8/15/12: More “No Drama” Numbers

By Roger Conrad • August 15, 2012

No real surprises: That was the story for the 30 Portfolio picks whose second-quarter results I highlighted in the August Canadian Edge. Numbers for the five companies spotlighted below similarly lacked drama.

I like positive surprises as much as anyone. With dividend-paying stocks, however, what we want is reliable growth, strong balance sheets and well-protected dividends, quarter after quarter. The best surprise is none at all.

Our picks’ ability to produce such steady results is definitely a strong testament to their unique strengths as companies. It’s also vindication of the durability of the dividend-paying model they once followed as income trusts and have continued to track as corporations.

Former trusts’ decisions to remain big dividend payers have had no shortage of skeptics. In fact, many analysts and investors continue to predict the deaths of former trusts, charging they simply can’t dish out big dividends, pay taxes and grow indefinitely.

The longer our companies put up these results, the less influence the skeptics will have over their stocks. In fact we’ve already seen a dozen or so break out to a higher range of valuations, particularly in the Conservative Portfolio.

It may take some time before IBI Group Inc (TSX: IBG, OTC: IBIBF), Just Energy Group Inc (TSX: JE, NYSE: JE) and other still deeply discounted companies to join them. And the solid numbers we’ve just seen in the second quarter surely won’t quell all fears. The memories of the 2008-09 crash and single-stock disasters like Yellow Media Inc (TSX: YLO, OTC: YLWPF) are still too fresh, concerns about Asian growth and Europe’s financial crisis still too pressing.

But it’s only a matter of time before they will, so long as they continue to post steady results like these. And while there’s sure to be plenty of volatility in the near term, we’ll be content to ride it out.

The Numbers

Starting with the Conservative Holdings reporting, EnerCare Inc (TSX: ECI, OTC: CSUWF) posted revenue growth of 5 percent, paced by a 25 percent gain at its submetering business. Submetering basically enables landlords and other building owners to have better control over energy usage, and the company continues to grab a rising share of the business.

Cash flow slipped by 2 percent, in part due to tough competition at the core water heater rental business. But distributable cash flow still covered the dividend by nearly a 2-to-1 margin, with the payout ratio coming in at 53 percent.

The company was also able to put through a 2.75 percent rate increase in its rental business and cut interest expense by better than 10 percent as it paid off debt.

Challenges going forward include competition in the water heater rental business, refinancing/paying off CAD240 million in debt maturing next year and the ongoing assault of private capital firm Octavian, which was narrowly defeated in a shareholder vote earlier this year to stack the board.

The latter is really only a worry for management, as an Octavian victory would likely mean a takeover and near-term windfall gain for shareholders. With current management, we can look forward to steady dividend growth for a long time to come.

The stock is basically flat this year, with dividends offsetting a drop in the stock. That makes now a solid entry point for those who don’t already own it. Buy EnerCare up to USD10.

Northern Property REIT’s (TSX: NPR-U, OTC: NPRUF) second-quarter funds from operations were slightly higher than last year at CAD0.60, producing a payout ratio of 64 percent. Occupancy rose to 96.4 percent, up from 95.1 percent a year ago.

As has been the case in recent quarters, the company benefitted from strong markets in Newfoundland, Nunavut and Yellowknife in the Northwest Territories. Northern Alberta (oil sands) and Vancouver Island were steady, while there was some weakening in Inuvik and northeastern British Columbia. Management noted a negative impact of roughly CAD0.02 per unit on funds from operations during the quarter due to its ongoing sale of its seniors’ housing portfolio, and it forecast “a greater impact” over “the next four quarters” as it invests the proceeds.

There’s also the matter of CAD173.4 million of deferred and CAD14.5 million in current taxes booked in the second quarter. As neither the REIT nor its advisors expect to be required to pay taxes, these costs are likely to be reversed at some point. But the company is going to have to wait for an official ruling from the Ministry of Finance to do so.

The upshot is we’re not likely to see a distribution increase at Northern until next year, when the tax issue is resolved and the senior home sales proceeds are properly deployed. Consequently, I’m not raising my buy target for this very strong REIT at this time. Buy on dips to USD30 or lower only.

RioCan REIT (TSX: REI-U, OTC: RIOCF) posted a 14 percent boost in its operating funds from operations in the second quarter. The gain on a per unit basis was 3 percent to CAD0.37, producing a payout ratio of 93.2 percent.

The numbers behind the numbers were also strong, with occupancy rising to 97.4 percent portfolio-wide from 96.9 percent a year ago. The REIT was able to push through an average rent increase of 13.4 percent with a tenant retention rate of 89.9 percent.

Finally, the company was also highly successful raising new capital as it expanded its portfolio. The latest venture is an alliance with Allied Properties REIT (TSX: AP-U, OTC: APYRF) to acquire sites in major urban areas of Canada for mixed use intensification.

Net operating income excluding acquisitions surged 1.6 percent in Canada and 1.3 percent in the US.

The company has faced some setbacks, including a CAD12 million impairment charge taken during the quarter for its investment in Cedar Realty Trust Inc (NYSE: CDR). The venture is an attempt to take advantage of emerging property values in the US. Overall US occupancy, however, actually rose during the quarter to 97.8 percent from 97.5 percent at the end of March.

As in Canada, RioCan’s investment in the US is focused on shopping malls backed by “national anchor” tenants, with REIT reliance on a single tenant limited to no more than 5 percent of overall revenue. This strategy has sustained the company in all manner of markets, and it promises to keep growth on track going forward.

My view has been not to raise my buy target until there’s another distribution increase. During the second-quarter earnings call founder and CEO Edward Sonshine stated that if the company’s “final budget for next year bears out at our current expectations, we will have achieved our goal of reducing our distribution ratios to a desirable level” and that it “would certainly put us in a position to recommend to our board at year-end that RioCan increase its distribution.”

Further, Mr. Sonshine asserted “this should get us back in our program of being able to deliver annual increases in distribution to unitholders.”

That’s great news, but until it happens my buy target for RioCan remains USD25 for those who don’t already own it.

Two Aggressive Holdings reported numbers this week.

Ag Growth International Inc (TSX: AFN, OTC: AGGZF) shares have been battered in recent months by the perception that sales of grain handling equipment will be compressed in the drought-affected US. That perception was confirmed as reality in second-quarter numbers today, and the stock again came under pressure.

Fortunately, there was also good news. Sales rose 14.9 percent, and cash flow surged 10.3 percent excluding one-time items. Profit per share excluding a loss on foreign exchange due to the strong Canadian dollar came in at CAD0.81, up from CAD0.77 a year earlier. That produced a payout ratio of 74 percent.

A record number of corn acres planted in the US triggered robust preseason demand for portable grain handling equipment. Seeded acres in Western Canada also bounced back from last year’s largely depressed levels, and the company continued to expand capacity globally with the acquisition of Airlanco and by boosting penetration of key markets in the former Soviet Union, South America and Asia.

All of these measures will boost second-half results. Unfortunately, they’re likely to be offset by the historic drought in the US (60 percent total sales), which has sharply reduced crop production forecasts and therefore demand for more grain handling equipment.

Encouragingly, management noted in its earnings release that cash flow in the second half of 2012 is still expected to “approximate 2011 levels.” It also asserts “the company’s dividend policy will not be altered in response to this short-term weather event” and is “optimistic” on 2013.

What’s probably out of the question until next year is a dividend increase. That plus investors’ general fear of all things resource-oriented likely explains the weakness in the stock, which is off about 11 percent so far in 2012, 8 percent including dividends.

But this is a growing global franchise that will weather this storm. Ag Growth remains a buy up to USD45.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH) shares have recovered some of the ground lost this spring, despite the cut in the company’s monthly dividend to CAD0.04 from CAD0.07.

The reduction was due largely to management’s reduced expectation for oil prices this year and its desire to limit dependence on credit lines as the company develops its portfolio of oil projects. These include some 730 light oil drilling locations acquired in Alberta and southeast Saskatchewan in the NAL Energy Corp takeover as well as the Lindbergh oil sands project I highlighted in the August In Focus feature.

Given the dividend cut and management’s guidance, Pengrowth’s second quarter results were pretty much right in line with expectations. Average daily production was 78,870 barrels of oil equivalent per day, a 4 percent boost over first-quarter levels and 11 percent more than last year. Oil and liquids accounted for 54 percent of that, as well as 102 percent of profit, as gas production lost money.

Lower energy prices hit funds from operations hard, with the second-quarter figure coming in at just CAD0.23, 50 percent off year-earlier results. That covers the lowered dividend rate comfortably (the payout ratio was 52 percent), though it definitely explains the dividend cut.

Encouragingly, full-year operating expense guidance remained intact at CAD13.75 per barrel of oil equivalent, as are capital spending and exit production targets (96,000 to 100,000 barrels of oil equivalent per day).

The company has more than half of its CAD1.25 billion credit line undrawn and only about CAD130 million in debt maturities to the end of 2013, which it should be able to roll over at lower interest rates.

Like all producers, Pengrowth is dependent on energy prices to generate cash flow, and its stock price will follow oil especially going forward. But trading well below the value of its assets in the ground (74 percent of book value), meaningful risk appears priced in. And any rebound in natural gas and oil prices will go right to the bottom line and stock price.

My new buy target for Pengrowth is USD8 for new investors, which takes into account the lower dividend rate.

Final Count

Here’s where to find my second-quarter earnings analysis and outlook for all Canadian Edge Portfolio Holdings. The only company not yet reporting is Student Transportation Inc (TSX: STB, NSDQ: STB), which is on a different reporting schedule. The company will release its fiscal 2012 fourth-quarter and full-year (ended Jun. 30) results in late September. Full-year results take somewhat longer to compile than quarterly tallies.

Conservative Holdings

Aggressive Holdings

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