In last month’s issue I emphasized that the analytical approach that’s driven Canadian Edge Portfolio decision-making since the advisory’s July 2004 inception would remain in place. Our research process is still driven by the CE Safety Rating System, which assigns a score of “0” to “6,” “6” being highest, according to the number of criteria a company meets.

The payout ratio remains the cornerstone of the System. It’s basically the dividend as a percentage of profits available to pay dividends.

Two of the six points in the Safety Rating System are determined by payout ratio. If a company’s payout ratio comes in below a certain level required for its sector, it gets a point. If it’s superior for its class and the payout ratio will likely stay in the safe zone for the next 18 to 24 months at least, the company will score two points.

Two more are determined by debt. Companies get a point for having a debt-to-assets ratio below a certain percentage designated for their group. They get another point if total obligations coming due the next two years as a percentage of total market capitalization (outstanding shares times share price) are less than 10 percent. The result is a gauge of refinancing risk for each company reviewed.

Criterion No. 5 is the nature of the business of each company. Basically, some business models are better suited to supporting dividends throughout the business cycle. Others are more susceptible to economic shocks.

Among the most resilient are pipeline, electric power, select infrastructure and various consumer-focused companies whose cash flows have proven to be steady over time.

By contrast, resource-focused names such as oil and gas producers are often subject to wild swings due to ups and downs for commodity prices, which can help or harm cash flows and, thus, dividends.

Companies in economically resistant businesses receive a Safety Rating point on this score, while resource companies do not.

The last criterion under the Safety Rating System is simply whether a company has cut its dividend over the past five years. If it hasn’t it gets a point; if it has reduced its payout it doesn’t get a point. This is a significant factor, as the last half-decade witnessed the worst global economic downturn since the Great Depression.

Companies that endured without reducing their dividends have been tested under the harshest of circumstances.

The Safety Rating System establishes a framework for analysis and assessing the quality of an underlying business.

There are circumstances, however, where a company can satisfy enough criteria to earn a high Safety Rating, though financial and operating numbers have only begun to reveal underlying weakness.

In December 2012, for example, Atlantic Power Corp (TSX: ATP, NYSE: AT) had a “5” Safety Rating and was counted among the CE Portfolio’s Conservative Holdings. Meanwhile, the deterioration of the North American wholesale power market and the difficulty of re-contracting projects in Florida were only just beginning to manifest in the company’s numbers.

It wasn’t until March, after management announced a drastic dividend reduction and a shift in the way it would go about adding new projects and cash flow, that we shaved three points off the company’s Safety Rating and moved it to the Aggressive Holdings.

Had we a crystal ball we would have closed out our position in Atlantic Power last fall, when it was trading above CAD15 and had through October 2012 generated a total return of nearly 200 percent since we added it to the Portfolio in October 2006.

Or we might have been more sensitive to management’s discussion of its Florida issues as well as the broader context of the troubled wholesale power market during the late fall and early winter, when the stock was still trading in a band around CAD12.

We did cut the Safety Rating to “4” in the January 2013 issue, a sign that we knew there was some trouble, specifically that the payout ratio, based on management guidance, wasn’t likely to remain within the range considered safe for Electric Power companies over the ensuing 18 to 24 months.

There was, of course, a lot more going on with Atlantic Power, but we didn’t know conclusively until management’s Feb. 28, 2013, announcement of fourth-quarter and full-year numbers.

What we have now, new to management of the CE Portfolio, is an opportunity to establish a more rigorous sell discipline, to be more sensitive to emerging underlying weakness in the businesses we cover so that we can avoid steep and painful capital losses.

That’s not to say we won’t make mistakes, or that we’ll never enter a position that we eventually close out for a loss. It does mean we’ll be quick to admit mistakes and to close them out before losses become irreparable.

The Safety Rating System establishes an objective framework. But exercising this more rigorous sell discipline requires a bit of subjective judgment. In other words, there is no trigger for a sell decision.

In many cases, for example, companies that cut dividends–which event would make for a simple sell sign–use the saved cash to shore up healthy-for-the-long-term-but-struggling-in-the-short-term operations and push on for greater growth–for shareholders, too–down the road.

But this–greater sell discipline–in addition to sticking with the analytical framework established by the Safety Rating System is the mandate we’ve established at the outset of our tenure in charge of Canadian Edge.

Let’s get started.

Cleaning House

IBI Group Inc (TSX: IBG, OTC: IBIBF) reported less-than-impressive results for the first quarter of 2013. Numbers for the first three months of the year showed further weakness for margins, and management’s guidance for the rest of the year was decidedly cautious.

On this basis we advised readers to sell the stock in a May 17, 2013, Flash Alert, noting:

Overall debt as a percentage of total assets was a relatively high 45.1 percent as of the end of 2012, and management sought and received an adjustment to get IBI in line with its fixed-charge coverage ratio for the year-end period. Among the three metrics that are the focus of IBI’s debt covenants is the payout ratio. This raises the specter of another dividend reduction should operating conditions not improve.

The following week IBI Group “suspended” the dividend.

Management was decidedly downcast in its statements supporting the earnings report, noting “some encouraging growth in private sector real estate development and in intelligent system work” in the US but also stating that projects for state and local governments are still hampered by lack of funding.

The company is also facing competitive pressures. “There remain,” according to management, “challenges in the current environment.”

In the UK IBI’s practice “has slowed as a result of the third consecutive quarter of contraction of national economic activity.” Activity in other international markets “is increasing and provides encouraging prospects.”

Management was alarmingly reticent to discuss IBI’s significant debt obligations coming due over the next 20 months during its first-quarter conference call, dismissing a question from an analyst with the following response, from Chairman and CEO Phil Beinhaker:

I don’t really want to discuss them now other than what we’ve said before, and that is that we are aware of them. And we are working on a variety of approaches to manage them in a timely manner and not to wait to the last day. And we have a number of alternatives and the board will consider them and deliberate on them and we look forward to implementing them over the ensuing quarters.

We discuss IBI Group at greater length in Dividend Watch List. Sell IBI Group if you haven’t yet, establishing a loss to offset any capital gains you may realize for 2013.

Colabor Group Inc’s (TSX: GCL, OTC: COLFF) share price continues to drift lower ahead of what’s expected to be the announcement of a reduced dividend come June 17, 2013. The stock, which established a post-June 2005 initial public offering closing low of CAD4.09 on June 7, is now priced to yield 17.6 percent.

As we noted last month, management was less than stirring in its endorsement of the current CAD0.18 per share quarterly dividend rate. CEO Claude Gariepy took pains, actually, to establish that dividend policy is matter of board responsibility, noting, “I have no mandate at this moment to challenge the fact that we have a CAD0.72 dividend.”

This sounds like an manager who might appreciate the greater freedom of movement a lower payout burden would entail in the aftermath of what he himself described as “disappointing” first-quarter results.

Crucially, Colabor’s progress on benchmarks we established when the company posted fourth-quarter and full-year 2012 results was difficult to see in its report for the first three months of 2013.

We were hoping to see a payout ratio approaching 50 percent. Management reported a 68 percent ratio for the 12 months ended March 23, 2013, down from 86 percent a year ago but up from the 52 percent figure reported for the fourth quarter of 2012.

As of the end of the first quarter debt-to-12-month EBITDA was 3.15-to-1, just below the prescribed maximum of 3.25-to-1, while the interest coverage ratio was 4.06-to-1, above the required minimum of 3.50-to-1.

And total debt-to-12-month EBITDA was 4.66-to-1, above the prescribed maximum of 4.50-to-1 and sufficient to cause Colabor to seek and receive a variance from its banking syndicate. Thus little progress on debt ratios, and while there was no upward spike” things have gotten a little more burdensome.

Comparable sales, meanwhile, were off by 1.8 percent, missing our benchmark of “positive comparable sales.”

As for achieving realized savings of CAD3.5 million based on the “action plan” described in the management discussion and analysis (MD&A) section of its 2012 annual report, management could point to no specific indication of success.

To its credit, management has launched initiatives to stimulate higher-margin sales; commenced a review of operations of the Eastern Quebec and New Brunswick division; completed the acquisition of T. Lauzon; and transferred meat-product purchasing from the Ontario Division and Eastern Quebec to Lauzon.

But there was nothing concrete as far as dollars and cents are concerned.

We suggested last month that conservative investors exit the position in favor of our May Best Buy selections. Based on the lack of progress on the benchmarks we established in March and the further deterioration in the share price, we’re ready to recommend that investors of all risk tolerances stand aside. Sell Colabor Group.

Just Energy Group Inc (TSX: JE, NYSE: JE) is the focus of a highly visible and deeply unflattering feature article in the June 2013 edition of the Toronto Globe and Mail magazine Report on Business.

Founder and Executive Chair Rebecca MacDonald is feature on the cover of the magazine, with the bracing tag “Hard Times, Hard Sell.” The article is also available online, here.

The piece raises several questions about Ms. MacDonald’s life story and her carefully cultivated public image. It leaves one wondering whether a tendency to hedge truth in favor of drama when it comes to personal matters manifests itself on the business side in the form of aggressive sales practices, questionable hiring and dubious accounting.

The most fundamental issue is how Just Energy–which in its most basic operating form is a broker; it owns no infrastructure, nor any commodity–will make money in an environment of low natural gas prices. Its key pitch in the past was that its contracts allowed consumers to lock in a fixed rate that allowed them to save money. But gas is no longer trading in the double-digit range.

It enumerates many instances where Just Energy operating units were fined and censured for its dealings with consumers, focusing on Illinois, where its sales people outright misled folks, including the elderly as well as disabled and non-English speaking target, into signing contracts under which they would pay in some cases two times the prevailing market rate for gas. The company was the subject of “nearly” 30,000 complaints in the Land of Lincoln.

The executive director of the Citizens Utility Board notes that “the latest data” for contracts entered into by Just Energy and companies like it with Illinois consumers “show that 92 percent” of those “have ever been offered have been money-losers” for consumers.

The state of New York and the province of Ontario have also assessed fines and sanctions against Just Energy because of its door-to-door sales tactics. “In Alberta in 2010,” the story notes, “three of the company’s salespeople pleaded guilty to charges that included forging signatures on energy contracts and pretending to be customers to phone verifiers.”

CEO Ken Hartwick acknowledged to the story’s authors that Just Energy’s compensation scheme for its sales force likely encourages aggressive tactics; these salespeople receive no salary, compensated instead based solely on commission.

Just Energy responded to the Report on Business story with a press release that questioned the motives as well as the competence of one of the sources who’s challenged the company’s representation of its financial situation.

This source, Al Rosen of Accountability Research Corp, is indeed a short seller, and he has made similar claims about other companies in the past. One justice of the Ontario Superior Court, in a 2012 opinion related to a case involving Western Coal Corp, wrote disparagingly of Mr. Rosen’s research.

But Mr. Rosen is just one among many Bay Street analysts cited in the story who question the ability of Just Energy to maintain its dividend policy while also funding its marketing efforts and its capital needs.

There are three things about Just Energy, on the face and setting aside the tawdrier aspects of the Report on Business profile, that still concern us, in particular its rising debt level, currently low and likely to remain range-bound natural gas prices, and the way the company acquires customers.

And there’s also the matter of servicing a CAD1 billion debt burden–up from zero in 2009–rung up as the company grew through acquisitions of competitors and of companies operating in similar businesses, such as electricity contracts and water heaters.

We had written favorably about Just Energy’s fiscal 2013 fourth-quarter and full-year results in a May 16 Flash Alert, Just Energy Just Does It. Based on what was reported Just Energy appears capable of supporting its current dividend rate, which at CAD0.07 per month is the result of a February 2013 cut from a prior rate of CAD0.10333.

The market also reacted positively to the report, pushing the share price as high as CAD7.62 as of May 30.

But we purport to favor high-quality businesses. And this article and the light it casts on not only the company’s reputation in Canada and the US but its financial health as well raises serious concerns about Just Energy’s ability to fit this bill.

We noted in the May 2013 issue that we planned to be more proactive as far as cutting losing positions loose from the Portfolio. Although we do not as a practice rely on the reporting of others to inform our buy-hold-sell decisions but rather rise or fall on our own bottom-up assessment of financial and operating numbers, the weight of the evidence here is compelling.

And we are talking about a company that just cut its dividend, one whose underlying business operations, although they may not be deteriorating, are not strengthening in a way that imbues us with confidence.

Just Energy has rebounded from the lows it plumbed just ahead of our assuming editorial control of Canadian Edge. This is an opportunity to get out but not at the bottom. Sell Just Energy.

Aggressive Assessments

On May 10 Wajax Corp (TSX: WJX, OTC: WJXFF) announced a 25.9 percent reduction in its monthly dividend rate.

Wajax had been on the Dividend Watch List because of weak fourth-quarter earnings and due to management’s oft-expressed willingness to trim the payout as it copes with ongoing difficulties associated with reduced drilling in the Canadian energy patch.

CEO Mark Foote acknowledged in a statement announcing results that numbers for the first quarter “were moderately less than…expectations and lower than last year,” attributing the twin shortfalls to continuing weakness in the oil and gas market and a decline in mining activity.

Management also expects oil and gas market weakness to persist through 2013, with demand for new equipment and aftermarket services for drilling and well stimulation continuing to be soft.

First-quarter mining-related declines were primarily due to the loss of the LeTourneau product line, which was only partially offset by other mining-related after-market improvements. Management noted that quoting activity remains reasonably strong for the Equipment segment as well as Power Systems’ electrical power generation business.

But project delays and reductions in capital spending have combined to limit the ability of many of Wajax’ customers to commit to new equipment orders. Management therefore expects mining-related sales to continue to be weak.

Earnings for 2013 are likely to be lower than in 2012, another factor, in addition to a weaker backlog and cloudy forecasts for oil and gas and mining activity over the balance of the year, behind management’s decision to cut the monthly dividend rate to CAD0.20 per share from CAD0.27.

Wajax posted a 6 percent decline in first-quarter revenue to CAD336.3 million. Wajax Equipment revenue slipped 2 percent, as lower mining equipment sales more than offset gains in equipment sales in the construction, forestry and material handling sectors and a 12 percent increase in parts and service volumes.

Wajax Power Systems and Wajax Industrial Components recorded decreases of 17 percent and 4 percent, respectively, primarily on weaker activity in the oil and gas sector in Western Canada.

Net earnings for the quarter declined 39.2 percent from CAD17.1 million a year ago to CAD10.4 million. The drop also was driven by oil and gas and mining softness, with CAD4 million attributable to the loss of the LeTourneau mining equipment line.

The new dividend rate will keep Wajax within its policy of paying out at least 75 percent of expected net earnings. And it will help the company survive a difficult period. Wajax has deep roots in the Canadian resources sector, with a history dating to 1858, and is well-placed to prosper once conditions improve.

In the meantime operations in other core markets such as construction, material handling and forestry have shown year-over-year improvements, and management’s strategic initiatives are beginning to bear fruit. It’s with an eye on continuing to invest in growth, at the same time focusing on containing costs, maintaining inventory and providing for working capital, that management trimmed the dividend.

Wajax’ dividend cut in many ways reflects the volatile nature of the industries of its primary focus, oil and gas and mining. Since March 2004 in fact Wajax has announced 15 dividend increases, taking the regular rate from CAD0.04 to as high as CAD0.36.

It’s also announced three cuts, from CAD0.36 to CAD0.20 in February 2009, from CAD0.20 to CAD0.15 in August 2009 and now, after three in that series of 15 increases, from CAD0.27 to CAD0.20.

Based on its track record it’s fair to say management could cut again during this difficult cycle for oil and gas and mining equipment providers. It’s also fair to say that Wajax will return to dividend growth once activity gets back to normal.

Wajax Corp remains a hold for aggressive investors willing to wait out the volatility.

It fits that all these trouble spots are concentrated in the Aggressive Holdings. Atlantic Power, however, was recently included among the Conservative Holdings.

Atlantic’s journey from reliable wealth-builder to Portfolio suspect was swift, driven by management’s Feb. 28, 2013, announcement of fourth-quarter and full-year 2012 numbers that included a 65.2 percent dividend cut and the articulation of a subtle but significant shift in its growth strategy.

Atlantic is now faced with the need to preserve sufficient cash to fund deals that may present longer lag times from investment to realization of cash flows, a major factor contributing to the new dividend policy.

The company faced a wall of skepticism when it reported results for the first quarter of 2013, but results for the first quarter of 2013 indicate Atlantic is making solid progress on five benchmarks we identified shortly after the dividend cut, including the sale of its Path 15 transmission line in California and the disposition of three Florida plants for proceeds of $173 million in cash.

Atlantic also syndicated its tax equity investment in its Canadian Hills wind project, hitting a third marker. The first-quarter payout ratio was 38 percent, fulfilling the fourth of our five criteria.

The asset sales and the Canadian Hills syndication generated $151 million in cash to redeploy toward new growth projects during the second half of 2013. And this is the major open question.

Management also reaffirmed its forecast for full-year 2013 project adjusted EBITDA of USD250 million to USD275 million, as well as its payout ratio range of 65 percent to 75 percent.

Atlantic noted good progress with recent projects, including the commencement of commercial operation for the company’s 53.5 megawatt Piedmont Green Power biomass project in Georgia. But no new projects were announced.

Management has done enough to justify keeping the stock in the Portfolio. But Atlantic Power remains a hold pending developments with new projects.

Extendicare Inc (TSX: EXE, OTC: EXETF) rebounded from the sharp selloff that followed its dividend cut announcement of April 29, 2013. The share price has given up ground in June as part of the wider selloff afflicting yield-focused equities, but there are no additional signs of a breakdown at the company level.

In fact, management is taking dramatic steps to isolate weak parts of the business as it works to establish a foundation to support the current dividend rate and from which to grow in the future, announcing along with first-quarter results that a special committee of the company’s board of directors is evaluating options to separate US operations from Canadian operations.

Extendicare reported a 4.1 percent decline in first-quarter revenue to CAD497.9 million, primarily due to the planned exit from Kentucky in 2012. Same-facility revenue grew by CAD8.7 million.

Average daily revenue rates for Medicare Part A and Managed Care increased by 4.3 percent and 3.1 percent, respectively, over the first quarter of 2012, and the Medicare Part A rate increased by 1.2 percent, while the Managed Care rate was flat.

Revenue from US operations declined by USD26 million to USD313.7 million in the first quarter. Revenue from same-facility operations improved by USD4.2 million between periods,

primarily due to the impact of higher average rates of USD10.9 million, partially offset by the impact of lower census levels of USD3.1 million, one less day this quarter of USD3.1 million and other lower revenue of US$0.5 million.

Same-facility average daily census (ADC) was lower by 202 this quarter compared to the first quarter of 2012, primarily due to a decline in Medicaid ADC of 201. Same-facility Skilled Mix ADC represented 23.5 percent of residents this quarter compared to 23 percent a year ago.

Revenue from Canadian operations grew by 2.5 percent to CAD181.6 million, primarily due to funding enhancements and increased home health care volumes.

Average daily revenue rates in Canada increased by 3.9 percent, and occupancy rates remained unchanged at a solid 98 percent. Adjusted funds from operations north of the border improved by 9.2 percent primarily due to tax savings.

Canadian home care operations volumes were up by 2.6 percent. Extendicare is the largest home care operator in Ontario based on hours of service provided, representing approximately 15 percent of the market.

The company’s level and quality of care puts it in good position to benefit in terms of patient retention and growth under the Ontario government’s plan to grow community-based care.

Two redevelopment projects in Northern Ontario–one completed in March and opened to residents in April and another  on track for completion in August and to open to residents in September, are forecast to add nearly CAD2 million to earnings once fully operational.

Earnings before interest, taxation, depreciation and amortization (EBITDA) declined 21 percent from a year ago and 26.5 percent sequentially to CAD39.1 million. EBITDA margin was 7.9 percent compared to 9.5 percent a year ago and 10.7 percent in the fourth quarter of 2012.

Adjusted funds from operations were CAD18.2 million, or CAD0.211 per share, down from CAD27.1 million, or CAD0.322 per share, a year ago and CAD26.8 million, or CAD0.312 per share, in the fourth quarter of 2012.

Management distributed CAD18.1 million, or CAD0.21 per share, to shareholders during the first quarter, a payout ratio of 100 percent of adjusted funds from operations.

Using first-quarter actual adjusted funds from operations numbers and the new dividend rate of CAD0.04 per share, Extendicare’s payout ratio would be approximately 57 percent.

As for the separation, it will happen, as management noted that operating in markets as divergent as the US and Canada in terms of senior care operating and regulatory environment “have long presented challenges to the market in assessing the company’s valuation.”

The differences have only been exacerbated by recent changes to US health care law and resulting federal and state spending cuts.

The only open question is what form the transaction will take. Among the possibilities: an outright sale of the US business or a distribution of the Canadian or US business. The latter would give shareholders ownership in two companies, one that would own and operate the Canadian business and one that would own and operate the US business.

Extendicare expects the separation to be completed “late this year,” the timing dependent on the form of the separation and the receipt of any necessary regulatory and shareholder approvals.

Extendicare is a buy under USD7 for aggressive investors.

Conservative Value

Longtime Conservative Holding Bird Construction Inc’s (TSX: BDT, OTC: BIRDF) share price has sagged since approaching its all-time high above CAD15 in early 2013. In fact, since hitting its closing high for the year of CAD15.08 on Jan. 21 Bird is down more than 20 percent.

At the same time the S&P/TSX Composite Index is off 6.6 percent in price-only terms, while the S&P 500 Index is 7.6 percent to the positive.

Selling was triggered initially by the loss of a major oil sands contract.

Bird’s capital depreciation has been offset somewhat by CAD0.3066 in total dividends paid as of this writing, with another CAD0.0633 due June 20. And that CAD0.0633 rate was boosted from CAD0.06 in March, effective with the April payment.

As we’ve often argued, there’s no surer sign of management confidence in future prospects than a dividend increase.

But Bird’s sharp share-price decline is legitimate cause for question, particularly in light of the fate that’s befallen a company that bears some similarities to Bird, IBI Group.

Results for the first quarter were far from spectacular.

Construction revenue, for example, decreased by 2.1 percent to CAD288.5 million compared to CAD294.7 million a year ago. And net income of CAD2.4 million was down from CAD6.4 million for the first quarter of 2012. Lower earnings are largely the result of   changes in the timing and mix of work executed in the respective quarters and higher general and administrative expenses in 2013.

Management had forecast that 2013 would be more difficult than 2012, but CEO Tim Talbott conceded that first-quarter numbers were below internal expectations. At the same time, however, Mr. Talbott noted that “management is cautiously optimistic that improving conditions should have a positive impact on results late in 2013 and into 2014.”

Among the factors supporting Bird’s dividend is a cash position of CAD112 million and the fact that the construction contractor will generate enough cash from operations to cover its payout even in what’s forecast to be a difficult 2013.

And Bird was recently awarded a CAD42 million contract to build a new performing arts center in Ontario. This won’t offset the loss of the oil sands contract on its own, but it does demonstrate the company’s ability to win work in a diverse array of settings.

Management reported a backlog of CAD1.029 billion as of March 31, 2013, down slightly from CAD1.074 billion a year ago and reflecting the loss of the oil sands contract.

Bird Construction, yielding 6.3 percent at these levels, is a buy under USD14.50.