SNC-Lavalin (SNC.TO) Analysis

A copy of this article originally appeared on Seeking Alpha.

Thesis

With respectable profitability over the past 10 years, and an incredibly strong dividend history, SNC-Lavalin (SNC.TO) would be a worthwhile addition to any dividend growth portfolio. However, its current valuation measured against its price-to-book, and price-to-earnings ratios, as well as when compared to its peers, demonstrates that even with strong dividend performance it is still overvalued. Investors would be better off putting this stock on their watch list, and adding when the price drops below C$40.00.

Background

SNC-Lavalin is a Canadian based engineering firm, which derives its income from six key streams, outlined below.

Collectively, the Mining & Metallurgy, Oil & Gas, Power, Infrastructure & Construction, and Operations & Maintenance, are referred to as the Engineering & Construction segment. Running parallel to this is the Capital Investments segment, which enters long term agreements which use either fixed cost or equity method accounting to record revenue.

Profitability and Stability

Beginning in F2013, SNC started reporting its revenue broken down between engineering revenue and capital investment Revenue. Except for F2009 and F2013, year over year (YoY) revenue growth has been positive, with the most recent year’s revenue coming in at +16% at over $9billion.

The share price has generally trended upwards over the past 10 years, with minor dips in F2008, F2012, and F2014:

The F2008 dip may be attributed to the Kerala Hyderoelectirc Dam Scandal, and the F2012 and F2014 dips may be attributed to the Libya business probe. Of course, this is speculation, but given the negative press it is a plausible explanation, especially since the underlying fundamentals relating to revenue remained consistently strong during that period.

One other financial stability figure to review is the current ratio. Typically, one would hope to see a current ratio of at least 1.50 (i.e. current assets more than covers current liabilities). As of the most recent fiscal year, the current ratio is 1.02 when comparing net current assets to net current liabilities. However, this number quickly climbs to 1.54 once you consider the ratio of short term assets to short term debt (i.e. vs. aggregate short-term liabilities). This is illustrated in the below chart, which breaks down short-term liabilities into its components of debt vs. de-facto liabilities.

Condensed Balance Sheet

Condensed Balance Sheet

Dividend

Dividends are an interesting metric when compared to share price. Provided the dividend payout ratio (i.e. the portion earnings paid to dividends) remains low, and the dividend remains consistent or increasing, a drop in a company’s share price often represents a buying opportunity. It is for this reason that I feel dividends can be observed separately from share price: whereas share price represents capital appreciation, dividends represent (immediate) realized gains to shareholders. That said, over the past 10 years, SNC’s dividend has risen from $0.23 in F2005 to $1.01 in F2015, representing a 14.40% compounded annual growth rate of dividends.

Overall, the dividend payout ratio has been consistently below 50% since F2010, and prior to that, it was consistently below 40%. Overall this indicates that there is still plenty of room for SNC to continue to raise dividends, even in the face of revenue headwinds.

Valuation

SNC’s current valuation is where it falls short in my view, based on the following:

  • Trailing-twelve-months (“TTM”) EPS of 2.03/share
  • Book value of $25.03 based on the most recent fiscal quarter results
  • Current share price of $56.52 (as of February 3, 2017)

Given these numbers, the stock has a price-to-earnings of 27.8, and a price-to-book of 2.2, yielding a Graham number (i.e. P/E × P/BV) of 60.8. SNC’s meaningful peers (Aecon (ARE.TO), Bird Construction (BDT.TO)) have an average P/E × P/BV of 25.0 for the most recent fiscal year, illustrating that SNC’s Graham number is more than twice that of its peers.

What this translates to, is that SNC is trading at much more than it should be at this time, when compared to EPS and/or book value. At the current TTM trailing EPS and book value, I would expect to see a price of no more than $33.81, if we have an upper limit of 22.5 for our Graham number. This puts SNC’s current price at roughly 1.7× what it should be, based on TTM EPS and book value based on the most recent quarterly results. This isn’t quite as bad as the Graham number multiple compared to peers (SNC’s 60.8 is 2.4× that of the peer average at 25.0), but it is still considerable.

Closing Remarks

Fundamentally, I like SNC. Its historical performance, even amidst two scandals, is stellar, and its dividend growth is spectacular. However, the valuation concerns me; as much as I don’t mind paying an “okay price for a good company”, at the current valuation it is no longer “okay”, just “bad”. I would consider buying on dips, and will re-review after the F2016 results are out to see where the valuation sits vis-a-vis its updated fundamentals.

Notes

All figures are reported in Canadian dollars.


Investment Goals: 2017

It’s that time of year where we start looking at investment goals for the new year.

I didn’t really have any goals F2016, except to become a member of thediv-net.com, which I’m happy to say that I was successful in accomplishing! I also mentioned in several posts in F2016 that up until recently I had lost focus on my investment portfolio. Well, for F2017, I plan on changing that trend.

To that end, the goals!

Goal 1: Increase TFSA Contributions

I have been an infrequent contributor to my TFSA for the past 2+ years. To pay off my business school loan, and to purchase a new house with my family, I made some significant withdrawals. Taking into account the $5,500 contribution limit for F2017, I have a little over $40,000 in contribution room in my TFSA. My goal for F2017 is to contribute to at least 50% of that limit, or $20,000.

Goal 2: Minimize Taxes

My investments fall into five investment books: a taxable margin account, a tax-free account, a tax deferred account, a certificated account, and a LIRA. My second goal for F2017 is to minimize taxes by consolidating investments into my tax deferred and tax-free accounts, where it is sensible to do so.

Selecting which investments go into tax sheltered accounts is not a trivial task. On the one hand, moving investments from my taxable account will defer any taxes payable (in the case of my RRSP), or eliminate taxes completely (in the case of my TFSA). However, tax sheltered accounts have a disadvantage in that any losses cannot be used to offset capital gains. This means that I will have to take a close look at the investments to ensure they are good fit to go into an account where I am unable to do any tax loss harvesting. Put another way: I have to ensure I am comfortable (financially, and psychologically) to move investments, confident that they will not go down in value to the point where I sell them at a loss.

That said, Goal 1 and Goal 2 are complementary: by moving investments from my taxable margin account to my tax-free account, I can easily come within throwing distance of Goal 1.

Moreover, by moving my US investments from my margin account to my tax deferred RRSP, I will reap an immediate 15% cost avoidance: US based stocks are not subject to the (15%) withholding tax on US dividends, which means I will receive the full amount of dividends from my US holdings.

Goal 3: Rebalance my Total Fund to my Target Allocation

When I started investing in earnest in F2012, I had a very rigid target allocation. The past few years I have deviated very far from that. So my third goal (and arguably the most important) will be to revisit my investment policy statement, and determine the appropriate asset mix for my investments.

Goal 4: Increase Passive Income by 5%

As I am a dividend investor, passive income is my primary goal for investing. Following my December 2016 results, I will be baselining my F2016 income, with a goal of beating that income by 5% this year.

I plan on accomplishing this goal through three key strategic activities:

  1. Re-allocation. I know for a fact that my portfolio is overweighted in some areas. Once I complete Goal 3, I will be reallocating funds to other holdings, to increase exposure to some of my more successful dividend holdings.
  2. DRIP Investing. I plan on increasing exposure to DRIP investments, as they provide a frictionless vehicle for quickly growing dividend income.
  3. TFSA Contributions. As mentioned with Goal 1, I plan on increasing my TFSA exposure. This increase will undoubtedly bring more passive income into the total fund.

Goal 5: Update and Expand Investment Research

Many of my investment research posts are horribly out of date. As the calendar year is starting, many companies I follow will be releasing their annual results in the coming months. I plan on updating all of the companies I follow based on F2016 results. Moreover, I am targeting to analyze at least four new companies this year.

And there you have it; the F2017 goals! I would love to hear what everyone else’s goals are for F2017.

Onwards and upwards!


Leveraging the Work of Others

I am often asked where I get my information, where I start, and what my process is.

The first thing for any investor, regardless of how s/he invests, is to have an Investment Policy Statement, or an IPS. I’ll touch more on IPS’ in a later post, but in a nutshell it describes your investing goals, strategy, how to meausure success, and risk tolerance. Overall, it measures the how and why you invest. I mention this, because one’s investing process is driven by their IPS, and the process in turn drives how and where you start.

As a dividend investor, I try to work smarter, not harder. There are a plethora of information sources out there. The universe of dividend paying companies is huge, and grows even larger when you expand this to income trusts (e.g. REITs), mutual funds, and ETFs. Because the universe is so large, it is challenging to find companies to invest in that meet my specific criteria:

  • Companies with strong dividend growth
  • Companies which are cheap (by cheap, I mean in terms of valuation, not the actual cost per share)
  • Companies which offer a decent yield
  • Companies which will help to diversify my exposure to different industries (i.e. not being overly concentrated in one type of company, such as “all banks”)

With that criteria in mind, there are a number of tools that one can use to help whittle down the universe of available stocks to invest in. And once this universe is whittled down, you can start focusing on which companies to take a deeper look at, before pulling the trigger and investing your hard earned dollars. That said, here are some of the tools I use to help in identifying companies to analyze, and hopefully purchase.

  • Blogs. I try to read a lot of blogs, but as most readers know, there are many, many blogs out there. It helps to be able to have a shortened list of blogs to peruse on a regular basis. My primary source of blogs is The Div-net, as it is composed of blogs focused on dividend investing. This makes sense, as there are several great bloggers who have already done a fair bit of research on companies to invest in (or not to invest in!). Beyond that, these blogs are a great source of inspiration for my own investment activities, and often help to push me to invest that one extra dollar into my investments.
  • Podcasts. I listen to three (four) bogs on a regular basis. These blogs are not all about investing, but they do act as a great source of inspiration for managing money. Moreover, they make the listener really think, which helps when you are doing deep analyses on companies to invest in.
    • Market Foolery / Motley Fool Money. These blogs are published Monday-Thursday, and Friday, respectively, and are the podcasts of fool.com. The show features a rotating list of speakers who work at fool.com, and is great for a daily recap of financial events, and an hour long recap on Friday. The host and speakers are great presenters, and I’m often left laughing under my breath on the streetcar home when I’m listening to them.
    • Planet Money. While not an investment podcast, Planet Money is a great source of things about, well, money. They cover a breadth of topics, everything from the full process to selling oil (right from pumping it out of the ground, to selling it to a gas station), the odd case of a shopping mall with two different minimum wages, and the investor of the Self-Checkout Counter (who knew that the inventor was a local Torontonian???).
    • Freakonomics. I’ve saved the best for last. I love the Freakonomic books, and the podcast is great for a weekly dose of diverse topics on economics. They cover everything to do with incentives, right from why belts are the worst invention ever, to the history of the Nobel prize.
  • News. Newspapers, and newspaper websites, are a great source of information. Regrettably, many newspapers how have “pay-walls” around them, so some of the more premium content is unavailable without a subscription. Frequent sites to visit? The Business and/or Investing sections of The Globe and Mail, Yahoo Finance (Canada), and Bloomberg.
  • Daily Email News Digests. I subscribe to two daily news digests, which typically deliver an email before 7:00 AM EST so I may read it on my way to work.
    • CFA Financial Newsbrief is put out by the Chartered Fianncial Analyst Institute, and is a great roundup of financial and economic events that have occured in the last twenty four hours (or over teh weekend in the case of the Monday edition). Within the email, there are short paragraphs describing the event, and links to longer articles on 3rd party websites such as Bloomberg, or Wall Street Journal.
    • Bloomberg Briefs. I actually subscribe to two Bloomberg digests, but they are both different versions of Bloomberg Briefs. If you go to the site, there a variety of daily digests which you can sign up for, for various financial products (ETFs, Bonds), different industries, and general financial and economic news.
  • DRIP Investing Centre. The DRIP investing Centre is the heavyweight of all information. On this site, you’ll find the Money Market Dividend Champion lists for both Canada and the US, available in Excel and PDF format. These lists are invaluable to the dividend investor, as they have information going back several decades for each company that pays a dividend in the Canadian and US markets. For my own criteria listed above, I was able to whittle the universe of 700+ stocks down to 15 stocks in less than 5 minutes, just playing with some filters in the spreadsheets. This has saved me countless hours of filtering and searching other websites for the same information. Importantly, it also lists an extrapolated Graham number, which is one of the key metrics I use for measuring the value of a company (e.g. to determine if it is cheap enough to buy). This in itself is a great time saving tool, since it avoids me researching a company, only to find that it is too expensive to invest in!

No investor is an island, and it helps to leverage the work of others! After all, the majority of us are retail investors who are trying to carve out the biggest piece of the pie that they can — and thanks to resource such as those listed above, we can eek out an even larger piece over time.

Onward and upwards!