Tag: SPB

Credit coming to a crunch

It is quite evident looking at bond trading that credit is coming to a halt, very quickly.

First of all, I notice debentures on various firms are plummeting – most of the underlying companies have lots of refinancings ahead in order to make it through. An example of this is Data Group (TSX: DGI.UN), which has had its debentures trade down to 60 cents on the dollar.

Sterling Shoes (TSX: SSI) announced they will not be making their interest payments on their debentures, effectively putting them in default – their interest payment is due on October 31, 2011 and will subsequently lead to a potential default sometime in November according to their prospectus (if enough debenture holders are able to declare a default).

Superior Plus (TSX: SPB) was lucky to get off a $75M debenture financing (with a 5-year term at 7.5%) in the middle of September before their common shares started to fall off a cliff – and took the debentures (series C, D, E, F) with them. Superior Plus is no stranger to this website, having predicted a dividend cut in the past.

Yellow Media is no stranger to this site either, but since I am still licking my wounds on this one, I will leave it at that with this company. Similar to Superior Plus, however, both companies are still free cash flow positive.

First Uranium (TSX: FIU) has had some serious issues regarding their operations and financing, and also some political risk thrown into the mix. As a result, its secured notes have traded down. Indeed, when looking at the management projections for the July to September quarter, management has projected they will be left with about $9 million cash on their balance sheet before they can make a (what they think) turnaround – instead, they just might be ready to default since they also have a CAD$150M debt payment on their unsecured debentures due June 2012. First Uranium is also no stranger to our site, having had the misfortune of investing in their notes and debentures in the past.

Finally, Connacher Oil and Gas (TSX: CLL) has had their common shares annihilated over the past couple months – their unsecured debentures are due on June 30, 2012 and are now trading at 85 cents on the dollar. This is quite interesting in light of the fact that the rest of the company’s debt is structured out until 2018 and they have set up a credit facility to be able to pay off these debentures. The risk is that the company will simply convert the debentures into equity and you end up with another Arctic Glacier (TSX: AG.UN) which underwent a lot of dysfunction after they did the same thing with a very low stock price. Those debenture holders would have been lucky to realize half the value of their debt, or if you timed it perfectly and had a small amount of debt to work with, about two-thirds.

A lot of credit-sensitive companies are trading lower. It is difficult to tell when it will end, but an investor picking up the scraps of companies that will, through organic business performance, be able to bounce back will be very rich – similar to how anybody investing in the corporate debt market in early 2009 made out very well.

Timing indeed is everything.

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.

Another example of yield chasing

Just after a week since I posted a review of Superior Plus, declaring that they probably would have to reduce their dividends in order to be financially sustainable, they announced their quarterly results today. Notably, they lowered expectations for 2010 due to warmer weather (and therefore less natural gas deliveries).

They also had the following snippet in their quarterly release:

– The financial outlook for 2010 has been revised to AOCF per share of $1.50 to $1.65 as a result of lower than anticipated second quarter results and a weaker than previously anticipated economic recovery for the remainder of 2010.

– The financial outlook for 2011 has been revised to AOCF per share of $1.85 to $2.05 as a result of a weaker than previously anticipated economic recovery forecasted for the remainder of 2010 and throughout 2011, particularly impacting Superior’s Construction Products Distribution business.

AOCF is “Adjusted operating cash flow”, which is a non-GAAP metric to approximate how much cash before capital expenditures is available to the corporation. Since their dividend rate is $1.62/share, this leaves the company little to negative real cash to provide for acquisitions (which they have done plenty of over the past couple years), debt repayment or capital projects.

The company’s stock traded down 7.9% as a reaction to their disappointing report.

Investors undoubtedly will be looking at Superior Plus’s 13.03% dividend yield and marvel what a bargain they are getting, but it seems likely they will be forced to reduce dividends and this is reflected in the market price.

Interestingly enough, Superior Plus has four issues of debentures that trade on the TSX – the issue maturing in December 2012 has a yield to maturity of 4.5%, while the issue maturing July 2017 has a yield to maturity of 5.9%. They appear to be priced very expensive and I would not touch them.

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.