Equity – Page 34

Yellow Pages Q4-2019: Dividends re-instated

(Past post on Yellow Pages – November 2019)

Yellow Pages (TSX: Y) reported Q4-2019 results today and it featured the first balance sheet since its 2012 recapitalization where it did not have any senior secured debt. This was eliminated at the beginning of December.

The quarter also featured a shade under $30 million in free cash generation, or a shade above $1/share. The most impressive aspect of the business is that cash flows through operating activities actually increased year-to-year despite revenues dropping from $577 to $403 million. It pays to focus on profitable business and management has had an insane laser focus on cost containment. I have not seen anything like it in my entire investing history.

A business cannot last very long if revenues drop 30% a year, and if they can stem this challenge, which I believe they will, the stock will be going much higher than the $11.70 it closed at yesterday.

The only debt remaining is a $107 million issue of convertible debentures (TSX: YPG.DB) which will be redeemed at the earliest possible moment at par, on May 31, 2021. If they redeem earlier they pay a 10% pre-payment fee, which makes no sense to do it currently. The conversion price is $19.04, and if they start making a significant impact on their revenue decline while keeping 38-40% EBITDA margins, it will likely be the holders that decide to convert into shares when the redemption is announced.

Finally, because the shackles of the senior secure debt are finally off, management has the flexibility of engaging in capital allocation decisions involving dividends and share buybacks. I was expecting some sort of equity buyback decision (there is a considerable incentive to seeing a higher stock price both from an insider perspective but also equitizing the convertible debenture), but instead, management announced they will pay 11 cent quarterly dividends in Q2-2020. This works out to a 3.8% yield on the $11.70 closing price.

A dividend also creates some interesting implications for how the stock trades. Once again, it will be on the radar of Canadian income ETFs. My suspicion is that Yellow Pages will continue to receive an uptick of activity as passive vehicles slowly get back into the stock. If the market capitalization gets even higher, it will start getting into the liquidity range of even more ETFs. This is yet another example of how momentum is a valid market strategy – passive vehicles often weight their investments by relative market capitalization, and when that goes up, you have to buy more without caring about the price…

My own model and fair value assessment of this stock suggest it should go higher. So far they have generated cash better than my initial estimates when I got into the stock in the first place.

Who would have ever thought – Yellow Pages started as an income trust and was a ‘stable’ producer of distributions. I bet few people thought in 2011 (when they slashed dividends to zero) that they’d ever see this day.

Disclosure – presently, this is my largest holding.

Confusing Capital Allocation – Transforce

Transforce (TSX: TFII), now known as TFI International, announced their year-end earnings today.

This post is less concerned about the results (they did a good job generating plenty of cash and reporting a year-end net income of about $4/share), but the following paragraph:

CASH FLOW
Net cash from continuing operating activities was $665.3 million during 2019 versus $543.5 million the prior year. The 22% increase was due to stronger operating performance and the impact of the adoption of IFRS 16. The Company returned $336.4 million to shareholders during the year, of which $80.7 million was through dividends and $255.7 million was through share repurchases.

$255.7 million returned from share buybacks (and mostly purchased at a cost lower than the current stock price which is about $44/share).

However, the next press release is for a 6 million share public offering to list on the NYSE.

There’s two issues here.

One is that a 6 million share offering will raise about CAD$264 million gross, or roughly CAD$250 net after offering expenses, assuming the stock doesn’t tank tomorrow. This is approximately the amount the company bought back in shares in 2019.

The other is that (just like Target), the logistics of Canadian companies operating in the USA is fraught with new risks and dangers. TFII already operates across North America, so it is not like they will be new at it, but the observation is they are trying to move their “centre” south. It’s probably more of an indictment on what management thinks of the current economic climate in Canada.

Management does have a relatively good track record on capital allocation, but the buyback “and let’s do an IPO!” is confusing.

However, in fairness to management, their balance sheet is looking a little debt-heavy and de-leveraging might not be a bad decision in case if this future recession (which is almost cemented into mythology) occurs.

Genworth MI Q4-2019: Adding the leverage

Genworth MI (TSX: MIC) reported their year end results last week.

Operationally they’re still minting a lot of money – loss ratio is 20% for the quarter, expense ratio is 20%, so they continue to earn 60 cents pre-tax for every dollar of insurance premium revenue they book. There doesn’t appear to be any storm clouds on the horizon.

An observation I will make is that with the new majority shareholder (Brookfield), they appear to now be deliberately targeting a higher return on equity policy. The company has been distributing a lot of cash in the form of special dividends:

During the fourth quarter of 2019, the Company paid a special dividend of $1.45 per common share, for an aggregate amount of approximately $125 million, on October 11, 2019 and a special dividend of $2.32 per common share, for an aggregate amount of approximately $200 million, on December 30, 2019. On January 15, 2020, the Board of Directors declared a special dividend of $2.32 per common share for an aggregate amount of approximately $200 million. This special dividend will be paid on February 11, 2020 to shareholders of record at the close of business on January 28, 2020.

In the span of a few months, the company has given off $6.09 in special dividends. Obviously I sold my shares too early! With these special dividends, however, the company is trading at about a 30% premium over book value, which is uncharted territory. Clearly given the cash generation capability of this business, it is likely to continue, but I have always wondered when there will be more competitive pressures in this market space – which if it occurs, will result in a dramatically reduced profitability landscape for the company. It won’t be triggered by the federal government – CMHC makes the lion’s share of the profit in this marketplace.

The company is obviously going to increase its leverage in the near future – on January 16, 2020 they took out a credit facility to allow them to borrow $200 million for a year, and another $500 million for 5 years. Part of this will be to rollover the $175 million in debt they have that will mature on June 15, 2020 but the remainder of it will probably head out the window in the form of special dividends so they can increase their return on equity from 11% to something higher.

Such strategies work until they start to face a large amount of mortgage claims whenever this near-mythical next recession occurs!

Gran Colombia Gold’s confusing capital allocation strategy, part 3

(Part 1 on June 12, 2019; Part 2 on November 16, 2019)

Gran Colombia Gold (TSX: GCM) raised CAD$40 million in an equity offering priced at CAD$5.60 which included an additional 3-year warrant to purchase stock at CAD$6.50/share. The offering was initially announced on January 27, 2020 when the stock closed at CAD$5.74, so when you include the price of the warrant, it was a fairly steep discount. The stock was halted mid-day when they announced the offering and it surprisingly did not tank the stock (that day – there was about another hour of trading left when they re-opened the stock).

According to the January 27, 2020 release, “The net proceeds of the Private Placement will be used for general working capital and corporate purposes, including repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.“, which continues the theme of selling stock to repurchase warrants (very confusing).

The reality is that I suspect the Marmato mine project is going to be really, really, really expensive and they just want to vacuum up as much cash as possible while the going is good, and gold remains at relatively elevated prices (although I will no profess to knowing whether gold’s existing US$1,574/ounce price is going higher, lower or staying steady, but it is under the per-ounce cash costs of their main Segovia mining operation). Shareholder value (let alone issuing a dividend) be damned!

What got my interest, however, is the decision made when the offering closed on February 6, 2020:

Gran Colombia also announced today that it will use a portion of the net proceeds of the Private Placement to redeem 30%, equivalent to US$19,162,500, of the aggregate principal amount outstanding of its 8.25% Senior Secured Gold-Linked Notes due 2024 (the “Gold Notes”) (TSX: GCM.NT.U) on March 31, 2020 (the “Redemption Date”), reducing the aggregate principal amount outstanding to US$44,712,500. The redemption price will be equal to 100% of the aggregate principal amount of the Gold Notes redeemed plus the Applicable Premium calculated in accordance with the provisions of the Gold Notes Indenture, currently estimated to be approximately 10%. Further details, including the actual amount of the Applicable Premium, will be announced later in March as it gets closer to the Redemption Date. The balance of the net proceeds of the Private Placement will be used for general working capital and corporate purposes, including potential repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.

Considering that a non-trivial amount of my portfolio is in these notes, I took interest in this decision. They are using about CAD$28 million of the gross CAD$40 million in proceeds of the equity offering to close out some of these notes, which to my calculations, are effectively at a 16% coupon rate at current gold prices. A fairly good capital allocation decision if you ask me, although they easily have justification to retire the whole batch of notes if they wanted to!

The reason why they did what they did is simply because once the 30% of notes are redeemed, it releases security on Marmato – the notes will then only be secured by the Segovia mine operation. In light of its current production, I will be happy to continue collecting coupons and having the quarterly redemptions proceed until I get cashed out.

I have no position in GCM equity nor do I anticipate having any in the future.

Finally, this creates a capital allocation strategy issue for me in terms of where to re-deploy the cash. It really was happy earning a very low risk 16%, but sadly no longer.

Atlantic Power – just a matter of time

When a company pays back debt, its enterprise value drops (or more specifically, the cash generation which leads to debt paydown is the cause of the enterprise value decrease because EV is market cap minus net debt, but I’ll insert this in before somebody comments on my illogical statement!). All things being equal, when material amounts of debt are paid back and the underlying entity is cash flow positive, it should eventually reflect an increase in market capitalization. This process sometimes takes a long time.

Atlantic Power today announced a revision to their credit agreement, which dropped the interest rate payable by another 25 basis points (to LIBOR plus 250bps), and if they can get their leverage ratio to less than 2.75:1 then it will go down another 25 basis points further. Atlantic Power had US$400 million in term loans outstanding in September 30, 2019 so this will result in somewhat less than a million a year in annualized interest rate savings going forward.

Reading credit agreement amendments (original April 13, 2016) might not be exciting, but sometimes a few nuggets of information here and there come out which are interesting. Section 2.15(d) of the agreement has the following debt paydown table:

The term loan component is extended to April 2025 which completely eliminates short term credit risk. The de-leveraging is mostly finished. The question is when the market will start to price in equity appreciation – after 2022 the company still has 12 power plants that are under power purchase agreements and generating considerable amount of cash flows.