3/27/13: Colabor’s Earnings and a Round-Up of Recent Dividend Cutters

By Roger Conrad • March 27, 2013

Colabor Group Inc (TSX: GCL, OTC: COLFF) closed the book on Canadian Edge Portfolio fourth-quarter earnings reporting season this week.

The highlights were as follows: higher-than-expected sales both including and excluding acquisitions; lower-than-anticipated earnings before interest, taxes, depreciation and amortization (EBITDA); lower-than-expected cash flow margins and earnings per share; and higher-than-expected cash flow per share.

The latter is management’s primary profit metric for determining sustainable dividends. The fourth-quarter tally of CAD42 cents per share was 20 percent above the year-ago number, and covered the dividend with a 52 percent payout ratio. Management has targeted a payout ratio of 50 percent or lower for 2013, and reiterated that goal during the company’s fourth-quarter conference call.

Sales were better than the Bay Street consensus for two reasons. First, the company completed a handful of successful acquisitions, notably of Viandes Decarie, which added CAD20.4 million to revenue.

Second, despite tough competition brought on in part because of a soft market for consumer discretionary spending on restaurants, “comparable” sales–or sales excluding acquisitions–were up 1 percent. The “Distribution” division saw 1.9 percent growth, while the “Wholesale” unit that sells to other distributors saw a 1.2 percent decline. The Distribution segment currently accounts for about two-thirds of net revenue.

Cash flow and margins were below expectations for two reasons. First, the company had some difficulties integrating information technology (IT) systems among several subsidiaries, and incurred costs and lost some sales as a result. Management assured investors during the conference call that the transition is complete and the problems have been resolved. The second reason was competition that forced Colabor to offer discounts and absorb some costs.

Earnings per share missed primarily because of a total of CAD6.6 million in charges, slightly less than half of which was entirely on paper and involved no disbursement of funds. These included CAD2.7 million for restructuring, CAD1.2 million for the non-renewal of a supply contract, and a half-million dollar loss from disposing of certain operations. Excluding those charges, which are not related to current operations, the earnings shortfall was considerably less, 32 cents versus 34 cents a year ago.

Finally, cash flow per share was higher primarily thanks to the company’s ongoing plan to streamline operations and cut costs. The aforementioned integration of IT platforms is a part of this effort, as is closing certain facilities and exiting unprofitable operations. Roughly 75 percent of targeted savings have been realized for 2013, for a total of CAD3.5 million.

The Outlook

Looking ahead, these savings will almost exactly offset the loss of a supply contract in Ontario that management first announced a year ago. CEO Claude Gariepy stated during the conference call he does not expect “the business environment to improve materially in 2013.” That means realized synergies from the “action plan” will be the primary driver of growth, along with the recently announced acquisition of T. Lauzon.

These numbers did include considerably more good news than bad news. Importantly, the payout ratio is definitely moving in the right direction, which means the company will have more cash available to reduce its debt leverage relative to capitalization.

Most of the improvement we saw in the fourth quarter in the various leverage ratios is probably due to seasonal factors that reduced borrowing needs. And management has warned that harsh weather likely curtailed first-quarter 2013 revenue. There’s also the possibility of future contract losses, despite the company’s aggressive efforts to keep its business. And the decision to exit tobacco distribution will shave another CAD50 million off the top line, though management said there will be minimal impact on cash flow even in the near term, as this was a marginal business at best.

The trend on leverage and the payout ratio, however, should remain well in line with the plans Colabor laid out a year ago, when it cut its dividend to the current rate. Management remains on the hunt for acquisitions in this still fragmented industry, which should improve margins further.

In other words, this company is still meeting the benchmarks for recovery that it set last year. And it’s still building a business for the long haul, despite a very tough market. As I pointed out last month, it has some powerful financial backers in its home province of Quebec, including the premier pension fund as a major shareholder. The company is even dealing well with higher fuel costs, with a combination of purchasing arrangements and passing along such costs to customers.

Like everyone else following or owning this stock, we’ll have to make another evaluation of Colabor when they announce first-quarter earnings on or around May 2. The key benchmarks to watch will again be the payout ratio based on cash flow per share–with attention to both the 12-month and quarterly figures–moving toward 50 percent; progress on debt ratios or at least no upward spike; realized savings from the action plan hitting the CAD3.5 million target; and positive comparable sales. There’s also a wild card in Revenue Canada’s probe of the company’s conversion to a corporation in 2009.

Although I had previously mentioned the possibility that Colabor could earn an upgrade to the Conservative Holdings following release of its fourth-quarter results, I’m not inclined to do so at this time.

For now, however, the stock is worthy of remaining an Aggressive Holding. And while I’m completely against averaging down or any similar strategy, Colabor is a buy up to USD8 for aggressive investors who don’t already own it.

The Other Cutters

Colabor is one of four current Aggressive Holdings to trim dividends over the past 12 months, the others being Atlantic Power Corp (TSX: ATP, NYSE: AT), IBI Group Inc (TSX: IBG, OTC: IBIBF) and Just Energy Group Inc (TSX: JE, NYSE: JE).

As I pointed out in the March “In Focus” article, the most surprising thing about dividend cuts is that shares of the offending companies often trade at higher prices 12 months later. The exceptions are companies in a complete state of meltdown, such as Yellow Media Ltd (TSX: Y, OTC: YLWDF) was in 2011 and Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) was last year.

Distinguishing the latter from the companies that do recover depends on identifying a set of benchmarks that management must meet–and being willing to cut holdings loose that fail to meet them. Conversely, you must be willing to hold these stocks as long as those benchmarks are being met, even if prices fall further in the near term. And above all, you must avoid the temptation to double down on positions.

Colabor shares were generally flat this week, both ahead of and after the earnings announcement. Since the dividend cut about a year ago, the stock has traded between a price of roughly USD7 to USD9 per share. Insiders have been steady buyers, and analyst opinion has trended more bullish, with two buys currently versus three holds and no sells.

By contrast, Atlantic, IBG and Just Energy have been quite volatile in recent days. Just Energy, for example, held a trading range between USD7.50 and USD8 for several weeks following its dividend cut in early February. Since mid-March, however, it’s nosedived again, hitting a low of less than USD6 before bouncing back the past couple days.

Just Energy’s slide is clearly due to continuing skepticism that management can hold the current dividend level. The company tried to calm investor fears on Tuesday, stating that the payout ratio “would be less than 100 percent” for the fiscal year ending March 31, 2014. As part of the updated guidance, the company released greater detail on individual contracts and also estimated CAD1.57 per share in earnings before interest, taxes, depreciation and amortization (EBITDA). That’s its primary metric for profitability, on which the dividend is based.

As it has done several times in the past, management also stated there has been no material change in its business prospects to support a decline in its share price. And it released several numbers to bolster its claim that it can maintain dividends, fund growth and pay down debt according to plan.

Unfortunately, credibility is low so soon after a dividend cut. Soon after management’s statement triggered a one-day recovery of 10 percent-plus in the stock, one analyst stated the concern that lenders could worsen the terms of the company’s credit agreement, which must be rolled over by Dec. 31, including possibly requiring an equity raise or dividend cut.

That’s unlikely if Just Energy does succeed in meeting its guidance. And given the current yield of more than 12 percent, the stock will likely move to much higher ground if it does.

The key at this point, however, is for the company’s numbers to move in the right direction, starting with fiscal 2013 fourth-quarter numbers due out around May 17. Since Just Energy typically realizes 70 percent of earnings in the last six month of its fiscal year, we should see enough cash flow to allow at least some deleveraging. And of course, trends in customer renewal rates, attrition, and acquisition costs should continue to be favorable.

If that is the case, Just Energy may lose a few more skeptics, and its price may recover a notch. More likely, however, we’ll see continued volatility as investors gauge trends in cash flow, and weigh the odds of a favorable extension of credit lines.

This is not a stock for conservative investors at this time. And again, I do not advise averaging down on this stock or any other fallen favorite. Despite the volatility in share price, I am keeping Just Energy in the Portfolio at this time for patient, aggressive investors as long as it achieves its operating benchmarks.

Atlantic Power: New Blood, New Hope

Atlantic Power has gone nowhere but down since cutting its dividend at the beginning of March. One likely catalyst is the plethora of shareholder lawsuits filed against the company this month–14 in all–charging management misled investors on dividend safety.

Clearly, the perception is there’s blood in the water. But before anyone gets too excited, it’s important to remember that the burden of proof is very high in these cases. Moreover, in my opinion, it’s pretty clear Atlantic’s demise is due to weakness in the power market that management had spoken of prior to the cut.

Admittedly, that’s in hindsight, and I’ve been as wrong as anyone about this stock this year. But the key question now isn’t whether these suits have merit–all shareholders will almost certainly get something if any guilt is proven. Rather, it’s whether the suits will impair the company’s ability to meet its recovery benchmarks.

Unfortunately, that’s a major unknown at this point. On the plus side, one of the five analysts rating Atlantic switched from “sell” to “hold” this week. And as of April 2, widely respected power industry veteran Edward Hall will become executive vice president and chief operating officer.

Hall’s previous job was presiding over AES Corp’s (NYSE: AES) global power operation, arguably an even more complex company than Atlantic. His appointment brings badly needed credibility to the management team, as well as a previous record of success dealing with a range of issues, including volatile power markets and multinational regulation. And he will have a hand in almost everything at Atlantic, from asset management to safety issues and engineering.

As for recovery benchmarks, Atlantic has also reached a deal with a venture led by Duke Energy Corp (NYSE: DUK) to sell its Path 15 power line in California. The company still must win regulatory approvals for the deal. Other benchmarks include completing the sale of the Florida plants, syndicating a loan for the Canadian Hills wind plant, reaching terms on at least one more power generation project and matching payout ratio targets.

Since the dividend cut, my advice on Atlantic has been for the most conservative to bail out, but for patient, aggressive investors to hold on, pending progress on the benchmarks.

That remains my advice despite the stock’s recent downside and likely volatility ahead. And I am more confident following the recruitment of Hall.

IBI: After the Report

Finally, IBI Group’s stock took a sharp spill following its release of fourth-quarter and full-year 2012 results. I recapped the company’s earnings in a March 22 Flash Alert (see link below), noting management’s progress toward meeting recovery benchmarks it laid out when it announced a dividend cut last December.

One number of particular interest was the fourth-quarter dividend payout ratio of 83.9 percent, a figure based on the old monthly dividend rate of 9.2 cents Canadian per share. Using the same figure for distributable cash flow–the relevant measure of profits–and the now reduced dividend level, the ratio would have been half that, or 42 percent.

Investor reaction since the numbers were announced, however, indicates considerable skepticism about management that so recently cut dividends. Following the earnings call this week, two Bay Street analysts cut their ratings on the stock, one to “hold” from “buy” and another to “sell” from “hold.” That in turn set off a two-day drop of more than 28 percent in IBI’s share price.

Pressure on margins was the stated reason for the bearish shift. But the real worry seems to be that external conditions will unravel further in 2013, and management’s steps to cut costs and expand markets won’t offset the damage.

There’s also the natural fatigue of owning an underperformer that doesn’t appear headed for recovery any time soon. That emotion seemed to boil during the conference call with a testy exchange between CEO Philip Beinhaker and an analyst, who pointedly questioned the company’s claim of being hurt by recessionary forces.

I can certainly understand the latter sentiment. And clearly, not all of IBI’s current problems can be blamed on subpar economic conditions in its business.

That said, much of the cash flow shortfall in 2012 does appear to be primarily due to factors that should reverse in 2013, including the cost of staffing cuts and postponement of revenue from certain contracts. Second, management’s guidance does appear quite cautious, with projections based on existing operations and excluding the impact of acquisitions.

Absorbing smaller companies has been a major contributor to previous years’ growth and is likely to continue this year in view of overall industry weakness. And while US growth is a question mark, it could also provide a great deal of upside for beating the very low bar for 2013 performance that management is setting.

I’m not entirely sanguine about holding this stock, and I’ll want to see management make progress meeting the benchmarks of its action plan. That will include achieving the 2.5 percent revenue growth anticipated independent of acquisitions; the 12 percent to 12.2 percent cash flow margins projected; a rise in fee-based revenue above the current 77 percent of business; at least stable backlog; and holding compensation to 68 percent or less of revenue. I’d also like to see at least one more high-impact acquisition and continuing declines in days needed to collect accounts receivable.

During the company’s conference call, management did seem to warn of a light first quarter, in part because of a lower number of days. That may mean weaker numbers in some or all of these areas. But by the second quarter, we should start to see some sharp improvement.

Many of the questions during the call focused on compensation, and how management planned to reduce it as a percentage of revenue. That’s where I expect to see institutions make their decisions following the next round of results (May 10), as well as the level of distributable cash flow. And that’s what’s likely to affect the stock price going forward.

Importantly, despite the writedowns and dividend cut in 2012, IBI still grew its business and fee volume, while extending expertise and geographic reach. That’s the most important reason for continuing to hold the stock, despite the losses we’ve seen so far.

Again, the key with each of these four stocks is meeting benchmarks for recovery. As long as they do, they’ll still be on track for recovery, and we’ll continue to hold them. Should they fail, we’ll move on.

Those who already own this less-than-fantastic four should continue to do so, though once again I do not advise averaging down. Conservative investors should steer clear. Aggressive, patient investors can buy Colabor up to USD8, IBI up to USD8 and Just Energy to USD8. Atlantic remains a hold.

Here’s where to find analysis of Canadian Edge Portfolio Holdings’ fourth-quarter and full-year 2012 earnings.

Conservative Holdings

Aggressive Holdings

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Comments Guidelines
B. Merz

Charles L Summers

Is there any hope of Colabor Group recovering ? Is it still a sell at this level ?

Investing Daily Service

Investing Daily Service

http://www.investingdaily.com/canadian-edge/articles/17591/all-the-trouble-in-the-portfolio/#GCL

Hi Mr. Summers:

In David Dittman’s June 7, 2013 article,he indicated that there are enough uncertainties in Colabor for hm
to consider it a SELL. The article is enclosed above.

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