Archive for January, 2010

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A time for year-end reckonings

Sunday, January 24th, 2010
VOX / PAST RECOMMENDATIONS
Report on Business: Globe Investor Column
A time for year-end reckonings
FABRICE TAYLOR
907 words
31 December 2009
GLOB
B7
English
2009 CTVglobemedia Publishing Inc. All Rights Reserved.

Fabrice Taylor is a chartered financial analyst. ftaylor@globeandmail.com

The Vox portfolio continues to thrive, although it is not – nor is it ever – without its blights.

In the fall of 2008 and again in March of this year we turned very bullish on big stocks. They have, of course, done well. The S&P/TSX composite index is up by more than 50 per cent since March, while the big U.S. indexes are also sitting on double-digit returns.

The analysis was complicated, technical and rigorous: Everyone is selling in a panic, so buy. How’s that for genius?

In the late spring and summer I figured the smaller stocks would have to start moving too, so I started to scan that landscape for cash. I found Mainstreet Equity, trading at $7. This real estate concern has a big footprint in commodity regions such as Alberta, British Columbia and Saskatchewan and is light in places like Ontario, where manufacturing is being decimated.

It also built up a war chest during the recession, largely by refinancing mortgages, and today has about $3 a share in cash. The stock is $11, so that was a great investment in June, up well over 50 per cent in about half a year.

I found two others, Seacliff Construction and Churchill Corp., both in the engineering and construction fields, with lots of cash and beat-up stock prices. They’re up 25 per cent and about 32 per cent, respectively, in four months so far.

Sometimes the market hands you a gift. I thought Aeroplan was one in June at $8 or so. Investors were worried about Air Canada and took it out on the frequent flyer program. Buyers of the shares at that time are up almost a third – not bad for six months of work.

My recommendation of Aastra Technologies was poorly timed if you took it right away, at around $29 a share in early May. The stock almost immediately sank to $20 (hopefully you waited a couple of weeks). That said, it’s $34 and change today so if you paid $29 and hung on – tough to do given the stock’s swoon, I know – you’re doing okay.

Ford was an eyebrow-raising recommendation in late April at $4 (U.S.), but I felt confident enough to buy some myself (after the column appeared of course). It’s $10 now, and I think the U.S. car makers are going to be way more competitive. I also think they’ll get a lot of help from governments, and Toyota and Honda et al. will pay the price.

My advice to avoid Gildan isn’t exactly aging well. It was $15 (Canadian) when I said so a year ago and it’s above $25 now. The math is clearly not working in my favour there. For what it’s worth I still don’t think it’s a great business but if you can make money on the stock then bully for you.

My call to avoid Yellow Pages Income Fund at around the same time fared better. Units were about $8 and are now $5.35. Not even a 15-per-cent yield skates you onside.

From what I’m reading I think there may be value in these sorts of companies eventually, but at lower prices and assuming they survive (they tend to have debt).

Where Vox really did well was on small caps. Wavefront Technology Solutions was 50 cents when I touted it. It’s $2.79 now, for a 450-ish per cent gain. The company’s technology, which allows oil producers to extract more from their reserves, is slowly gaining traction.

Landis Energy was another call. Trading at 40 cents at the time, the company, which has a gas storage play in Nova Scotia, has since put itself up for sale and is quoted at 75 cents.

Cyberplex was another small cap on my radar but I got to it late: It was worth $1.50 then, it’s now $1.14. But it’s still interesting and trades at seven times forward earnings (yes, it has earnings).

One of my few short recommendations appears to be starting to pay off: ZENN Motor Co., which wanted to build electric cars, was north of $4 when I cast suspicion on it at the end of April. It did go to $6 but is back below $4 now. I think it’s going a lot lower.

Bearish calls on Research In Motion, meanwhile, were looking good until it knocked out the lights in its latest quarter. On Oct. 9, I argued its best days were behind it (meaning the stock). It was quoted at $71 then, but very quickly sank to $60 before rebounding. Now, it’s back to $71.

I stand by my call, having recently upgraded some RIM software on my BlackBerry and found it way worse than the older version. Any company that allows inferior products – and I mean inferior to what it had before – to ship out the door is doomed.

Probably our most bullish call was on natural gas this past summer, when it hit its lows. So far that’s looking good, although the weather is helping. Long term it will prove itself. You heard it here first.

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The tricks of tech; The potential rewards are huge, but so are the pitfalls

Sunday, January 24th, 2010
INVESTING
Report on Business Magazine
The tricks of tech; The potential rewards are huge, but so are the pitfalls
Fabrice Taylor
810 words
30 December 2009
GLOB
22
English
2009 CTVglobemedia Publishing Inc. All Rights Reserved.

There’s nothing more fun in investing than technology stocks. Sadly, few sectors are as dangerous. The trouble with techs and biotechs isn’t just that many hot new companies never make money; it’s that even the ones that do often don’t create any value over the long term.

If you’re a computer buff, you may remember 3dfx Interactive, a dominant graphics-card maker in the 1990s. It went bankrupt, however, in 2002. It’s very hard to stay abreast of an industry that’s always changing, but some solid overall rules can help you.

The first rule is simple: If something looks too good to be true, it probably is. One good example: Research In Motion. RIM dominated the early years of the smart-phone market with its BlackBerry, which had some proprietary technology but wasn’t unique enough to keep out competitors.

One number to watch is return on equity (ROE). Companies that make a lot of money on each dollar they invest attract competitors. RIM’s ROE was a lofty 40% for its fiscal year ended last Feb. 28. But unless a competitive advantage is durable, a leader’s product often becomes commoditized, and its profit margins and ROE suffer.

That competitive advantage may not be a patent. It may be better to have a user base for your product or service that has little need to change providers (like Google‘s) or that can’t switch, because of the high cost of changing (like Microsoft‘s). Google and Microsoft may not survive forever, but they have a better shot at it than RIM.

A second rule is to look for profits and what’s done with them. A lot of tech companies can’t pay earnings back to their shareholders as dividends because they have to constantly reinvest so they won’t fall behind their competitors.

Take Open Text Corp.: In its past three fiscal years, the company has made about $130 million (U.S.) in profits, but it hasn’t paid any dividends or bought back stock. In fact, it has sold new shares to finance part of the more than $625 million (U.S.) of investments. The result? Not that impressive: Annual sales are up about $190 million (U.S.). If companies are reinvesting heavily with little to show for it, beware, even if the bottom line looks good.

Research and development is the basis of the third rule: Spend, spend, spend, but spend wisely. Look at total R&D spending as a percentage of revenues. It should stay somewhat constant, and it should produce results. Nortel spent $11 billion on R&D over the six years before it filed for bankruptcy protection last January, yet its revenues fell.

Finally, watch out for compression of share price multiples. Often when a tech company takes off, both its share price and its multiple climb–if its earnings, say, double, its price-earnings ratio may quadruple as growth investors bet on continued profit increases.

Unfortunately, the process can work in reverse. Edmonton’s CV Technologies (now Afexa Life Sciences) burst onto the scene with its Cold-fX remedy in 2003, and profits climbed to $10 million in 2005. Then competitors started making similar ginseng-based products that were inferior, but much cheaper. The company’s profits skidded to $640,000 in 2006, and a loss in 2007. As earnings fell, the price investors were willing to pay for each dollar of earnings also declined, and Afexa’s share price bottomed at 23 cents in December, 2008. That’s the kind of excitement you want to avoid.

Source thompson datastream

***

TIP SHEET

Value

15.3 Recent price-earnings ratio (trailing 12 months)

- Aastra Technologies Ltd. Aastra makes olde schoole telephony gear, digital voice-network products, Internet protocol gear and the like for businesses. But there’s nothing tired about its profits. Cash flow from operations should swell to $87 million in 2010 from $77 million last year, says a National Bank Financial analysis. There’s even a chance it will exceed $100 million. The company’s recently announced quarterly dividend of 15 cents a share requires just $8 million in cash flow. Guess they could dial that up quickly.

Growth

15.2% Growth in rental revenue, first nine months of fiscal 2009 versus 2008

- Mainstreet Equity Corp.

Calgary-based Mainstreet entered the recession with $8.5 million in cash.

It now has about $25 million. That’s a handsome war chest for an acquisitive residential rental real estate concern, especially when competitors are sucking wind, if they’re getting any air at all. Put that cash to use and, in time, profits will move up, dragging the share price with them.

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Labrador Iron Ore on rebound from a rocky bottom

Sunday, January 24th, 2010
VOX / ROYALTIES
Report on Business Column
Labrador Iron Ore on rebound from a rocky bottom
FABRICE TAYLOR
741 words
24 December 2009
GLOB
B7
English
2009 CTVglobemedia Publishing Inc. All Rights Reserved.

Fabrice Taylor is a chartered financial analyst.

ftaylor@globeandmail.com

Royalties are hot commodities these days. Look at Franco Nevada. Look at the oil patch, where feeble gas producers are selling a pound of their flesh in the form of an overriding royalty.

Most notably, look at the Labrador Iron Ore Royalty Income Fund. It’s doubled since hitting a rocky bottom 12 months ago. With dividends, it has done even better. And it’s still going up.

This is a little baffling at first glance. For an income fund, the stated yield looks low at less than 5 per cent. On top of that, the fund couldn’t cover its distributions from cash flow in the past year; it had to dip into its cash pile.

And finally, the high dollar has to hurt where it counts.

But scratch beneath the surface and you can make a case for owning this thing.

First, an explanation of the assets: Labrador owns a 7-per-cent gross overriding royalty on the production of the Iron Ore Company of Canada, whose claim to fame may be that it was once run by Brian Mulroney. But I’m digressing.

Royalties are wonderful things. You get paid before anyone else: before the workers, before the bond holders, before the tax man and before the shareholders. You don’t worry about expenses, in other words, because as far as you’re concerned there are none. You only worry about volumes and prices.

And worry you did in the past year, as Iron Ore didn’t operate at full capacity and didn’t earn great prices for its iron, hence the need for distributions from cash.

The fund also owns a 15-per-cent equity stake in IOC and earns a small amount of commissions – 10 cents a tonne – on what IOC sells.

There’s no leverage in a royalty stream, yet the swings in Labrador’s revenue are breathtaking. In 2007, Labrador earned royalties of $53-million (after paying a 20-per-cent tax to the Province of Newfoundland and Labrador). In 2008, it soared to $129-million. On 32 million units out, that’s a big move.

And the value of the equity stake, which is affected by leverage (meaning that because of fixed costs a change in revenue leads to a much bigger change in profits), would have soared in similar fashion. Indeed, IOC paid dividends to shareholders.

This year’s recession brought the opposite effect. Royalty income in the first nine months of the year fell by more than half and adjusted cash flow per unit was a mere third of what it was the year before. Even royalty owners get burned by drastic price swings.

It looks like the old pendulum is moving the other way now though. Demand is back. IOC was back to full production in the third quarter – and spot prices are firming up. India, one of the biggest producers in the world, will import iron this year. Although some say that’s temporary as it fires up supply, it’s still a sign of rising demand.

Steel demand historically peaks at about 1000 kilograms per capita in industrializing nations. Neither China nor India are close to that yet. With about two billion people between them, that’s a lot of demand. It won’t happen tomorrow, but it takes a while for new supply to come on stream.

The hair in the soup is the Canadian dollar. Part of the drop in Labrador’s financials, mentioned above, is because of volumes and pricing, but a good part is also from foreign exchange. Some pundits see the dollar going to par with the greenback. That’s only another nickel or so but it would hurt.

Iron ore prices are, for the most part, set annually early in the year by producers and consumers. Given the rise in price of exchange traded commodities like copper, negotiated iron prices will likely be a lot higher next year than this.

Labrador units have done well, but they once changed hands for $60 before being interrupted by an inconvenient financial catastrophe.

In 2008, the distribution was almost $5 per unit.

That could happen again if the dollar behaves as it should. And don’t forget that stocks that do well tend to keep doing well.

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Ma Bell: Safe, modest gains that ring true

Sunday, January 24th, 2010
VOX / DIVIDENDS
Report on Business: Globe Investor Column
Ma Bell: Safe, modest gains that ring true
FABRICE TAYLOR
788 words
18 December 2009
GLOB
B11
English
2009 CTVglobemedia Publishing Inc. All Rights Reserved.

Fabrice Taylor is a chartered financial analyst.

ftaylor@globeandmail.com

BCE Inc. seems a lot less worried than investors about the telecom sector, raising its dividend and volunteering to finance pension costs. What is the company thinking? Hasn’t it heard of Globalive?

A better question might be what are investors thinking. BCE shares yield more than 6 per cent. Ten-year government bonds yield half that. If you include earnings, not only dividends, BCE shares “yield” more than 9 per cent. Are they really so risky as to deserve that kind of premium? Research In Motion, in my view much riskier, yields 7.5 per cent (on earnings) and pays no dividend. I know, I know: RIM’s earnings are growing more quickly – at least for now. Who knows what’s going to happen in that hypercompetitive industry? BCE’s earnings are far easier to predict and, in my view, Bell has a moat around its business, RIM does not.

BCE’s earnings don’t rise much, but rise they do. From 2006 to 2008, revenues were basically flat but earnings before interest, taxes, depreciation and amortization were up 3 per cent. That’s not much, granted. It’s hard to lose a million highly profitable land lines – more than 10 per cent of your total – and watch your profits surge.

But things are getting better. RBC Dominion Securities estimates BCE profit at $2.47 per share this year and $2.63 in 2011.

Again, not exactly jaw-dropping but more reliable than potash or copper or technology earnings.

Investors liked BCE’s move yesterday, and for good reason. It suggests that earnings might be higher next year than consensus. The deductible pension payment saves $135-million in taxes.

And, all together, these moves add to free cash flow and earnings per share when all is said and done.

The psychological signs are probably more important. The board, and management, are obviously confident that the company will be able to compete and contend just fine.

And investors should be happy because BCE is breaking with history and putting cash to good uses instead of squandering it, as it did for so many decades. This is BCE’s second buyback announcement and third dividend increase since privatization plans fell apart last year.

And there’s probably more to come – modest gains, yes, but safe gains, and I stress safe. Investors have been fretting about competition in telecoms for the past decade. The worry waxes and wanes, but it’s always there. Analysts slice and dice the numbers to make the case for or against investment, but it’s usually not a particularly convincing case.

I think the analysis is simpler. First, the amount of money we spend on telecommunications is going up. Look at your cellphone bill. Look at your Internet bill, your cable bill. You like high-definition TV? You’ll pay for it. Long-distance calling is basically free now if you know how to get it, but so what? Bell’s cash flow still goes up.

The telecom business as a whole is growing and while new entrants are always a threat, they don’t exactly grow on trees. It’s not easy to break into the business.

I’ve met Globalive CEO Tony Lacavera and talked with him about his plans. He struck me as a bright guy with a plan. He has deep-pocketed backers too. But believe me, he’s not in this to lower your cellphone bill. He’s in this to make money. He sees Bell’s and Rogers’ and Telus’s fat mobility profit margins and he wants some.

And he’ll get some, but not with a raging price war. He can’t afford that. Will pricing suffer? It will have to, a little, but that’s hardly a secret. It’s priced in.

Will incumbent margins suffer? Yes, a little, but that’s priced in too. What might not be is the extent to which phone companies can find ways to save money, cutting costs, sharing infrastructure and so on. They already are.

BCE has not done well compared with the stock market over the past five years. The market has a 24-percentage-point advantage over that period. But if you look only at the return from dividends, BCE has been a better investment. Dividends are far less volatile than capital gains (i.e. the price of a stock) and that has made BCE a safer bet.

That’s not likely to change moving forward. Lower returns, less risk. There’s room for that in a portfolio.

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