Armtec Infrastructure: Incoming!

By David Dittman • July 8, 2011 • Dividend Watch List

Dividend Watch List

Three How They Rate companies announced reductions to their dividends last month. The greatest fallout was at Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF), which eliminated its entire distribution after posting abysmal first-quarter numbers.

The results clearly took Bay Street by surprise, demonstrated by the stock’s plunge starting in early June from a longstanding trading range in the mid-teens to a low of just CAD2.53 per share by Jun. 22. The stock price has since benefitted from some bargain hunting but is still nearly 80 percent below where it began the year.

The company is now the target of at least one shareholder suit. That stems from the fact that from mid-March to early April it raised CAD57.8 million selling 3.565 million shares at a price of CAD16.20 each.

That money was used to cut debt, no doubt a plus in the company’s recent negotiations with creditors. On Jun. 27 those lenders agreed to amend an existing deal, allowing Armtec to draw up to CAD65 million in additional funding. However, it does raise questions as to just what Armtec management knew about how things were going as well as what it might be forced to do less than two months later.

Forecasting the outcome of a court case such as this is always speculative. Those interested in pursuing a claim against the company should contact Sutts, Strosberg LLp, which on Jun. 17 filed a class action suit on behalf of all those buying the stock from Mar. 30, 2001 to Jun. 8, 2011. That’s approximately the period I’ve covered Armtec in How They Rate under Business Trusts with a hold rating. The law firm’s contact information is: via telephone, 1-800-229-5323, extension 8285, or 519-561-6295; and via the Internet, www.strosbergco.com or www.arfclassaction.com.

As for the numbers, revenues actually rose 4.8 percent. The company’s Engineered Solutions division’s 21.4 percent revenue growth was able to offset lower Construction and Infrastructure Applications product volumes; revenue from the latter was down 15.6 percent. Profit plunged, however, to just 6.4 percent of sales from 11.9 percent a year earlier. Meanwhile, cash flow swung sharply negative, as competitive pressures took their toll even as order backlog remains depressed. Management also blamed “weather conditions” for lower work volumes.

Another disturbing item in the results was “finance expense,” essentially the cost of servicing Armtec’s debt, which surged by 74.6 percent. That figure will probably rise further following the amendment to the company’s credit agreement, though the company apparently faces no significant debt maturities now until mid-decade.

Based on the numbers behind the numbers, there are some hopeful signs for the company’s underlying business. For one thing, it’s been successful winning transportation infrastructure projects. These are a very secure source of revenue and, once won, are largely immune from recession pressures. Selling, general and administrative expenses (SGA) were also lower as a percentage of revenue than a year ago, the benefit of a 2010 corporate reorganization.

In assessing Armtec’s outlook, management has hopeful things to say about the company’s ability to rebuild backlog through private-sector work, particularly on the growing Engineered Solutions side. Nonetheless, it also stated it “does not anticipate improvement until the end of 2011” while margins “are not expected to fully rebound to pre-recession levels during 2011.”

There’s one other very big problem here, at least in my view. Armtec management had previously stated its desire and ability to pay a quarterly dividend at an annualized rate of CAD0.40 per share. The abrupt reversal of that pledge, combined with the hefty volume of red ink in the first quarter, is a severe blow to credibility.

No Bay Street analysts changed their opinion in the wake of this news, and the count remains current one buy, four holds and two sells. The stock appears to have stabilized, and it’s hard to imagine much additional downside from a price of just 34 percent of book value.

On the other hand, I don’t see a lot of merit to holding a company paying no dividend that makes this kind of jarring moves with little or no warning. Sell Armtec Infrastructure.

On Jun. 14 New Flyer Industries Inc (TSX: NFI-U, OTC: NFYIF) announced it would convert from an income deposit security (IDS) to a common stock, pending approval of unitholders. The board also set a post-conversion dividend rate approximately half of the current annual rate of CAD1.17 per unit, or a new monthly rate of about CAD0.04875 per share. And it stated that between now and August 2012 it would pay a special dividend resulting in an overall annual payout of CAD0.77 to CAD0.93 per share.

Doing the math, that’s a special one-time payment of between CAD0.185 and CAD0.345. The company will continue to pay at CAD0.0975 per month until the conversion, which is expected later this year.

In stark contrast to the Armtec move, the market reaction to the New Flyer cut was quite muted. In fact, after a few days of volatility the stock has rebounded pretty much to where it was before the announcement. That’s in large part because the market was already pricing in a cut following first-quarter earnings that indicated the company is facing very difficult business conditions. But in my view it’s also because–providing further contrast with the Armtec move–New Flyer management has been up front with shareholders.

Also, New Flyer’s report did contain one very solid piece of news: New orders once again replaced finished contracts in terms of dollar volume in the first quarter. Last month management secured its first bus sale to a Quebec customer in over 40 years, and it also inked new business with Metrolinx, an agency of the Ontario provincial government created in 2006.

The post-conversion New Flyer will still pay a competitive yield of around 7.6 percent paid monthly. Meanwhile, the cash saved ensures it will weather today’s tough conditions in its business with a market-leading position, particularly in clean and efficient energy buses that municipal fleets will increasingly turn to as budgets improve. That may take a while. But New Flyer Industries is again on stable ground and a buy up to USD10, as it was last month.

Note that Bay Street is now unanimously bullish on the stock, after three analysts upgraded it last month.

Westshore Terminals Investment Corp’s (TSX: WTE-U, OTC: WTSHF) 11 percent cut in its distribution from the level last quarter is the result of paying income taxes for the first time, which cut into distributable cash flow. It’s also the result of no longer dishing out special payments from cash reserves, as management did to avoid taxes in the company’s final year as an income trust.

The company’s current yield is now only about 4 percent. That’s far less attractive than the other energy infrastructure companies I track in How They Rate, particularly the four in the CE Portfolio’s Conservative Holdings.

On the bright side, there are very few risks. All revenue basically comes from managing a terminal that’s one of Canada’s most important for shipping metallurgical coal to overseas markets. And traffic is on the rise, thanks to robust demand for met coal globally and secure contracts with the country’s more prolific producers, including Teck Resources Ltd (TSX: TCK/B, NYSE: TCK). Fee-based contracts eliminate most commodity price exposure as well.

Cash flows and therefore distributions–the latter track the former closely–should get some upside in the last two quarters of the year, as has been the case historically. Those disappointed in the yield post-reduction and looking for more do have the option of selling Westshore Terminals near its all-time high. Those more concerned with total return can still buy on dips to USD24 or lower.

Below is the current Dividend Watch List, highlighting companies with dividend-threatening challenges at their core businesses. Not all of those listed below are sells, and they can be buys if the price is right.

The List will change, as always, with the onset of second-quarter earnings season later this month. I’ve included comments in How They Rate on what I’ll be watching for when results are announced. Aggressive and Conservative Holdings are highlighted in more depth in Portfolio Update.

I’ve listed approximate reporting dates below for these companies. Note that Brompton is a mutual fund and doesn’t report earnings per se.

  • Brompton VIP Income Fund (TSX: VIP-U, OTC: BVPIF)–N/A, SELL
  • Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Aug. 12 (confirmed), Hold
  • CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Aug. 12 (estimate), SELL
  • Colabor Group Inc (TSX: GCL, OTC: COLFF)–Aug. 6 (estimate), Hold
  • FP Newspapers Inc (TSX: FPI, OTC: FPNUF)–Aug. 10 (confirmed), Hold
  • Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Aug. 11 (estimate), Hold
  • Interrent REIT (TSX: IIP-U, OTC: IIPZF)–Aug. 12 (estimate), SELL
  • Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–Aug. 10 (estimate), Buy @ 5
  • Yellow Media Inc (TSX: YLO, OTC: YLWPF)–Aug. 5 (estimate), Hold

One of these companies did report its first-quarter earnings after the publication date of the June 2011 issue, FP Newspapers Inc (TSX: FP, OTC: FPNUF).

The numbers weren’t particularly impressive on their face. Like all print media companies, FP’s challenge is to boost its digital or Internet-based business to keep pace with the long-term decline in its print business. And while management has done a good job holding its own so far, the jury’s still out on whether the company will ultimately be successful.

Digital sales were up a robust 45 percent in the quarter from last year’s tally, for example. But overall revenue, even including the effect of a recently inked printing contract, sank 5.2 percent. Cash flows fared even worse, dropping 20.7 percent.

One reason was a continued weak market for print advertising. Classified ad revenue dropped 10.9 percent and only flyer distribution revenue managed gains, rising 5.1 percent. Circulation revenue dropped 8 percent overall, as the company relied more on single copy volumes and lower paid subscriptions. Commercial printing revenue also dropped, due to the decision of the Toronto Globe and Mail not to renew its contract.

Offsetting the decline was a drop in operating expenses of 1.1 percent. Employee compensation costs fell 2.1 percent, despite a wage increase in collective agreements. That was partly offset by a 7.3 percent jump in newsprint expense and a 1.4 percent increase in delivery costs.

FP’s remains a very cash-rich business. Distributable cash flow for the quarter fell sharply to just CAD0.092 per share from CAD0.274 a year ago. That pushed the quarterly payout ratio to 163 percent.

Management still seems to be gauging the dividend to 12-month distributable cash flow to strip out seasonal factors. And by this measure coverage was solid at 72 percent. In its statement on the company’s outlook, management projected that less-than-expected advertising revenue growth would be offset by a home delivery rate increase. It also stated the expectation that new printing contract cash flow would offset any drop in advertising cash flow.

As long as it’s even moderately successful, FP’s dividend should hold this year. After that, success will depend on growing the Internet business and holding as much of the print business as it can. The company plans to invest CAD1.2 million–the bulk of capital spending–on the web printing units and ancillary components at its newly acquired Steinback operation to boost printing capacity. And the company should also benefit from Chinese investment in its territory, which is heavily agricultural.

There are no guarantees with FP, just as there can’t be for any company with so many uncertainties. This is no conservative income stock. But yielding nearly 12 percent, there’s plenty of compensation for aggressive investors willing to punt if it becomes clear management isn’t able to meet its goal. Hold FP Newspapers.

Note that FP’s old economy-to-new economy transition challenges are very similar to those facing Aggressive Holding Yellow Media Inc (TSX: YLO, OTC: YLWPF). I reviewed that company’s trials and tribulations in depth most recently in a Jun. 27 Flash Alert.

Since then management has made progress on the sale of its Trader assets by winning regulatory approval. That should at least temporarily answer the oft-repeated rumors that the deal and its CAD745 million in proceeds to Yellow Media were in trouble. Until the money is in the bank, however, nothing is set in stone.

Simply, holding Yellow is a speculation, just like holding FP is. It’s not for anyone who can’t stomach the risk of the stock heading further south, even after recent declines. If the company can complete the Trader sale, cut debt and post some decent second-quarter numbers–including distribution coverage by cash earnings and growth of its Internet business–it still has a chance to make money. If it can’t, we’re going to see more carnage.

Hold Yellow Media only if you’re willing to make that wager–but by all means, not in enough quantity to sink your portfolio.

Bay Street Beat

One final group of Canadian Edge Portfolio recommendations reported first-quarter results after publication of the June issue, including Conservative Holdings Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF), Extendicare REIT (TSX: EXE-U, OTC: EXETF), IBI Group Inc (TSX: IBG, OTC: IBIBF), Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) and Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and Aggressive Holding Ag Growth International Inc (TSX: AFN, OTG: AGGZF).

Capstone Infrastructure management is now indicating an extension of its power purchase agreement with the Ontario Electricity Financial Corp beyond 2014 for the 156 megawatt combined cycle gas cogeneration Cardinal power plant in Ontario–which accounts for more than half of Capstone’s installed capacity–could be agreed by the end of 2011.

The stock earned an upgrade to “buy” from “market perform” from Cormark Securities. That’s a rating that needs no running through Bloomberg’s standardizer–and a price-target boost to CAD8.75, up from CAD7.75 just a month ago, or prior to the release of first-quarter results.

At the other end of the spectrum, National Bank Financial established new coverage of the stock with an “underperform” tag and a CAD7 price target. Overall two Bay Street analysts rate Capstone a Bloomberg-modified “buy,” five have it a “hold” and one–the late-arriving National Bank Financial–is a “sell.”

As noted in the first-quarter earnings summary included in the Jun. 10 Flash Alert, management affirmed that Capstone’s dividend–CAD0.66 per share annualized–is “expected to be sustainable through 2014.” Numbers for the first three months of the year were in line with CE expectations, as was management’s guidance for the balance of 2011. Solid dividend coverage and the potential for payout increases in the near term justify a USD9 target for Capstone Infrastructure.

Extendicare REIT management hinted strongly at an imminent dividend increase in its first-quarter conference call. The move is contingent on the finalization of the way its US health care centers are funded. A sustained focus on higher-end Medicare patients south of the border is paying off in higher profit margins and reduced costs.

More than 80 percent of Extendicare’s patients are of the “high” and “ultra-high” classifications, up from 78.4 percent a year ago. Meanwhile, “skilled mix” services now account for 23.6 percent of the overall, up from 22.6 percent, offsetting the impact of lower admissions because of a stagnant economy. Extendicare’s approach to the market should insulate it from the worst impacts of federal efforts to reform health care in the US.

Extendicare is covered by only four Bay Street analysts, one of whom downgraded the stock to “sector perform” from “sector outperform.” The analyst, from CIBC World Markets, reduced his price target from CAD14 to CAD11.50. The CIBC rating is a “hold” in Bloomberg parlance, which makes the long-term-care-facility REIT’s overall buy-hold-sell line two-two-zero

For Canadian Edge’s part, Conservative Holding Extendicare REIT–with a 7.8 percent yield–is a buy up to USD12.

IBI Group is something of a darling on Bay Street in the aftermath of first-quarter earnings season/the buildup to second-quarter earnings season. Nine analysts have a Bloomberg-adjusted “buy” rating on the stock, while three rate it a “hold.” There are no “sell” calls. TD Newcrest boosted the stock from “hold” to “buy” in the wake of first-quarter earnings, though the target price remained fixed at CAD16.50.

IBI continues to reach beyond North American to ensure its continuing growth, announcing this week a deal to build 10 underground stations for a light-rail line in Tel Aviv, Israel. IBI also finalized a strategic alliance with CRJA Landscape Architects, a Boston-based outfit with a strong presence in the Northeast US and growing ones in key international markets such as China and the Middle East.

IBI Group–a June High Yield of the Month–reported solid first quarter numbers and is a buy up to USD15.

Innergex Renewable Energy received a similar vote of confidence from its Bay Street constituents after reporting a 52 percent rise in output and a 48.2 percent increase in revenue. All Bay Streeters that addressed the matter maintained their ratings on the stock in the aftermath of solid first-quarter earnings. Innergex is a buy up to USD10.

Northern Property REIT has five “buys” and five “holds” on Bay Street and not a single “sell.” All of them reiterated their recommendations after Northern reported first-quarter earnings. The REIT is a buy up to USD28.

Meanwhile, Aggressive Holding Ag Growth International sports a similar Bay Street split, with four “buys,” four “holds” and zero “sells” among the eight analysts who cover it. That’s after PI Financial Corp and Wellington West Capital Management issued upgrades following revelation of first-quarter numbers, with buy targets of CAD54 and CAD50, respectively. Ag Growth–which closed at CAD46.79 Jul. 7–is a buy up to USD50.

As pleasant as that was, it was “Bay Street Beat-down” last month for Aggressive Holding Yellow Media Inc (TSX: YLO, OTC: YLWPF), which suffered a series of public blows despite the fact that the only real news, toward the latter half of the month, was, if anything, positive. But Yellow suffered a downgrade or a price-target reduction from just about every analyst who covers the stock and loud calls for management to slash by half or even eliminate entirely its CAD0.0542 per month dividend payment in favor of de-leveraging the balance sheet, which includes CAD2.1 billion in debt.

The buy-hold-sell line on Bay Street, Canada’s Toronto-based equivalent to New York’s Wall Street, is zero-10-two, not a pretty one considering the judges notoriously skew bullish in their ratings. Bloomberg standardizes otherwise discrete terminology brokerage houses use to indicate their feelings about stocks. But there’s no way to describe the eyes Yellow Media at this point as anything but jaundiced.

There’s no question that Yellow’s is a difficult road. It will be made easier with the cash from the Trader sale, which will allow it to reduce its leverage ratios. At least one observer, however, presents an analysis that suggests Yellow Media can cover its current payout, support growth and meet its costs into 2012, which gives it still more time to prove its case to what’s now a skeptical (for them) jury of analysts.

Commenting on the Trader deal, DBRS forecast on Jun. 30 that the CAD745 million in cash Apax Partners is paying for the asset will allow Yellow to shave its debt-to-EBITDA (earnings before interest, tax, depreciation and amortization) ratio from 2.74 to around 2.0, which the Canadian bond rater believes positions it better for what will remain a bumpy ride until Internet operations are sufficient to sustain the business and the payout.

Print directories will remain the biggest contributor to revenue following the Trader disposition. And this business faces “significant risks as it transforms from a print-placement and listing organization into an online/digital media and marketing service provider.” DBRS has maintained all its ratings on Yellow Media, with a “stable” trend.

This guarded, at best, optimism is rooted in Yellow Media’s “reasonable” progress in the early stages of its shift, as more than 25 percent of Directories revenue was from the digital side of the business in the first quarter of 2011, up from 18 percent a year ago. Too, DBRS cites “relatively steady EBITDA and cash flow from operations.”

But, as even CEO Marc Tellier conceded in an interview in May, shortly after the release of results, Yellow won’t satisfy the many who question the survival of the dividend–the business, even–until online revenue reaches parity with print revenue. And Mr. Tellier is still unable to set a timeline for when that might happen, when its transformation from ugly print duckling to 21st century Internet swan will be completed.

It might never happen, at least according to a Credit Suisse analyst who downgraded Yellow from “neutral” (translated to “hold” in the Bloomberg system) to “underperform” (or “sell”) and reduced his 12-month price target for the stock from CAD5 to CAD2 based on “accelerating” declines on the print side of the business. Credit Suisse noted that in Edmonton the number of advertising pages in Yellow’s most recent book was down 14 percent from a year earlier, faster than a 2009-to-2010 decline of 12 percent and 3 percent the year before that. The analyst cited double-digit declines in other urban markets.

The concern is that online/digital revenue won’t accelerate fast enough to make up for these declines. Other investors go a step further, pointing out the “absurdity” of Yellow Media paying a dividend with a debt burden so large.

“It’s ridiculous,” said CEOPaul Tepisch of High Rock Capital Management, which holds Yellow Media debt, “that they are paying a dividend given the leverage in the business.” The quickest way to make short sellers go away and put the company back on firmer footing, Mr. Tepish told the Toronto Globe and Mail, is to make a full commitment to reduce the leverage on the balance sheet. “They have a glorious opportunity to do the right thing and right-size their capital structure and come out of this stronger.”

The hope is that the CAD745 million from Trader–once all approvals are had–will take enough of a bite out of its CAD2.1 billion debt that Yellow will avoid a credit-rating downgrade, which would, in turn, bring on tighter loan covenants that could include strictures on future dividends. According to a statement released by Yellow on the deal’s approval by Investment Canada, the company said completion of the sale “remains subject to satisfaction of other customary conditions.”

Following a longer-than-anticipated review period, it won’t close during the second quarter, as forecast when the deal was announced back in March. It’s now expected to close this month.

Once one of the best, brightest income trusts, Yellow Media now sports a 24.2 percent yield, based on an annualized payout of CAD0.65 per share and a Jul. 7 closing price of CAD2.69. If it gets cut in half, the yield is still 12.1 percent. At this point it’s for the adventurous only.

Tips on DRIPs

Last January Baytex Energy Corp (TSX: BTE, NYSE: BTE) opened its dividend reinvestment plan (DRIP) to US investors. Baytex’s DRIP, like other plans of its kind, will allow shareholders to reinvest their monthly cash dividends in additional shares without paying commissions.

Baytex joins other New York Stock Exchange-listed Canadian companies that extend the convenience of a DRIP to US investors. US securities laws restrict participation in DRIPs sponsored by foreign companies that don’t register their offering with the Securities and Exchange Commission (SEC). Most plans of Canadian income and royalty trusts that do sponsor DRIPs aren’t registered under the United States Securities Act of 1933, as amended. US investors, therefore, aren’t eligible to participate.

Two CE Portfolio recommendations, Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) and Provident Energy Ltd (TSX: PVE, NYSE: PVX), do allow US investors to participate in their respective DRIP offerings, with certain limitations. Information about Penn West’s plan is available here. Click here for more information about Provident’s DRIP.

Penn West, Provident and now Baytex, because they’re listed on the NYSE, have therefore opted into US filing and registration requirements. It’s basically a matter of how much overhead expense trusts are willing to absorb.

Conservative Holding Atlantic Power Corp (TSX: ATP, NYSE: AT), which listed on the NYSE in July 2010, continues to “evaluat[e] options for a Dividend Reinvestment Program” and “hopes to have this option available to shareholders in the future.” NYSE-listed Aggressive Holding Enerplus Corp (TSX: ERF, NYSE: ERF) has a DRIP for Canadian investors but has not opened it to US investors.

We’ll continue to track Atlantic Power and any other Portfolio Holdings that indicate they’re considering or announce that they will sponsor DRIPs open to US investors.

Companies under How They Rate coverage that sponsor DRIPs open to US investors include (click on the links for more information):

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