Category: Equity

Uranium One now majority controlled

Uranium One’s shareholders voted convincingly in favour of the takeover of a majority stake in the corporation by a Russian “crown” corporation SC Atomredmetzolo (“ARMZ”) with approximately 91.99% of non-ARMZ shareholders in favour of the transaction.

The salient terms of the agreement is that ARMZ will take a 51% majority stake, and pay the rest of the shareholders $1.06/share in a cash dividend. Shareholders, assuming they haven’t already sold at market value, will be in for the ride and will have to make sure that their interests are in alignment with the majority ownership.

This is almost the reverse case of Magna International, where the Stronach family is being paid a considerable sum by the corporation to relinquish its controlling stake.

Investors should always be very cautious in making sure whenever they invest in companies that have majority or near-controlling ownership stakes that their interests are in alignment with the large shareholders. While a majority stake is not necessarily an exclusion criterion to considering a potential investment, it does raise the bar considerably higher. I tend to have a high aversion to majority or near-majority controlled domestic corporations as they can abuse minority shareholders.

The debenture holders, however, should be looking good – Uranium One has a December 31, 2011 issue that has a 4.25% coupon that is a very probability candidate for maturity at par; between the bid and ask, it is trading at 98.5 cents. Once you factor in capital gains, it is a relatively low risk 5% return on investment. Uranium One has another outstanding debenture issue that matures in March 2015 and this one is muddied by the fact that the conversion privilege (at $4/share) is close to the common stock price – this issue is trading at around 105 cents.

It is not likely that the 1.3 years between now and December 31, 2011 will pose much of a credit risk for the initial debenture issue – the corporation is likely to refinance this debt. However, the 2015 debenture has more embedded risk simply due to the time between now and the March 2015 maturity – you never know how much of the company assets will get stripped out. The worst case scenario is that ARMZ will try to to repatriate the assets (mainly agreements to mine and sell Uranium, mostly from Kazakhstan) of Uranium One into some other corporation controlled by ARMZ. You then don’t have to worry about the bankruptcy of a Canadian corporation once the assets have been stripped out of it, and debenture holders and shareholders alike would be left with nothing. It is unlikely this scenario will happen by 2011, but by 2015 it becomes somewhat more likely.

Suffice to say, I won’t be touching the equity or debt of this corporation.

A basic guide on how to do Canadian equity research

Whenever I hear of a publicly traded company, I follow a fairly standard methodology to do some basic research on the firm.

In a perfect world, you try to do research before looking at the share price of the company. The whole idea of the research methodology is to pin down a valuation for the equity (or in some cases, debt) and seeing a stock price contaminates what should be an unbiased analysis. You want to come up with your own valuation, rather than looking at the market’s valuation and then thinking of ways to rationalize the stock price. Unfortunately 9 times out of 10, the first thing I do is pull up the stock quote. I’ve been trying to train myself to no longer do this, but it is really, really difficult to not see a quote attached to an article.

Once I am ready to research, I pull off these documents from SEDAR in this order:

1. If the “nearest” financial report is an interim statement, I pull down the interim financial statements and MD&A document and read them. Doing analysis on this alone is time-consuming, and you look for tidbits in the statement, get an idea of how the company is capitalized and look at the cash situation. If the “nearest” report is an annual one, I read that and the MD&A.

2. Then I read the management information circular, and look at executive compensation scheme, insider ownership, and executive biographies and get a “feel” for who is running the firm, and who is on the board.

Usually by this point, you can come up with a ballpark number and then it becomes irresistible to look at the share price and hence valuation. Which then leaves:

3. Pulling up the stock chart, and then looking at any significant price moves, and then connecting those price moves to various news releases of the company;

4. Reading every news release of the company over the past X years, chronologically, and then looking at the reaction of the stock to what is significant news;

5. Reading the latest annual report (not the glossy version, the dry financial version) with its MD&A, and/or the Annual Information Form, which is also a good document that has information that is not contained in the interim statements;

6. Insider trading is available on SEDI and can influence a decision. While insider selling is not necessarily a negative signal, whenever you see insider buying it gets your attention much more.

7. The company’s website.

Usually by this point you spent many hours of reading and synthesizing information, and should have a pretty good idea as to what makes the company “tick”. Then the next step is to have a sector-wide comprehension and start investigating competitors, and firms up and down the supply chain to get a feel for the economic variables at stake. This is a never-ending process and eventually at some point you cut it off and then make a buy/sell/leave alone decision.

Learning to prune investment candidates at stage #2 is a very good skill to have – I usually set price triggers on those companies, and when the triggers are hit, I get an email and this triggers me to take a second look at the company to see if anything has changed. In the second half of 2008, so many companies were triggering low price alerts that I had a very, very difficult time keeping up with what was literally an avalanche of securities. I probably could have performed better in 2008 had I had more time to look at all the securities that were flashing at me.

Today, there is hardly anything that triggers my low price alerts, so I am using different screens to put some companies on the research queue.

Silly market tidbit of the day – GM

While General Motors is pondering going public again, one should keep in mind that their predecessor company (pre-bankruptcy) is now known as Motors Liquidation Corporation. They had their name changed to not confuse the general public into believing they owned shares in something that might be worth something.

The pre-bankruptcy shares of General Motors, amazingly enough, still trades at 50 cents a share. When all of the court settlements are completed, this will go to zero.

People should study why this is the case – why an asset that is fundamentally worth nothing is trading at something above zero. In addition, short-selling the stock is not as easy as one would think.

Another week of summer trading

I don’t think price movements should be taken too seriously this week or for the rest of the month. The price changes do create volatility that can be taken advantage of, however.

That said, I am beginning to have a few “hits” on my equity radar that are deserving of more research, so hopefully I will have enough time to look at them since I have been taking things relatively easy myself.

I continue to trim my long-term bond position in Limited Brands; I had the selling side of the trade at the 52-week high, but I didn’t have my entire position filled and now the position is trading about 1% less than that amount which is somewhat frustrating – I just wanted to clear out the whole thing at 96 cents. TRACE has the bonds at 92 cents on the dollar, while the exchange-traded version had them at 96 cents on the dollar, so I am unloading and taking my money. I remember the days that TRACE had them at least 5-10 cents higher in the bond market vs. the exchanges, so the market is relatively inefficient on these illiquid issues – a high volume day is considered to be $50,000 traded.

I also note my other long-term bond positions are creeping higher. If they get to the 8% yield stage I’ll consider a liquidation of them, and leak the position and fully dump them at around 7.5%. I also have to time whether I can unload them in 2011 for roughly the same value for tax reasons. TRACE has those exchange-traded issues and the bond values at roughly the same value at present so I am not losing a premium valuation by waiting.

I am also trimming my only equity position, which I had a very minor stake in. It was an obscure play that was slightly under-valued and had a market catalyst that never emerged. It has appreciated somewhat, so I am selling it. With my track record it will probably go up 2000% over the next 3 years after I dispose of it all.

All of this should make for a third quarter update that should hopefully show some more cash in the portfolio – assuming I don’t buy anything, it will get over 10%. Although cash yields a paltry 2% at present, it gives me the opportunity to strike at other opportunities when they arise and come to my attention. It is very difficult to do this when “fully invested” since going into margin to invest involves its own separate set of risks.

I am playing things ultra-conservatively, which doesn’t make for good writing, but at least I will be solvent.

I am also still looking for income-oriented securities, but I am finding this entire sector to be swamped with over-valued issues. It is painfully clear to me that the large amount of money sloshing around there is looking for yield.

Superior Plus – why do they look cheap?

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.