Summary

• Shares of this company surged last week, with an 18%+ upside breakout and a 10X increase over average trading volume.
• Strong fundamentals, coupled with forex benefits, favorable macro environments, and aggressive M&A activity in this sector combine to offer a solid investment choice.
• Investors staking out a position in this 102-year old Canadian Packaging Income Trust can expect superior capital appreciation on top of a 5.7% dividend paid monthly.
• The current historic magnitude in volume and the price breakout suggests a potential takeover suitor or smart money institutional investor has identified a bargain.

Sometimes, you can learn more from detecting signs of what smart money is doing than you can from breaking news and financial analysis. Last week proved this to be the case for Richards Packaging Income Fund (OTC:RPKIF. TSX: RPI.UN).

When I last wrote about Richards Packaging Income Fund on January 30, 2013. it was at $8.94 per share. Since that time, it has risen to close on February 18, 2015 at $16.65, an 86% capital gain. Additionally, $1.66 ($Cdn) in dividends has also been delivered over those 25 months. Buyers that acted on my buy suggestion have reaped a total return of 105%.

I am revisiting this alpha performer today due to this past week’s spectacular 18% upside breakout on 10X volume, which provides a clear signal marking this as the time to be a buyer. Several attractive factors all converge to make Richards Packaging a strong growth candidate going forward for both capital appreciation and dividend growth. Continuing growth driven by operational results suggests 36% upside, coupled with a 5.5% annual distribution yield for the next 24 months, and potential for 59% to 229% capital gains on a possible takeover. This week’s breakout provides the timing catalyst to enter or increase positions now.

1. Fundamentals continue to look good, even better than those which have supported the 86% advance since my earlier article. Organic growth, cost efficiencies, and an ongoing buyback program all continue to reinforce reliable performance.
2. The strong US dollar and accelerating US economy are adding a boost to this Canadian company’s competitiveness and financial results.
3. The packaging industry has an excellent outlook going forward.
4. Mergers & acquisition (M&A) activity for the industry expanded by an aggressive 55% in 2014 and remains robust entering 2015.

Breakout: The Catalyst

This past week, shares have surged from $14.25 to $16.69 on three days of volume — each in the range of 10 times the normal average — with shares currently eased back slightly at $16.23, while volume remains 5 times normal. This unusual activity suggests very sophisticated buying. (NOTE: All prices used in this article are $CDN, unless otherwise stated).

Unusual patterns exhibiting historic levels of magnitude in volume and price breakout, such as this, almost always indicate it is time to buy. Two possible explanations offer themselves to explain this sudden development. Either a smart money institutional investor has taken a hard look at the strong fundamentals, coupled with the global rigid packaging industry macro environment and favorable forex outlook and concluded these are bargain prices, or a takeover suitor has stepped forward.

Several factors lead to my suggestion that this breakout surge is powered by a single buyer rather than a large group or broad market:

1. The 140,000 share volume over 2 days is very illiquid. At typical average daily volume, it represents over 30 days of trading. An orderly liquidation of this accumulation would take well over 2 months in order to not completely oversaturate the normal market. This is not a signature of casual speculation or quick trading.
2. There is no significant breaking news that could be pointed to as a trigger of this activity. (A favorable recommendation by BNN was issued about 1 hour before the breakout, but seems unlikely to have spurred public buying to drive the surge — which occurred too soon after the publication, with far too large and sustained a volume for it to likely tie to the article release, and no such jump in activity was seen in the other 2 top stock picks included in the same article).
3. The volume surge and price breakout began with a burst and remained with steady pressure for the following two days.
4. A steady 10X normal trading volume continues on pace in the third day of the breakout.
5. After the initial breakout, bid pricing remains sophisticated so as to provide steady pressure above $16.00, neither seeking to attract unusually large blocks with a high bid nor to freeze the market with severe downward bid pricing. The small lot trading (normal for RPI.UN) is encouraging long-time holders to take their capital gains, while still amassing large total purchase volumes for the buy side.
6. The buyer investment in just 2 days represents over one full month of normal dollar activity in the shares.
7. This pattern is of historic significance for Richards Packaging, never before having shown anywhere near such a combination of volume and price surge.

What It Means

Smart Money - A sophisticated investor has taken a close look and determined that the company is a bargain at $16.25 per share. The extreme departure from normal trading patterns in the shares in the absence of significant news, and done in a way to drive only a moderate share price increase, is what I call a horse track signal. Many years ago, when I was just a middle class 16-year old, our neighbor was an avid horse track fan and wagered $1,000s per race. One day, he took me to the races and taught me his system. Pete’s horse track system was simple. He watched for a pattern in the tote board odds, where a moderate (maybe 5 or 8 to 1 initial odds) horse would slowly build in high odds, and then all of a sudden, just seconds before the betting windows closed, the odds would drop sharply. Pete believed this was an indicator that the bookies were laying off their wagers onto the track instead of holding their risk themselves. This would be smart money with a superior insight into the horses and the real odds of them finishing in the top 3. Thus, the horse track system tries to identify and follow the smart money. Surprisingly, the system does seem to work. Pete won over $10,000 that day. I know nothing about horse racing, but have used the system on the ponies a few dozen times over the years when I have found myself dragged to the track with friends or at a charitable event at the off-track betting parlor. In every case, I have indeed won for the evening, and probably averaged over 80% success on the individual races. Identifying the smart money and following it is very rewarding.

I took these lessons and applied them to the stock market back in the 1970s and ’80s, when true penny stocks (under $1) were traded and there was no internet. I would simply watch the penny stocks listed in the morning newspaper. First, I would eliminate those with big news or in a fad (solar, for instance, during a solar hype period). A quick scan down the volume list then would indicate which stocks were trading unusually big volumes. These I would note down and watch for a few days. I watched for a pattern, where the volume would remain high until the price began to move significantly and then would fall away, letting the price ease off again, and then the volume would surge again until it drove prices to jump, ease again, then repeat for a few days. I found this pattern to be a sign of sophisticated buying from smart money. Surely nobody plunked down millions of dollars on a tiny unknown company with no big news or a public fad driving it, unless they had done enough homework to at least suggest nothing bad was likely to confront the company. Thus, I converted the Horse Track System into the Penny Stock Picker, and I was very successful with it for a few years until penny stocks became too popular, waves of pump and dump brokers emerged and the internet later rose with various scams and flash fads that all added to much noise. Eventually, true penny stocks faded as they were barred from the major exchanges.

I still watch for smart money patterns, and a breakout on surging volume with sophisticated buying patterns is one of those. This past week of trading in Richards Packaging is exactly such a pattern. If you like the idea of following smart money, then you should be ready to follow it into Richards shares.

A Takeover or Buyout Suitor - I think there is reason to believe this smart money may be more than just a savvy investor — it may represent the start of a buyout.

As I mentioned above, daily volume for Richards is generally under 4,000 shares, often below 2,000. A large position is very illiquid. It is not likely that an investor would amass a share volume that would require over 45 days of orderly liquidation to cash out of in order to reap potential profits.

In addition to the illiquidity of the recent accumulation, several factors favor suitors for Richards:

• M&A activity has been running high for the packaging industry for the past year, and recent deals have been at a 54-229% premium over Richards, based on EV/Revenue ratio and other financial metrics.
• With a base of over 11,000 customers, a position as the largest rigid packaging company in Canada and the 3rd-largest in North America. Richards offers great synergy and leverage of resources for combination into a competitor in this rapidly consolidating industry.
• Richards’ already attractive margins can be additionally improved by melding into the operations of a significantly larger packaging company, where economies of scale, distribution chains and consolidation of product lines add an extra kicker to an acquisition of a fine company on its own merits.

Back To Basics: The Fundamentals

Four factors are in place to drive strong fundamentals and profitability for the next few years:

• Growth in organic sales from stronger North American economies will provide continuing performance improvements in sales, margins, and profits. The IMF forecasts 2015 US growth at 3.6% and Canada at 2.3%. These represent improvements over 2014, a year which saw excellent results for RPKIF.
• A favorable USD/CDN forex rate and expected continued strength of the USD will deliver continued growth in net currency translation, while also adding competitive advantage for Richards in its large U.S. market.
• Overexpansion of inventory during the 2nd half of fiscal 2014 (exceeding $2.8 million) will be drawn down in 2015, providing a built-in boost to 2015 results.
• The plunge in crude oil and petroleum-derived resin products will yield large savings in the cost of goods and decreased shipping and operating costs. These should provide a significant boost to 2015 results over those of 2014, where currency translations accounted for most revenue growth.

Overall industry growth is expected, so Richards’ operating revenues should also continue to grow at a long-term pace of 4.9% per annum.

This should drive share price performance along the trend of the past two years as investors return valuations to pre-Great Recession levels. Absent any M&A developments, Richards shareholders can expect to see 20-36% capital growth over the next 2 years as the share price rises to bring the $0.882 annual distributions down from the current 5.5% yield to an industry-average 4%. A four percent yield from the current distribution levels equates to $22.05 (35.9% premium over the current share price).

The Plastics & Packaging Investment Banking Sector Report compiled by William Blair & Co. also shows a strong industry growth record and projects the trend to continue.

Richards Packaging’s Buyout Value

The buyout value for Richards can be inferred from EV/Revenue metrics of some recent notable M&A activity in the Packaging industry. With RPKIF’s current EV/Rev. ratio standing at 1.04 after last week’s breakout, there is significant upside potential. A selected group of recent industry takeovers during 2014 for medium-sized global packaging companies indicates Buyout-EV/Rev ratios ranging from 1.6X to 2.38X. This equates to a premium over Richards’ Friday close of $16.23 from 54% to 229% (an upside of $8.76 to $20.94 per share).

Selected 2014 Packaging Takeovers w/ EV/Rev Valuation