How They (We) Fared

By Roger Conrad • March 9, 2012 • Portfolio Update

Last month I highlighted four market and economic trends critical to our companies’ health and performance in 2012:

  • Record-low corporate borrowing costs.
  • Tumbling natural gas prices, coupled with rising underlying demand (factoring out weather) and soaring production.
  • Signs of accelerating economic growth in the US.
  • How news affects increasing momentum investing in dividend-paying stocks.

Over the past few weeks we got a chance to see how these trends affected Canadian Edge Portfolio recommendations in fourth-quarter and full-year 2011 earnings. And what we’ve seen is both reassuring and promising for the rest of 2012 and beyond.

All are using these trends to their advantage to keep finances healthy and dividends well-covered in the near term while laying the groundwork for building growth in years to come. At this point none of our stocks have significant near-term debt maturities.

Dividend payout ratios have fallen to their lowest levels in years, despite the fact that many companies are paying corporate taxes for the first time.

Finally, even falling natural gas prices are shaping up to be a net positive for CE Portfolio Holdings.

Even those companies that should be exposed to the drop appear to be turning things to their advantage.

There are still more than a few stocks in the Canadian Edge coverage universe, including some in the Portfolio, that have yet to report.

Here’s where we stand, starting out with what we’ve seen so far. Note the Flash Alerts are archived at www.CanadianEdge.com.

Companies listed as “March Portfolio Update” are all discussed in this article.

Conservative Holdings

Aggressive Holdings

Here’s what we’ve yet to see:

Conservative Holdings

  • Artis REIT (TSX: AX-U, OTC: ARESF)–Mar. 14 (confirmed)
  • Colabor Group Inc (TSX: GCL, OTC: COLFF)–Mar. 12 (estimate)
  • IBI Group Inc (TSX: IBG, OTC: IBIBF)–Mar. 21 (estimate)
  • Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–Mar. 23 (confirmed)
  • Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–Mar. 13 (confirmed)

Aggressive Holdings

  • Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–Mar. 14 (confirmed)
  • Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–Mar. 15 (confirmed)

Fourth-quarter and full-year results always take longer to report than other numbers because of expanded reporting requirements companies face.

That’s true in Canada as much as in the US–and the result is that the results aren’t so important for the static measures such as balance sheet items but for the dynamic measures such as guidance and health of key operations.

But with the possible exception of Enerplus Corp (TSX: ERF, NYSE: ERF)–see Dividend Watch List–every company reporting thus far came in with strong numbers that supported the current dividend, strengthened the balance sheet and set the stage for long-term growth by strengthening key business areas.

xThat’s also true of the seven companies to report since my most recent Flash Alert on Feb. 29. From the Conservative Holdings, they are High Yield of the Month AltaGas Ltd (TSX: ALA, OTC: ATGFF), Bird Construction Inc (TSX: BDT, OTC: BIRDF), Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) and Provident Energy Ltd (TSX: PVE, NYSE: PVX).

From the Aggressive Holdings, they’re Parkland Fuel Corp (TSX: PKI, OTC: PKIUF), Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) and Vermilion Energy Inc (TSX: VET, OTC: VEMTF).

Conservative Numbers

Starting with the Conservative Holdings new to this season’s “reported” roster, AltaGas increased its fourth-quarter funds from operations by 14.3 percent, excluding one-time items.

That fueled a full-year increase of 19 percent, which prompted management to declare another dividend increase of 4.5 percent, effective with the March payment.

As I note in High Yield of the Month, these results reflect solid performance for the company’s fee-driven natural gas infrastructure operations, power plants and regulated utilities.

The first are being driven by the booming natural gas liquids (NGL) business, with the company’s facilities seeing both higher volumes and improved “frac” pricing spreads. The second primarily benefitted from adding new wind and hydro capacity.

And utility operation enjoyed a boost from the acquisition of Pacific Northern Gas, a system set to benefit from the beginning of liquefied natural gas (LNG) exports from the Pacific Coast to Asia.

Management continues to spur growth in all three areas, including the acquisition of SEMCO, as discussed in High Yield of the Month. That should enable the company to follow through on plans to accelerate dividend growth in coming years. In the meantime AltaGas is a buy up to my raised target of USD32.

Bird Construction posted lower full-year 2011 earnings relative to 2010. But the construction company’s 40.2 percent jump in fourth-quarter net–fueled by 47.3 percent revenue growth–was right in line with management expectations and reflects a steadily improving environment as well as the continuing payoff from last year’s merger with HJ O’Connell. So does the 9 percent dividend increase announced with the earnings, to a new monthly rate of CAD0.06 per share.

The key for Bird is to continue to win new contracts, preferably from the private sector. The company’s success weathering the 2008-09 debacle and the soft construction market that’s followed has been its ability to make up for a slumping private sector with public-sector contracts.

Such contracts have become more difficult to come by over the past couple years, and margins are lower as well. The beauty of the O’Connell deal is it revived Bird’s private-sector push by adding expertise in industries that are enjoying unprecedented growth, for example mining. That should keep results moving higher in coming quarters.

I’ve held my buy-under target for Bird at USD13 since the last time the company raised its dividend. Now, with management pushing it up once again, I’m raising the target to USD14.

With no debt and a secure niche, Bird Construction is a solid buy for conservative and aggressive investors alike under USD14.

Davis + Henderson posted a 54.7 percent increase in fourth-quarter cash flow on a 13.1 percent jump in revenue. That was mainly thanks to the acquisitions of Mortgagebot and ASSET, which were immediately accretive to profits and provided opportunity to leverage growth through added expertise.

Breaking down the operations, cheque services–the company’s original core and still nearly half revenue–saw a 1 percent increase in sales, as new features offset the steady decline in traditional paper products. Loan registration services took revenue 51.3 percent higher, lending technology services saw a 43.2 percent boom, while loan-servicing programs ticked ahead by 1.4 percent.

Coupled with a rise in expenses of only 3.9 percent, it’s no wonder management pronounced these results “consistent with its strategic objectives” when it released them. And they’re certainly consistent with the company’s reliably strong results in recent years.

The payout ratio for the fourth quarter was 71.8 percent, leaving room for modest dividend growth going forward, especially since the company has no debt maturities the next two years.

Davis + Henderson stock has come a long way back from the lows of last year, when investor pessimism for its key customers–Canadian banks–was at low ebb.

But it’s still trading below my buy target of USD20 for those who don’t own this very conservative, well-positioned company that’s definitely made the turn from paper to web.

Provident Energy’s most important ongoing development is the merger with Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF). That deal is up for a shareholder vote on Mar. 27. My recommendation is a “yes” vote for holders of both companies, as this merger will create a much stronger combination than either of them on their own. Assuming enough shareholders agree, this deal will close shortly after that, and Provident shareholders will immediately see a large dividend increase.

Like its merger partner before it, Provident on its own posted strong results for the fourth quarter of 2011. Gross margin–the company’s primary measure of its profitability–rose 7 percent, keyed by strong results at two of its NGL assets, Redwater West (fourth-quarter margin up 13 percent) and Empress East (margin up 3 percent).

Overall adjusted cash flow rose 14 percent. That pushed the payout ratio down to just 45 percent for the quarter based on funds from operations. Excluding one-time items funds from operations per share rose 33 percent in the quarter, reflecting both an expanded asset base and strong margins for the NGLs it specializes in.

These results should get even better going forward. Capital spending to expand assets more than doubled in the fourth quarter versus year-ago levels. Meanwhile, global appetite for America’s NGLs is as robust as ever.

Provident shares will take a bath from current levels if the Pembina merger doesn’t go through. Downside very likely would be around USD9 to USD10 per share, or where the company traded before this deal was announced. But the key here is Provident is the best kind of merger candidate: solid whether or not any deal emerges.

The stock’s a hold until this deal hopefully goes through. Otherwise, Provident Energy is a buy on any dip to USD10 or lower.

Aggressive Numbers

Turning to the Aggressive Holdings that turned in numbers, Parkland’s full-year distributable cash flow surged 89 percent, as it successfully integrated recent acquisitions and dealt with the challenges of a difficult refining market and mild winter.

Fourth-quarter distributable cash flow per share dipped 17 percent, in part because of a greater number of shares outstanding. But that was still good enough to cover the dividend comfortably, with a payout ratio of just 61 percent for the fourth quarter and 48 percent for the full year.

Fourth-quarter volumes remained robust, with fuel volumes rising 12 percent overall. Commercial volumes rose 6 percent, while retail fuel volumes surged 23 percent.

Excluding the impact of acquisitions, fuel volumes overall rose 6.4 percent, reflecting the company’s dominance of valuable niches in the industry. Even wholesale propane sales were healthy, thanks to the exit of a major competitor from several major markets.

Parkland also posted strong progress on controlling operating costs, a key objective for the past several years. Operating costs per liter were cut 3 percent over the past 12 months, which pushed up gross profit per liter by 2 percent in the fourth quarter. Management also was able to use low interest rates and the company’s rising financial fortunes to refinance its debt, with the result that interest costs will be reduced by roughly CAD6 million in 2012.

Parkland’s biggest challenge in coming years is replacing the marketing and supply agreement it’s enjoyed with Suncor Energy Inc (TSX: SU, NYSE: SU). But management reports that even here it’s made solid progress expanding its marketing expertise and finding alternatives.

This last probably more than anything else is responsible for Parkland’s robust share price performance this year, which has extended a rally that began back in early October. The stock is now a bit above my buy target of USD13, which at this point I don’t intend to raise until the dividend is increased. But Parkland Fuels is certainly a strong buy on any dip below USD13.

Investors might be forgiven if going into this earnings season they doubted Peyto Exploration & Development’s prospects. After all, the price of its primary product–natural gas–has crashed and burned. And like all commodity producers, Peyto’s profit is heavily affected by price.

As it turned out, no one need have worried. The company first showed its numbers for production and reserves, all of which are extremely robust. Full-year production rose 38 percent to an exit rate of 42,100 barrels of oil equivalent per day. But reserves still surged 24 percent, 19 percent on a per-share basis. The company replaced 452 percent of its production with new proven reserves.

Operating and development costs are the lowest in the industry. In fact, the company could arguably produce gas profitably at a price as low as USD1 per million British thermal units. That’s a level unlikely to be reached under even the most bearish scenarios. But coupled with the company’s low cost of capital and low payout ratio, it should deliver a great deal of comfort for Peyto’s prospects even if the gas market gets worse than it already is.

Now we also have Peyto’s fourth-quarter financials. And, despite a 15 percent drop in its realized selling price for natural gas, they’re simply outstanding. Fourth-quarter funds from operation rose 9.1 percent, pushing the payout ratio down to just 30 percent, less than the full-year rate of 31 percent that was fueled by a 22 percent jump in 12-month funds from operations.

Rising production–up 35 percent per share in the fourth quarter–was the key. A 31 percent jump in average realized selling prices for oil and natural gas liquids (output up 15 percent) was another solid plus. But the real secret to Peyto’s over-the-top numbers was costs that are still just CAD2 per barrel of oil equivalent, or about 33 cents per million British thermal unit equivalent.

That’s far and away the lowest cost structure in Canada, and it means Peyto can produce profitably at gas prices that would literally shut down much larger players, including EnCana Corp (TSX: ECA, NYSE: ECA).

These low costs are thanks to control of unmatched reserves but also operating expertise and conservative and effective financial management.

It’s truly a one-of-a-kind story. And it enables Peyto to act in ways that would potentially bankrupt rivals. 2011 capital spending, for example, was 43 percent higher than in 2010.

Peyto plans to spend another CAD400 million to CAD450 million in 2012, heavily weighted toward the second half of the year, when the company anticipates other gas drillers will be reducing activity. And this is all in the context of reducing debt-to-cash flow to a ratio of 1.5-to-1 in 2011, down from 1.7-to-1 in 2010.

Peyto’s real value to investors is the extreme discount it trades at relative to the value of its assets in the ground. This wasn’t the case in late 2011, when the stock was soaring toward the mid-USD20s.

But now selling the high teens and with many afraid of anything to do with natural gas, Peyto is again a strong bargain for those who don’t already own the stock, up to USD22.

Vermilion Energy saw its fourth-quarter funds from operations per share soar 31.5 percent from 2010 levels and 13.2 percent sequentially from third-quarter levels. Full-year 2011 funds from operations, meanwhile, rose 33 percent, locking in a payout ratio of just 39 percent, or  144 percent including all capital spending.

The company also stayed on track for reaching its long-run production goal of 50,000 barrels of oil equivalent by 2015. Output grew 10 percent in 2011 and is on track to increase at least 6 to 8 percent in 2012, with an exit rate of between 37,000 and 38,000 barrels of oil equivalent per day. Growth last year was keyed by Australia (output up 11 percent) and the Netherlands (up 17 percent).

Starting in 2014 the Corrib project offshore Ireland will come on stream. A key onshore pipeline has now won approval from Irish regulators, which was the last official hurdle to getting the full project online. At that point Vermilion’s cash flow should rise by nearly a third, even as its capital costs diminish. This will set the stage for another dividend increase, which will lift the price of the stock and prompt an upward revision for my buy-under target.

Until then the company will continue to prosper from its incremental increases in production as well as favorable pricing. Alone among the Canadian producers that were formerly income trusts, Vermilion sells the majority of its oil and gas at global prices, which are higher than North American prices up and down the line. That’s a huge plus for the company, resulting in average realized selling prices of USD105 per barrel of oil and USD6.50 per million British thermal units for its gas.

In North America there is no real LNG exporting capacity. That’s not the case in countries such as France and Australia, which together account for roughly 60 percent of Vermilion’s cash flow. The result is the company can count on much higher cash flows than its rivals in Canada, where its main expansion interest is light oil in the Cardium trend.

Along with Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–which has yet to report–Vermilion is the only oil/gas producer income trust never to cut its dividend. That doesn’t change the fact that it remains a commodity producer and is therefore ultimately dependent on changes in oil and gas prices. But it is a testament to management’s commitment to the dividend, ability to factor out risks and commitment to growing assets in a predictable, low-risk way.

That’s all the reason you should need to add Vermilion Energy to your portfolio at a price below USD50, if you haven’t already. And once Corrib comes online the company will have scale to grow even faster, which should be bullish in anyone’s book.

Other Stocks to Watch

I’ve resolved this year to be far less tolerant of companies that really do show business weakness. The good news so far this year is no Portfolio Holdings have failed to measure up. That’s comforting indeed and the reason why I’m not making any changes this month.

If there is one thing I’m worried about this year, it’s the extreme drop in natural gas prices since last summer. Encouraging results from Peyto and ARC Resources Ltd (TSX: ARX, OTC: AETUF) from before lessen my apprehension about any Portfolio Holdings. But this is a trend which shows no sign of reversing in the early weeks of 2012, and which I believe has yet to show its full impact on a range of industries.

For power producers like Atlantic Power Corp (TSX: ATP, NYSE: AT) falling gas prices are nothing but bullish, as I point out in this month’s Feature Article. Just Energy Group Inc (TSX: JE, NYSE: JE) has also found a way to make lower prices work for them. And energy infrastructure outfits like AltaGas and Pembina Pipeline make their trade off of increased throughput, which is often helped by lower pricing.

On the other hand, companies that rely heavily on the production of natural gas to make their cash flows are undeniably worse off now. The only question is how well they can absorb the lower pricing or whether they’ll wind up flat on their back like Perpetual Energy Inc (TSX: PMT, OTC: PMGYF), a former Portfolio Holding that’s now sliding perilously close to bankruptcy.

I’ve highlighted Enerplus Corp as having a dividend that’s vulnerable to falling natural gas prices. That’s a fate management might avoid by successfully tacking to becoming more of an oil and natural gas liquids producer. But until we get a few more quarters of earnings in, the jury will be out. And all investors need to recognize the uncertainty.

That, however, is a stark contrast to companies like Peyto and ARC, which have been able to remain predominately gas producers but make more money than ever by pumping it out more cheaply than anyone else. ARC has already announced fourth-quarter and full-year 2011 profits that reflect sharp growth as well as the fact that 71 percent of cash flows now come from oil and NGLs. My advice is still to buy ARC Resources up to USD28 if you haven’t yet.

Keyera Corp (TSX: KEY, OTC: KEYUF) ran up sharply at the end of 2011, only to fall back sharply in early 2012. That raised questions from many investors if something wasn’t very wrong at the owner of NGL infrastructure.

Ironically, the chief catalyst for the pullback appears to be simply investors’ emotional swings, the same force that was responsible for the parabolic rise in the stock in late 2011.

One significant event was a successful stock offering this year, which no doubt raised fears of dilution. But these worries should certainly have been quelled by the company’s robust fourth-quarter results, which showed solid performance of each of its fee-based operations.

The bottom line is nothing has changed at Keyera, either positive or negative, to justify the volatility in the share price of recent months.

The good news is the stock is now back in a bargain range, and in fact I’m raising my buy target to USD44 for anyone who doesn’t already own it.

Dundee REIT (TSX: D-U, OTC: DRETF) has now completed its merger with Whiterock REIT, extending its lead as Canada’s largest owner and operator of office properties. The breakdown of Whiterock unitholders’ selection was just 27 percent for the all cash and the balance in equity. That’s a big plus for the balance sheet. And it’s still expected to be shortly accretive for distributable cash flow.

The REIT’s current yield of 6 percent plus is far superior to dividends paid by US office REITs. But a progression of stronger results makes a dividend increase increasingly likely in coming months.

In any case, Dundee REIT has executed a huge deal here and is a buy up to USD35 for anyone who doesn’t already own it.

EnerCare Inc (TSX: ECI, OTC: CSUWF) is tearing up the track as a renter of waterheaters and submetering firm. But it’s also been targeted by major investors as not fully maximizing shareholder value.

That’s forced management to work harder to convince investors the company isn’t better off sold, as rival UE Waterheater was for a huge premium nearly five years ago.

In my view, this company has proven its ability to grow in difficult environments and is on the come. Selling now won’t maximize anyone’s shareholder value on that score. A takeover deal now, however, would likely have to be done at a rich premium, which would give us a rich immediate gain.

I’m willing to entertain what Octavian Capital–the prime mover in this case–can come up with. But for now, I’m perfectly happy to recommend this company up to USD10 for anyone who doesn’t already own it.

Finally, Crescent Point Energy won’t release earnings until Mar. 15, at which point I’ll be issuing a Flash Alert to highlight its prospects and numbers. But the company did issue some very significant news last month, dramatically increasing its stake in the oil-rich Bakken region. That promises robust growth in output, even as the company takes advantage of still superior pricing for oil. Buy Crescent Point up to USD48.

Stock Talk

Comments Guidelines

Add New Comments

You must be logged in to post to Stock Talk OR create an account