Category: Equity

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 CN Rail Cash Machine

CN Rail reported their Q3-2010 result; it indicates they have recovered well from the economic crisis.

Although CN’s equity price is relatively high in terms of the cash they are able to deliver to shareholders (most notably they are spending about $300M/year above the rate they are amortizing), there are worse places to put “stable” cash – the equity trades more like a bond. This is another example of when people talk about “asset classes” that you cannot just put a blanket on “Canadian equity” and consider every share of every corporation to have the same risk/reward characteristic.

In terms of the actual numbers, the business was able to generate about $2.78 per share of free cash flow over the past 9 months. Annualized, this is about $3.71 in free cash, on top of a $67 equity price justifies the “relatively high” remark with respect to valuation.

Despite the high price (which is very near all-time highs), it is likely that CN’s total return over the next 10 years will outperform the equivalent Canadian 10-year bond, which yields 2.74%. The railways (CN and CP Rail) will likely be successful cash generating entities as long as Canada and the USA remain politically stable, and also are a benefactor of high energy prices – freight rail competes very well against trucking when it comes to goods movement.

Unlike most utilities, all railways have one very valuable piece of paper which is impossible to obtain – the right of way in major urban centres. If you were to give somebody $100 billion from scratch and got them to construct a railway, there is no way you could transform that capital into an income-bearing instrument that would yield better than the government bond. One of those reasons is property acquisition and track right of way – something Warren Buffet was thinking about when he bought out Burlington Northern. The only way you’d be able to get any sort of reasonable return is just to buy the railway outright, but even then the government could step in, citing “national interests”.

A relatively quick trade

I am now slowly unwinding my trade in Davis + Henderson Income Fund (TSX: DHF.UN). If the units go higher by approximately 5%, I will be exiting the entire position compared to the partial sale of my position as of this writing.

While I do not have concerns about the stability of their distributions (especially as they will be reduced 35% or to $1.20/share after they convert to a corporation), I do have concerns about the ability of management to grow the company’s free cash flow from existing levels. They have been pursuing a strategy of growing revenues and income through acquisition, which is generally a risky method compared to growing organically. So far, it has worked for them. The question is whether it will continue to doing so – which is never a given.

This company is not unique at all in the income trust sector to being bidded up. All sorts of income-bearing securities are becoming very expensive.

Although DHF will pay 5.85% a year (at 20.50 per share) in eligible dividends in 2011 when they convert to a corporation, I do not think this cash stream is worth paying the current price for given other investment opportunities – none of which give yields.

What I find interesting is it is likely retail investors that will be focusing on the 5.85% yield instead of looking at the underlying business and asking what they are purchasing. I am not complaining – I am taking this opportunity to take some more of my portfolio off the table and holding yet even more cash for future deployment.

The net gain is approximately 25% above cost basis; not factoring in the few distributions that occurred between the purchase price and the disposition, not bad considering that the upside is more limited than the downside.

What to do when your shares rise

Long-time readers should be able to see this chart and know what security I am talking about, but I have purposefully omitted the name and ticker and price scale just to illustrate. The security in question is quite “yieldly” so it is susceptible to the huge increase in demand we are seeing for income-bearing securities.

Here is a 3-year chart:

Here is a 6-month chart:

Finally, here is a 1-day chart (approximately up 7% for the day):

There is seemingly no fundamental news involved, which makes me suspect this was purely technical trading occurring. The volume was not excessively high compared to average volume.

Question – do you sell the spike? Do you get greedy and see what happens the next week?

Fundamentally speaking, the security involved is priced slightly above my fair value range. It already consists of a relatively large fraction of my portfolio, so choosing to lighten up is the obvious answer. I can’t help but think, however, that by getting “greedy” that I can get an extra 10-20% out of this that I would otherwise have not received by using a more fundamental trading method. By scaling out of your positions slowly, exiting piece by piece as the price goes higher, you can participate in some upside, but continue to reduce your risk as the price continues to rise.

2010 capital gains are starting to be a big concern for me tax-wise, but fortunately there are some units of this security in my RRSP that I can start off with on a tax-free basis.