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.

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.

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.