3/15/12: Four Report, Four Excel

By Roger Conrad • March 15, 2012

Since the March issue went to post four more Canadian Edge Portfolio Holdings have reported fourth-quarter and full-year 2011 numbers. All turned in results that supported dividends, boosted balance sheets and set the stage for reliable growth in 2012.

Quarterly numbers reported this late are of limited utility in one very real respect: Anything based on a static measure or snapshot is outdated. This includes most balance sheet items, particularly current assets such as cash and/or current liabilities such as short-term debt.

On the other hand dynamic measures–i.e., anything to do with growth rates and guidance–are probably more important than they would be if the numbers were reported earlier. That’s in part because it won’t be long until we have a new set of numbers for the first quarter. And with the year now two and a half months old it’s become considerably more clear what’s working in 2012 and what may not.

As a result, my focus in analyzing the four companies highlighted below is much more on dynamic measures than on the static. The most important balance sheet items have to do with debt coming due the next couple years as well as debt refinanced in recent months.

For these four companies maturing debt wasn’t a problem last year and–thanks to timely refinancings in recent months–it’s not a problem for 2012, either. The only debt of note is what will be taken on to make acquisitions going forward. But since the cost of capital is always integral to any decision to purchase assets, the upshot is debt isn’t much of a risk for any of these companies.

As for the dynamic measures, all four came in with very strong growth in the fourth quarter of 2011. And while management remains conservative in its operating and financial policies, all four are clearly positioned for strong growth in 2012.

The only challenge for each of these companies is unit price. Make sure before you purchase any of them that they’re selling below my buy targets.

Ag Growth International Inc (TSX: AFN, OTC: AGGZF) delivered a robust 35.6 percent boost in its fourth-quarter revenue, increasing cash flow by 26 percent excluding items. That pushed earnings per share decisively into the black.

Sales of commercial handling equipment were up in North America, as agribusiness customers’ preseason demand for portable equipment surged to a record. This offset startup costs incurred at the Twister Greenfield storage-bin plant as well as what CEO Gary Anderson called an “off year” at the Mepu division in Finland, a focus for future growth. Excluding those items–which totaled CAD13.5 million–2011 cash flow was up 11.8 percent.

Encouragingly, management’s outlook for 2012 is increasingly robust. That’s based on expectations for a large number of corn acres to be planted in the US as well as normal weather conditions in Western Canada, where planting was severely curtailed in 2011. The company also expects a better year at Mepu based on moderating costs and improving margins. And it’s reducing the initial costs of recently expanded North American operations.

The US remains the company’s most important market, contributing 60 percent of 2011 revenue. That’s versus roughly 21 percent in Canada and 19 percent from markets outside North America. The Canadian portion should rebound in 2012, assuming planting conditions normalize. But Ag Growth also continues to move aggressively to promote sales in developing world markets, including Argentina, Columbia and Latvia. Order backlog from international operations (outside North America) is now roughly double what it was a year ago.

Including the one-time costs cited above, Ag Growth’s full-year payout ratio came in at 75 percent of funds from operations. Excluding the costs, it would have been much more in line with last year’s 58 percent. And guidance is for 2012 to return to 2010 levels.

Ag Growth’s results are affected by two other factors that are largely outside its control, steel prices and exchange-rate swings. Steel costs have surged in recent years and are currently about 30 percent of overall production costs. The good news is that’s only slightly above the 29 percent level of 2010, demonstrating the company’s ability to at least partly mitigate the fluctuations with long-term contracts. This is critical to being able to pass price increases along to customers.

Currency swings are partly offset by the fact that at least some costs are incurred in foreign terms. But management still faces a challenge each year managing the exposure of the 75 to 80 percent of revenue coming from overseas to the Canadian dollar’s generally upward direction. These results are encouraging in that regard. In any case the robust growth of US agribusiness continues to more than offset any weakness on the currency front.

Ag Growth’s financial strength is best demonstrated by its continued ability to expand its business profitably on a global basis. The company has no maturing debt until 2014 and continues to generate funds to spur growth. Until the payout ratio comes back down, I’m not expecting a dividend increase.

But the stock remains a buy up to USD40 for aggressive investors who don’t already own it. Note that recent consolidation in the global agriculture business could make the company a takeover target as well.

Artis REIT (TSX: AX-U, OTC: ARESF) posted a 32 percent increase in funds from operations per unit in the fourth quarter of 2011 and a 20 percent jump in full-year results. That was enough to take the three-month payout ratio down to 81.8 percent and the full-year tally down to 89.3 percent from 108 percent and 106.9 percent, respectively, in 2010.

The diversified commercial landlord acquired 32 properties in 2011 for CAD678 million. This increased its total to 163 income-producing properties covering 17 million square feet throughout Canada and the US. It was also the major catalyst for a 48.3 percent jump in quarterly revenue and a 50.4 percent increase in net operating income (NOI).

Artis also boosted the profitability of properties it already owned, lifting fourth-quarter same-property NOI by 2.6 percent. Occupancy ticked up slightly to 96.1 percent including committed space, from 96 percent at the end of 2010. Asset and property management is now in house, potentially taking a major bite out of future operating costs. In addition, the REIT both extended the average term of its leases by a year (5.6 years) and reduced the average age of its properties by four years.

The average rate on renewing leases rose 2.7 percent in the fourth quarter, with a tenant retention rate of 78.2 percent. That was partly offset by a drop in the average rate on new leases, due to a greater number of properties under management as well as the loss of a major tenant in Vancouver.

The good news is the trend for renewing leases remains positive for 2012, when 9.3 percent of Artis’ portfolio is up for renewal. Another 12.1 percent comes up in 2013. As of mid-March 2012 56.2 percent of the 2012 expiring leases and 26.8 percent of the 2013 expiring leases have been renewed at an average rent increase of 2.7 percent. And with the remaining lease rates some 4.3 percent below market rates, we should see at least a similar rate of increase as they’re renewed.

Once heavily dependent on Alberta’s energy patch, Artis’ portfolio quality continues to improve. The top 20 non-government tenants account for just 23.6 percent of overall revenue, with the largest single tenant just 2.7 percent. Today just 29.3 percent of the portfolio is in Alberta, with 24.1 percent in the US, 20.1 percent in Manitoba, 11.5 percent in Ontario. 9.3 percent in British Columbia and the balance in Saskatchewan.

This geographic diversification is complemented by asset-class mix, which is now 41.1 percent industrial, 37.6 percent office and the rest retail. And the current expansion pipeline promises to further broaden Artis’ reach and revenue stream, further insulating it from economic ups and downs.

The REIT’s expansion and vastly improved profitability probably still aren’t enough to fund a distribution increase in the first half of 2012. But the trend is clearly for higher profitability, setting the stage for a boost possibly later this year. Until this happens, I probably won’t lift my long-standing buy target for Artis beyond USD15. But it’s a strong buy on any dip below that price for those who don’t already own it.

Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) blasted off to a 35 percent jump in fourth-quarter funds from operations (FFO) per share to CAD1.32. That pushed full-year FFO up 26 percent to CAD4.65 per share. The full-year payout ratio was 59 percent, while the fourth-quarter payout was just 52 percent.

Energy producer profits boil down to a combination of production volumes, costs and realized selling prices. Crescent lifted its overall output 16 percent in the fourth quarter from year-earlier levels, spurred mainly by an 18 percent jump in output of oil and natural gas liquids (NGL). Liquids were 91 percent of production and nearly all of cash flow.

Realized selling prices for oil and liquids came in at CAD90.88 per barrel, a jump of 20 percent over last year, more than offsetting a 10 percent drop in the realized selling price for its natural gas (CAD3.48 per thousand cubic feet). Meanwhile, operating expenses per barrel of oil equivalent fell 2 percent to CAD11.17, one of the lowest cost bases for liquids-focused producers in North America.

Crescent’s Bakken/light-oil growth story shows no sign of slowing down in the year ahead. The company spent CAD458.9 million on development capital activities in the fourth quarter, bringing the full-year spend to CAD1.24 billion, including CAD80.5 million on land, seismic assessments and new facilities to exploit new developments. It also exceeded its targets for average annual 2011 output and exit production, despite a particularly disruptive spring breakup season, punctuated by heavy flooding in Saskatchewan.

The company boosted its base of proven reserves by 12 percent in 2011, replacing 248 percent of last year’s production. Based on conservative assumptions, net asset value per share rose 7 percent, 14 percent including dividends paid, to CAD38.42. And Crescent recorded average Finding and Development costs of CAD18.52 per proved-plus-probable barrels of oil equivalent in new reserves. Reserve life based on proved reserves is a robust 9.9 years, 15 years based on a proved-plus-probable basis.

These are outstanding figures, and they stand to be further augmented by management’s ability to continue finding targets for profitable acquisitions. Coincident with fourth-quarter earnings, for example, the company announced the CAD99.1 million acquisition of Reliable Energy, a junior oil company with activities near the Saskatchewan-Manitoba border. That deal allowed the company to again increase its output guidance for 2012 and beyond.

So did the Wild Stream purchase announced earlier in the first quarter, which added 5,400 barrels of oil equivalent per day of production with the promise of much more down the road. The company also reached a deal with PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF) to acquire 2,900 barrels of oil equivalent per day of oil weighted output in the Viewfield Bakken, as well large parcels of undeveloped lands in that region in other deals. And it’s expanding its reach across the border into the North Dakota Bakken as well.

Despite robust capital spending, Crescent’s balance sheet remains quite solid, with debt-to-cash flow expected to be less than 1-to-1 this year. Bank lines featured CAD1 billion in untapped credit at last count. There are no debt maturities for 2012 or 2013. That’s in large part thanks to the company’s ability to issue equity at favorable prices. The Reliable Energy deal, for example, is financed entirely by stock, with the exception of CAD20 million in assumed debt.

Looking ahead to the rest of 2012, rising production and robust pricing for oil and natural gas liquids promise a solid first quarter. Further out, cash flows are safeguarded by the company’s 59 percent hedge position for 2012, which is 32 percent and 16 percent for 2013 and 2014 respectively.

This won’t hedge out all energy-price exposure. And in light of the company’s robust plans for capital spending, a dividend increase this year can probably be ruled out. It does, however, strongly back management’s guidance that the current CAD2.76 per share annualized rate will be maintained. On top of the company’s immense and growing resource wealth, there’s plenty to keep the stock a very attractive buy up to USD48 for those who don’t already own it.

Northern Property REIT (TSX: NPR-U, OTC: NPRUF) boosted its 2011 funds from operations to CAD2.35 per unit, up 8.8 percent from last year. That took the payout ratio down to just 65.3 percent. Fourth-quarter funds from operations surged 18 percent to CAD0.59, driving down the ratio to 64.3 percent.

The keys were solid performance of the existing properties and a handful of successful acquisitions. Apartment vacancies portfolio wide dropped to 3.7 percent, with same-store income growth up slightly despite some one-time property costs. Meanwhile, the REIT closed on 240 units in Saskatoon, 33 near Nanaimo and 53 in Labrador City, for a total cost of CAD26.3 million.

These cities aren’t household names. But this means Northern has a key competitive advantage: It’s literally the only game in town in many of Canada’s most resource-rich but remote areas. This year, management expects to bring 87 apartments in Iqaluit into operation and has development plans for 58 units in Yellowknife and 142 in Lloydminster.

Property in Nunavut, a key area for recent expansion, is now 99.5 percent leased. Yellowknife properties are 97.5 percent leased, despite softer conditions in the second half of 2011. Even Fort McMurray, capital of the oil sands region, which has suffered from overbuilding in recent years, has shown solid improvement, with vacancy now around 9 percent, down from 14 percent in September 2011.

Dawson Creek–in the center of the Montney Shale development–has cut vacancy from 18 percent a year ago to just 2 percent to 3 percent now. And the Nanaimo properties, which hit 20 percent vacancy briefly last year, are now 94 to 95 percent occupied. All this speaks to unmatched skills from management at operating profitably in remote areas where weather and economic volatility are always major factors.

Canada’s shifting rules for REIT taxation remain a point of uncertainty. Northern owns a master-leased seniors facilities portfolio that falls outside the official definition of REIT income. Management’s plan is to sell these facilities and then restructure so as to comply with yet-to-be issued final rules for REITs.

The good news is no matter what happens current dividends shouldn’t be affected. The bad news is we’re not likely to see another distribution increase until the issue is finally laid to rest. The most likely route of divesting the non-exempt operations will leave the REIT with a sizeable chunk of cash on its balance sheet, which management has pledged not to invest until there are real opportunities in its far-flung markets.

So long as the cash isn’t invested it will remain on the balance sheet, boosting financial flexibility but posting only negligible returns. In a worst-case this will put upward pressure on Northern’s payout ratio, possibly starting as soon as the second quarter of 2012.

CEO Jim Britton, however, assured investors during the company’s fourth-quarter conference call that the distribution is “not an issue as we cycle sale proceeds into new properties.” That’s borne out by the low payout, strong finances and the fact that less than 10 percent of earnings currently come from properties to be divested.

Until this issue is past Northern Property, I likely won’t raise my buy target past the current level of USD30. But I remain very comfortable holding the REIT, which continues to earn all six points under my Canadian Edge Safety Rating System.

The Other Numbers

With these four announcements, three Canadian Edge Portfolio Holdings still have yet to report results. Colabor Group Inc (TSX; GCL, OTC: COLFF) will report its numbers on March 22. Fellow Conservative Holding IBI Group Inc (TSX: IBG, OTC: IBIBF) has confirmed March 26 as its announcement date, while Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) will report March 23.

I’ll send out a Flash Alert as these numbers come in. One other piece of news worth noting is that Enerplus Corp (TSX: ERF, NYSE: ERF) is proposing replacing its dividend reinvestment plan–which is available only to Canadians–with a stock dividend program open to all shareholders. That will further shepherd cash for development, further reducing the need to borrow. Hold Enerplus.

Here’s where I’ve analyzed data and guidance for the rest of the CE Portfolio.

Conservative Holdings

Aggressive Holdings

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