is that this is legislation that should pass and there's all sorts of machinations around. Is it being held hostage? Is it part of this bill or is it that, is it going to hurt the other side or help the other side during an election year?

And so it's kind of hard to run the table in 2024 with complex issues, with executive that do not have a very good congressional relationship with two houses of opposite parties that don't have good relationships with each other. And all three are right around parity. And so there's a lot you can get done when it's 60:40 that you can't get done when it's closer to 50:50 because everybody's just grabbing for that kind of short term advantage versus things kind of settling.

So I think the easiest route in 2025 is if Biden won. But you could see a Republican version of this too. So you just need a little bit of clarity. And maybe a little bit more of a stable majority and this will get signed into law. I think the culture has moved so far and younger members of both houses and both parties have moved so far that we are going to get this law. And meanwhile, we're going to make money and grow and become more kind of operationally sound and then everything changes the next day once it's just like any other industry.

The thing that's amazing is that, you know, I always say, if it's in the press, it's in the price. And I say, well, the market’s a discounting mechanism, but this is in the press, it's not in the price and the market's not a discounting mechanism because a lot of mainstream investors are simply going to wait until the law is done and then they're going to pour in capital in competition the next day, how the existing industry is impacted by this one very good thing and one very bad thing is going to be what determines the winners and losers in cannabis.

DS : Great point. Now, I want to go to an article you just put out; you said that the number of states with legal cannabis could rise from to 23 to 31. Maybe you can touch on your thoughts there. But then also as a follow up, if you could just walk us through how SHF actually makes money off of being the fintech to those cannabis companies.

CD : Yeah. So we have at the state level, we're making a lot more progress than at the federal level. And that's very, very good for this company that does the finance. The thing I'm really waiting on at the federal legislation is, when are mainstream companies going to buy them, kind of the exit. The end result I think is going to be mainstreaming this and that's going to come after federal legislation.

But at the state level, it's more and more states that we can do business in. How they profit? And it really is important to understand this because it's really changed a lot and improved a lot recently and nobody's following this company. I mean, it's virtually unknown. So I don't think people have really gone through the math.

There's kind of five things that are really changing. One is that they capture the float on the deposits. When interest rates were zero that wasn't a valuable thing. But now at about 5.4%, they get 75% of interest on that cash. It works out to about 4% the value of their float and deposits. And other contracts, it's 50:50, but they have a very, very good relationship with one credit union. They have good relationships with a bunch of other banks and so they get a lot of money on float. They just signed a new deal with Five Star Bank, ( FISI ) is the ticker, in New York, but they're going to take that national so we could end up with this huge deposit base flipping 4%.

Service charges on accounts in cannabis are extremely profitable. It works out to about $800 per account per month. They don't have other choices. SHF charges a lot of fees. They pay the credit union or banks. It works out to about $25 per account per month and keep the rest. So that net amount is very, very valuable on service fees.

Lending, they get 1.5% of origination fees. They get about 10% net interest. Their first loss on loans that they originate, but they get to use the balance sheets of the banks and of the credit union that they came out of and the loans are quite good. They're low, low loan to value, typically real estate loan, but they have as collateral the real estate, but it has extra coverage because they also have the cannabis license and also personal guarantees.

So dealing with people who don't have options, you have kind of massively over collateralized loans that you're getting 10% plus a 1.5% origination fee on which is a great business. At the same time, their expenses are declining. They’ve kind of got to be more efficient with scale, expenses going down, a big uptick in earnings because of the higher interest rate from the credit union relationship.

This new FISI relationship could really grow it. And so they're making money, they're profitable and the market just hasn't seen it yet. And that's what we're doing, while we're waiting. And so that's going to be one year, two years, three years, five years, some number of years between now and an exit. I think the exit comes very quickly after full legalization. But meanwhile, you're playing a game without competitors.

DS : And to break it down, the exit being an acquisition. Is that right?

CD : Yes. No, I think, you look at the -- stock price is under a dollar now, which I think is just left for dead, misunderstands the nature of it. The balance sheet is a problem, but it's kind of a problem between semi-related parties that are all working together to maximize the value of this public company. It’s not going to file for bankruptcy.

It's not going to be diluted towards zero. It's worth $1 to $2 today as a standalone. It's worth $3 to $4 a share with this legislation. It's worth $5 today. Is it take over Canada, that could come within the next two or three years. Could be more, the math and the warrants are a lot more complicated because you have to figure out perhaps dilution, timing and so forth. But they cost almost nothing and are probably worth high teens, number of pennies maybe $0.20 in a takeover.

They're probably worthless other than in a takeover because the strike price is well above where a takeover probably would be done at. But in a takeover, you get kind of a Black-Scholes valued price for them. I guess it'll work out to be kind of $0.20 or so.

Then there's a lot of leverage beyond that. If it's a low exit price from here, say if the stock is a 2x from here, the warrants are 2.5x. It doesn't sound that much more exciting. But then it very quickly gears the direction of the warrants in a bonanza scenario. So I own a little bit of both. But the stock is already small, already a liquid, and already very -- it's a leveraged equity, right? It's a lottery ticket where you will make many times your money if this even is approximately, right? So I don't know if you need even more of those characteristics with the warrant.

DS : Chris, let's go ahead and wrap it up there. I can't thank you enough for coming, sharing that name, talking to us about commodities today. Obviously, just a reminder to everyone listening. The ticker is SHFS. Really can't thank you enough.

CD : A way to remember it is it used to be called a better name. Safe Harbor. Kind of confusing because in their presentation is the safe harbor. So you can remember Safe Harbor, and it’s a financial company. So SHF, Safe Harbor Financial Holdings.

DS : And I just want to say for everyone that wants to check out more of your research, they should head over to Seeking Alpha, check out Sifting the World . You have a newsletter too, I believe. Is that right?

CD : Yes. So I have a new one coming out. I'm complicated and I'm -- I just do the content. I respond to whatever somebody asks me to write. We have a new free newsletter coming out. Please go to Seeking Alpha, click on follow for free. You'll get this and other hopefully good ideas. But I do my investing rating there and this new one should be coming out any day now.

DS : Yeah. And everyone, I mean, I read all of your stuff. I hope everybody else will indulge in it as well. Everybody that's looking at mergers and acquisitions and litigation, Chris is your guy. He's helped me personally 10 times over I feel like already. So I hope you enjoyed the episode. Chris, thank you again once more and everyone have a great day. We'll see you next episode.

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