The most basic rule of successful investing is to buy low and sell high. The first part of this two-step process is a key to successful mergers-and-acquisitions strategies for companies, though in this context prices are negotiated to be fair to both sides of the transaction.

Nevertheless, businesses that add assets amid sluggish economies or difficult sector conditions that make weaker competitors consumable are setting foundations for long-term growth.

Consolidation boosts scale, and it can drives revenue and earnings growth that might otherwise be lacking due to macro conditions.

M&A can also be driven by strategic considerations, as businesses look to expand on existing capabilities or establish new, complementary services.

This month we have three big deals to report for CE Portfolio Conservative Holdings.

TransForce Inc (TSX: TFI, OTC: TFIFF) has been an aggressive consolidator in the North American logistics market during a difficult period for the sector.

In late December 2013 TransForce completed the acquisition of Clarke Transport Inc and Clarke Road Transport Inc, two subsidiaries of Clarke Inc (TSX: CKI), for CAD100.5 million and announced it would buy Vitran Corp for USD136 million. And in June 2014 it inked a deal to acquire Transport America Inc for USD310 million including debt.

Last month TransForce made its big move, reaching an agreement to acquire Contrans Inc (TSX: CSS, OTC: CTFIF) for CAD495 million, or CAD14.60 per share, in cash.

The transaction will be financed through a CAD550 million credit facility.

Contrans is one of the largest transportation companies in Canada, with a national presence and a wide array of specialized truckload services. For the 12 months ended March 31, 2014, Contrans generated total revenue from continuing operations of CAD580 million and earnings before interest, taxation, depreciation and amortization (EBITDA) of CAD80 million.

Contrans, a specialty truckload business with a particularly strong market position in Ontario and a small position in Quebec, is a good complement to TransForce, which has a strong specialty truckload presence in Quebec but no real presence in Ontario.

Management also reported solid second-quarter numbers that suggest TransForce has expanded its market share just as fortunes for the North American logistics sector are improving along with the continental economy.

Total revenue increased by 12.2 percent to CAD889.1 million, mostly reflecting a total contribution of CAD102.3 million from the acquisitions of Vitran, Clarke Transport and Clarke Road Transport.

Excluding acquisitions, revenue declined due to the phase-out of rig-moving activities, the non-renewal of unprofitable business from Velocity’s customers in US same-day services and the sale of non-core businesses.

These factors were partially offset by a solid increase in Waste Management revenue and by the effect of the US currency appreciation on US-dollar denominated sales.

Effective cost management drove a 27.6 percent increase in earnings before interest and taxation (EBIT) to CAD79.5 million, equal to 8.9 percent of total revenue, up from 7.9 percent for the prior corresponding period.

TransForce improved its year-over-year EBIT margin in all business segments, especially in the Package and Courier segment.

Adjusted net income grew by 25.1 percent to CAD49.1 million, or CAD0.48 per share, from CAD39.2 million, or CAD0.40 per share, a year ago.

TransForce recorded a non-cash goodwill impairment charge of CAD27.8 million before income taxes for the disposition of its rig-moving services business.

Excluding this charge, net income for the second quarter was CAD62.8 million, or CAD0.61 per share, versus CAD26.6 million, or CAD0.28 per share, in the second quarter of 2013.

Free cash flow was CAD97.4 million, or CAD0.99 per share, driven by proceeds from the sale of property and equipment amounting to CAD57.3 million and strong cash flow from operating activities. This enabled TransForce’s acquisition strategy (CAD44.8 million), the repayment of long-term debt (CAD35.7 million) and the repurchase of shares (CAD4 million) during the quarter.

Management’s focus will now turn to integrating recent acquisitions and reducing debt. TransForce’s debt-to-EBITDA ratio is 3.5 times but that should fall to 3 times within a year thanks to the free cash flow that will be generated by what’s now a bigger company.

The deal with Contrans is a solid culmination of TransForce’s acquisition strategy. Though management has not entirely ruled out opportunistic, tuck-in deals, the complementary, strategic and accretive deal for Contrans establishes it as Canada’s leading specialized transportation logistics company.

TransForce’s focus on operations and successful execution of its consolidation strategy bodes well for future top-line, bottom-line and dividend growth.

TransForce, which has established a significant scale advantage relative to its Canadian trucking peers, is now a buy under USD27.

On July 17, 2014, EnerCare Inc’s (TSX: ECI, OTC: CSUWF) board of directors dismissed a potential CAD790 buyout bid from its largest shareholder Augustus Advisors LLC on the basis that “the indicated price of between $13.50 and $15.00 per share did not represent full value for EnerCare’s shares and was not sufficient to form the basis of meaningful discussions,”

On July 25, EnerCare management announced a CAD550 million deal to acquire the Ontario-based waterheater rental and repair business of Centrica Plc (London: CNA, OTC: CPYYF, ADR: CPYYY) that indicates, contrary to Augustus’ argument to shareholders, present leadership is quite able to generate value as a public rather than a private entity.

Direct Energy services more than 1.1 million rental waterheaters and has 550,000 protection plans. It also sells and installs HVAC units and provide other home and small commercial services.

The deal is expected close in the fourth quarter.

The CAD550 million purchase price will be funded via a CAD310 million bought-deal equity offering and a private placement of CAD100 million of EnerCare common shares to Direct Energy, which will become EnerCare’s largest shareholder. The remainder will come from a CAD223 million four-year variable term loan. A portion of this loan will be used to refinance EnerCare’s existing CAD60 million facility, which is due in January 2016.

EnerCare’s banks have also committed to a five-year, CAD100 million revolving credit facility.

EnerCare was once a part of Centrica’s Ontario waterheater business before it was spun out as Consumers Waterheater Income Fund in 2002.

Octavian Special Master Fund LP is the actual owner of the shares that Augustus is managing.

EnerCare beat back a proxy challenge by Octavian in April 2012, when the activist investor called for a shareholder vote to expand the board and elect four of its own nominees. It also wanted to talk about the company’s strategy with EnerCare’s management. Proxy advisory firms sided with EnerCare management, and in early 2013 Octavian gave up management of the shares to Augustus.

Like EnerCare’s, Direct Energy’s Ontario services business is built on long-term customer relationships and recurring revenue. Its predictable cash flow will support EnerCare’s ability to boost returns to shareholders.

EnerCare and Direct Energy remained highly interdependent; the companies are in the 12th year of a contractual arrangement where EnerCare owns the waterheater and HVAC assets and Direct Energy services its portfolio, receiving 35 percent of the related rental revenues in return. The acquisition will consolidate the ownership assets and services revenue in a single portfolio.

The deal should by highly accretive. On a combined basis 2013 pro forma adjusted EBITDA and distributable cash per share would have been higher by 22 percent and 87 percent, respectively.

During its conference call to discuss the transaction EnerCare management noted that it had identified many new opportunities for the combined business to create additional value through the launch of new products, through enhancement of the customer experience and geographic expansion.

The increased scale of the combined business should provide a solid platform from which to drive its growth strategy, though integration will be the priority for the first 12 months following consummation. Similar corporate cultures based on a shared history and the companies’ continuing relationship over the past decade-plus should ensure a smooth transition.

EnerCare’s share price spiked in mid-July, upon revelation of the Augustus offer, to above CAD13.50 on the TSX. It’s trading at CAD13.72 as of midday Friday, Aug. 8, up from a 2014 closing low of CAD9.50 on Feb. 5.

Since Jan. 1, 2011, when Consumers Waterheater Income Fund completed its corporate conversion and changed its name, EnerCare has boosted its dividend five times; coupled with share-price appreciation it’s generated a US dollar total return of 138.5 percent.

The S&P/TSX Composite Index is up 13.6 percent including dividends, the S&P 500 Index 65.8 percent.

For 2014 EnerCare has posted a US dollar total return of 38 percent versus 9.9 percent for the S&P/TSX Composite and 5.8 percent for the S&P 500.

EnerCare will report second-quarter financial and operating numbers on Aug. 14. We don’t anticipate management will announce an immediate dividend increase, but we do expect to see one before the end of 2014.

And the Direct Energy deal certainly boosts the value of the business. We’re raising our buy-under target for EnerCare to USD13.

Finally, Shaw Communications Inc (TSX: SJR/B, NYSE: SJR) has agreed to buy privately held Colorado-based data center operator ViaWest Inc for USD1.2 billion in cash and assumed debt. The deal requires regulatory approval and is expected to close in September.

ViaWest will operate as a stand-alone Shaw subsidiary, led by co-founder and CEO Nancy Phillips.

In last month’s Portfolio Update we reported that Shaw posted fiscal 2013 third-quarter and year-to-date revenue growth of 1 percent and 2 percent, respectively.

Total operating income before restructuring costs and amortization was up 3 percent for the quarter and 1 percent for the nine months ended May 31.

Net income for the third quarter of fiscal 2014 was CAD228 million, CAD0.47 per share, versus CAD250 million, or CAD0.52 per share a year ago. Nine-month net was CAD695 million, or CAD1.45 per share, compared to CAD667 million, or CAD1.40 per share, for the prior corresponding period.

Shaw posted a second consecutive quarter of solid revenue-generating unit and financial trends, with cable subscriber statistics particularly positive.

ViaWest was one of the largest privately held data-center operators in the US. Over the past decade ViaWest has grown from five data centers in two markets to 27 data centers in eight Western US markets, including Denver, Dallas and Phoenix. It’s eying an expansion to the East Coast in the next 18 months.

Shaw highlighted ViaWest’s 90 percent contract renewal rate and diverse customer base, with its top 10 clients representing 28 percent of revenue. The company has 1,300 customers overall.

It’s a meaningful opportunity for Shaw to expand its data backup, disaster recovery, Web hosting and related services for businesses.

The acquisition provides Shaw a growth platform and is another significant step in expanding the Canadian telecom’s technology offering.

Shaw joins other traditional telecom and cable operators in expanding business services through acquisitions as a means of drive the top line amid slowing growth for traditional services.

Shaw began developing its own data center in 2013 after purchasing Envision, a fiber-optic network operator in Calgary, Alberta. The data center is expected to open next spring.

Shaw will be able to connect the Calgary data center to ViaWest’s facilities in the US.

That opens the door for improved data backups and cloud services. Shaw Communications remains a buy under USD24.

Conservative Update

The majority of CE Portfolio Holdings have reported second-quarter results over the past month, with most posting financial and operating numbers this week.

Overall, results have been solid.  There of course are pockets of concern, including, most notably among Conservative Holdings Dream Office REIT (TSX: D-U, OTC: DRETF).

What’s particularly concerning about Dream Office is the unit-price performance relative to other Canadian real estate investment trusts (REIT).

Dream Office, .like its peers, has recovered from the spring 2013 “taper tantrum” that took rate-sensitive equities to the woodshed. But its recovery has been less robust than August Best Buy RioCan REIT (TSX: REI-U, OTC: RIOCF), for example, which is up 13.1 percent, including distributions and in US dollar terms, from its Aug. 15, 2013, low of CAD23.47, or fellow Conservative Holding Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), which is up 13 percent from its recent low, established on Oct. 4, 2013.

Dream Office has recovered by 9.8 percent from the Dec. 5, 2013, low it established after former Federal Reserve Chair Ben Bernanke hinted at the end of “quantitative easing” and rising interest rates in May 2013.

In 2014 RioCan has generated a total return of 7.7 percent, CAP REIT 8.8 percent and Dream Office 2.5 percent.

Relative weakness is likely the result of a soft Canadian office market, while RioCan’s malls and CAP REIT’s apartments continue to enjoy more favorable macro conditions.

At the same time, Dream Office is outperforming the broader office market in Canada.

Canadian credit rating agency DBRS recently noted that while occupancy levels remain healthy across each real estate subsector, in the mid- to high 90 percent, the office segment has experienced a slight decline due to decreased tenant demand and a general increase in sublet space.

According to Commercial Real Estate Services (CBRE), the Canadian office vacancy rate averaged 10.3 percent in the first quarter of 2014, the highest level since the third quarter of 2005. This represents an increase of 60 basis points quarter over quarter and 170 basis points year over year.

The market also saw negative net absorption for the fifth consecutive quarter, an accumulation of 1.46 million square feet for the first quarter of 2014.

These results were largely attributed to the lack of new demand for office space, as tenants are reducing their overall space needs to adopt new workplace strategies as well as a continued increase in sublet spaces, which nearly doubled compared to the first quarter of 2012.

For the second quarter Dream Office reported portfolio occupancy as of June 30, 2014, of 94.1 percent, well above a national average of 89.6 percent. And management completed 664,700 square feet of leasing during the quarter at incrementally higher rates.
Dream Office has leased approximately 2.6 million square feet to tenants taking occupancy in 2014, or 85 percent of the leases maturing in 2014.

The portfolio average in-place rent was CAD18.14 per square foot, up from CAD17.97 as of March 31, 2014, and CAD17.54 as of June 30, 2013. Management estimates market rents to be 8 percent above average in-place net rents, establishing solid embedded rent growth potential.

Adjusted funds from operations (AFFO) per unit were up 4.9 percent year over year and 3.2 percent sequentially to CAD0.64.

Funds from operations per unit increased 1.4 percent year over year and were flat compared to the first quarter at CAD0.73.

Net debt-to-gross book value at the end of the quarter remained low at 47.3 percent, while the REIT’s weighted average rate of interest was 4.22 percent. Interest coverage remained solid at 2.9 times.

Dream Office operates a high-quality portfolio in an efficient manner. It’s outperforming an otherwise weak Canadian office sector. The REIT is generating solid growth, with the distribution well covered by funds from operations.

At the same time, the unit price is stuck in a trading range. When the office market turns for the better Dream Office will likely live up to its name. For now, however, there are better opportunities, particularly in retail, residential and industrial REITs.

We have more on one potential alternative, Dream Office’s affiliate Dream Industrial REIT (TSX: DIR-U, OTC: DREUF), which was spun out in October 2012, in this month’s In Focus feature.

We’re reducing Dream Office REIT to a hold.

Please note that How They Rate has key second-quarter financial and operating details for the following Conservative Holdings:

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)
• Artis REIT (TSX: AX-U, OTC: ARESF)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF)
• Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)
• Canadian Apartment Properties REIT (TSX: CAR, OTC: CDPYF)
• Cineplex Inc (TSX: CGX, OTC: CPXGF)
• DH Corp (TSX: DH, OTC: DHIFF)
• Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)
• Keyera Corp (TSX: KEY, OTC: KEYUF)
• Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)

Note that results for RioCan REIT (TSX: REI-U, OTC: RIOCF) are discussed in this month’s Best Buys feature.

Aggressive Update

The decline of oil and gas prices, along with a turn away from riskier assets, amid rising tensions in the Middle East won’t show up in second-quarter numbers for energy producers. It is, however, a point to bear in mind as we get deeper into the third quarter.

Pressure will be particularly acute for Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF), which is trying to repair its balance sheet by selling non-core assets and using the proceeds to pay down debt. The trouble is the company is divesting producing assets the cash flow from which would otherwise support the dividend.

Declining oil prices put additional pressure on core assets to make up for that lost support. Lightstream, management of which has done a solid job executing its turnaround strategy, albeit aided by what had been strong crude prices, continues to walk a fine line.

Our other oil and gas producers continue to post solid production-per-share growth numbers. Further investment in growing output will of course be determined by commodity prices. But the rest of them are generally low-cost producers that can withstand the current commodity slump.

But Lightstream is in a different boat. Production growth is limited due to the fact that management must devote significant cash flow to debt reduction while maintaining the present dividend rate.

Indeed management on Friday, Aug. 8, announcing financial and operating results for the second quarter, cut its 2014 average and exit production rates in a sign that executing amid such tight restraints is a difficult task.

After a sharp run up while oil prices rallied into June, the share price has collapsed in recent weeks. Today’s earnings announcement added additional downside pressure.

We identified Lightstream as a Best Buy in the May 2014 CE, and from May 9, when it closed at CAD7.06 on the TSX, through June 20, when it closed at CAD9.03, we seemed prescient.

But tensions in the Middle East–including Iraq and the Levant–have ratcheted significantly since then, and oil prices have suffered. The generic front-month crude futures contract traded on the New York Mercantile Exchange hit its 2014 closing peak of USD107.26 on June 20, from whence it’s declined to USD97.65 as of Aug. 8.

That’s a 9 percent slide. Lightstream’s loss is more than 32 percent in US dollar terms.

CE is not a platform for traders. We are long-term-focused, with a strong bias toward buying and holding high-quality companies. We view ourselves as owners of the businesses in which we invest much like a small business owner views his or her operation. We enter with the intention of sticking around for the long haul.

That is until we see signs of fundamental deterioration in the underlying business. We don’t want to turn our endeavor to build wealth for the long term into a Sisyphean task, constantly starting at the bottom of the mountain with that boulder.

We noted at the time of the May 2014 Best Buy recommendation of Lightstream that it was for aggressive investors. We also noted that management had “established a good trajectory as it attempts to thread the needle of fixing the balance sheet via asset sales but maintaining production and cash flow…” and, further, that “a 6.5 percent yield, with the current dividend rate looking very sustainable, is solid compensation for the potential risk.”

The facts, revealed in the company’s second-quarter financial and operating report, have changed, and with it our view on the stock. We’re cutting Lightstream to a hold.

Average production for the quarter was 42,513 barrels of oil equivalent per day (boe/d), at 80 percent oil and liquids, in line with the figure management pre-released in May. But current production is approximately 39,000 boe/d, which is down 7.5 percent from the second quarter due to asset sales and lower-than-expected results from certain Swan Hills, Brazeau Cardium and non-operated Falher wells.

The third-quarter slowdown led management to cut its full-year average production forecast to 41,000 to 43,000 boe/d from 43,500 to 45,500 boe/d and its exit production rate to 40,000 to 43,000 boe/d from 45,000 to 47,000 boe/d.

Full-year CAPEX guidance has also been reduced, to CAD500 million to CAD550 million from CAD525 million to CAD575 million.

For the second half of the year, Lighstream plans to execute the remaining 48 percent of its drilling program, with 23 wells planned in southeast Saskatchewan, 23 wells in the Cardium and one in Alberta/British Colombia. Lighstream is deferring four operated Swan Hills wells until a review of the play is completed.  

At the same time, with year-to-date figures ahead of internal expectations, management maintained its 2014 cash flow outlook and continues to forecast an all-in (dividends plus CAPEX) payout ratio below 100 percent.

Management expects to see full-year funds from operations of CAD635 million to CAD665 million, or CAD3.18 to CAD3.33 per share.

Cash flow for the second quarter was CAD177 million, or CAD0.87 per share, versus CAD168.2 million, or CAD0.86 per share, a year ago.
Lightstream exited the second quarter with net debt of approximately CAD1.985 billion, or approximately 2.8 times second-quarter cash flow. That includes CAD931 million drawn on its CAD1.3 billion secured termed credit facility. Net debt has been reduced by 17 percent during 2014.

So far in 2014 Lighstream has sold assets producing approximately 3,015 boe/d for CAD351 million, putting the company on track to hit its goal of CAD600 million by the end of 2015. All proceeds have been used to reduce debt.

Debt-reduction efforts have thus far been impressive. But Lightstream’s ability to exceed internal cash flow targets for the first half of the year was due in large part to favorable commodity prices. And that key factor has changed.

Without meaningful production growth Lighstream is likely to underperform better-situated peers, including August 2014 Best Buy Vermilion Energy Inc (TSX: VET, NYSE: VET).

Lightstream Resources is now a hold.

Please note that How They Rate has key second-quarter financial and operating details for the following Aggressive Holdings:

• Acadian Timber Corp (TSX: ADN OTC: ACAZF)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)
• Enerplus Corp (TSX: ERF, NYSE: ERF)
• Extendicare Inc (TSX: EXE, OTC: EXETF)
• Magna International Inc (TSX: MG, NYSE: MGA)
• Newalta Corp (TSX: NAL, OTC: NWLTF)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)
• Wajax Corp (TSX: WJX, OTC: WJXFF)

Note that results for Vermilion Energy are summarized in this month’s Best Buys feature.

The End of Q2

Here are estimated and confirmed dates for the last set of operating and financial numbers from Canadian Edge Portfolio Holdings for the second quarter.

Conservative Holdings

• EnerCare Inc (TSX: ECI, OTC: CSUWF)–Aug. 14, 2014 (confirmed)
• Northern Property REIT (TSX: NPR, OTC: NPRUF)–Aug. 12, 2014 (confirmed)

Aggressive Holdings

• Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–Aug. 13, 2014 (confirmed)
• Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–Aug. 14, 2014 (confirmed)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–Aug. 13, 2014 (estimate)