Category: Equity

Confusing Capital Allocation – Transforce

Transforce (TSX: TFII), now known as TFI International, announced their year-end earnings today.

This post is less concerned about the results (they did a good job generating plenty of cash and reporting a year-end net income of about $4/share), but the following paragraph:

CASH FLOW
Net cash from continuing operating activities was $665.3 million during 2019 versus $543.5 million the prior year. The 22% increase was due to stronger operating performance and the impact of the adoption of IFRS 16. The Company returned $336.4 million to shareholders during the year, of which $80.7 million was through dividends and $255.7 million was through share repurchases.

$255.7 million returned from share buybacks (and mostly purchased at a cost lower than the current stock price which is about $44/share).

However, the next press release is for a 6 million share public offering to list on the NYSE.

There’s two issues here.

One is that a 6 million share offering will raise about CAD$264 million gross, or roughly CAD$250 net after offering expenses, assuming the stock doesn’t tank tomorrow. This is approximately the amount the company bought back in shares in 2019.

The other is that (just like Target), the logistics of Canadian companies operating in the USA is fraught with new risks and dangers. TFII already operates across North America, so it is not like they will be new at it, but the observation is they are trying to move their “centre” south. It’s probably more of an indictment on what management thinks of the current economic climate in Canada.

Management does have a relatively good track record on capital allocation, but the buyback “and let’s do an IPO!” is confusing.

However, in fairness to management, their balance sheet is looking a little debt-heavy and de-leveraging might not be a bad decision in case if this future recession (which is almost cemented into mythology) occurs.

Genworth MI Q4-2019: Adding the leverage

Genworth MI (TSX: MIC) reported their year end results last week.

Operationally they’re still minting a lot of money – loss ratio is 20% for the quarter, expense ratio is 20%, so they continue to earn 60 cents pre-tax for every dollar of insurance premium revenue they book. There doesn’t appear to be any storm clouds on the horizon.

An observation I will make is that with the new majority shareholder (Brookfield), they appear to now be deliberately targeting a higher return on equity policy. The company has been distributing a lot of cash in the form of special dividends:

During the fourth quarter of 2019, the Company paid a special dividend of $1.45 per common share, for an aggregate amount of approximately $125 million, on October 11, 2019 and a special dividend of $2.32 per common share, for an aggregate amount of approximately $200 million, on December 30, 2019. On January 15, 2020, the Board of Directors declared a special dividend of $2.32 per common share for an aggregate amount of approximately $200 million. This special dividend will be paid on February 11, 2020 to shareholders of record at the close of business on January 28, 2020.

In the span of a few months, the company has given off $6.09 in special dividends. Obviously I sold my shares too early! With these special dividends, however, the company is trading at about a 30% premium over book value, which is uncharted territory. Clearly given the cash generation capability of this business, it is likely to continue, but I have always wondered when there will be more competitive pressures in this market space – which if it occurs, will result in a dramatically reduced profitability landscape for the company. It won’t be triggered by the federal government – CMHC makes the lion’s share of the profit in this marketplace.

The company is obviously going to increase its leverage in the near future – on January 16, 2020 they took out a credit facility to allow them to borrow $200 million for a year, and another $500 million for 5 years. Part of this will be to rollover the $175 million in debt they have that will mature on June 15, 2020 but the remainder of it will probably head out the window in the form of special dividends so they can increase their return on equity from 11% to something higher.

Such strategies work until they start to face a large amount of mortgage claims whenever this near-mythical next recession occurs!

Gran Colombia Gold’s confusing capital allocation strategy, part 3

(Part 1 on June 12, 2019; Part 2 on November 16, 2019)

Gran Colombia Gold (TSX: GCM) raised CAD$40 million in an equity offering priced at CAD$5.60 which included an additional 3-year warrant to purchase stock at CAD$6.50/share. The offering was initially announced on January 27, 2020 when the stock closed at CAD$5.74, so when you include the price of the warrant, it was a fairly steep discount. The stock was halted mid-day when they announced the offering and it surprisingly did not tank the stock (that day – there was about another hour of trading left when they re-opened the stock).

According to the January 27, 2020 release, “The net proceeds of the Private Placement will be used for general working capital and corporate purposes, including repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.“, which continues the theme of selling stock to repurchase warrants (very confusing).

The reality is that I suspect the Marmato mine project is going to be really, really, really expensive and they just want to vacuum up as much cash as possible while the going is good, and gold remains at relatively elevated prices (although I will no profess to knowing whether gold’s existing US$1,574/ounce price is going higher, lower or staying steady, but it is under the per-ounce cash costs of their main Segovia mining operation). Shareholder value (let alone issuing a dividend) be damned!

What got my interest, however, is the decision made when the offering closed on February 6, 2020:

Gran Colombia also announced today that it will use a portion of the net proceeds of the Private Placement to redeem 30%, equivalent to US$19,162,500, of the aggregate principal amount outstanding of its 8.25% Senior Secured Gold-Linked Notes due 2024 (the “Gold Notes”) (TSX: GCM.NT.U) on March 31, 2020 (the “Redemption Date”), reducing the aggregate principal amount outstanding to US$44,712,500. The redemption price will be equal to 100% of the aggregate principal amount of the Gold Notes redeemed plus the Applicable Premium calculated in accordance with the provisions of the Gold Notes Indenture, currently estimated to be approximately 10%. Further details, including the actual amount of the Applicable Premium, will be announced later in March as it gets closer to the Redemption Date. The balance of the net proceeds of the Private Placement will be used for general working capital and corporate purposes, including potential repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.

Considering that a non-trivial amount of my portfolio is in these notes, I took interest in this decision. They are using about CAD$28 million of the gross CAD$40 million in proceeds of the equity offering to close out some of these notes, which to my calculations, are effectively at a 16% coupon rate at current gold prices. A fairly good capital allocation decision if you ask me, although they easily have justification to retire the whole batch of notes if they wanted to!

The reason why they did what they did is simply because once the 30% of notes are redeemed, it releases security on Marmato – the notes will then only be secured by the Segovia mine operation. In light of its current production, I will be happy to continue collecting coupons and having the quarterly redemptions proceed until I get cashed out.

I have no position in GCM equity nor do I anticipate having any in the future.

Finally, this creates a capital allocation strategy issue for me in terms of where to re-deploy the cash. It really was happy earning a very low risk 16%, but sadly no longer.

Atlantic Power – just a matter of time

When a company pays back debt, its enterprise value drops (or more specifically, the cash generation which leads to debt paydown is the cause of the enterprise value decrease because EV is market cap minus net debt, but I’ll insert this in before somebody comments on my illogical statement!). All things being equal, when material amounts of debt are paid back and the underlying entity is cash flow positive, it should eventually reflect an increase in market capitalization. This process sometimes takes a long time.

Atlantic Power today announced a revision to their credit agreement, which dropped the interest rate payable by another 25 basis points (to LIBOR plus 250bps), and if they can get their leverage ratio to less than 2.75:1 then it will go down another 25 basis points further. Atlantic Power had US$400 million in term loans outstanding in September 30, 2019 so this will result in somewhat less than a million a year in annualized interest rate savings going forward.

Reading credit agreement amendments (original April 13, 2016) might not be exciting, but sometimes a few nuggets of information here and there come out which are interesting. Section 2.15(d) of the agreement has the following debt paydown table:

The term loan component is extended to April 2025 which completely eliminates short term credit risk. The de-leveraging is mostly finished. The question is when the market will start to price in equity appreciation – after 2022 the company still has 12 power plants that are under power purchase agreements and generating considerable amount of cash flows.

When a CFO quits

Looking at Stuart Olsen (TSX: SOX). It’s been on my radar simply because I see their name in the fitness facility that I so happen to exercise in. They also (or likely one of their subcontractors) apparently botched up the concrete job in the City of Richmond’s new swimming facility, which needless to say, is not good for them.

Here is a relevant timeline:

September 9, 2019: SOX’s CFO resigns:

Stuart Olson Inc. (TSX: SOX, SOX.DB.A) (“Stuart Olson” or the “Company”) today announced the departure of Daryl Sands, Executive Vice President and Chief Financial Officer.

“I would like to thank Daryl for his over 14 years of service and wish him well in his future endeavors”, said David LeMay, Stuart Olson’s President and Chief Executive Officer.

The Company also announced the appointment of Dean R. Beacon as interim Chief Financial Officer.

…

Stuart Olson has commenced a search for a new Chief Financial Officer.

January 8, 2020: New CFO hired.

CALGARY, Jan. 8, 2020 /CNW/ – Stuart Olson Inc. (TSX: SOX) (“Stuart Olson” or the “Company”) today announced that it has completed its search for a new Chief Financial Officer.

Effective January 9, 2020, Bharat Mahajan will assume the role of Executive Vice President and Chief Financial Officer. Mr. Mahajan replaces Dean Beacon who has held the position of interim Chief Financial Officer since his appointment was announced on September 9, 2019.

Mr. Mahajan is a Chartered Professional Accountant and brings over 28 years of senior and executive level professional experience to the Company. He has a proven track record of generating value as a Chief Financial Officer. Most recently, Mr. Mahajan held the role of Chief Financial Officer at Daseke, Inc. (“Daseke”), the largest owner and leading consolidator of specialized transportation in North America. Daseke acquired Aveda Transportation and Energy Services Inc. (“Aveda”) in 2018. At the time of the acquisition, Mr. Mahajan had been the Chief Financial Officer of Aveda and was asked to take on the same role with Daseke on completion of the transaction.

“I am pleased to welcome Bharat, as our new Executive Vice President and Chief Financial Officer. His financial expertise and extensive accounting leadership experience in public companies will strengthen our abilities to execute on our growth and diversification strategies,” said David LeMay, Stuart Olson’s President and CEO.

January 24, 2020: New CFO quits, old interm CFO comes back.

CALGARY, Jan. 24, 2020 /CNW/ – Stuart Olson Inc. (TSX: SOX) (“Stuart Olson” or the “Company”) today announced that its Executive Vice President and Chief Financial Officer, Bharat Mahajan, has notified the Company of his decision to resign and that he has accepted a different position.

The Company also announced the appointment of Dean R. Beacon as Executive Vice President and Chief Financial Officer. Mr. Beacon previously held the position on an interim basis from September 9, 2019 to January 8, 2020.

The obvious question is – what the heck happened? Two weeks into the job and he’s leaving?

When a long-time CFO exits the company, it could be for a myriad of reasons, including the fact that he/she just has done their job for king and country and wants a graceful exit – nothing to do with the underlying performance of the company. However, when a new CFO is hired and they leave 12 business days after the fact, it leads one to speculate.

A few possibilities:

a) He came in, saw some huge ethical issues, and got out;
b) He came in, the CEO did not like his personality and/or work performance (isn’t an interview process supposed to pick up on this?) and effectively told him to leave;
c) He came in, realized he was over his head, and got out?

I can’t identify a scenario where this sequence of events portends a good outcome for a publicly traded company. They have to release their audited year-end financial results by the end of March.

Unfortunately, I can’t get a borrow on the stock.