Equity – Page 33

FLIR Systems

This is a short post. No hard financial analysis here.

A few weeks ago I purchased some stock in FLIR Systems (Nasdaq: FLIR). I have been familiar with the company for more than a decade, but this is because of their technology and less from a financial perspective although I have checked in from time to time.

They hit a few sweet spots for my investing criteria. One is that their technology is likely to be utilized in mass deployment across the planet in regards to temperature detection. The other is that they have US Military contracts and have a sufficient amount of their IP and technology on-shore (some supply chain is manufactured in China but not the military sensitive ones for obvious reasons). As a bonus, they are getting into the UAV, military robotic and sensor business, and they have strategic synergies that will work with this.

Financially, the only real current blemish is that they have US$425 million in the form of a unsecured note due on June 2021, but I do not envision any difficulty them rolling it over later this year or early next one. They are cash flow positive. Prior to Covid-19, I generally got the sense the market viewed them as a stagnant business (their position in IR imaging was quite strong competitively).

As this is a large-cap stock ($5 billion market capitalization) I am not worrying about my rambling spiking up their share price. They’re even one of the smaller components of the S&P 500. But clearly somebody with money clued in today how well positioned this company is strategically in the post Covid-19 environment. I’m not a typical large-cap stock investor but this one was too much to resist in the depths of the CoronaCrisis.

The other company I considered was Fortive (NYSE: FTV) but they are a larger industrial products company and have other economic sensitivities that I particularly did not care for.

Ag Growth International

I have taken today to complete my position in Ag Growth International (TSX: AFN), a Winnipeg-based company that can be classified as “all things grain-related”. I started picking up shares in the 16s and even 15s but today was a good chance to top it up to a full position. I also have a small portion of the debentures (TSX: AFN.DB.D).

I’ll spare you from the cut-and-paste description of their business from their annual information form, but the business is about providing everything you can imagine it takes running a grain and feed-based farm on an industrial scale. The sales from the business are international, and they are an integrator of various agricultural technologies.

The stock is not widely followed. There is hardly any ‘buzz’ at all from the usual message boards, BNN, etc., which is always a plus (less buzz means less competition for accurate stock pricing).

The thesis for the recovery of this COVID-19 investment (the stock has been taken down about 2/3rds since the COVID-19 pandemic) is pretty simple.

People have to eat. Food has to be grown (whether plant or animal) and the quantities of food that need to be produced require industrialization and equipment. Farming for over a century has shifted toward industrialization which promotes gigantic yields, and this industrialization requires investment in proper capital equipment to obtain these yields.

As long as the population is rising, food consumption will remain a core industry where demand over a medium range period of time will be steady – any demand not met today will simply be reflected in demand experienced later on in time.

Thus, COVID-19 should have a transient effect on the business of AFN.

Financially, 2019 was a poor year due to various cyclicalities of the grain business. In a more “normal” earnings environment, the company should be able to earn at least $3/share of GAAP net income and I would expect to see this in future years. The only financial issue of concern (and likely the reason why the stock has been taken down so much) is that they are quite leveraged, with about half of their debt via a senior secured revolving credit line, and the other half through issued unsecured debentures (AFN.DB.D to H on the TSX), which currently trade at YTMs of 10-12%. The original cost of capital for the unsecured debt was around 5%, and the secured debt at a function of LIBOR plus 1.45 to 2.5%. At the end of 2019 the combined rate was 5.11%, but this surely has gone down due to the rate cuts post-COVID-19.

To this extent, they made the not so surprising news release last night that they are reducing their dividend from $2.40/share to $0.60/share and this will allow them to deleverage. They extended the credit facility to 2025, and obtained a relaxation of the senior debt covenant. The next issue of debt that is due is AFN.DB.D, which is due on June 2022, and is also convertible into stock at 95% of TSX market value if the company so chooses – typically in the past it has rolled over the debt and when things normalize that is the likely route here.

The risk is that COVID-19 is prolonged and there will be some form of permanent demand destruction among the customers (e.g. if the industrial farms were to exhibit financial stress and had to scale back their capital investments), but I am discounting this possibility in the longer term just simply because of what I wrote in the earlier – people have to eat, and capital investment in farm equipment is required to facilitate this need. It is easily conceivable that we can see a $60 stock price again like two years ago, but it will take some time to get there. I can wait.

Atlantic Power – Tender Offer

Atlantic Power (TSX: ATP) announced yesterday they are doing a dutch auction tender for up to 12% of its shares (US$25 million) between US$1.95 to US$2.20/share.

If they gave it out as a dividend it would be approximately 23.7 cents per share.

During the tender period (which expires on April 30) they are prevented from buying back stock on the open market or buying back convertible debentures. They are still free to purchase preferred shares, however, which I suspect they are still buying back to maximize the NCIB.

Atlantic Power, by virtue of the nature of its business and contracted cash flows, has ample amounts of disposable cash in addition to being able to pay off its term facility.

This tender offer is right in the middle of the CoronaPanic and I’ll have to commend management for striking while things are at a panic low. They clearly were bored of buying shares on the open market.

Up until March 24, 2020, year-to-date they bought back 2.63 million common shares and 564,159 preferred shares (all classes, so $14.1 million par value). At the mid-point this tender offer will retire another 12 million shares.

This is a constructive dividend – shareholders that want to tender can cash out and receive capital, while those that remain on will own about 12% more of a company. It will also likely serve as a floor for the common share price until the end of April.

GFL Environmental Units

(Please note I wrote this a couple days ago when prices were different but didn’t get to hitting the ‘publish’ button until now)

GFL (TSX: GFL, also NYSE: GFL) is the fourth largest North American solid waste (garbage) collection companies, behind (Waste Management, WM; Republic Services, RSG; Waste Connections, WCN). GFL vomited out its IPO after a couple false starts in early March, just before the CoronaPanic really reared its ugliest days.

(GFL Prospectus from IPO)

If there is one guarantee on this planet, it is that waste collection will continue to be a viable business that can attract customers, and also be inflation-adjusted. There will be competitive cyclicalities that will cause margin compression, but the field also contains geographical barriers to entry that also will protect said margins, in addition to having captive customers (who the heck doesn’t produce waste?).

Financially, they have been operating as a roll-up operation; there is a lot of goodwill and intangibles on their balance sheet to reflect this history of acquisition (well beyond the equity line on the balance sheet). Patrick Dovigi is the founding CEO (from 2007) and retains a 3.7% economic stake and 27.7% voting stake in the company after the IPO – he’s also still very young – at the age of 40, he is still managing the empire.

At the beginning of March they went public at US$19/share, and the proceeds were primarily to reduce debt. They had a lot of it – about $7.7 billion, but this will be reduced to around $4.4 billion after the offering.

Financially, the operation makes money, especially when using the somewhat flawed EBITDA metric (approximately $800 million in 2019), but the “I” and “DA” amounts are significant – the company’s financial leverage was high, and garbage collection is intense on capital expenditures. They have been growing at such a large rate that they got overextended, and hence were forced to vomit this public offering out. They are going to enter a stage where they will become more efficient, and that should justify metrics that are closer to their counterparts (the companies listed in the first paragraph on this post).

(Prospectus for Tangible Equity Units)

They also sold “Tangible Equity Units” which trade as GFLU, which consist of 2.6316 shares of GFL plus US$8.5143 of a subordinated note. The units will be converted into shares on March 15, 2023 or earlier under some circumstances. The shares given will also be reduced to 2.193 if the shares of GFL trade above US$22.80, and it is a sliding scale between US$19 to US$22.80 (note that this represents US$50 of equity per unit). The subordinated note component has interest of 4%, and is amortized over a three year period with quarterly payments (consisting of roughly US$0.75/quarter per unit).

GFL currently trades at US$14/share and GFLU trades at US$41, or about a US$4.35/share above its immediate value and $17.51 if you assume full realization of US$50 of equity (which is currently worth US$36.84 at a US$14 equity price). Considering this as a hybrid instrument, you get a clean amount of upside for the first 36% of equity appreciation, and then this is effectively subject to a sold call option, until a further 20% appreciation from the US$19 par value.

An interesting hybrid instrument that I have taken a tiny stakes in, and no more.

Mid-stream oil and gas

Low oil prices hurt producers for obvious reasons.

They also are hurting the mid-stream, but this is for less obvious reasons – low prices means curtailment of capital expenditures, which typically mean lower volumes, which means less money for midstream producers. Volume is the dominant variable for the mid-stream, not prices.

The flip side of this equation is lower prices stimulates consumption, which means higher oil prices, which means higher capital expenditures… you get the picture. There is an equilibrium factor that depends on mutually dependent factors in order to “solve the equation”. In Excel, this would typically be a circular equation, but when applied in real life, the input variables are much more fuzzy, and thus it makes the output chaotic and difficult to predict where the true “landing spot” is (which never exists – it is always ever-moving).

The other clear factor is that when oil and gas companies are not making profits, there is an element of counterparty risk.

One broad-brushed way of investing in the US mid-stream sector is through the Alerian MLP ETF (AMLP) which got killed yesterday. The constituent companies are fairly stodgy oil and gas pipeline MLPs which give out most of their income in the form of distributions. Normally MLPs are very adversely taxed for Canadians, but the AMLP structure is a corporation. It distributes its income mostly in the form of a return on capital, but for tax purposes, it is equivalent to foreign income. However, in a registered account, this is a non-factor. At the low of $4.14/unit, it was trading at a yield of 18% and even when factoring in the inevitable decline of shale production in the USA, seems to be a reasonable risk-reward proposition as investors seek yield.

To a lesser degree, Canadians can also invest in Enbridge (TSX: ENB), TransCanada (TSX: TRP), Pembina (TSX: PPL), and for those interested in Albertan intra-provincial pipelines, Inter-Pipeline (TSX: IPL). However, the income to price disparity is not nearly as present as the American analogs (including Kinder Morgan, Williams, etc.).

Pembina, in particular, has gotten killed simply because it faces a risk that the Trans-Mountain pipeline is not going to be constructed, especially with the crash in oil prices and the general incompetency of our Trudeau-led federal government. The assets they picked up from the old Kinder Morgan Canada were quite good. Enbridge and TransCanada should also do well – the big loser going ahead will probably be the oil-by-rail trade – if production slows down, this volume will be the first to get scrapped, not the pipelines.