3/22/12: Colabor Stumbles, Innergex Builds

By Roger Conrad • March 22, 2012

Only one Canadian Edge Portfolio Holding–IBI Group Inc (TSX: IBG, OTC: IBIBF)–has yet to report fourth-quarter and full-year 2011 earnings. The architectural and infrastructure project planning company’s management now plans to release numbers on Tuesday, Mar. 27.

We have, however, now had our first real stumble of this reporting season: food and related products distributor Colabor Group Inc (TSX: GCL, OTC: COLFF).

The company reported a steep and unexpected decline in fourth-quarter profit to CAD2 million, from CAD3.2 million a year earlier. This induced management to intensify its ongoing cost-cutting plan, which now includes a 33 percent reduction in the quarterly dividend to a new rate of CAD0.18 per share.

On the plus side, the company did report a 1.6 percent boost in comparable sales growth for the fourth quarter, which doesn’t include acquisitions. This encouraging trend indicates that existing operations are holding and gaining market share. It also builds on previous quarters, producing a 0.9 percent boost in comparable sales for the year.

On the minus side, however, these improved sales came at the price of lower profit margins. The result was a 10.5 percent drop in cash flow, despite a 24.3 percent increase in sales including acquisitions.

Management expects the cost savings from accelerated plans to begin meaningfully boosting profitability starting in the second half of calendar 2012. The lack of near-term debt maturities is a plus–in fact, the next will be a CAD150 million credit agreement that extends to Apr. 28, 2016, on which CAD96.2 million is drawn. That’s down from CAD113.46 million at the end of the third quarter.

Colabor uses credit primarily as bridge financing to fund acquisitions. And management intends to use money saved from the dividend cut to further pay down outstanding balances. This will keep the company in good shape to continue executing acquisitions to build scale, which in turn will enhance its ability to reduce costs and boost profitability.

Using 12-month cash flow per share–the primary metric of profitability and dividend safety–the payout ratio based on the prior rate was about 94 percent. Based on the new rate the ratio comes down to a considerably more modest 62.6 percent.

Working against Colabor is tough competition in the food service distribution industry, with distributors slashing margins to retain customers–who are suffering from consumers’ constrained, post-recession spending habits. So long as this is the reality, Colabor will obviously have an uphill battle posting meaningful growth, other than what it achieves with acquisitions.

In the words of CEO Claude Gariepy, results “fell well short of expectations.” He also stated the company does “not expect the business environment to improve materially in 2012,” meaning “improvement in profitability and cash flow will come primarily from the execution of our action plan to optimize operations” including “focusing on major markets” where “our market shares are well below potential.”

The dividend cut does bring the payout down to a level that should be sustainable, as well as allow further debt reduction and growth. The company also plans to continue repurchasing its common stock, having bought back 351,800 shares at an average price of CAD9.08 per share during 2011.

Today’s actions understandably surprised many investors, including two research houses covering the stock who switched their recommendations from buy to sell in response. That’s the primary reason for the wild action in the share price today.

On the other hand, until today’s earnings announcement and dividend cut, Colabor shares had traded above my buy target of USD10 consistently since late November 2011. I had hoped to raise the target following another quarter demonstrating management’s growth and optimalization plans were working. But, barring that, the stock was effectively a hold.

Today’s drop definitely takes the share price under USD10. But in light of these numbers I don’t advise anyone to buy Colabor at this time. I’m also dead-set against averaging down in its shares or the shares of any other company that’s suffered or suffers a similar fate.

Rather, Colabor’s greater-than-thought leverage to economic growth merits moving it to the Aggressive Holdings.

I still like this company’s management and business plan, which is very similar to the asset/operations aggregation strategies successfully executed by TransForce Inc (TSX: TFI, OTC: TFIFF) and Newalta Corp (TSX: NAL, OTC: NWLTF). Both of these companies overcame stumbles along the way to growth. Their stocks have returned roughly 30 percent so far this year.

This is still my eventual expectation for Colabor. And given its lack of debt pressure and the likelihood the dividend will hold, the stock’s unlikely to fall much further in the near term. But unless we do see some more favorable numbers–the next are slated for release May 4–Colabor is a hold. And if numbers deteriorate again in May, I’ll be out.

Fortunately, as was the case for 34 of 35 Canadian Edge Portfolio Holdings to report results this time around, Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF) turned in solid numbers, supporting its dividend, balance sheet and growth plan. That’s basically executing the construction of hydro, solar and wind power plants, all of which is fully contracted to government entities and major utilities at preferential renewable energy rates.

Power generated rose 17.5 percent during the quarter over year-earlier levels. Operating revenue was up 23.5 percent, and cash flow increased 15.2 percent. This was despite weather conditions that held generation to 86.8 percent of long-term averages.

The key growth catalyst was last April’s acquisition of Cloudworks as well as a full-year of benefits from the merger of the former income trust with its parent. The main inhibitor during the quarter was weak hydrology in British Columbia, coupled with a higher cost structure from adding the new assets.

One quarter’s poor water conditions are frequently the next’s bounty. That’s clearly demonstrated by the fact that full-year 2011 output was right in line with historical averages. Meanwhile, adjusted cash flow from operating activities–the key benchmark for profitability and paying dividends–rose 71.6 percent for the full year to CAD77.025 million (CAD0.95 per share). This made for a modest payout ratio of 61.1 percent.

The company has only modest near-term debt maturities, mainly a CAD53.4 million loan coming due Dec. 31, 2013, on which CAD46.3 million is currently drawn. The power producer, however, is definitely in an expansion mode, as it continues to build and occasionally buy new assets.

The good news is the plan will produce extremely reliable revenue as soon as new facilities start operating. During the second quarter of 2012, for example, Innergex will start up a solar farm that will generate an additional CAD16 million in revenue under a 20-year contract with the Ontario Power Authority. The Montagne Seche and Gros-Morne I wind farms started up in late 2011 and will collectively generate CAD13 million in annual revenue this year, also fully contracted for the long haul.

To fund these and other projects, Innergex raised nearly CAD700 million in capital markets in 2011 and looks likely to do more as it brings a range of hydro, wind and solar projects on stream the next few years. The near-term downside of being so capital-intensive is that dividend growth is unlikely.

This, in my view, means Innergex should only be purchased on dips to USD10 or lower. Over the long term, however, this strategy should catapult the stock to much higher levels, even as business risk remains very low.

Here’s where I’ve analyzed data and guidance for the rest of the CE Portfolio. I’ll have a Flash Alert next week rounding up results at our last reporter, IBI Group.

Conservative Holdings

Aggressive Holdings

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