Equity – Page 3

Yellow Pages – Drawing more blood from the stone!

Some history – last year, Yellow Pages announced a $100 million share buyback at a set price and shareholders almost unanimously agreed to a pro-rata buyback at $12.58 per share. They bought back 7,949,125 shares and at June 30 they had 26,607,424 shares outstanding. I wrote a little about it here.

Fast forward to today, and we have the following announcement:

Yellow Pages Limited (TSX: Y) (the “Company”), a leading Canadian digital media and marketing company, today announced that the Board has approved a distribution to the Company’s shareholders (the “Shareholders”) of approximately $50 million by way of a share repurchase from all shareholders pursuant to a statutory arrangement under the Business Corporations Act ( British Columbia ). The arrangement will be effected pursuant to a plan of arrangement (the “Arrangement”) which provides that the Company will repurchase from Shareholders pro rata an aggregate of 4,440,497 common shares at a purchase price of $11.26 per share, which represents the volume weighted average price for the five consecutive trading days ending the trading day immediately prior to October 19, 2023.

Yellow has 18,658,347 shares outstanding as of June 30, 2023, so this share buyback will result in a reduction of 23.8% of shares outstanding and bring them to about 14.2 million shares. At June 30, 2023 they had $64 million of cash on the balance sheet.

In the past four quarters, they have been able to generate $90 million in adjusted EBITDA, or about 1.6 times EV/EBITDA. The ITDA is about $10 million and the large cash drain has been the maintenance of the corporate pension plan which is still listed as a $37 million net liability, but this is slowly getting rectified.

Here is the really interesting proposition – the dividend is currently a $3.55 million quarterly cash outflow. The company is easily generating enough cash to cover the dividend. After the buyback is concluded, the 20 cent quarterly dividend could be raised to 26 cents per share and be cash neutral. At 26 cents per share, the company trades at a 9.2% yield. This is going to be difficult for algorithmic traders to avoid especially considering that the “melting ice cube” business is not melting nearly as quickly as one would expect, considering it is the Yellow Pages, after all.

If Yellow manages to generate another $80 million adjusted EBITDA over the next four quarters (this is not a given – my own model has them closer to $75), about $55 million of that will be pure cash flow and they’d be able to repeat this same maneuver again in 2024. If their stock price doesn’t move from there, another $50 million buyback would render the dividend yield at 13% – would the market be able to resist?

The funny thing is that there is a low enough price that one would actually want to purchase more Yellow Pages. Good luck, however – it takes about 2,000 shares of trading to move the stock price 70 cents per share!

I have had countless amusement and bewilderment, not to mention immediately dismissive and credibility-destroying reactions when telling people this is my longest lasting investment currently in my portfolio. For good memories, read my coming out of the Yellow Pages closet here.

Inflation – boosts prices, but boosts costs as well

When inflation is mentioned, instinctively one’s financial reaction is to own hard assets – the asset value will rise in nominal terms. In real terms, the value stays static – if you go and buy a lawnmower, that lawnmower will keep its value as a great grass-clipping instrument minus the accumulated depreciation of usage. Non-depreciating hard assets are even better, but owning a stack of silver bars does nothing except sit there and look pretty unless if you’re planning on processing the material into some better industrial usage (like analog photography!).

Another logical place would be to invest in companies producing hard assets, such as mining companies. However, the cost to haul materials out of the ground and to refine them are also subject to inflationary pressures.

Looking at the metallurgical coal market, spot Australian met coal has been reaching lofty levels (about US$350/ton), so the few publicly traded companies out there have been able to make a fortune given that costs are typically much lower than this price level. The demand for steelmaking coal is still strong despite recession concerns (although headwinds are forming – take a look at STLC, for example).

The commodity, however, has to get itself out of the ground and loaded onto ships. There is a gigantic volume of material to process. This takes capital and expertise – capital was fairly easy to obtain since most of the coal companies have delevered and can access plenty of money, but it is clear the expertise (having people with brains and experience to do the job) is getting more expensive by the month.

On October 2, 2023, ARCH delivered the following guidance (an earnings warning):

… due primarily to ongoing challenges mining in the first longwall district at its Leer South mine [,] Arch is revising its full year 2023 guidance for coking coal sales volumes to 8.6 to 8.9 million tons and its average metallurgical cash cost guidance to $88 to $91 per ton.

Contrast this with their July 27, 2023 release which had guidance at 8.9 to 9.7 million tons and a $79 to $89/ton cash cost.

On October 12, 2023, AMR delivered the following guidance (another earnings warning):

On top of some weather-related problems that caused vessel delays in the quarter, we experienced mechanical issues at DTA that hampered the ability to load and ship our coal. … Along with lower-than-expected shipment volumes in the quarter, we sold some lower-priced tons from the development areas at new mines during the pricing trough early in the quarter, which negatively impacted our average realizations for the period.

In light of the logistics challenges we have experienced throughout the year, we lowered our overall shipment volume guidance and tightened the ranges to reflect our expectations for the balance of the year. Additionally, due to further investments in employee wages as well as the significant movement of the met coal indices, which directly impact sales-related costs, we are increasing our Met segment cost of coal sales guidance for the full year.

“due to further investments in employee wages” – i.e. you need to pay people a lot to show up to work for a very dirty job these days! This was a triple whammy – lower volumes, lower realization of pricing, and increased costs. On the cost side, it went from $106-112/ton to $110-113/ton.

These are not likely to be the only, nor last warnings on costs coming out of commodity companies going forward. We are seeing these costs increase on almost all commodity firms – the question is how well each individual firm can roll up their sleeves and retain talent. Eventually the demand-supply dynamic of the commodity product will normalize and resemble some function of cost and when this occurs, the low cost producers will survive, while the higher cost producers will face increasing financial pressure until some entities break and cease production. Given the lack of capital pipeline in the fossil fuel world, this might take longer than a traditional commodity cycle, but it will eventually occur.

There will be a day when I will be writing about things other than commodities, but valuation-wise, many of those commodity equities are still trading at valuations that are nowhere close to those of the broader markets, both for ESG-exclusion reasons and anticipation that the industry is somehow going to be imperiled by some phase-out. It is very ironic that this belief is one of the primary causes of the industry’s profitability at present – capital constraint restricting supply is creating a higher price environment than if capital were flowing freely.

Aimia receives a go-private offer

Two going private offers in the same day!

Aimia (TSX: AIM) – a company I have written about here many times before in the past – is receiving a $3.66/share cash offer from its 30% shareholder, Mithaq Capital.

Needless to say it is terrible to be a shareholder of Aimia – do you take the $3.66 sure bet and cash yourself out at under 40% of book value (albeit dropping despite them having invested a ton of money into two private businesses) or do you hold on and put up with the completely sub-standard management that could have done far better by just sticking their money into an S&P 500 index fund? Tough decision.

One thing I do know – part of Aimia’s value proposition is its $269 million in capital losses that has accumulated since June 30, 2023. If this buyout does proceed, Aimia will not be able to utilize this. That said, glossing over their portfolio, I’m not sure how much in the way of capital gains management could realize going forward, so perhaps it doesn’t matter.

The only question I would have is for those preferred shareholders – they are very illiquid and are trading at around 12% yields at the rate-reset assuming the 5-year government bond trades as it is today.

Neighbourly Pharmacy going private

Just over two years ago, Neighbourly Pharmacy (TSX: NBLY) went public at $17/share.

Their valuation post-IPO puzzled me given the relatively simple nature of the business (retail pharmacy consolidator) and especially given the competitive landscape (you’re competing against Loblaws a.k.a. Shopper’s Drug Mart, Rexall, and the like). So while I kept a corner of one eye in the stock, I was never really interested.

The balance sheet also traded like a serial acquirer – tangible networth was negative, and financial metrics weren’t that great in relation to valuation despite posting quite healthy “adjusted EBITDA” numbers. They had lease liabilities as one might expect from a retail pharmacy operation. More relevantly, they had a couple hundred million in debt which wasn’t over-leveraged but wasn’t exactly confidence-inspiring given the interest rate environment (the loan was at BA-plus and termed to May 2026).

However, in the past few months, the stock really started to trade down to a point where I was getting interested.

They got as low as $12.05/share yesterday before today morning their 50% shareholder decided to just say ‘screw it’ and put in an offer to buy the remaining half and go private for $20.50/share. It is very likely the offer will be accepted by the remaining shareholders. They would be stupid not to.

It’s too bad considering that my own pen-and-paper valuation would have started buying them below $10/share (about 5 times EBITDA). Sort of got close, but not quite.

The analogy here is like a leopard or cheetah stalking in tall grass looking at a target and waiting for the right moment to pounce, but in this case the prey got away before they even got to the point where they were close. There will be other opportunities ahead but there is always this feeling of regret when you put some of your most valuable commodity (time and brainpower) into something that doesn’t come to fruition.

Pipestone Energy – Strathcona Resources

Shareholders of Pipestone Energy last Wednesday approved (with a 67/33% yes/no vote) a reverse merger with Strathcona Resources. Strathcona (substantially owned by a private fund) will own 91% of the remaining entity, while Pipestone shareholders will own 9%.

Needless to say the valuation received by Pipestone shareholders was lacklustre (hence describing the minority protest vote). On August 1st, when the reverse merger was announced, the stock traded down 10% to close at $2.42. After the deal with approved, the stock is now at $2.14. It has dramatically unperformed as almost every other oil and gas equity has appreciated considerably since then. Next week they will complete the acquisition and there will be a share consolidation.

Strathcona has assembled a bunch of relatively interesting assets over the past decade. Considering I have owned debt securities of some of the entrails they have devoured, it is something I still keep track of once in awhile, but now they are public I can continue taking a more relevant look at them.

One of them was the acquisition of Pengrowth Energy for $0.05 a share (and the assumption of their not-inconsiderable at the time debt of about $700 million). I had owned Pengrowth’s convertible debentures ages ago (and they were matured at par, pretty much just before the company was running into liquidity issues). An interesting asset was the SAGD heavy project near Lindbergh, but it was relatively inefficient (recently reported steam to oil ratio was around 4), producing around 20k boe/d.

The total estimated production of Strathcona and Pipestone is 185,000 barrels/day, at apparently a $735 million sustained capital spend (this estimate seems a little bit low in my estimation). At US$80 WTI the estimated EBITDA is $2.5 billion. The metrics at the current commodity price structure is relatively favourable. The market cap, at $2.14/share, will be about $6.8 billion and the debt that will get added on will be in excess of $3 billion. Relatively speaking, the valuation is roughly in the ballpark of (a small number of) peers, so paying attention to asset quality and management’s intentions on how to best work with their capital remain to be seen.

One thing is undeniable – Waterous Energy Fund (the private owner of Strathcona Resources) is going to make a fortune on their investment in Pengrowth Energy made back in 2019. They timed the low nearly perfectly (I do not think they could be faulted for not foreseeing Covid-19). That said, there are other companies out there that have proven shareholder-friendly policies and are trading at even better valuations.