Portfolio Updates – June 2018

Highlights

  • Lack of Aecon buy-out triggered large drop
  • TTM income still > $8M which puts us on track to meet our 2018 goal
  • Asset allocation still skewed towards equities

Monthly Performance Summary

As I mentioned in my last update, I purchased some GE call options which expire in January 2020. Those options continue to be the biggest drag on the portfolio. Other than that, the Canadian Government blocked the potential takeover of Aecon which I spoke of in a previous post. When the acquisition was first announced Aecon surged 22% in my portfolio, and since then it has dropped back down to “normal levels”. So, while my net gain on Aecon is practically flat, I did experience a material drop in the portfolio in May.

Interestingly, on a month over month basis both the LIRA and EPSP portfolios are lagging the benchmark, which is odd because those two portfolios are couch potato portfolios, as is the benchmark; one would think that they should be tracking each other. However, the variance could be attributed to a few factors:

The LIRA has not been rebalanced in some time, and there is now some tracking error. The portfolio is overweight a few percent in VXC and underweight 5% in VAB. There is also a growing cash position. The portfolio is due for a manual rebalancing soon.

The EPSP portfolio is combined couch potato and shares of my employer through the stock purchase plan. The stock purchase plan is approximately 33% of the portfolio so the remaining 67% is couch potato. But that means that the 75% equity is skewed, and not a perfect tracker to the couch potato.

On a TTM perspective we have been diverging more and more away from the benchmark. The benchmark TTM for June 2018 is 9.96% whereas the total fund is only 3.77%, a whopping 6% spread. Again, a large percentage of this can be attributed to the material decline in the margin portfolio due to the GE options. The other factor is that the certificated portfolios contain Riocan, and H&R REIT, both of which cut their DRIPs earlier this year, resulting in a drop in both holdings. Since REITs are large proportion of the certificated portfolio, insofar as those positions drop, the overall portfolio drops, increasing drag on TTM returns.

Passive Income

As always, passive income is the primary objective of my portfolio.

Passive income has been “okay” the past few months. As expected, non-quarter months (i.e. January, February, April, May) beat the benchmark, but this leveled out on the quarter months (March, June). The reason for this is that VCN and VXC, which are key components of the benchmark, only pay realized returns once a quarter, but the actual fund has dividend payments and distributions scattered throughout the year. But what we really want to see is the TTM passive income, in the following chart.

The good news here is that I am still beating the benchmark. All things being equal, I would rather beat the benchmark on passive returns than on total returns, reason being that I am creating an income fund, not a capital gains fund. Based on that metric, TTM for the benchmark was around $6,750, whereas our fund broke the $8,000 mark. More precisely, I gained 21% more passive income than the benchmark. All in all, that is an impressive feat in my view.

Allocation

Last but not least, allocation remains a key point of concern.

Equity is still a dominant force in the overall fund, weighing in at north of 70%, well above the 55% target. For the next six months I will be focusing on increasing real estate exposure:

  • This will add some more balance to the portfolio
  • From a passive income perspective, REITs provide a better opportunity than fixed income
  • REIT ETFs are a cost effective addition to the overall fund since I can buy ETFs through Questrade for next to no commissions.

Closing Remarks

The first six months of the year have not been stellar, but they have not been necessarily bad either. At an aggregate, the losses I experienced were expected (e.g. Aecon dropping, GE dropping). But, as a long-term investor I am not overly concerned. I have literally decades for Aecon to increase back in value, and my GE options have over 16 months before expiry which gives plenty of runway for them to recoup any paper losses.

A bigger concern is passive income over the next six months. 3% of the portfolio was reserved to pay off my car in August of this year (the final “balloon payment” from my finance arrangement with the car dealership), which will mark a material loss on the liquid portion of the portfolio since those funds were in my TFSA account. That drop will also remove $250 of passive income from the overall portfolio; not a large amount but it does represent 3% of overall passive income.

As it stands, the TTM passive income positions me to meet my 2018 passive income goal of $8,100/year. However, if we take 3% off of that, I will miss the goal. My hope is that by investing aggressively in REITs to re-balance the portfolio, the higher yield on REITs will make up for the lost passive income.

Onwards and upwards!

 


Exco Technologies Ltd. (XTC.TO) Analysis – F2016 Update

I last reviewed Exco Technologies earlier this year, and at the time had recommended them as a buy. Exco recently announced their audited financial results for the 2016 Fiscal Year, so now is a good time to update the analysis to see if this recommendation holds.

Let’s take a look at the aggregate recommendation criteria:

Criteria Value Threshold Pass?
Strong financial condition Current Ratio 2.03 1.50 YES
Earnings Stability Number of most recent years of positive EPS 6.00 3.00 YES
Earnings Stability Number of consecutive years of negative EPS 2.00 1.00 NO
Dividend Growth Compound Annual Dividend Growth 16.57% 2.00% YES
Share Price Growth Compound Annual Share Price Growth 10.59% 3.00% YES
EPS Growth Compound Annual EPS Growth 35.25% 3.00% YES
Moderate P/E Ratio P/E 10.81 15.00 YES
Moderate P/BV Ratio P/BV 1.84 1.50
Moderate P/E*P/BV Ratio P/E × P/BV 19.93 22.50

We can review the EPS, dividend, and free cash flow metrics first, since these speak to some of the fundamental cash flow attributes of the firm:

10 year Dividend, EPS, and Free Cash Flow per Share Growth

Compound annual dividend growth for the trailing 10 years has increased from 14.88% in F2015 to 16.57% in F2016, which was accompanied by an increase in the quarterly dividend to $0.07/quarter earlier this year. EPS compound annual growth has dropped a little: in F2016 the growth is now 31.23%, down from 33.03%, using F2007 as a base year. This does not concern me, as growth is still on an upward trajectory, and as you can see from the data, free cash flow per share is growing at a healthy pace.

As an aside: in F2015 when calculating CAGR of EPS growth I used a reference year of F2005, which gave me a CAGR of 12.32% between F2005 and F2015. However, because F2006 had a negative EPS, this makes comparables difficult. For comparison purposes. I have used a CAGR from F2007-F2015 vs F2007-F2016 when comparing EPS growth rates.

The other reason I am not concerned about a minor drop in EPS growth is the dividend payout ratio:

10 Year Dividend Payout Ratio vs EPS and FCFPS

In F2016, the dividend payout ratio against EPS and free cash flow per share was 24.13% and 26.80% respectively. F2015 had a payout ratio against EPS of 23.86%, and a payout ratio against free cash flow per share of 45.78%. Even though the payout against EPS has gone up in F2016 (because the dividend rose faster (17.39% year over year) than EPS (16.10% year over year)), at 24.13% there is still ample room for dividend increases in the long run. In other words: I am not concerned about the dividend being impacted in the foreseeable future.

I remain neutral on my views of overall profitability strength:

10 Year Profitiability Strength

Revenue has been going up year over year, however the growth in that revenue has dipped somewhat in F2016 (YoY growth in F2015 was 35.31%, while it was only 18.20% in F2016). Profit margins have remained consistently above 8.00%, which is a positive sign: Exco has managed to keep profit margins above this support level for the past three years. But, with the acquisition of AFX (discussed below), I expect revenue growth to match or exceed F2016 by this time next year.

From a valuation perspective, the company is still relatively cheap:

Graham Number as of 2016

The Graham number is sitting at a very healthy 19.93, which is below our threshold of 22.50. If you recall, when I analyzed the company based on F2015 financials the Graham number was 37.87, but at the time of my review it was sitting at 13.72 based on forward EPS at the time. So it has gone up relative to my last valuation, but is still cheap in my eyes. In fact, I doubled my position earlier this week when there was a dip to the low $10.00/share range.

Reviewing the annual report, the company came in under the consensus F2016 EPS: actual EPS was 1.12, vs. a mean forward estimate of 1.14. However, even at 1.12, this was a 16.10% increase over the previous year. Exco completed the acquisition earlier this year of AFX Industries LLC which added significantly to its revenue streams on a go forward basis, to the tune of 11.40% for their consolidated sales revenue for the year. This acquisition also saw the overall debt load of the firm go up: net debt went from $21million in F2015 to $110million in F2016, $100million of which was related to the acquisition. Overall however, I feel that this is a positive story for Exco since it has already added to their overall sales revenue.

Two other points to consider for Exco are the currency exchange rate, as well as the effects of president-elect Donald Trump. A weakening Canadian dollar has been very favourable for Exco:

Over the year, the US dollar averaged 7% higher ($1.32 versus $1.24) against the Canadian dollar contributing $15.2 million in sales to the current year. Similarly, the Euro averaged 5% higher ($1.46 versus $1.41) against the Canadian dollar contributing $5.7 million to sales.

Source: 2016 Annual Report

With regards to the president-elect, if he does go through with moving more jobs into the US and/or increasing duties (or completely eliminating NAFTA), I am not sure what this will do to Exco exports from Canada to the US: as the US is a key trading partner, there may be a material impact on the quantity and dollar value of goods shipping from Canada to the US. That said, Exco is making serious movements in other parts of the world:

  • AFX is a key supplier to BMW, giving them access to European markets
  • Operations in Thailand are giving them a launchpad to better penetrate the Asian market

Activities such as this lessen my worry about impacts of the president-elect at this point: even if there are material changes to NAFTA, with Exco’s Canadian customers, and access to other markets such as Europe and Asia, will mitigate any effects.

With the above in mind, I maintain my recommendation of buy for Exco Technologies Ltd.

Disclosure: Long XTC.TO as of December 9, 2016.