Superior Plus – expect a dividend cut

I have been posting about this very high-yield stock since late July, stating that their dividends would have to be chopped by about 25% or so to maintain their financial health.

Their last quarterly announcement was generally below expectations, and for the comparable period from 2009, they are down about $19M in operating cash flow.

They were trading at about $13.50/share when I posted about them originally, and they are now at $10.80/share. Their indicated dividend is still a whopping $1.62/share, but it is more likely than ever that management will reduce the dividend by a factor of 40-50% (compared to my expectations of 25% before), and that this increased dividend cut has been baked into the stock price. It is likely when they make the announcement the shares will drop further, as retail investors that assumed they were getting a 15% yield will be bailing out.

The company operationally makes money and will likely make money in the future, but their primary problem is they have slightly over a billion dollars of debt on the books and the financial leverage is quite high. SPB debentures are still all trading at around par, so management would be very wise to cut the dividend, and then lengthen the term structure of their debt – the first of which matures in December 2012. One never knows when this mania for fixed income will resolve itself.

SPB sticks out on my equity radar like a sore thumb (and likely on the radar of many others), but there is a reason why I am not buying it.

Whistler Blackcomb – quick IPO analysis

Whistler Blackcomb will be trading next week under ticker symbol WB in Toronto.

They priced their shares at $12 – down from the expected $15. The entity, assuming no exercise of the over-allotment, will have 37.8 million shares outstanding, so $12/share will have a capitalization of $454M.

The final prospectus was released on SEDAR yesterday and I went through it. What Fortress is leaving behind for the public is the empty husk of an entity that is heavily indebted, negative tangible equity on the balance sheet, and 97 cents of pre-capital expenditure cash flow to play with from the September 2009 fiscal year. 2010 will be a slightly worse year in terms of cash flow.

The biggest sham of this IPO is the dividend talk – 97.5 cents per share, based on a very flawed calculation on page 19 which will be very safe to say will not be sustained. Still, you will have enough retail investors that would be foolish enough to purchase shares strictly based on the 8.1% yield, but my guess is that this yield is not going to be sustainable in the medium term. They will have enough of a cash buffer ($29 million) to fund dividends beyond their cash generation, but it will not last long.

There is value in the shares, but certainly not at $12/share. This one is an easy avoid. I might take a look at the shares if they dip below about $5.30/share – they’ll likely get there once they cut distributions and/or have a bad season and/or are forced to recapitalize their $255 million debt.

There is more quantitative work that went behind this post, but for the sake of readability I have omitted most of it and stuck to the salient details of this IPO.

How this stock will trade will be interesting to watch – I suspect it will do a little better than $11.40/share (IPO proceeds minus fees) simply because it is an “income stock”.

The big macroeconomic picture

Sometimes when you step back, get away from the computer for a couple days, and then step forward again, you take a different perspective on things. Such as what to sort through first in an inbox that has 60 unread emails.

I have typically experienced that a hands-off approach works better than a hands-on approach to portfolio – every time you touch your portfolio, you have to be making a correct decision compared to the person on the other end of the trade.

This time when I returned, I noticed that practically all resource and commodity-based equities, in addition to the broad indexes were up. My portfolio received a minor increase, so it is always emotionally difficult to look at everything else go up, but I am buffering that against the fact that I have a risk-adverse portfolio with a significant amount of cash.

The two obvious factors that went on this week was:

1. US Congressional Elections – Republicans take the House, Democrats keep the Senate. My projection here is that the state of the fiscal situation in the US government will not change to a significant degree – there will be massive fiscal deficits for years to come. It will be unlikely that this new congress will be able to restore some sort of fiscal balance. In fact, the decision might be whether to bail out certain states or not, which have accrued liabilities that is far beyond their ability to pay. What is interesting is that the market predicted this result in advance, but there was no significant market reaction.

2. Federal Reserve engaging in potential quantitative easing – they announced a number less than what the market was expecting, but announced it nonetheless.

The big macro issue is that in order to stimulate exports, countries are reducing the value of their currency by pumping more of it into the economy, which you see in the form of government deficits. Since every country that has an export base is doing the same thing, you do not see much of a shift in relative valuation, but you do see a shift in valuations with hard assets, such as commodities and to a lesser degree, equity and debt. This creates a rather volatile situation in the marketplace.

I don’t know how this will resolve itself – my instinct has always been to purchase commodity-linked equities, but it feels like a crowded trade. Cash feels like it is depreciating by the day. Fixed income has valuation and risk/reward issues, especially if/when long term rates increase. Shorting long-term bonds is something to be considered, but doesn’t alleviate the problem of what to do with cash. Income-related securities have also been bidded to the roof, and barring any price corrections between now and year end, one of my 2011 predictions will be that income-related securities will underperform.

The least of what seems to be all ugly options is cash, specifically Canadian currency cash. There are a few reasons for this:

a. You can get a 2% yield on it (retail) or slightly less in institutional amounts (1-year treasuries are about 1.2% right now in Canada).
b. The Bank of Canada is not engaging in quantitative easing. In fact, by smartly increasing short term rates to 1%, they have probably done the whole country a favour.
c. Being a Canadian resident, I am intimately familiar with the country and the Bank of Canada, although I should point out there are three provinces that I have yet to visit.
d. Cash is very liquid and can be deployed at a button click’s notice into something better that appears on the radar.

Ultimately, investing in what you know will be in demand, at a good price is the generic fallback, macroeconomics be damned. But the macro situation is becoming something an investor has to pay very close attention to even with their microeconomic investments. A couple weeks ago I mentioned that some of my research lead me to place orders in two (US-denominated) securities. One of them went above my order price and has not gone back down. The other has been hovering in a range, and I have established a 6% position in.

Besides for this, I continue to watch, although I know my US cash holdings feel vulnerable to depreciation of purchasing power.

The first few days of November

The big looming issue is the US Congressional Elections. Since the actions of the US government have a heavy influence in the marketplace (e.g. raising taxes), I will be taking a break and watching the show. Expect posting to be light for the next couple days.

Almost all the pundits are predicting the Democratic party will be losing control of the US House of Representatives, and possibly the Senate, but either way this will mean gridlock for the US government – something traditionally favourable to the market since it is difficult for a split government to implement rule changes that increase risk.

Potash Corporation takeover should be approved

The Canadian government has until November 3 to make a decision on whether they will allow the takeover of Potash Corporation (TSX: POT) to proceed.

I do not know what the decision will be politically – the only time that the Canadian government has exercised its right to refuse a foreign takeover of a Canadian company was in 2008 when Macdonald Deitweiller (TSX: MDA) was prevented from selling itself as Canada did not want its sole satellite manufacturer going into foreign hands.

As a matter of public policy the sale should proceed. First, the buying company is overpaying. Secondly, the media (and Saskatchewan government) is making it sound like that Potash Corp is the only potash producer in Canada – while they are large, it is not the only source of Potash production in the country.

If the Canadian government refuses this sale, you will likely see any built-in takeover premiums of large Canadian companies be reduced. This is also an increasing trend as of late – governments trying to protect their strategic interests in natural resources, including oil and gas, uranium, water, metals and other resources. One wouldn’t be shocked to see the ultimate resource – intelligent people – be a future (but hidden) consideration in the future.

Politically, however, the decision might be different.