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  Hemisphere has potential for a rich harvest

BENJ GALLANDER and BEN STADELMANN

Friday, October 12, 2012

It was a summer to forget for many living in the central United States. Terrible drought, of a sort not seen since the 1950s, was worsened by intense heat in June and the hottest month ever recorded for July.

While damage to fields caused prices for corn and soybeans to hit record highs, the dry weather sped up the harvest, with production dropping below year-earlier levels for the first time since 1974. That severely hurt global supply, as this region is the world's top grower and exporter of these crops.

Thankfully, it was not comparable to the horrendous Dust Bowl of the 1930s that motivated John Steinbeck to write his classic novel The Grapes of Wrath, which became a multi-Oscar winning film starring Henry Fonda as Tom Joad. In those days, drought caused the topsoil to dry out and poor agricultural practices left fields vulnerable to erosion. The soil was plucked by high winds to create dust storms, resulting in severe agricultural destruction.

It likely won't placate farmers dealing with the consequences of the drought of 2012, but farming techniques have thankfully improved due to education and technology.

A small-cap Canadian company that we own in the agricultural sector is Hemisphere GPS. It designs and manufactures GPS precision products that provide guidance for work such as applying chemicals and controlling tractors in farming operations.

The firm does have a separate precision products segment, but revenues in the agriculture division typically contribute 80 percent of the total.

The company announced in August that the climate had a negative impact on second-quarter results. Total revenues dropped by 3 percent to $19.6 million and gross margins also thinned. In Canada, sales rose by 10 percent to $5.6 million, while revenues in Asia, Australia, Europe and South America, which comprise about one-third of the corporate total, grew slowly.

However, U.S. revenues tumbled by 14 percent to $6.8 million, and that really hurt, as the U.S. is HEM's largest customer. For the first six months of 2012, the company made about $1 million, down 62 percent from the same period in 2011. Since Americans tend to invest in new technology to improve yields when they have excess capital, having a hard year likely means they will not be buying in the short term, and results will be meagre again in the third and fourth quarters.

What is quite interesting for us as contrarian investors is that we have not been sticking to the Contra playbook with Hemisphere. We bought in, and then sold out 15 months later — below the sell target. This was due to management overpromising and underdelivering.

The trade worked nicely, however, as the sale at $1.19 provided a gain of 65 percent. When the stock swooned, more was acquired a year ago at 66 cents. Underlying the purchase was the simple knowledge that producing an adequate food supply never goes out of style.

The company's reputation for inconsistent execution likely led to the ouster of Steven Koles last month. The board appointed Rick Heiniger as president and CEO to make Hemisphere "a more profitable, focused, streamlined and market-driven innovation company." Heiniger has been an active board member since 2005 and founded a firm later acquired by Hemisphere.

Hemisphere GPS has a pristine balance sheet with zero debt, but cash has dropped to $6 million as it builds inventory. The large amount of goodwill increases the likelihood of the accounting minions deeming a write-off as necessary at some point.

There are some big competitors in the GPS sector, including behemoth Deere and Company. If the drought persists and there is another bad growing season, the competition might drive prices down, causing a harsh impact on our small firm. However, there are rumours that a bigger player might be shopping for an outfit like HEM.

People looking to acquire a small-cap play in the Canadian agricultural industry have few choices. For that reason, this candidate is not that far off investors' radar. When it produces results, it can move higher quickly, while at this time of year it might experience pressure from tax loss selling. That can produce a good time to buy. We see the potential for a five-bagger in Hemisphere if the CEO can take the company through a rough patch and deliver on some of the enticing features offered by its GPS products.

Here's hoping Rick's experience has less of Tom Joad's discontent and a lot more of the success of a Tom Jones — either the Welsh singer or the character in the Fielding novel.


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