Investoid

Thicken My Wallet has mused about the increasing popularity in infrastructure firms. He indicates that companies like RBC are investing in the sector now and that it may become the new fad sector.

I think the infrastructure sector has a lot going for it at the moment. The continuing development of the BRIC countries as well as Eastern Europe has lead to increased demand for new capital projects to meet the needs of the increasingly wealthy populations of these nations. As a result the sector is in a cyclical growth period, one that will probably last for several years, if not a couple of decades, since most of these projects take many years to build.

One way to play this sector is to look at infrastructure services firms. I believe these companies will also benefit from this cycle, but are better value since they typically have higher margins than the actual bricks & mortar developers and/or operators. Much like oil services firms, they benefit greatly from the rush of new development, but will also be faced with reduced revenue earlier in the cycle than the actual developers.

One holding I have in this area right now is IBI Income Fund (TSX: IBG.UN). The fund owns 50% of the IBI Group, which provides consulting, planning, design, implementation and analysis for urban land, facilities, transportation and systems projects. They have done everything from designing Alberta’s SuperNet to venue planning for the 2010 Olympics. The other part of IBI Group is owned by a management partnership, whose payouts are tied directly to the payouts IBG makes to unitholders.

Financial Analysis

IBI has been growing steadily over the past few years, through a mixture of organic growth and acquisitions. The company has been buying up small, mature firms with a solid client base around the world as they increase their global presence. While the company still has a heavy reliance on North American revenue, they have been making inroads in China and other emerging markets.

In the most recent quarter, revenues were up 17.4% Y/Y, with organic growth of 13.8%. Their net margin has been increasing as well, although their cash flow decreased slightly due to one-time capital improvements.

For an income fund, distribution cash and payout ratios are of utmost importance. The payout ratio is currently around 80%, which is quite a bit higher than last year. The company has increased distributions twice in the past year, which partially accounts for the higher payout ratio (the capital project costs is also a factor).

Stock Analysis

The company’s float is rather illiquid – the bid/ask spread can be as much as $0.90 at times and the daily volume is quite low. Despite these facts the stock has had a pretty solid appreciation in the past year, mainly due to the increasing distribution.

The company still yields over 8%, which is fairly solid for an income trust with strong growth potential, high cash flows and a good payout ratio. IBI is a relatively small firm (only $144M Cdn market cap), and is only covered by one analyst. This is a company that’s pretty much under the radar, which is part of the reason I like it. In order to reap substantial capital gains on top of the income distribution, its profile will have to be increased. See my comments on investing locally for more details on what I think about under the radar firms.

While the eventual taxation changes to the firm will diminish its income potential in 2011, IBI will still reap a pretty good yield in the future. I think this is a solid medium term holding if you can set a bid at a price you like and be patient for it to be filled.

As I mentioned at the beginning, I think that services firms are a great way to play the infrastructure sector. They typically have better margins and generally do not face cost overrun issues that could materially affect profits. But their performance will lead the sector, since most of their work is done prior to actual development. Thus it’s important to keep an eye on the announcement of future projects and assess when the cycle it nearing its peak.

Like a lot of other bloggers, I think RBC’s (TSX: RY) drop of over 2% on Friday was an overreaction to marginally lower than expected results. As I’ve said before, the value of mean analyst earnings estimates is dubious at best. As lots of people have indicated, this represents a good buying opportunity to pick up RBC shares at a relatively cheap price.

Since I want to maximize the benefit of this drop, I am looking at an options trade. For instance, the July 07 $60 call options closed yesterday at $1.10, the same price they did on Friday which is where I looked at picking them up at. They had closed at $1.90 on Thursday, representing a 42% drop. As RBC’s price returns to its previous levels in the next few days/week or two, the price in the options should return to close to the level they were at (they may be slightly less due to the time decay).

I am currently in the process of switching brokers so I don’t have funds to trade this right now, but I think it’s a pretty good, but risky, short term investment. I’ll check back by the end of the week and see how the trade is fairing.

Note: this is not investment advice, you must do your own due diligence. Please see my disclaimer for full details.

Disclosure: I hold a position in ADV.

I’ve been following The Money Diva’s quest for understanding dividend stocks, and have been also looking to add more dividend paying stocks to my retirement portfolio. Thus I made a new screen using my trial version of ChartSmart and set up a new screen to look for stocks whose dividend has increased or remained steady the past few years, while at the same time has some undervalued features to it. One of the stocks that stood out for me was Addenda Capital (ADV: TSX).

Company Analysis

• ADV is an investment management firm specializing in the active management of fixed-income portfolios. While this typically involves bonds and the like, the company does utilize leverage and derivatives in some investment strategies.
• In terms of assets under management, the company’s customer base is 66% pension funds, 15% mutual funds, 11% insurance companies, 7% endowment funds and only 1% private clients. All its clients are Canadian, with the vast majority in Quebec.
• ADV has over $28 billion in assets under management, with revenues of around $36 million.
• The senior management team has a solid track record, with a mix of founding members and external experience. The company uses a clear evaluation process to meet its client’s investment objectives.

Financial Analysis

• Revenues increased 9.6% last fiscal year, while EPS was up 13%. All of its growth has been organic.
• The company currently has a $1.32/shr dividend (based on the current quarterly dividend price), which is a 5.48% yield based on the April 16 closing price.
• The company has a great history of dividends and dividend increases. The dividend on common shares increased 19.6% last year and increased 64% last year.
• The company has a high payout ratio and has stated that it is targeting a payout ratio of approximately 90% going forward. While the company has increased dividends on a quarterly basis in the past, management has indicated that future increases will be on an annual basis.
• Employee bonus compensation is tied directly to EBITDA margins, which is a somewhat unusual measure but seems appropriate for this company. Management holds about 20% of the outstanding shares.

Stock Analysis

• The company has five analysts following it with an average rating of hold.
• According to TD Newcrest, the company has a strong history of above-market performance relative to the relevant bond benchmark indices.
• CIBC Wood Gundy rates the stock as ‘market perform’ as of Jan 30, with a 12 month target price of $30. It was downgraded as a result of the runup in the price to $27, but the price has since come back down to about $24. The analyst sees the company as a solid firm, but sees only modest 5-8% growth in the coming 1-2 years.
• The company announced on March 15 a buyback program for up to 10% of its outstanding shares. The company does not have a record of actually buying back shares.

Risk Analysis

• The company’s main risk pertains to capital market risk tolerance by its clients. For instance, if pension funds begin to have a higher risk appetite, or otherwise believe that more exotic investments will provide better risk-adjusted returns (eg. Hedge funds, real estate, etc.), then they may shift funds away from fixed investments. This is somewhat mitigated by the exotic investments the company uses in some of its pooled funds.
• The other main risks are performance & interest rates. If the company’s team is unable to maintain its strong performance, clients may divert their funds elsewhere. Rising interest rates would negatively affect their investment returns, although their clients would likely see broad-based declines in their fixed income assets, and thus relative performance will be even more important.

I believe ADV is an excellent long term investment that will provide strong dividends for the foreseeable future. If the company continues to grow I could see it gaining a wider audience and its price increase until its dividend yield is more in line with other financial companies (3-4%), although it may always carry a discount due to its relative small size in the financial sector and its largely Quebec focus.

Despite my tech background, I currently don’t have any tech stocks or index funds in my portfolio. I think part of the reason for that is that Canada’s tech index is so heavily weighted on RIM, but also because there is a dearth of up and coming public tech companies, relative to the U.S. I plan on looking at more Nasdaq-based companies in the future, but in the meantime I have been looking at Systems Xcellence (SXC – TSX / SXCI – Nasdaq), which is a company that has a dual listing.

Company Analysis

• SXC is a pharmaceutical software provider. Their business focuses on managing the prescription drug supply chain.
• Two primary market customers:
• Payor customers such as Blue Cross/Blue Shield and Governments
• Provider customers such as chain and independent pharmacies
• Currently the payor market represents approximately 70% of revenue, providers the remainder.
• Revenue is concentrated in the U.S. (over 95%).
• The company had a U.S. IPO on Nasdaq in the past six months, which has raised its profile in the U.S.

Market Analysis

• Total market size for payors and providers: $4.5B.
• Growth potential:
• The number of prescriptions being filled is increasing as North American population ages.
• In addition, number of prescriptions per individual is increasing.
• Payor customers are looking to increase operational efficiencies to reduce administration costs.
• Pharmacies require effective solutions to manage increasing volume.

Financial Analysis

Stock Analysis

• Since dropping to $12 (Canadian) in June, the company’s stock has increased dramatically. It reached a high of over $25, but has since pulled back to the $21.50 range.
• The stock is more volatile than the Canadian IT index (as represented by XIT), but is strongly correlated to it.
• According to the company, 12 analysts cover the stock on both sides of the border. According to GlobeInvestor, the consensus recommendation on the stock is a strong buy.

Opinion

Overall, I think this company is in a solid growth sector and has demonstrated strong organic growth over the years. I like the space they’re in and the fact that they are part of the solution to manage overall costs in the health care system, rather than being a cost driver.

Using my valuation models, I have arrived at fair value prices pretty close to SXC’s current price. I think that the stock is fairly valued at this point given future expectations, but if the stock continues to fall to $19 or so I think it becomes a good value and I will be looking to accumulate some for my portfolio.

Since March Madness is just getting underway, I decided to analyze Score Media (SCR: TSX) in depth. This company has been around for more than a decade now, and started a simple cable score ticker service. It has since morphed into a full fledged sports media company, with a comprehensive sports channel that has a mix of live sports, taped events and sports news, as well as various new media offerings.

Company Analysis

• Score Media Inc. is a media company with various broadcast (Score Television Network), internet (score.ca, scorepoker.com), mobile (Score Mobile) and next generation radio (Score Radio) assets.
• Score television is available in more than 5.9 million homes, while Score Radio is available around North America on SIRIUS Satellite Radio.
• The company is targeting the 18-34 (primarily male) demographic for its advertisers.
• In a December 2006 interview, John Levy, the CEO, saw ad rates growing for live event broadcasts, despite the impending crunch in ad rates for television overall.
• Nonetheless, the company has expanded into new media to retain its customer base and provide advertisers with a captive audience.
• On the television front, SCR’s primary competitors are Bell-owned TSN and Rogers-owned Sportsnet. Of the three, Score is the smallest in terms of audience.
• According to the CRTC, Levy and his relatives hold a rather large proportion of SCR (over 40%), while Alliance Atlantis holds about 22% (which was bought by CanWest Global in January 2007).

Stock Analysis

• The stock has risen dramatically in the past few months, primarily based on takeover rumors as well as large purchases by CanWest/Alliance Atlantis.
• The company’s shares are relatively illiquid, although trading activity has increased recently due to the above rumors and interest in the company.
• The company has one analyst covering it (Andrea Horan, Genuity Capital Markets), which rates it a buy. According to unverified reports, Genuity has been purchasing some modest amounts of SCR since January).

Financial Analysis

• Revenues were up 15% year over year (ending Aug 31, 2006), while cost of goods sold as a percentage of revenue has steadily dropped to 44% from 57% in 2002.
• The company has dramatically reduced its debt obligations (through a share offering and internal cash flow) and now a manageable debt load. As a result, interest expense has been dramatically reduced going forward.
• Earnings per share were up nearly 5 times to 0.14 from 0.03 in 2005. However, nearly 75% of total earnings was due to tax refunds due to loss carryforwards (ie. earnings were about 0.04 without the tax effect).
• The company has over $63 million in non-capital income losses tax credits available, the bulk of which expire in 2008 and 2009. Based on a ‘usable more likely than not’ valuation, the company pegs the value of these loss carryforwards at $9.1 million.
• Operating cash flows have been strong the past couple of years, with last year’s running about $0.04 per share.
• Analyst expectations for EPS this fiscal year is only 0.04, with FY 2008 being 0.06.

I created my own set of valuation models for this stock (which I typically do when analyzing a stock deeply). Even with generous growth and low income tax estimates for the near term, I could not justify the current $1.75 valuation on the stock. I believe that last year’s 0.13 EPS is a one-off due to the tax refund, and think this year’s EPS will be just 0.04 or 0.05 and will probably grow just a cent or two each year for the foreseeable future.

That said, I can see how this company is a desirable takeover target for CanWest. Furthermore, CanWest would be likely to be able to use all of SCR’s tax shelter, whereas the company itself will not generate sufficient earnings to use them prior to their expiration. Thus I can see the company being more valuable to CanWest or a similar profitable acquirer than as a standalone entity.

So, if you think SCR will be acquired in the near future, then it is currently undervalued. However, if the company is not bought out the shares look pretty pricey at the moment. I would be more interested in the stock if it pulls back to the $1.10-$1.15 range, which I think could happen if it is not purchased soon and as quarterly income figures come in below last year’s one-time spike.

Depending on your viewpoint, SCR is either a speculative buy or a sell right now. Since I can’t decide which is the more likely scenario, I am neutral.

Note: This is my personal opinion and not a recommendation for anyone else to buy this stock. This site does not purport to tell people, or suggest to people, what they should buy or sell for themselves. Please see my full disclaimer for all the details.

Last week I talked about what makes a good technology growth stock investment. Not all technology stocks fit into this category nowadays, as the several areas of the technology sector have matured (eg. operating systems, networking gear, database software, etc.) and are no longer going to have the growth to justify high P/E valuations.

Research in Motion (TSX: RIM, Nasdaq: RIMM) is a company that can still be seen as a growth stock (or at least has to be given its Price /Earnings ratio). RIM one of the darling stocks on the TSX. It enjoys high institutional investment, strong growth in the past 7 years, and a killer product known around the world (how many companies get their product affectionately entitled a drug by their users). Nonetheless, from a valuation perspective I don’t think RIM is a good investment.

Company Analysis

• RIM is run by co-CEOs Jim Balsillie and Mike Lazaridis. While this is an unusual setup for a large company, is has worked extremely well for RIM. I’ve listened to Jim speak at the Banff Venture Forum and he is a very down to earth person with little ego. I believe that management is quite solid and has a solid performance record with this company.
• Luckily (from a business perspective), Balsillie was ousted as the Pittsburgh Penguins owner, meaning he can focus on the business full time.
• About 75% of RIM’s revenue is generated by its BlackBerry device sales, with most of the remainder from service agreements with carriers and large businesses and a small amount in software sales.
• Gross profit has been increasing steadily, from 39% in 2002 to 57% last year.
• The company has been profitable for over three years and has been growing earnings per share by nearly over 200% in that time.
• The company places a high value on R&D, spending over $150M last year. As a percentage of revenues, R&D spending has decreased from 12% in 2002 to 7% last year.
• The BlackBerry is the undisputed leader in corporate e-mail devices. Most major companies have invested in RIM back-end hardware and software to facilitate push-email technology.
• RIM has a strong intellectual property war chest for its proprietary hardware and software. Nonetheless, it is at continual risk of litigation given the complexity and vast popularity of its offerings, and the company has had to pay large settlement fees in the past (most notably to NTP).
• The company has been attempting to make inroads in the growing consumer market for hybrid phone/e-mail devices. The BlackBerry Pearl is the company’s current mainstream offering.

Competitive Landscape

• Previously, the company’s main business competition was the Treo line of products made by Palm. However, today there is a growing number of smartphone manufacturers coveting both the business and consumer markets.
• Some major manufacturers include HTC, HP, Samsung, Nokia, and Motorola.
• While RIM has its own Java-based operating system, most other manufacturers (except Nokia and to a certain extent Palm) have opted to use the Microsoft Mobile platform.
• This increased competition is likely to squeeze profit margins as manufacturers attempt to gain market share through aggressive pricing and heavy marketing.
• RIM has not had an unqualified success in terms of Pearl sales, as RIM is discovering that the consumer market is looking for additional and different features than what the business market is accustomed to.

Personal anecdote: I have looked at getting the BlackBerry 8800, since RIM’s products have a solid reputation for quality. While the 8800 had most of the features its predecessors lacked and that I was looking for, I couldn’t believe they still didn’t have Wi-Fi available. To me this was a deal-breaker, since so many GSM smartphones like the HTC TyTN have this and more.

RIM seems to be serially 18-24 months behind in terms of features. When Jim was asked about this in late 2005, he indicated that they saw it as a tradeoff in dependability versus getting hot features out quickly.

I see parallels between RIM and Nortel in Canada (not necessarily because of some impending collapse on RIM’s part). Everyone knows RIM’s story and as a result I think there’s a disproportionately high amount of individual and institutional investment in this stock, which is part of the reason for its high PEG valuation relative to its peers.

Given RIM’s volatility, I would be foolish to say that people can’t make good money by investing in (or trading) this stock. And management may easily prove me wrong – they’ve been counted out before and have merely produced extremely high growth fairly consistently. Nonetheless, I believe the company will underperform the market over the medium term.

I wrote about why you should be overweight in Canadian financials a little while ago. I said that they were good long term investments and there was rarely a time not to buy, but if you’re looking to add to your position you should wait for a bit of a pullback.

Well despite strong earnings results, XFN has dropped nearly two percent as a result of the Chinese mini-correction. The sector did not really rebound on Friday as I expected, and right now there’s a good buying opportunity.

My two favourite banks - National Bank and Scotiabank - also took a rather large hit with little rebound. This is particularly interesting with respect to National, which reported record profits and strong growth across all divisions. Perhaps the market is hesitant on NA due to the fact that their CEO is stepping down. But the new CEO has been with the company for quite awhile and was running their brokerage previously.

I’d say it’s a good time to pick up some of these stocks if prices remain depressed on Monday.

Note: The author currently holds a long position in DVT.

I initially analyzed DivestCo (DVT: TSX) in this previous post. DivestCo continued with its acquisition strategy today by purchasing BlueGrouse Seismic Solutions (BGH: TSXV). This was an all-stock transaction that was at quite a premium over BGH’s recent stock price.

As a result of the news, BGH’s stock soared 33% today, while DVT’s sunk sunk over 8%. After reviewing BGH’s financials, this appears to be a positive move by DVT. BGH had a poort third quarter in 2006 led by the downturn in gas exploration. Nonetheless, the company and management has built a solid record of improving earnings and revenue in the past 7 years.

However, the all equity deal is different from their past financing arrangements and is not necessarily the most appropriate capital they should be using at this point. Hopefully DVT will use the same type of forgivable loan incentives they have given to management of their previous acquisitions to retain good management and get buy-in for the growth of DVT.

I am still bullish long term on DVT despite the pullback in the past week.

Disclosure: As of February 26, I hold a long position in DVT.

I came across DivestCo (DVT:TSX) while doing some value screens. After doing some more detailed analysis on the company, I must say I believe the stock is quite undervalued. Below is a more detailed analysis on the stock.

Business Background

• DVT is a diversified oil & gas services company specializing in seismic data and related services
• The company focuses on supplying data for sites in the B.C. and Prairies regions.
• DVT is growing through a combination of acquisitions and organic growth (primarily acquisitions)
• DVT wants to be the largest acquirer of seismic data in the 2006/2007 period for the Western Canadian Sedimentary Basin
• The company has four main business segments: data, consulting, software and services
• All businesses are profitable, except for the consulting division
• The company has a good track record (4+ years) of profitability
• Revenues have increased 108% on average each year since 2002, earnings have increased by 138% on average each year since 2002
• The company does not issue a dividend, nor is one apparently on the horizon

Business Environment

• The company is in a relatively competitive field
• Competitors include IHS, Pason Systems, Petroleum Geo-Services, Pulse Data, CGG Veritas, and Seitel
• Currently the company is relatively small compared to some of its competitors.
• The biggest macro factor for this company’s success is climate for oil & gas exploration (which is in turn driven by oil & gas prices)
  • Corporate execution is also a major factor. Specifically, their success depends on selecting appropriate locations to complete geological surveys. If they over invest in an area that has little value to their potential customers, their revenues and earnings will be significantly affected
  • The ability for the company to acquire companies at reasonable prices is another factor. As management has stated their intention to continue growth through acquisition, this will be a major determinant in their future returns.

Company Analysis

• Insider ownership is over 30%, according to their most recent investor relations presentation
• According to the 2006 Q3 Financials, several of the senior executives of the companies which were bought were issued forgivable loans to purchase shares as part of their buyout terms. The prices for these shares were in the $4.50 range, and the loans are forgivable based on employment milestones. To me this is a good indication that management of these firms believe that the company’s share price has a fair bit of upside remaining.
• The company announced a Normal Course Issuer Bid (NCIB) last month to repurchase up to 5% of current shares outstanding. However, the company did not repurchase any shares during their last NCIB. Note that they have little cash on hand to currently purchase a material amount of shares.
• The average weighted price of stock options that were issued in 2005 was $5.11. Since this average is currently out of the money, the managers and employees receiving these options have incentive to have the company’s performance improve.
• Their acquisitions have been financed by a mixture of debt and equity, as well as cash from operations. They are demonstrating good fiscal responsibility, as they are not overleveraging the company to fuel top line growth.
• Management revised 2006 revenue and earnings upward in June.
• Despite breaching loan covenants by having negative working capital in Q3 2006, their lenders simply acknowledged this breach and did not enforce any violation terms. This demonstrates to me that their lenders are comfortable with the company’s status and are confident in the company’s ability to rectify the situation.
• The company has been consistently operating cash flow positive during the current acquisition spree. This shows me that the company is purchasing solid assets with good operating performance.

Given this company’s growth potential, this company seems extremely cheap at only 10 times trailing earnings. Even if their earnings were flat for the foreseeable future, this company seems to be undervalued. Their Q4 2006 financials are expected to have record revenues and earnings, due to the backlog that occurred after a slowdown in Q3.

In my opinion, DivsetCo is a buy at the current closing price of $4.00.

Note: This is my personal opinion and not a recommendation for anyone else to buy this stock. This site does not purport to tell people, or suggest to people, what they should buy or sell for themselves. Please see my full disclaimer for all the details.

I am currently overweight financials in my retirement portfolio and will likely remain that way over the long term. I get my exposure to financials two ways currently:

1. Via the approximate 35% weighting financials have in the TSX/S&P Index, which I replicate using the TSX/S&P Index Capped iShares (XIC)
2. Via the TSX/S&P Financials iShares (XFN)

I like the Canadian financial stocks for several reasons:

1. Barriers to entry: the banks in Canada enjoy some level of barriers for their core services in Canada, from retail banking to investment banking and corporate services. While some small progress has been made by multinationals (such as ING) on the low end of financial services, their limited success only highlights how tough it is to break into this country.
2. Willingness to accept fees: as is currently being highlighted by the NDP, Canadians accept a lot of fees with little resistance. Whether it’s ATM fees, regular account fees or high mutual fund MERs, we seem to accept them all in stride, even when they increase (insert whatever cliché you wish about Canadians and our ‘nice’/passive personalities; it seems to apply here). This factor pads the profit margins of financial firms and is quite stable regardless of the economic cycle (less so for the mutual fund companies though).
3. Yield: in today’s low yield environment, it’s nice to get an extra 2-3% annually in a stable dividend. When government long term bonds are currently yielding only about 4%, you can really see the advantage to owning financials.
4. Currently, there is little to indicate that interest rates will be increasing in this country. Inflation (ex-housing) is pretty stable and low, while the economy is not growing that strongly. If anything, I see a rate decrease if the US housing collapse ends up affecting enough resource suppliers in Canada and depressing our GDP figures further.
5. Outperformance: since January 1, 2002 the financials have outperformed the capped iShares by 3% annually in terms of total return (all figures calculated based on figures available at Yahoo Finance Canada). Note that this does not provide any diversification away from the market risk associated with the TSX. The correlation between the XFN and XIC over this time period is 0.989, meaning you are not reducing your market risk in any meaningful way.

In the past 5 years financial stocks as a whole have risen steadily with only a few brief pauses or drops. In my opinion, you can’t go wrong buying XFN at nearly any time. But, if you’re already invested in XFN and are looking to get some additional return, here are a couple of tips.

1. Wait until there’s a slight pullback (4% or more) to purchase more. You may get a chance in the near future if Finance Minister Flaherty acts along the lines of his current comments and does something to restrict ATM fees or some other bank profit machine.
2. Pick the specific stocks which have consistently outperformed the financials index. Of the large banks, the two that pop up in terms of 5 year historical performance in Bank of Nova Scotia (BNS) and National Bank (NA). Both have outperformed XFN by at least 2.5% annually since January 1, 2002 on a total return basis. Of the two, BNS is less volatile, while NA has outperformed BNS by about 0.8% annually since 2002. Both offer solid yields in the 3.3% range.

I’ll update these to outright long-term buys if there’s a pullback on any of these three stocks in the near term without material news which affects their long outlook.