The Stock

Why Now? After announcing bad fourth-quarter 2010 results and cutting its distribution from an annualized CAD1.62 per share to CAD1.20 Superior Plus Corp (TSX: SPB, OTC: SUUIF) has bounced around and off lows just north of USD11 per share. The new dividend rate, which is still paid monthly, is well covered by adjusted cash flow, even based on underwhelming fourth-quarter figures.

The market’s overreaction to the most recent quarterly disappointment, combined with management’s much more conservative guidance as well as reversal of unfavorable external conditions during the current quarter versus the year-ago period, set the stage for upside surprise over the course of 2011.

Lock in a sustainable 11 percent-plus yield at these levels, look for the stock to rally to north of USD14 and collect a check every month while you wait.

The Story

It’s an easy thing to do a Bloomberg screen and throw money at the biggest double-digit yields you come up with, quite another to find a sustainable payout. Within that decidedly un-august crowd we’ve found one company that could provide that combination of “deep value” and “high dividend” that defines the pursuit at Big Yield Hunting.

David: Superior paid CAD0.13 per unit per month from June 2006 until April 2008, when it bumped the payout by half a cent to CAD0.135 per unit. And there it held until last month. That’s when the reality of the North American economic situation finally filtered into management’s forward-looking guidance. The negative impact on the bottom line of increased interest expenses, combined with operational realities, forced Superior to cut its distribution by 26 percent.

Management reported adjusted operating cash flow per share for the year ended Dec. 31, 2010, of CAD1.29. At the new annualized payout rate of CAD1.20 per share we’re talking about a payout ratio north of 90 percent…

Roger: Ninety-three point oh-two, to be exact.

David: Not exactly “CE Conservative Holding” material.

Roger: That’s true. But “payout ratio” is only one component of the Safety Rating picture, and that you have to consider from a dual perspective. If a company’s payout ratio comes in below a certain level required for its sector, it gets a point. But if it’s superior for its class, the company will score two points.

And we also want to know some things about debt–such as how much there is relative to total assets and how much of that is coming due over the next 24 months. Probably the most important thing, and this is because what we do is make judgments between and among companies, is understanding the kind of business we’re evaluating. It’s all relative–in other words, numbers that threaten payout safety for an Oil and Gas company may be perfectly normal for a Gas/Propane name.

So, sure, if we considered just this assumed fourth-quarter 2010 payout ratio, we’d deem it “at risk,” according to the Safety Rating System: It’s a Gas/Propane company with a payout ratio above 90.

But let’s take management’s worst-case guidance for at face value: On the low end they’re looking for adjusted operating cash flow per share of CAD1.40, an assumed payout ratio, according to management’s chosen metrics, of 85.7 percent. By the numbers, that’s not “at risk.”

With a debt-to-assets ratio below 50 percent, leverage doesn’t appear to be an issue.

Let’s take the next, critical step and look at how things are going for Superior on the ground.

David: Right: “Buy the business.”

Roger: Exactly. Whether we’re chasing down a big yield to tide us over until we see a solid price pop or establishing a core, wealth-building holding for the long term we need to know what’s happening on the ground. Operational weakness, after all, threatens the payout and, therefore, the share price.

Our goal with Big Yield Hunting is to point out the risks and determine whether there are inefficiencies in current market pricing that’ll allow us to enjoy a big capital gain, too.

David: OK, Superior operates in basically three areas. The original is energy services, which is essentially propane distribution. Then there’s specialty chemicals and construction products, which management has added to in more recent years.

Management likes to tout the diversity of its business mix and the stability this lends to the payout. Recent history argues otherwise, of course. No. 1, these guys had a pretty crummy fourth quarter, in fact a rough 2010 all around. And No. 2, management cut the dividend by 26 percent, the numbers at the end of last year being the proverbial writing on the wall.

Roger: That’s really the thing isn’t it? Investors are always unforgiving of dividend cuts, and they should be. But every once in a while, there’s that over-reaction that opens the door for a really big gain–provided the bottom is really in.

David: That’s what I think. See if you agree. The new dividend rate looks well covered, but only a few investors seem to believe it. One reason in addition to track record might be the business seems just a little too spread out. But management’s decision to cut hard now has fulfilled the “sustainability” promise.

Margins for propane distribution–which is the biggest part of the revenue mix, at about 40 percent–were lower for the year and the fourth quarter. But first-quarter 2011 comparisons to the year-ago period are likely to look good. The construction products division is still hostage to the US housing market, but in recent days we’ve seen positive data on that ugly front.

And the specialty chemicals business actually grew earnings for the fourth quarter of 2010 (by 56.5 percent) and for the year (8.5 percent). I see value here; it looks like the market has overreacted to the dividend cut and the guidance reduction.

Roger: Having a lot of moving parts does scare some. But I actually like what I saw in energy services, even in the last quarter. We had a full contribution from the US refined fuels businesses Superior acquired in the fourth quarter of 2009, which was positive.

And the primary reason overall results were worse was because commodity prices flat-lined, leaving less opportunity for the company’s supply portfolio management business to profit from price swings. That’s far from a permanent state of affairs. Of course it didn’t help that volumes were lower for Canadian propane for the year, but things did get better–residential, commercial, industrial–by the fourth quarter.

Seasonality factors–other than weather, actually–as well as what’s clearly been an historically weak recovery had more to do with Superior’s less-than-superior–had to do it–performance.

Forgive the pun. But it seems to me the company has put itself in position to benefit from a reversal of fortune, for lack of a better characterization.

David: Energy services, of course, accounts for the lion’s share of revenue. It’s the workhorse. The show pony right now is specialty chemicals. Through ERCO Worldwide it’s a leading supplier of sodium chlorate to the pulp and paper industry. Its chloralkali products are used by municipalities and private industry for water treatment, food processing, fertilizers, agricultural intermediates and in oil and gas exploration and production.

ERCO’s also the second-largest producer of sodium chlorate in the world. According to the company website it has “the world’s largest installed base of modern chlorine dioxide generators and related technology and is the second-largest producer of potassium products in North America.”

Roger: A strong pulp market should keep sodium chlorate demand strong, and continued improvement in the North American industrial economy will support chemical demand, which is positive for ERCO’s chloralkali business. During an otherwise gloomy fourth-quarter conference call management noted that the sodium chlorate side of the business should provide stability, because basically everyone was “sold out” for 2011 and 2012, which means pricing power for providers.

This seems to validate management’s decision to expand the Port Edwards facility, which was completed in the fourth quarter of 2009. Port Edwards operated at a faster clip throughout the entire fourth quarter and is on track for another solid quarter.

David: As for the construction products segment, which sells commercial and industrial insulation and specialty walls and ceiling installations, the fourth quarter of 2010 looked a lot like the many periods before it: bad.

Roger: That’s undeniably true, and it’s my primary beef with management, which made the decision to invest in this business heavily shortly before the recession. They’re still reeling from that move. Earnings before items declined from CAD10.9 million to CAD7.4 million.

On the other hand, that too is well baked into Superior’s own projections as well as its share price. It can’t really hurt us any more. In fact, the only side this segment can provide is upside. There’s even some reason to expect it, with US housing at least bouncing along a bottom. Moreover, the Canadian market has stabilized, after roaring along amid historically cheap mortgage costs before Canadian authorities tightened things up.

David: And even here management has taken steps to tighten up the operation in anticipation of an eventual recovery. Perhaps it’s survival mode, but that’s enough if the other segments perform.

That’s another way to look at Superior: a modest but free option on a US housing recovery–along with an 11 percent yield.

Roger: Superior Plus Corp, which will announce first-quarter 2011 earnings and host a conference call on May 4, is April’s Big Yield. Buy it up to USD11.60.

David: I like it. I really like it.

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• TODAY: Superior Plus Corp (TSX: SPB, OTC: SUUIF)–Buy < USD11.60