Another example of yield chasing

6 August, 2010 | Sacha Peter | No Comment

Just after a week since I posted a review of Superior Plus, declaring that they probably would have to reduce their dividends in order to be financially sustainable, they announced their quarterly results today. Notably, they lowered expectations for 2010 due to warmer weather (and therefore less natural gas deliveries).

They also had the following snippet in their quarterly release:

- The financial outlook for 2010 has been revised to AOCF per share of $1.50 to $1.65 as a result of lower than anticipated second quarter results and a weaker than previously anticipated economic recovery for the remainder of 2010.

- The financial outlook for 2011 has been revised to AOCF per share of $1.85 to $2.05 as a result of a weaker than previously anticipated economic recovery forecasted for the remainder of 2010 and throughout 2011, particularly impacting Superior’s Construction Products Distribution business.

AOCF is “Adjusted operating cash flow”, which is a non-GAAP metric to approximate how much cash before capital expenditures is available to the corporation. Since their dividend rate is $1.62/share, this leaves the company little to negative real cash to provide for acquisitions (which they have done plenty of over the past couple years), debt repayment or capital projects.

The company’s stock traded down 7.9% as a reaction to their disappointing report.

Investors undoubtedly will be looking at Superior Plus’s 13.03% dividend yield and marvel what a bargain they are getting, but it seems likely they will be forced to reduce dividends and this is reflected in the market price.

Interestingly enough, Superior Plus has four issues of debentures that trade on the TSX – the issue maturing in December 2012 has a yield to maturity of 4.5%, while the issue maturing July 2017 has a yield to maturity of 5.9%. They appear to be priced very expensive and I would not touch them.

Tags:
Posted in Canada | No Comments »

Dividend payouts is not a reliable financial metric

6 August, 2010 | Sacha Peter | 1 Comment

I note that Manitoba Telecom, a boring but profitable firm providing telecommunication services in Manitoba, released their quarterly results today with a dividend cut – from $2.60/share to $1.70/share, paid quarterly.

With 65 million shares outstanding, this amounted to a reduction from $169M/year to $111M/year.

Given its free cash flow, which is now estimated to be around $160-190 million, this is a rational decision by management because it will give the company some room to either build up cash reserves or de-leverage from its approximate billion dollar long-term debt balance.

The market took down the common stock from $27.32/share to $24.98/share. Part of this is due to the reduction in expected earnings, but also likely due to investors bailing out on the payout cut.

The important lesson for an investor is that you cannot just look at the dividend yield and assume it will be stable – the company must be able to make enough cash, plus enough for future capital expenditures and debt repayments, in order to justify that dividend. Ultimately, the dividend itself is a metric that is should only weakly associated with the proper valuation of an equity security.

Manitoba Telecom has been on my watchlist for ages, but I still do not find any compelling value in the stock. This is another classic case of yield chasers getting burned.

Tags:
Posted in Canada | 1 Comment »

BC Lower Mainland Real Estate liquidity drying up

5 August, 2010 | Sacha Peter | No Comment

Skimming the Greater Vancouver Real Estate, and the Fraser Valley Real Estate statistics packages, it is not surprising in the least to see volumes decline in the July month-to-month comparisons.

The reason is very simple – the introduction of the HST and the threat of higher interest rates. While HST has an impact on new homes sold, the threat of higher interest rates also pushed demand forward. Even though short term interest rates have a smaller impact on the longer-term fixed rates than most people think, it is likely that most financially unsophisticated people would think that rates (at least in the short run) are going up, so they must “lock” their purchases in today.

Usually the opposite thinking works better – the best time to buy real estate are when interest rates are high – since real estate is a credit-driven market, one would surmise that once credit becomes more expensive, real estate demand would drop and subsequently prices would have to lower in order for transactions to proceed.

If the 50% reduction in sales reported is sustained for the following year, you are bound to see price reductions as people that need liquidity in the short-term will be forced to reduce their asking prices. The people that are not urgently seeking liquidity are more likely to sit on their high asking prices and not have a transaction occur.

In terms of sheer valuation (costs vs. income potential/rent savings), Vancouver real estate is by far and away an expensive option. I’ve already explained some other intangible components to the valuation, but one major pillar of real estate has been its “safety” perception by the local populace. Once the “real estate is safe and/or never loses value” mantra disappears, you remove one of the intangible components of demand in the market.

I do not foresee a collapse in the market like we saw in certain USA markets, but a protracted period of time where the price level does not move and/or a slow downturn in prices is likely in the cards.

Posted in Canada, Real Estate | No Comments »

Rogers Sugar announces 3rd quarter results

4 August, 2010 | Sacha Peter | 4 Comments

Rogers Sugar Income Fund announced their quarterly results yesterday. The operational performance is not relevant to this post, but rather the announcement of how they will be treating their distributions after 2010 is over:

Management of Lantic and the Board of Trustees of the Fund continue to work on a plan to convert from the current income trust structure to a more conventional corporate structure. This conversion is expected to be effective as of January 1, 2011, in order to allow the current Unitholders of the Fund to maximize the benefits of the current income trust structure. The current intention is to pay quarterly dividends of approximately $0.085 per share, in order to maintain cash dividends to shareholders of the converted structure at levels that would provide an after-tax distribution equivalent to that currently enjoyed by our taxable Canadian Unitholders. The amount of dividends paid following the conversion will be at the discretion of our Board, and will be evaluated quarterly and may be revised subject to business circumstances and expected capital requirements depending on, among other things, earnings and other conditions existing from time to time.

Currently the distribution rate is $0.46/unit of interest income. At yesterday’s closing price of $4.91/unit, this translates into a 9.37% yield. A $0.085/quarter dividend translates into $0.34/year, or a 6.92% dividend rate. This is also a 26% haircut from the current payout rate. This is relatively comparable to other businesses that are publicly traded and give out dividends representing most of the free cash flow of the corporation.

The following table is a before-and-after concerning a unitholder’s after-tax distributions in British Columbia, assuming the units are held in a non-registered account, using 2010 rates (which is a critical assumption of this model, 2011 marginal rates will be slightly different due to changes in the dividend tax credit):

After-Tax Income:
Income Range Marginal Rates $0.46 $0.34
Low High Income Dividends Income Dividend Difference:
$ - $ 35,859 20.06% -12.59% $ 0.368 $0.383 (0.0151)
$ 35,859 $ 40,970 22.70% -8.79% $ 0.356 $0.370 (0.0143)
$ 40,970 $ 71,719 29.70% 1.29% $ 0.323 $0.336 (0.0122)
$ 71,719 $ 81,941 32.50% 5.32% $ 0.311 $0.322 (0.0114)
$ 81,941 $ 82,342 36.50% 11.08% $ 0.292 $0.302 (0.0102)
$ 82,342 $ 99,987 38.29% 13.66% $ 0.284 $0.294 (0.0097)
$ 99,987 $ 127,021 40.70% 17.13% $ 0.273 $0.282 (0.0090)
> $127021 43.70% 21.45% $ 0.259 $0.267 (0.0081)

As we can see, the after-tax dividend post-2011 is slightly higher than the pre-tax income distribution for all income brackets.

Also, as I have written before, anybody holding income trust units (other than REITs) in their RRSPs and TFSAs should be moving them into their non-registered accounts at the beginning of 2011.

After-Tax: After-Tax:
Income Range Marginal Rates $0.46 $0.34
Low High Income Dividends Income Dividend Difference:
$ - $ 35,859 20.06% -12.59% $ 0.368 $0.383 (0.0151)
$ 35,859 $ 40,970 22.70% -8.79% $ 0.356 $0.370 (0.0143)
$ 40,970 $ 71,719 29.70% 1.29% $ 0.323 $0.336 (0.0122)
$ 71,719 $ 81,941 32.50% 5.32% $ 0.311 $0.322 (0.0114)
$ 81,941 $ 82,342 36.50% 11.08% $ 0.292 $0.302 (0.0102)
$ 82,342 $ 99,987 38.29% 13.66% $ 0.284 $0.294 (0.0097)
$ 99,987 $ 127,021 40.70% 17.13% $ 0.273 $0.282 (0.0090)
> $127021 43.70% 21.45% $ 0.259 $0.267 (0.0081)

Tags:
Posted in Canada | 4 Comments »

Dog days of Summer

3 August, 2010 | Sacha Peter | 2 Comments

August is the month that the market (including myself) takes a break.

Thus, any action you see in the marketplace should be taken with a grain of salt.

I am in the camp that the next macroeconomic foot to drop will be related to the onset of inflationary pressure, but in order to see this you need a very spontaneous change of mentality amongst market participants that cash is something to be throw into assets, as opposed to cherished because of high uncertainty in terms of US government policy. There has been a lot of money throw into the economy, but the money has not been sloshing around – it has been saved up in the balance sheets of financial corporations. When this money eventually gets released, it will be ugly.

However, the bond market, where you can lend your money to the US government at 2.91% for 10 years, seems to say otherwise.

It is very difficult to predict exactly when this phenomenon will occur, or whether I am just another kooky market analyst that has no idea what he is talking about. There is one element that I think everybody can agree with – the sheer amount of government debt will be crippling unless if there is some sort of monetary inflation, whether now or later. It is very unlikely that the government will be repaying this debt with equal-value or deflated-value (i.e. higher purchasing power) dollars.

In the meantime, I continue to wait patiently and observe where the currents are going. My current answer is that the money is swimming to income-oriented securities and since my portfolio has been loaded with these since early 2009, I will be waiting for appropriate exit opportunities. Even after all of the investment managers turn off the autopilot switch on their portfolios when they return home this September, I don’t think it will be the end of the universe for fixed-income securities. This is fortunate since some positions are at the upper range of my price bands and I don’t want to needlessly dispose them in calendar year 2010 exclusively for tax reasons. Although taxation is important, it should not dominate the decision to sell a security above fair value.

Posted in Canada | 2 Comments »

Canadian mobile service market heats up

28 July, 2010 | Sacha Peter | No Comment

Rogers has just fired their own broadside with the introduction of another virtual mobile service, Chatr, which feeds off of their own phone network (very similar to Fido, another Rogers-owned company).

It is very obvious with their pricing structure, and the cities that they are in that they are strictly trying to wipe out Wind Mobile and/or Mobilicity off the face of the planet. What’s hilarious is that Wind Mobile has no spectrum license in Quebec (other than the Ottawa-Gatineau area), and Rogers/Chatr’s service offerings are identical to the locations offered by Wind Mobile – Vancouver, Edmonton, Calgary, Toronto and Ottawa. On Montreal, they stated:

“We’re working out some translation issues in Montreal, but it will very soon be our sixth market,” Chatr’s senior vice-president Garrick Tiplady said in an interview.

Translation issues indeed! More like “There’s no rush since our competition isn’t there!”

You can be sure as Wind Mobile expands to other cities and/or expands their coverage in their existing cities, that Chatr will come up with “service enhancements” to incorporate those areas into their own “home network” as well.

Their pricing plan is, for the most part, identical to Wind Mobile’s structure, with the most notable exception that on Rogers/Chatr’s $35 plan, they charge 25 cents to recover your voicemail, and they charge for incoming text messages.

Since the coverage areas between Chatr and Wind is nearly identical, I have no idea who would sign up to them.

As I stated in a previous post, the new entrants to the Canadian wireless market are not going to be making any money. The only reason why Rogers is doing any of this is to bankrupt Wind Mobile and Mobilicity – Rogers/Chatr’s offering adds absolutely no value whatsoever to the Canadian mobile marketplace other than wasting consumer’s time as they have yet another offering to review.

Posted in Canada | No Comments »

Superior Plus – why do they look cheap?

28 July, 2010 | Sacha Peter | 1 Comment

A company that has always stuck out like a sore thumb on my stock screens has been Superior Plus (TSE: SPB). It does this by virtue of its relatively high dividend yield ($1.62/share, $13.50/share = 12%). It converted from an income trust to a corporation and did not reduce its payout rate simply because it was able to engage in some financial engineering to give it a very, very significant tax shield ($800 million in pre-tax income = approximately $200M in tax) against future income taxes.

Putting a complicated tax story into simple terms, income trusts were able to engage in transactions with loss-bearing corporations to give themselves a shield against future income taxes, something corporations were unable to do because there are extensive CRA rules that explicitly define how you can and cannot do it. Superior Plus essentially bought out Ballard Power Systems, while the previous Ballard Power Systems formed a new corporation, transferred its assets to that corporation, and life went on as normal, except that they monetized $800 million in tax losses for approximately $50 million. The Canadian government was able to close this for future income trusts in the 2010 budget.

One reason why Superior Plus is able to maintain their high dividend rate is that they can avoid paying Canadian income taxes for the foreseeable future, assuming the CRA and/or tax courts will rule that such transactions were valid (i.e. they had some form of business substance opposed for just doing a transaction for tax reasons, which there are court precedents established). So their CFO gets high grades for pulling off that transaction, assuming it works!

The company itself is diversified into four segments – energy (propane, fixed-price energy contracts), specialty chemicals and construction products dealing with insulation, walls and ceilings. The businesses weighting, by gross profit as stated in the March 2010 quarterly financials, is roughly 60/20/20. The company traditionally has been profitable, with revenues around $2.2-$2.5 billion, and income around the $70M range in the last two full fiscal years. Cash generation has been significant, with about $200M generated in the last two years, and averaging about $100M in capital expenditures. Dividend payments are about $150M/year at the existing rate.

This is the area where an investor should stop and think – if your business is sending $250M out the door, but is only generating $200M in cash, how does that get bridged? Long term debt issuance. Indeed, debt from the end of 2007 to 2009 has gone up approximately $370M to pay for this and some acquisitions. About half their total debt load is in bank loans, and half of it is in debentures. Indeed, the market doesn’t seem to mind this – their debentures are all trading close to par value. Their balance sheet otherwise is unremarkable, with equity minus goodwill/intangibles at around negative $150M.

Unless if Superior Plus is able to either generate more cash, or reduce capital expenditures, their dividends currently are unsustainable and probably need to be chopped by about 25% or so for the health of the overall company. They would be smart to think about de-leveraging a little bit – they have about $240M of debentures due in December 2012 and one would consider that the after-tax cost of capital is higher when you have such a huge tax shield to work with.

This is likely the reason why Superior Plus is trading relatively “cheaply” – investors clearly have priced in the fact that their dividend distribution rate is too high given their cash flow and capital expenditure requirements. The company otherwise appears to be in good shape, but I won’t be investing in their equity at existing prices.

Tags:
Posted in Equity | 1 Comment »

Fine-tuning my BP model

27 July, 2010 | Sacha Peter | No Comment

About two weeks ago I stated to exit “between $45 to $50/share”, but there have been a couple significant events between now and then and the price response I’ve judged – one is the departure of the CEO (which was to be expected for his very lackluster performance in this whole matter – he did not care, and won’t be caring after a massive severance package payout) and the accrual for the project (approximately $32 billion dollars) which was roughly what I had expected (my estimate was $40 billion). Note that this amount is not a cash amount, but rather it is an accrual expected to be paid out in the future. If the oil spill is less damaging than expected, they will reverse this in the future and take a gain.

Because of income tax provisioning, the after-tax cost to shareholders will be less than this.

Also you can be sure that other, less performing projects will be thrown under the bus – this is always something to be aware of when companies make massive charge-outs. Tech companies doing mergers back in the internet boom were infamous for doing this, and was a reason why such financial statements looked better – if you keep on taking “one time charges”, your continuing operations will look great!

Since predicting the price of BP has been much more of a political game than financial, I believe being able to compile both sectors into a blended decision is one of my competitive strengths in the marketplace. Upon retrospection, I believe my initial price estimate for BP was high, and will now lower my exit parameters to “$42 to $47″ per share. I would hazard a guess that it will get into this range by year’s end as the public consciousness fades onto other issues – such as the impending war in the Middle East (due before Obama’s exit in 2012) and how the US Congress will end up making themselves look like even bigger fools in a mis-guided attempt to save their collective skins in the November mid-term elections. The collateral damage that both events will leave should erase the BP oil spill from our short-term memories.

Since the price target is not materially above BP’s existing share price, the risk/reward ratio is not tremendously good. Obviously back a couple months ago when oil was still gushing in the Gulf, the risk was much higher. The “emotional” feel of this story is a fairly good lesson on the rule of the stock market – you don’t see low prices without risk. If you see what you think is a low price, but can’t see what the risk is, then chances are there is a hidden risk out there you are not aware of. Find out what it is before buying.

Finally, on the issue of collateral damage, Anadarko (NYSE: APC) and Transocean (NYSE: RIG) which had a 25% residual interest in the project and the drilling contractor, respectively, have both gotten killed in this crisis. They both look like better risk/reward ratios than BP is at the moment.

Posted in Canada, Equity | No Comments »

Income trust conversions and RRSPs

26 July, 2010 | Sacha Peter | No Comment

On January 1, 2011 there will be a slew of Canadian income trusts that will be converting to corporations. In addition to these, all other income trusts that are not related to real estate will have their distributions taxed. Either way, the dividends or distributions will be considered eligible dividend income for a Canadian investor.

This means that for those investors that have these instruments in an RRSP that what was previously given off as income will now be heavily favoured with respect to taxation, and will be relinquishing the tax benefit by keeping these securities. The obvious action would be to swap these securities with equivalent cash at the beginning of 2011. You can then populate the RRSP by purchasing the relevant income-bearing securities when the market timing is convenient.

A middle-income bracket investor in BC (between $41k and $72k) that is able to shift $1,000 of dividend income from the RRSP to a non-registered account, and swapping into the RRSP $1,000 of straight income will be saving approximately $284.10 at tax time.

It is worth thinking about this procedure throughout the second half of 2010 and see if one can purchase income-bearing instruments if/when the market conditions are appropriate. It is also a good time to think about portfolio balancing.

What is making life difficult for most income investors is that income investing (such as going for dividends or securities with larger-than-GIC yields such as preferred shares) is coming back in vogue with the retail investing arm. Such securities are being purchased without consideration of underlying value in the company’s ability to pay such income. An example would be the equity of Rio-Can, which is the largest Canadian REIT; although I believe their income payouts (6.88% on a $20.05 unit price at present) is stable, in terms of valuation, investors are purchasing something that appears to be more than fully valued and will likely not provide material upside on income payouts.

If/when the debt market seize up again, such securities will look significantly more attractive than they are today. Chasing yield when the going is good involves much more risk than chasing yields in the middle of a crisis.

Posted in Canada, Taxation | No Comments »

Why RESPs are not a popular product

26 July, 2010 | Sacha Peter | No Comment

I extensively analyzed RESP’s in an earlier post, coming to the conclusion that a person is likely better to wait until the last moment that they are convinced their children will be heading to upper-level education before opening one.

The Globe and Mail is reporting how RESPs are having a rather lacking participation rate and goes into detail why this may be the case. I believe the explanation is simpler than this, and it boils down to two reasons:

1. People do not have disposable income to invest in an RESP, and are choosing to allocate it elsewhere for more immediate priorities;
2. Opening up an RESP leads to potential losses, and people would not want to lose money on their children’s education fund compared to their own investments – ergo, they will be sticking to extremely safe fixed-income products, and given the interest rates available, it is not really worth it at the moment.

There are plenty of scholarship funds out there that try to prey on people that fall under category #2; unfortunately for those that read the fine print, they will likely be throwing away their money on these conceived structured products that are designed to enrich the scholarship fund managers.

The government is trying to promote RESPs to lower income individuals by offering significant incentives to putting money in them. For example, if you earn less than $40,970 in a year, you will qualify for the Canada Learning Bond, which is a “free” $500 plus $100/year that your income is below that level into the RESP. If your income is less than $38,832/year, your contributions will be eligible for a 40% match by the government for the Canada Education Savings Grant, as opposed to the 30% or 20% brackets if you make more income.

Many lower income individuals are usually too busy working to pay attention to any of this and thus will not be taking advantage of money of these benefits. This is even assuming they are not falling under category #1, mainly that they do not have enough disposable income to be thinking about RESPs for their children.

Posted in Canada | No Comments »

« Newer Entries
Older Entries »