High Yield of the Month
If you can’t think past the next three months, the last thing you want to own is a lagging stock. No matter good it may look on paper, chances are you’re going to run out of patience before it finally comes around.
On the other hand, if you can handle being down in a position for a while, the laggards are where the money is. And waiting for the payoff is that much easier when there’s a double-digit dividend yield involved.
The key is finding companies that have been losing in the stock market but winning in business. You’ve got to stay vigilant to ensure earnings are solid and the company is gaining value. That means you’ve got to be willing to dump a losing position if the business does start to come unraveled. But as long as the underlying fundamentals stay solid, your position will ultimately pay off.
Both High Yields of the Month fit the bill of loaded laggards. In 15 years, Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) has grown revenue at an incredible 35 percent compound annual rate, enroute to becoming Canada’s largest industrial waste management and environmental services provider. Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF), meanwhile, now holds a virtual monopoly on telephone directory services in Canada and has built a thriving business on the Internet as well.
The pair has been in the CE Portfolio for some time. I originally recommended Yellow Pages back in August 2004; Newalta was added in April 2005. Both are up from their initial recommendations, thanks to high, growing distributions. But they’ve nonetheless been quite volatile on the way and now trade well off their old highs.
Newalta’s plunge from the high 30s to mid-teens began with the sharp slowdown in Canadian natural gas drilling in late 2006. It accelerated in the face of the Halloween trust tax announcement and continued in 2007, as worries grew the trust wouldn’t be able to maintain distributions. The shares finally touched bottom in mid-January as recession worries hit the market.
Yellow, meanwhile, began to slide in mid-2006 before taking a major hit in November on the taxation news. Management immediately raised its distribution, pledging that it would be able to literally “outgrow” its future tax burdens and maintain at least its current distribution rate. That held the shares steady until early this year, when they began to slide in earnest on worries that a slowing economy would eventually crush the directory business.
Today, Yellow currently sells for only about 90 percent of book value, while Newalta trades for just 1.5 times rapidly growing sales. Both stocks yield north of 11 percent. And both sell for little more than half their all-time highs.
Ironically, these trusts represent far more valuable businesses today than they did at their mid-2006 peaks. Both have posted accelerating earnings growth in recent quarters. And their distributions are much better protected as well. The upshot: Despite their fall from grace over the past two years, they’re better buys than ever.
Of the two, Newalta has had the more difficult road. Before its stress tests began in summer 2006, the trust’s biggest customer was the Canadian energy patch, which contributed more than half of income after a major wave of expansion.
When natural gas prices began to plummet and drilling activity dried up, so did a good chunk of the trust’s business cleaning up sites. In the end, the saving grace was that management was already thinking ahead to reduce Newalta’s dependence on the sector.
The first key was a massive investment into industrial eastern Canada, including the purchase of a lead-acid battery recycling facility last year. First quarter revenue from eastern operations rose 96 percent over last year’s levels as net margin—sales less operating costs and amortization—surged 232 percent. And those gains came despite tough winter weather conditions that restricted some activities.
Equally important, Newalta continues to expand these operations aggressively. Growth capital expenditures in the east for 2008 are more than 97 percent of total capital costs. One project basically involves doubling the size of the lead-acid battery facility.
Growth in the east has made Newalta’s cash flow far less dependent on the energy patch. And it’s reduced seasonality as well, as western division revenue is typically stronger in the first quarter than the eastern division, while the opposite is true of the second quarter. The third and fourth quarters are typically best for both halves.
The second key to Newalta’s turnaround is a relentless focus on costs. The company succeeded in increasing profit margins at both divisions, in large part by beating its goal of cutting selling, general and administrative (SGA) expense to 9.9 percent of revenue from 10.6 percent the year before. It also increased its portion of recovered crude oil by 30 percent, which it generates from recycled waste.
A year ago, Newalta management pledged to investors that it had the strategy in place to both dramatically grow the trust and continue to pay its generous distribution. In the first quarter of 2008, they proved it. For the first time in well more than a year, operating income and earnings both exceeded totals from the year earlier. In fact, first quarter earnings were the highest since third quarter 2006 and beat Bay Street expectations by nearly a third. Equally important, funds from operations covered distributions handily for the first time in a while.
Looking ahead, it should only get easier for management to follow through. A major new investment in oil sands centrifugation services is likely the first step toward putting Newalta’s talents to work full bore in an industry known as much for its mushrooming waste problem as it is for exponential growth. And the trust continues to find more opportunities for acquisitions, as well as profitable build-outs of its current projects.
Finally, the trust is in excellent shape to cash in on the revival of conventional Canadian and US gas drilling that’s apparently underway. And high prices for oil and other commodities should keep sales of by-products from cleanup operations robust. That’s a formula that should keep profits surging in coming quarters.
One factor that attracted me initially to Newalta is its consistently conservative financial management, with very little reliance on issuing new shares for growth. Should it choose to make a major move, however, it still has 81.5 percent of its “safe harbor” room (nearly CAD1 billion). That’s a lot of room to expand its current 30 percent share of the market for waste recovery.
The major point of uncertainty with Newalta is what management will do in view of 2011 trust taxation. In my view, however, a business growing this quickly and selling this cheaply is worth buying, no matter what shade of clothing it’s going to wear. Buy Newalta Income Fund for robust growth and high income up to USD25.
In contrast, Yellow Pages’ management has left no ambiguity about where it stands on the impact of 2011 taxation. In fact, we’ve already seen three distribution increases since Halloween 2006.
The key question: Can it deliver on those promises? Given the continued negative action in the share price, skeptics abound. Their ranks don’t include Yellow’s insiders, who have been buyers. Nor are many on Bay Street numbered among them—given that seven of the 10 analysts following the stock rate it a buy and only one recommends selling.
About a year ago, a pair of Bay Street analysts floated a “study” alleging Yellow’s print directory business was rapidly evaporating. This year, the bear case has turned to the idea that both print and Internet advertising operations would be hit hard by a weakening North American economy. Others have pointed to the pressures currently faced by US yellow pages companies as comparables—such as competition from Web giant Google—that would eventually catch up with the trust.
Yellow answered these worries head on with its robust fourth quarter 2007 results and again with even more impressive first quarter 2008 earnings. Headline distributable cash flow (DCF) per share surged 12.9 percent on a 7.8 percent increase in overall revenue. That was an actual acceleration from the 10 percent growth of DCF per share registered in the fourth quarter.
The most compelling number in the report was a 47.7 percent increase in consolidated online revenue. From the time it was acquired and later spun off by a Kohlberg Kravis Rorberts-led private capital consortium, Yellow has focused like a laser beam on transitioning its business to the Internet. To that end, it redefined its business from directory publisher to integrated advertiser, purchasing a range of other advertisers even as it built alliances rather than rivalries with Google and other Web giants.
Online revenue has now crossed 10 percent of total sales for the first time. Meanwhile, the trust has continued to snap up the remaining independent directory companies in Canada and pushed directories margin to a new high at 60.2 percent. And it’s aggressively added products to its profitable niches such as Auto Trader.
Finally, it’s been able to accomplish this explosive growth with minimal external financing, actually buying back 5 percent of its shares this year. In management’s words, that will “accelerate the reduction in the payout ratio during the transition period to a traditional corporate structure to be completed in late 2010.” That’s pretty good confirmation it means what it says about paying out big post-2011.
These results should lay to rest any worries about Yellow’s business. But there’s another potential reason for recent selling: a mad scramble to load up on the red-hot energy producer trusts, in part to avoid underperforming the S&P Income Trust Index. That’s the kind of market move that always proves temporary, though it can make it uncomfortable to those who hold on through the turmoil. But it’s really a great opportunity for those who are light on Yellow Pages Income Fund to buy some shares up to USD14.
For more information on both Newalta Income Fund and Yellow Pages Income Fund, visit the How They Rate Table. Click on the “.UN” symbol to go to the Web site of our Canadian partner MPL Communications for press releases, charts and other data. These are substantial companies, so any broker should be able to buy them, either with their Toronto or over-the-counter symbols. Ask which way is cheapest.
Note that both trusts’ dividends are considered qualified for tax purposes in the US. Tax information to use as backup for filing them as qualified—whether or not there are errors on your 1099—is listed on the Canadian Edge Web site under the Income Trust Tax Guide.
Also, as is customary for virtually all foreign-based companies, the host government—in this case Canada—withholds 15 percent of distributions to US investors at the border. This tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can be carried forward to future years.
*Recent USD Price as of 06/04/08
On the other hand, if you can handle being down in a position for a while, the laggards are where the money is. And waiting for the payoff is that much easier when there’s a double-digit dividend yield involved.
The key is finding companies that have been losing in the stock market but winning in business. You’ve got to stay vigilant to ensure earnings are solid and the company is gaining value. That means you’ve got to be willing to dump a losing position if the business does start to come unraveled. But as long as the underlying fundamentals stay solid, your position will ultimately pay off.
Both High Yields of the Month fit the bill of loaded laggards. In 15 years, Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) has grown revenue at an incredible 35 percent compound annual rate, enroute to becoming Canada’s largest industrial waste management and environmental services provider. Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF), meanwhile, now holds a virtual monopoly on telephone directory services in Canada and has built a thriving business on the Internet as well.
The pair has been in the CE Portfolio for some time. I originally recommended Yellow Pages back in August 2004; Newalta was added in April 2005. Both are up from their initial recommendations, thanks to high, growing distributions. But they’ve nonetheless been quite volatile on the way and now trade well off their old highs.
Newalta’s plunge from the high 30s to mid-teens began with the sharp slowdown in Canadian natural gas drilling in late 2006. It accelerated in the face of the Halloween trust tax announcement and continued in 2007, as worries grew the trust wouldn’t be able to maintain distributions. The shares finally touched bottom in mid-January as recession worries hit the market.
Yellow, meanwhile, began to slide in mid-2006 before taking a major hit in November on the taxation news. Management immediately raised its distribution, pledging that it would be able to literally “outgrow” its future tax burdens and maintain at least its current distribution rate. That held the shares steady until early this year, when they began to slide in earnest on worries that a slowing economy would eventually crush the directory business.
Today, Yellow currently sells for only about 90 percent of book value, while Newalta trades for just 1.5 times rapidly growing sales. Both stocks yield north of 11 percent. And both sell for little more than half their all-time highs.
Ironically, these trusts represent far more valuable businesses today than they did at their mid-2006 peaks. Both have posted accelerating earnings growth in recent quarters. And their distributions are much better protected as well. The upshot: Despite their fall from grace over the past two years, they’re better buys than ever.
Of the two, Newalta has had the more difficult road. Before its stress tests began in summer 2006, the trust’s biggest customer was the Canadian energy patch, which contributed more than half of income after a major wave of expansion.
When natural gas prices began to plummet and drilling activity dried up, so did a good chunk of the trust’s business cleaning up sites. In the end, the saving grace was that management was already thinking ahead to reduce Newalta’s dependence on the sector.
The first key was a massive investment into industrial eastern Canada, including the purchase of a lead-acid battery recycling facility last year. First quarter revenue from eastern operations rose 96 percent over last year’s levels as net margin—sales less operating costs and amortization—surged 232 percent. And those gains came despite tough winter weather conditions that restricted some activities.
Equally important, Newalta continues to expand these operations aggressively. Growth capital expenditures in the east for 2008 are more than 97 percent of total capital costs. One project basically involves doubling the size of the lead-acid battery facility.
Growth in the east has made Newalta’s cash flow far less dependent on the energy patch. And it’s reduced seasonality as well, as western division revenue is typically stronger in the first quarter than the eastern division, while the opposite is true of the second quarter. The third and fourth quarters are typically best for both halves.
The second key to Newalta’s turnaround is a relentless focus on costs. The company succeeded in increasing profit margins at both divisions, in large part by beating its goal of cutting selling, general and administrative (SGA) expense to 9.9 percent of revenue from 10.6 percent the year before. It also increased its portion of recovered crude oil by 30 percent, which it generates from recycled waste.
A year ago, Newalta management pledged to investors that it had the strategy in place to both dramatically grow the trust and continue to pay its generous distribution. In the first quarter of 2008, they proved it. For the first time in well more than a year, operating income and earnings both exceeded totals from the year earlier. In fact, first quarter earnings were the highest since third quarter 2006 and beat Bay Street expectations by nearly a third. Equally important, funds from operations covered distributions handily for the first time in a while.
Looking ahead, it should only get easier for management to follow through. A major new investment in oil sands centrifugation services is likely the first step toward putting Newalta’s talents to work full bore in an industry known as much for its mushrooming waste problem as it is for exponential growth. And the trust continues to find more opportunities for acquisitions, as well as profitable build-outs of its current projects.
Finally, the trust is in excellent shape to cash in on the revival of conventional Canadian and US gas drilling that’s apparently underway. And high prices for oil and other commodities should keep sales of by-products from cleanup operations robust. That’s a formula that should keep profits surging in coming quarters.
One factor that attracted me initially to Newalta is its consistently conservative financial management, with very little reliance on issuing new shares for growth. Should it choose to make a major move, however, it still has 81.5 percent of its “safe harbor” room (nearly CAD1 billion). That’s a lot of room to expand its current 30 percent share of the market for waste recovery.
The major point of uncertainty with Newalta is what management will do in view of 2011 trust taxation. In my view, however, a business growing this quickly and selling this cheaply is worth buying, no matter what shade of clothing it’s going to wear. Buy Newalta Income Fund for robust growth and high income up to USD25.
In contrast, Yellow Pages’ management has left no ambiguity about where it stands on the impact of 2011 taxation. In fact, we’ve already seen three distribution increases since Halloween 2006.
The key question: Can it deliver on those promises? Given the continued negative action in the share price, skeptics abound. Their ranks don’t include Yellow’s insiders, who have been buyers. Nor are many on Bay Street numbered among them—given that seven of the 10 analysts following the stock rate it a buy and only one recommends selling.
About a year ago, a pair of Bay Street analysts floated a “study” alleging Yellow’s print directory business was rapidly evaporating. This year, the bear case has turned to the idea that both print and Internet advertising operations would be hit hard by a weakening North American economy. Others have pointed to the pressures currently faced by US yellow pages companies as comparables—such as competition from Web giant Google—that would eventually catch up with the trust.
Yellow answered these worries head on with its robust fourth quarter 2007 results and again with even more impressive first quarter 2008 earnings. Headline distributable cash flow (DCF) per share surged 12.9 percent on a 7.8 percent increase in overall revenue. That was an actual acceleration from the 10 percent growth of DCF per share registered in the fourth quarter.
The most compelling number in the report was a 47.7 percent increase in consolidated online revenue. From the time it was acquired and later spun off by a Kohlberg Kravis Rorberts-led private capital consortium, Yellow has focused like a laser beam on transitioning its business to the Internet. To that end, it redefined its business from directory publisher to integrated advertiser, purchasing a range of other advertisers even as it built alliances rather than rivalries with Google and other Web giants.
Online revenue has now crossed 10 percent of total sales for the first time. Meanwhile, the trust has continued to snap up the remaining independent directory companies in Canada and pushed directories margin to a new high at 60.2 percent. And it’s aggressively added products to its profitable niches such as Auto Trader.
Finally, it’s been able to accomplish this explosive growth with minimal external financing, actually buying back 5 percent of its shares this year. In management’s words, that will “accelerate the reduction in the payout ratio during the transition period to a traditional corporate structure to be completed in late 2010.” That’s pretty good confirmation it means what it says about paying out big post-2011.
These results should lay to rest any worries about Yellow’s business. But there’s another potential reason for recent selling: a mad scramble to load up on the red-hot energy producer trusts, in part to avoid underperforming the S&P Income Trust Index. That’s the kind of market move that always proves temporary, though it can make it uncomfortable to those who hold on through the turmoil. But it’s really a great opportunity for those who are light on Yellow Pages Income Fund to buy some shares up to USD14.
For more information on both Newalta Income Fund and Yellow Pages Income Fund, visit the How They Rate Table. Click on the “.UN” symbol to go to the Web site of our Canadian partner MPL Communications for press releases, charts and other data. These are substantial companies, so any broker should be able to buy them, either with their Toronto or over-the-counter symbols. Ask which way is cheapest.
Note that both trusts’ dividends are considered qualified for tax purposes in the US. Tax information to use as backup for filing them as qualified—whether or not there are errors on your 1099—is listed on the Canadian Edge Web site under the Income Trust Tax Guide.
Also, as is customary for virtually all foreign-based companies, the host government—in this case Canada—withholds 15 percent of distributions to US investors at the border. This tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can be carried forward to future years.
| Daylight Resources Trust & Pembina Pipeline Income Fund | ||
| Toronto Symbol | NAL.UN | YLO.UN |
| US Symbol |
NALUF
|
YLWPF
|
| Recent USD Price* |
20.05
|
9.72
|
| Yield |
11.2%
|
11.8%
|
| Price/Book Value |
1.61
|
2.63
|
| Market Capitalization (bil) |
CAD0.838
|
CAD5.120
|
| DBRS Stability Rating |
none
|
STA-1 (low)
|
| Canadian Edge Rating | 4 |
1 |
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