Rogers Sugar Q4-2019 – not a good trend

Rogers Sugar reported their fiscal year-end results yesterday. I wrote about them mostly recently in their last quarter. The erosion of the profitability of their maple division is continuing to hurt the company. The highlight is the following:

Rogers is able to make a 17% gross profit on sugar refining, and this has been stable (indeed, threat of substitutes is the primary competitive force). However, on the maple division, profitability has continued to decrease due to competition. This is continuing to hurt the company’s financial performance.

On the cash side, the company continues to distribute more capital in dividends than they are able to sustain with operating cash flows plus capital expenditures:

This is financed with debentures, and a bank line of credit and a revolving facility – which is increasing. The credit pressure will increase if this keeps up. They even spent a little bit buying back stock despite the cash situation, which they probably rationalize in their heads by a 6.9% yield rate (at the $5.22/share they purchased the stock with the 36 cent dividend), but without paying attention to the debt, these sorts of repurchases are going to be much more expensive for shareholders today!

We see the equity markets are starting to get concerned – Rogers is down about 5% today after the annual report. Rogers does have a couple convertible debenture series outstanding which are trading near par presently (with a 5% and 4.75% coupon, maturing in December 2024 and June 2025, respectively) which clearly shows they are not in dire straits by any means, but things are headed in the wrong direction.

The clear conclusion is that the diversification into maple is not turning out very well – the people selling the businesses probably knew more than Rogers did about the future outcome.

At $4.80/share I am still not interested in the equity, although I’m sure yield chasers will love the 7.5% yield.

Gran Colombia Gold’s confusing capital allocation strategy, part 2

Read “part 1” here. Gran Colombia Gold (TSX: GCM) announced their quarterly results a few days ago.

At September 30, 2019, the cash position was at US$63.2 million. There is another US$5.8 million that goes to the noteholders. Total debt is US$91 million (US$73.6 million in notes due April 2024, CAD$20 million in convertible debentures due April 2024, convertible at CAD$4.75). The leverage situation is better than it has been for these guys for ages.

Cash-wise, in the past 9 months, the company has made US$38.7 million in free cash flow (operating minus expenditures on mines, but not including SSP.TO investments). As long as gold remains at current price levels, they should be able to generate cash along these lines.

Now this is where things get wonky.

From June 12, 2019 through September 30, 2019, the Company purchased a total of 137,100 warrants for cancellation at an average price of CA$2.41 per 2024 Warrant.

The warrants have a strike price of CAD$2.21/share. Ignoring the time value of the warrants (which is not inconsiderable), GCM effectively repurchased stock at CAD$4.62/share. If they repurchased the actual common shares, they would have paid less.

On November 5, 2019, the Company closed a non-brokered private placement (the “Private Placement”) with 2176423 Ontario Ltd., a corporation that is beneficially owned by Eric Sprott. Through the Private Placement, Mr. Sprott acquired 3,260,870 units of the Company at a price of CA$4.60 per unit for a total investment of CA$15 million, the proceeds of which will be used for general working capital and corporate purposes. Each unit consists of one common share and one common share purchase warrant exercisable into a full common share at CA$5.40 per share expiring November 5, 2023.

This is just strange and contradictory capital allocation. A few months after effectively repurchasing stock at $4.62/share, they then sell a bunch of it at $4.60. There was no need to raise CAD$20 million in debentures back in April 2019, and there is no need to raise CAD$15 million in November… unless if they’re planning on blowing a lot of money on everything else. Their common stock would likely be higher today if they had not done so.

The notes are very likely to be called out or mature, while the common stock will be quite sensitive to the price of gold.

One other theory that I have is the following, and this is relating to GCM dumping their selling partners late last year:

As described in Note 11a, in January 2019, the Company terminated its long-term supply agreement related to the sale of its gold and silver production in Colombia. On May 10, 2019, the Company received notice of a request to settle the dispute, as permitted under the supply agreement, under the Rules of Arbitration of the International Chamber of Commerce. In its notice of arbitration, the former customer has requested reinstatement of the supply agreement and damages related to the intervening period since the supply agreement was terminated. In the alternative, the former customer is claiming general damages in the amount of $50 million, or such other amount as may be determined prior to or at the arbitration, punitive and/or exemplary damages of $1 million, repayment of $0.2 million of disputed interest and reimbursement of costs and expenses related to the arbitration. The Company believes as a result of breach of performance by the former customer on numerous occasions that it had a justifiable basis for terminating the supply agreement and will vigorously defend its position in the arbitration proceedings. The Company believes that it is more likely than not that it will not have any liability from arbitration.

If the company has a 49% probability they will have liability (which is “more likely than not it will not”), they might have a justification for assembling a bunch of cash – much better to have it on hand to pay out instead of scrambling into the markets with your hand stretched out!

The end of Temple Hotels

Temple Hotels (TSX: TPH) is finally going to be removed from the public markets for CAD$2.10/share by majority shareholder Morguard (TSX: MRC).

Temple has been the target of a slow motion takeover which, in 2015, was effectively finalized by Morguard by the assumption of its asset management agreement, and repurchase of debt securities. After, they proceeded to raise capital through rights offerings which resulted in Morguard accumulating a 73% stake in the company. An entity associated with Clarke’s (TSX: CKI) Armoyan, owns 17% of Temple and agreed to be bought out by this price.

I said a long time ago I was wondering what the heck Morguard was doing meddling with Temple given Temple’s financial statements – even after injecting a bunch of equity capital, the company still appears to have sub-standard financial metrics. Four years after this slow motion takeover, my thoughts still persist. It’s one reason why I wasn’t exactly looking at the prospect of buying equity at CAD$1.80/pop, which was the trading price it was very thinly trading at for most of this year (heaven forbid if I was forced to participate in another rights offering).

Statement on Brookfield Asset Management and its family of subsidiaries

Too complex. Bruce Flatt is undoubtedly a genius (in John Malone style), but compare Brookfield with the relative simplicity of Berkshire (despite Berkshire controlling a much larger asset base) and there is such a huge night and day difference. My general issue with large conglomerates with lots of partially owned but controlled subsidiaries is that you run into agency issues with the boards having common members, but having to guess which arm of the company is going to be advantaged (or whether it mostly flows to management).

So a long time ago, I excluded Brookfield and its subsidiaries from being investment candidates – too difficult. I’ve always taken a superficial liking to Brookfield Property Partners (TSX: BPY.UN) (their takeover of General Growth was well timed), but even that entity has a snake’s pit of issues relating to structure. There’s a whole bunch of other REITs trading on the TSX (and indeed the NYSE) that give property exposure with a lot less complexity.

The DREAM preferred share comes to an end

Dream Unlimited (TSX: DRM) had a class of preferred share (TSX: DRM.PR.A), which by virtue of their split from Dundee Corp (TSX: DC.A) had an unusual characteristic – it had a par value of $7.16/share, and was redeemable by the company or the shareholder at any time. In the meantime, it paid out a quarterly coupon of 12.53 cents per share, or 7% on par. The company retained an option to redeem the preferred shares for their own stock at 95% of a prior trading range of DRM stock or cash (or a $2 floor).

This preferred share has been trading for quite some time, and by virtue of DRM’s relatively stable balance sheet, was never in threat of suspending its dividend.

As such, yield-hungry investors could use this preferred share as a cash parking vessel. Even better yet, the dividends that were paid were eligible dividends which would qualify for the dividend tax credit in non-registered accounts. Over time, however, DRM.PR.A became over-utilized and started to trade at a significant premium to par:

The peak was on August 31, 2019 when some poor soul paid $7.56/share for this, or a 40 cent per share premium over par value. This investment would have taken over three quarters of dividends in order to pay itself off. Indeed, at this price the current yield would have been 6.63% for a perpetual investment.

All good things, however, come to an end. Today, DREAM Unlimited announced a substantial issuer bid on their common shares and also the following paragraph:

The Company also intends to redeem all of its outstanding First Preference shares, Series 1. As at November 11, 2019, there were 4,005,729 Preference shares, series 1, issued and outstanding. They may be redeemed at the option of Dream, at any time, at a price of $7.16 per share, plus all accrued or unpaid dividends up to but excluding the redemption date.

As such, one of the best cash parking vessels on the TSX will be off the ledgers. I would expect the shares to crash 4% tomorrow in trading. Fortunately I sold the last of my DRM.PR.A in 2018.

To my knowledge, there is only one other financial instrument that trades in a similar manner, which is Birchcliff Energy’s preferred shares (TSX: BIR.PR.C) which are redeemable by the holder as of June 30, 2020. They also give out a 7% coupon. They are also trading above par. Although the premium is very modest at present, when adjusting for the dividend dates it effectively makes these shares at a tiny discount. There is more balance sheet risk with Birchcliff given its spacing in the natural gas industry, hence why it is not trading wildly above par value at present, in addition to a potential share conversion price at a floor of $2/share (Birchcliff common closed at $2.21 today). I’ve held some of these since February 2016.