A Seemingly Unlikely High-Yield Play

By Ari Charney • September 25, 2013 • Canadian Edge Weekly

As the third-largest school bus transportation provider in North America, Student Transportation Inc (TSX: STB, NSDQ: STB) has an intriguing story and an enticing 8.5 percent yield that has attracted substantial support from income-hungry retail investors. Nevertheless, it’s worth scrutinizing how such a small company–its CAD582.5 million market capitalization puts it toward the lower-end of the small-cap range–can support such a sizable payout.

To be sure, Student Transportation has been the very model of dividend consistency, paying a monthly dividend for 104 consecutive months, since February 2005. And the company is pursuing a consolidation strategy in a highly fragmented industry, with a tailwind from an era of tighter government budgets, where cash-strapped school districts are anxious to save money by outsourcing their transportation services.

As part of its roll-up strategy, Student Transportation has steadily acquired local school bus operators–mostly in the US, where the Canadian firm derives the vast majority of its revenue–in an extended acquisition spree over the past several years, though the pace of its M&A has slowed more recently. According to data provided by both the company and Bloomberg, Student Transportation has closed 31 acquisitions since 2004, including 23 since 2008 and eight in calendar-year 2011 alone. Included in this tally is the latest set of acquisitions, announced on Sept. 17, of two school bus companies, one in New Jersey and the other in Pennsylvania.

In financing these acquisitions, Student Transportation has shrewdly taken advantage of the historically low interest rate environment, which has allowed it to issue debt relatively cheaply, as well as make successful secondary equity issuances to yield-starved investors. As of June 30, which marked the end of Student Transportation’s fiscal year, the company reported USD220.2 million in long-term debt on its balance sheet.

Long-term borrowings have nearly doubled over the past five fiscal years, with long-term debt jumping to 113.2 percent of shareholders’ equity at the end of June, compared to 65 percent back in 2008. However, the picture is somewhat less dramatic when viewed from the perspective of long-term debt as a percentage of total assets, which climbed to 42.9 percent from 33.2 percent in 2008. At the same time, goodwill, which is the premium paid beyond book value for the intangible assets of acquired companies, accounts for a substantial 27 percent of Student Transportation’s assets.

Meanwhile, Student Transportation’s weighted average of non-diluted shares outstanding has more than doubled, to 79.4 million shares from 32.2 million shares five years ago. The share count has grown via secondary issuances of 1.7 million shares in 2008, 12 million shares in 2009, and 12.25 million shares in 2012. Still, management noted that low-cost debt has enabled the company to avoid making additional secondary issuances, since the last one in March 2012.

The company’s dividend reinvestment program (DRIP) has also added incrementally to the share count, including 1.3 million shares in fiscal-year 2012 and 1.5 million shares in fiscal-year 2013. Like DRIPs at other Canadian-domiciled firms, retail investors must be Canadian residents in order to be eligible to participate. Dividends are reinvested without commissions at a 3 percent discount to the average share price of the five trading days preceding the payment date.

Student Transportation has attempted to offset some of this potential dilution via a buyback program, which in Canada is referred to as a normal course issuer bid. Nevertheless, share repurchases have been relatively minimal over the past two fiscal years, at just 96,300 shares and 401,076 shares, respectively.

Fortunately, net income per share has improved to CAD0.05 in fiscal 2013 from a loss of CAD0.22 in fiscal 2008 (the company reports its results in US dollars, but per-share data is listed in Canadian dollars). The most recent result also marks a recovery from the dip to CAD0.03 in profits per share in 2011-12, after the company posted CAD0.05 in profits per share in 2010. So from an earnings-per-share (EPS) standpoint, dilution appears to have been mostly kept in check, though it does show that the company’s roll-up strategy has yet to translate into sufficient growth in EPS to more than offset the rise in share count.

Furthermore, dividend coverage is definitely a concern, since the total annual payout of CAD0.56 per share is multiples of the firm’s EPS. But when adding back non-cash charges, such as depreciation and amortization, to net income, the payout ratio appears to be a more manageable 69.1 percent. The company’s fleet of 9,600 school buses results in a significant depreciation expense, which totaled USD41.9 million in fiscal 2013. In their earnings call, management cited a payout ratio of around 79 percent, though I wasn’t able to locate their methodology for arriving at that figure.

Once we finally enter a rising-rate environment, Student Transportation won’t be able to pursue acquisitions as aggressively, nor will it have the same level of support from income investors, as some will inevitably shift their attention toward fixed income. As such, management will have to reorient their focus toward organic growth. At that point, we will watch to see whether the company’s scale has truly enabled it to not only support its payout, but also achieve enduring growth in earnings per share.

Here’s where to find our analyses for Portfolio Holdings that have reported earnings for the second quarter of 2013:

Conservative Holdings

Aggressive Holdings

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Roy Singleton

Roy Singleton

Does Surge Energy deserve a look, based on its dividend history, and rising profit from its vast area of potential
drilling resources?

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