6/10/11: Strong Results for a Shaken Market

By Roger Conrad • June 10, 2011

Four more Canadian Edge Portfolio recommendations reported their first-quarter results this week. That leaves just Northern Property REIT (TSX: NPR-U, OTC: NPRUF) to turn in numbers, which management has announced it will do on Jun. 14, with a conference call the next day.

With the second quarter of 2011 now in its final weeks, the numbers are most important for what they say about guidance going forward. The four companies reporting are a diverse group, ranging from conservative power producers to global grain handling equipment company Ag Growth International Inc (TSX: AFN, OTC: AGGZF).

What the results had in common was they affirmed the solid financial health of these companies, which also look set to fare well the rest of the year. Note that Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF) is the former Macquarie Power & Infrastructure. There are no tax consequences for investors with the name change and the monthly dividend remains the same at CAD0.055, just as it’s been since February 2010.

Strong results haven’t been enough to prevent selling of CE Portfolio stocks the past few weeks. In fact, with very few exceptions, companies currently trade below where they did before reporting numbers. That’s mostly due to the weakness in the overall stock market and many investors’ desire to cut their perceived risks. But companies that disappointed investors have faced sharp selloffs.

Bird Construction Inc (TSX: BDT, OTC: BIRDF) didn’t get hit nearly as hard after reporting tough first-quarter numbers last week as it did a few months ago after coming in with weak third-quarter 2010 results. That may be at least partly due to the dividend increase announced in March as well as to still strong order backlog and the fact that much of the shortfall appears weather related. But it nonetheless now trades once again below my buy target of USD12.

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) has stabilized the past couple weeks. But the stocks is still more than 10 percent below its level before last month’s announcement of a 50 percent dividend cut to finance capital spending to develop oil and natural gas liquids reserves. The stock remains a buy up to USD5, but only for those who want a highly leveraged bet on natural gas.

Colabor Group Inc (TSX: GCL, OTC: COLFF) shares have also stabilized the past few weeks, but only after falling from more than USD13 to less than USD11 in a couple days trading. The key issue remains how well the company will be able to pass along operating costs to customers the rest of the year, a time when conditions in the food and related products distribution business are soft. A slackening of oil and gasoline prices may help and the company appears to have successfully completed its acquisition of Skor. But until we see second-quarter numbers, the stock’s a hold.

And that also goes for Yellow Media Inc (TSX: YLO, OTC: YLWPF), which actually reported fairly steady numbers but has been knocked around by rumor and innuendo since. Management maintains it will hold the dividend and that the sale of a portion of its Trader business for CAD746 million in cash is on track. Meanwhile, this week management announced a “strategic agreement” with foursquare, a location-based social networking site.

The deal is expected to drive more traffic to Yellow’s web-based advertisers and upgrade its system’s capabilities; both are keys to the company’s ability to compete going forward. The level of market skepticism that it will succeed is deep. But as always the answer of who’s right will lie in the numbers, with the next batch due out in early August. Until then Yellow Media is a hold for speculators.

The good news is the other 31 companies in the Canadian Edge Portfolio didn’t disappoint with their first-quarter numbers and look set to post another round of solid results starting in late July. With more than a few now below my buy targets (see the Portfolio tables at www.CanadianEdge.com), now’s a good time to pick any you’re light on. That includes June High Yields of the Month Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) and IBI Group Inc (TSX: IBG, OTC: IBIBF). Here’s the Roundup of this week’s five reporters.

Ag Growth International Inc (TSX: AFN, OTC: AGGZF) posted a 28 percent jump in first-quarter 2011 sales, fueled by a 62 percent boost in revenue from outside North America. Demand for the company’s grain-handling equipment soared in Eastern Europe, South America and the Middle East, vindicating management’s diversification strategy and more than offsetting the negative impact of a rising Canadian dollar and poor crop conditions in western Canada. US operations were also robust, thanks to strong harvests fueled by high product prices.

Cash flow was strong, as earnings at the Hi Roller and Union Iron divisions surged. That was offset by seasonal factors that affected the Finland operations. But overall profit per share nonetheless surged 15 percent versus year-earlier levels. Adjusted cash flow was even better, rising 20 percent from year earlier levels. Excluding the impact of acquisitions, operating margins as a percentage of revenue rose from 39 to 40 percent.

Dividends of CAD0.20 per month were covered by a solid 1.65-to-1 margin by “basic diluted average profit per share” after foreign exchange losses due to the strong Canadian dollar. That’s a clear demonstration not only of company earnings’ ability to cover dividends regularly, but also of Ag Growth’s ability to manage a rising loonie despite extensive operations outside Canada.

As for the balance sheet, Ag reduced its bank debt to zero during the quarter. Long-term debt is now just CAD23.8 million, consisting solely of a single issue maturing Oct. 29, 2016, and paying interest of 6.8 percent. Overall finance costs in the first quarter were flat versus year-ago tallies, illustrating the company’s ability to grow without expanding debt.

There’s more cash flow and distribution growth ahead for this Northern Tiger. An amended shareholder rights plan, meanwhile, ensures any takeover will be at a substantial premium. My buy target for Ag Growth International remains USD50 for any who don’t already own it.

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF) came in with a 6.3 percent boost in revenue and a 1.4 percent increase in cash flow for its first quarter 2011. Adjusted funds from operations per share slipped 28.4 percent, but dividends were still covered by a solid 1.32-to-1 margin by distributable cash flow (75.8 percent payout ratio), and electricity output rose 1.7 percent.

The results continue to reflect the loss of cash flow from the sale of the 42 percent stake in Leisureworld, and management’s determination to invest the cash proceeds deliberately as acquisition and construction opportunities arise. One of these is the now completed purchase of 33.3 percent of the Varmevarden, Sweden, district heating business. The Amherstburg Solar Park also progressed toward start up at the end of this month, at which time it will generate a steady stream of revenue under a 20-year contract with the Ontario provincial power authority.

Operationally, the Cardinal gas cogeneration facility ran well and benefitted from higher wholesale market power prices. So did the Erie Shores Wind Farm, which also enjoyed better wind conditions, as did the Whitecourt biomass power plant.

Management now expects cash flow and funds from operations to be higher than in 2010, after excluding one-time costs for efficiency measures. The full-year payout ratio based on distributable cash flow, excluding such expenses, is projected at 110 to 120 percent. That’s above the prior estimate of 100 percent, due in large part to the conversion of convertible debentures for common shares.

Capstone, however, still anticipates a drop in the payout ratio to 85 to 90 percent next year, the first full year in which Varmevarden and Amherstburg will generate cash flow. And management affirmed in its first quarter conference call that the “dividend policy of 66 cents (Canadian) per share on an annualized basis is expected to be sustainable through 2014.”

In sum, there were no real surprises in these numbers and the subsequent guidance released by management. This is still a very well-capitalized company with efficient power plants that will generate strong cash flows going forward, and which will become ever-more valuable as North American companies demand ever-greater amounts of generation that emits less carbon dioxide.

Betting now is the Cardinal power plant contract will be rolled over at a generous rate, which will free up management for a potential dividend increase down the road. In the meantime, the current yield is generous and well covered. Buy Capstone Infrastructure up to USD9 if you haven’t yet.

Extendicare REIT (TSX: EXE-U, OTC: EXETF) posted a 2.3 percent boost in its first quarter 2011 revenue and a 3.3 percent increase in cash flow, excluding adjustments for foreign exchange. Cash flow margin of 11.5 percent was solid, equaling last year’s level. Adjusted funds from operations came in at CAD0.308 per unit, covering the distribution by a strong 1.47-to-1 margin (payout ratio 68 percent).

Management cited solid returns from the company’s “same facility” operations–which exclude the impact of acquisitions and dispositions–along with improved Medicare census levels and improved government funding. The company also completed the first phase of a USD639 million of refinancing, which is set for a final close by the end of the year.

The company now derives 67.9 percent of its total revenue from the US. That places it somewhat the mercy of volatile exchange rates, which it must manage to preserve profit. US operations are also faster growing and more profitable, with cash flow rising 8.4 percent and margins at 13.2 percent, up from 12.2 percent a year ago. By contrast, operating margin on Canadian operations was only 8.5 percent in the first quarter, down from 9.9 percent a year ago.

Adjusted funds from operations per unit were 2.8 percent lower than last year due to the impact of a strong Canadian dollar. They were higher, however, excluding exchange rate changes.

Heavy involvement in the US also makes the company vulnerable to changes in US health care law, as well as regulation and enforcement. Medicare is currently studying a change in rates that could potentially reverse higher revenues in effect since October 2010. The new rules could also affect earnings by changing delivery of therapy and assessment processes. The company looks for a ruling by early August, with a relatively benign outcome.

The company’s strategy the past several years has been to boost its percentage of Medicare patients in the “high” and “ultra-high” classifications, raising profit margins and cutting costs. Extendicare now has 80.2 percent of Medicare patients at its facilities in these categories, up from 78.4 percent a year ago. “Skilled mix” services are now 23.6 percent of the resident mix, up from 22.6 a year ago. That’s offset lower overall admissions, due to the sluggish economy, and it should shield US operations from the worst of any changes in US law.

During the company’s first-quarter conference call CEO Tim Lukenda stated once “proposed funding changes for our US healthcare centers” are finalized, “the board of trustees intends to revisit the REIT’s cash flow position and projected payout ratio to consider the advisability of an increase to the REIT’s current distributions.” That’s a strong vote of confidence in Extendicare’s prospects, despite the uncertainty of exchange rates and Medicare politics. So is management’s continued expansion push in Canada.

The stock is off slightly in the wake of the announcement. But there’s little to complain about in this report, particularly as the company prepares to return to dividend growth. Yielding nearly 8 percent, Extendicare REIT is a buy up to USD12.

Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) has also sold off a bit in the wake of announcing its first-quarter results. But with the numbers strong and well within forecasts–and provoking no changes in analyst opinion and little controversy in the conference call–it’s likely the action is due entirely to market factors. And as is the case with Extendicare, it’s given investors a chance to buy at a good price if they haven’t yet.

The company posted a 52 percent increase in output, largely due to merger between the former Innergex Power Income Fund and its parent. Revenue surged 48.7 percent, and cash flow rose 37.2 percent. Adjusted cash flow from operating activities–the account from which dividends are paid–was up 45.5 percent, and covered the CAD0.145 quarterly dividend by a solid 1.12-to-1 margin.

That protection looks even more secure in the context that power generation from facilities was just 93.2 percent of normal, due to lower than average water flows in British Columbia and less than typical wind conditions in Idaho. Moreover, only 14 percent of company generation is typically realized in the first quarter of the year, due to seasonal factors, along with 17 percent of revenue. The result should be a drop in the 89.2 percent payout ratio deeper in the year.

Innergex’ future growth lies in successfully expanding its renewable energy portfolio by buying/building new facilities and locking them into profitable long-term contracts. First-quarter results reflected its continued progress, including the successful acquisition of Cloudworks’ 75 megawatts of hydro capacity, which are under a 40-year contract. That deal also netted 80 megawatts under development and 800 megawatts of water license. The company also bought a solar project with 30 megawatts of direct current capacity under a 20-year contract.

On the construction front, CEO Michel Letellier affirmed in the first-quarter conference call that Innergex’ wind project in Quebec is “advancing very well,” with the first turbines received and the company on target for a December full startup. A second expansion of the project is slated for launch in December 2013.

Looking ahead, management expects hydro production to gradually recover to historic norms, citing a recovery in the second quarter. The company’s geographic and source diversification, however, virtually ensures a base level of earnings no matter what conditions prevail.

That plus the generous dividend make Innergex Renewable Energy a solid buy up to USD10 for conservative investors, even as it appears on track for robust long-term growth as well.

The Rest

Once again, here’s where to get information and analysis on all the Canadian Edge Portfolio picks reporting first-quarter numbers and guidance of the rest of 2011.

If you’re reading on the web, simply click on the document name to go directly to the specific company writeup in question. If you’re printing go to www.CanadianEdge.com to access the appropriate Flash Alert or article. Flash Alerts are listed under “Alerts” on the top bar. The May Portfolio Update article can be accessed by clicking on “Articles” from that top bar and going to the article “Volatility, High Expectations and Earnings.”

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