6/17/11: Lower Prices and Northern’s Numbers

By Roger Conrad • June 17, 2011

Guarding against a greater crash has become priority No. 1 for many investors. Spooked by Greece’s continuing debt woes, the lack of a deal between Democrats and Republicans on US federal debt, less-than-inspired economic data and a selloff that’s nearly two months old, many are convinced something worse than 2008 is looming–and that it’s time to cut exposure to anything perceived as vulnerable.

Risk-aversion selling has hit Canadian stocks in two ways. First, prices have dropped as sellers have cut exposure to stocks considered linked to natural resource prices. Second, money has come out of the Canadian dollar, as the currency is perceived as linked to oil prices.

The loonie’s US dollar value is currently off about 3.5 cents from its late April peak. That’s hardly catastrophic, but every dip does increase losses for US investors.

One consequence of the past weeks’ selling is a number of Canadian Edge Portfolio companies are again trading below my buy targets. That includes all of the Aggressive Holdings, with the exception of Yellow Media Inc (TSX: YLO, OTC: YLWPF), which rates a hold. And except for hold-rated Colabor Group Inc (TSX: GCL, OTC: COLFF) and still richly valued AltaGas Ltd (TSX: ALA, OTC: ATGFF), Cineplex Inc (TSX: CGX, OTC: CPXGF), Keyera Corp (TSX: KEY, OTC: KEYUF) and Northern Property REIT (TSX: NPR-U, OTC: NPRUF), all of the Conservative Holdings are either below target or only a few cents above.

Both the June issue’s High Yields of the Month are superb values now: Conservative Holding IBI Group Inc (TSX: IBG, OTC: IBIBF) up to USD15 and Aggressive Holding Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) up to USD15.50. Both are actually down slightly from when they announced very strong first-quarter earnings. In fact, that’s been the case for most other Portfolio companies.

As I’ve pointed out throughout this reporting season in Flash Alerts and regular issues of Canadian Edge, of the 35 stocks in the Portfolio, only Bird Construction Inc (TSX: BDT, OTC: BIRDF), Colabor Group and Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) posted first-quarter numbers that could be construed as disappointing. Even Yellow Media met management guidance and had solid dividend coverage.

All four stocks took an initial hit following their earnings releases. Bird has since recovered most of its lost ground. Colabor and Perpetual, on the other hand, have slid further in recent weeks as investor pessimism has grown. So has Yellow Media, whose slide has become news in the absence of any real facts as the stock has hit new all-time lows in recent days.

Here’s my take on this. First, it’s important to realize that the downward action in these stocks is being driven by emotion, not actual news. The next real batch of that will come with the release of second-quarter numbers. Based on the timing of first-quarter releases, that should be in early August for Colabor, Perpetual and Yellow, as possibly as late as the beginning of September for Bird.

Until then, market action is going to driven by rumor and innuendo as much as anything. That could be quite powerful, and it could drive these stocks down further.

However, odds are strong that second quarter numbers when released will be better than first-quarter numbers. In Bird’s case, activity is picking up in its major markets for construction, though fires in Alberta may be interrupting some activity. Perpetual is benefitting from higher liquids production, and natural gas prices have averaged higher in the second quarter than the first. Finally, Colabor is likely to face fewer cost pressures, even as it realizes the benefit of recent acquisitions.

Yellow’s ability to complete the sale of a piece of its Trader operation this month will likely have a major impact on its share price in coming weeks, given that a rumor of closing problems did trigger some selling. But it has continued to announce new strategic moves, including the launch of a new wireless search platform.

Even a modest improvement in results will safeguard dividends at these companies. Meanwhile, except for Bird, all are arguably already priced for still more dividend cuts. Good coverage means less fear, and almost certainly a share price recovery.

The bottom line: I’m sticking with all four positions for now, with the following caveats. These stocks are only for investors who can shoulder the risk of a dividend cut in the next several months, if events don’t work out as hoped. No one should average down in hopes of getting a lower overall cost basis. Loading up again and again on a falling stock is only going to anyone more emotional. Equally, I advise strongly against any use of leverage in these stocks, as well as stop-losses.

If you follow these rules, you won’t have an emotional attachment to these stocks, and you won’t lose your shirt if things don’t work out. Meanwhile, you’ll have a stake in investments that could still produce explosive returns over the next year if things do roll in their direction.

These same investing rules, by the way, apply to all Canadian Edge Portfolio recommendations. This selloff could go on a while longer, driving down prices and pushing up percentage yields even more. On the other hand, it may end relatively quickly, as last year’s Flash Crash did.

The only way to be ready for both possibilities is to maintain discipline: Buy only when stocks hit designated buy targets, and stick with them as long as the underlying business is sound regardless of market mood and rumors. Balance your holdings to avoid over-exposure to any one stock and diversifying.

Finally, invest to your comfort level. If the likes of Colabor and Yellow make you nervous, stick to more conservative fare. Again, that will help you keep emotion out of your decisions, which is always the greatest risk in an uncertain market like this one.

One stock worth a look now is Vermilion Energy Inc (TSX: VET, OTC: VEMTF), which appears to have been sold off below my buy target on misplaced concerns about exposure to hydraulic fracturing in France, which that country has now banned.

The company’s French operations are primarily drilling and work-over programs and are a small portion of overall output as well. Moreover, its global operations allow it to sell on markets in Europe and Asia, where energy prices are higher than in North America. Vermilion Energy is a buy up to USD50 for those who don’t already own it.

Another to watch is Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF), the former Macquarie Power & Infrastructure Corp. The company has scored an investment-grade credit rating from S&P (BBB-), which should help it raise capital for further development.

The 20 megawatt Amherstburg Solar Park is on track for completion this month, which will produce more cash flow starting in the third quarter under a 20-year contract with the Ontario Power Authority. A preferred share issue should eliminate near-term refinancing risk. Yielding well over 8 percent and on track for safe, steady growth, Capstone Infrastructure is a buy up to USD9.

Solid Report

Northern Property REIT’s (TSX: NPR-U, OTC: NPRUF) first-quarter numbers proved to be well worth waiting for. Revenue grew 10.1 percent and net operating income grew by 13 percent, while funds from operations per unit rose a robust 11.3 percent. The payout ratio based on funds from operations fell to 71.6 percent for the quarter, down from 77.1 percent last year.

The strong results were in part due to a sharp drop in vacancies for the company’s apartment portfolio to 4.9 percent, from 7.3 percent in 2010. Management was also successful locking down acquisitions of new properties, closing on another 381 apartment units in two locations during the quarter. In April the REIT purchased three more industrial facilities.

Northern Property continues to benefit from solid growth in more remote regions of Canada, including Nunavut, where vacancies are less than one half of a percentage point of properties. The REIT is often the only game in town in these areas, which have seen an influx of residents as the country’s resource wealth is unlocked. That’s offset the continued weakness of some markets, such as Fort McMurray, Alberta. The town in the heart of the oil sands has seen vacancy rates come off in the past year, but still has an apartment occupancy rate of just 87 percent.

Northern Property’s last dividend increase of 3.4 percent was announced in mid-August and was effective with the Sept. 15 payment. These solid operating results indicate investors should be able to count on another boost about the same time this year, though during the first-quarter conference call REIT President James Britton stated “neither the management nor the board have really applied themselves to considering that at this point.”

The shares now trade as a “stapled unit,” combining debt and equity, a consequence of Canada’s post-Jan. 1, 2011, rules for REITs and the company’s investment in seniors’ facilities. Management is now studying “strategic” initiatives for the properties, which could re-simplify the capital structure.

Northern’s location in resource development areas means it will continue to benefit going forward from the bull market in energy and materials. But even if the trend takes a pause or temporarily goes into reverse, the REIT is well protected by strong finances, cost controls and niche positions in remote markets. Management continues to lock in low cost, long-term financing where feasible and it’s had success with equity offerings as well.

As a result, Northern is even better prepared for an economic relapse than it was in 2008, when it was able to grow even while others in the REIT sector were floundering. I won’t raise my buy target on the units until there is a dividend boost. But Northern Property REIT is a buy on dips to USD28.

Here’s the final listing for where to go to get first-quarter numbers and analysis for Canadian Edge Portfolio picks. Click on the document name to go directly to the write up in question. Those printing out can go to the website (www.CanadianEdge.com) to access documents directly.

Conservative Holdings

Aggressive Holdings

The Next Batch

Finally, here’s when we can expect to see Canadian Edge Portfolio holdings report their second-quarter profits. I’ll be updating the list as dates are firmed up.

Conservative Holdings

  • AltaGas Ltd (TSX: ALA, OTC: ATGFF)–Jul. 29 (estimate)
  • Artis REIT (TSX: AX-U, OTC: ARESF)–Aug. 11 (estimate)
  • Atlantic Power Corp (TSX: ATP, NYSE: AT)–Aug. 9 (estimate)
  • Bird Construction Inc (TSX: BDT, OTC: BIRDF)–Aug. 5 (estimate)
  • Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPUF)–Aug. 9 (estimate)
  • Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–Aug. 10 (estimate)
  • Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Aug. 9 (estimate)
  • Cineplex Inc (TSX: CGX, OTC: CPXGF)–Aug. 12 (estimate)
  • Colabor Group Inc (TSX: GCL, OTC: COLFF)–Aug. 4 (estimate)
  • Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–Aug. 10 (estimate)
  • Extendicare REIT (TSX: EXE-U, OTC: EXETF)–Aug. 5 (estimate)
  • IBI Group Inc (TSX: IBG, OTC: IBIBF)–Aug. 4 (estimate)
  • Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–Aug. 10 (confirmed)
  • Just Energy Group Inc (TSX: JE, OTC: JUSTF)–Aug. 12 (estimate)
  • Keyera Corp (TSX: KEY, OTC: KEYUF)–Aug. 3 (confirmed)
  • Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–Aug. 5 (estimate)
  • Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF)–Aug. 5 (estimate)
  • RioCan REIT (TSX: REI-U, OTC: RIOCF)–Jul. 29 (estimate)
  • TransForce Inc (TSX: TFI, OTC: TFIFF)–Aug. 1 (confirmed)

Aggressive Holdings

  • Acadian Timber Corp (TSX: ADN, OTC: ACAZF)–Jul. 28 (estimate)
  • Ag Growth International Inc (TSX: AGF, OTC: AGGZF)–Aug. 11 (estimate)
  • ARC Resources Ltd (TSX: ARX, OTC: AETUF)–Aug. 4 (estimate)
  • Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–Jul. 28 (estimate)
  • Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)–Aug. 3 (estimate)
  • EnerCare Inc (TSX: ECI, OTC: CSUWF)–Aug. 9 (estimate)
  • Enerplus Corp (TSX: ERF, NYSE: ERF)–Aug. 5 (confirmed)
  • Newalta Corp (TSX: NAL, OTC: NWLTF)–Aug. 5 (estimate)
  • Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–Aug. 12 (estimate)
  • Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)–Aug. 4 (estimate)
  • Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–Aug. 10 (estimate)
  • Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–Aug. 10 (estimate)
  • PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–Aug. 5 (estimate)
  • Provident Energy Ltd (TSX: PVE, NYSE: PVX)–Aug. 11 (estimate)
  • Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–Aug. 9 (estimate)
  • Yellow Media Inc (TSX: YLO, OTC: YLWPF)–Aug. 5 (estimate)

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