A tad overpriced, and wonky financials due to conversion to/from an income trust, and changes to IFRS. Revisit in 2013.
Overview of the Business
Bird Construction (“Bird” or “the firm”) is involved in general construction services in Canada, nation-wide, with a focus on St. John’s, Halifax, Saint John, Wabush, Montreal, Toronto, Winnipeg, Calgary, Edmonton, and Vancouver. The bulk of the work performed by the firm is carried out on behalf of the firm by sub-contractors, and Bird mitigates the risks of working with subcontractors through a number of tools and processes:
- Paper (e.g. bonds, notes, obligations) are facilitated through one of the major Canadian banks
- Depending on the magnitude of the work, work performed by subcontractors requires promissory notes or similar vehicles to guaranty the work. Bird also closely monitors the performance of subcontractors to ensure that the work is being completed in an accurate and timely manner
While the net income for a given period is a fair indicator of the work that Bird has performed, being a construction contracting company, they have a significant number of contracts which secure future work, and future cash flow. Going through the financial statements, this work is referred to as “backlog”, and serves as a decent proxy for forward looking revenue (but not necessarily net income).
Bird is a relatively simple business to understand: they book deals (contracts) for work, farm out the work to subcontractors, and keep any payment after the subcontractors have been paid off. Bird focuses on the industrial, commercial, and institutional market sectors, and as per their corporate strategy, outsources any design work that they cannot accomplish to a degree that they feel would best benefit the customer. This is reassuring in a firm since it demonstrates their ability to focus on their core competencies, while still leveraging outsourcing relationships to have other projects designed on their behalf. At the end of the day, the actual construction is farmed out to subcontractors, so the design of the work is agnostic to the work actually being performed.
All discussion relates to the period of 2002-2011.
|Strong financial condition||Current Ratio||1.30||1.50||NO|
|Earnings Stability||Number of most recent years of positive EPS||10.00||3.00||YES|
|Earnings Stability||Number of consecutive years of negative EPS||0||1||YES|
|Dividend Growth||Compound Annual Dividend Growth||20.77%||2.00%||YES|
|Share Price Growth||Compound Annual Share Price Growth||14.51%||3.00%||YES|
|Moderate P/E Ratio||P/E||16.01||15.00||NO|
|Moderate P/BV Ratio||P/BV||2.92||1.50|
|Moderate P/E×P/BV Ratio||P/E × P/BV||46.71||22.50|
The share price of Bird has had compound year over year growth of 14.5%, which represents a good return on capital over the period. There was a significant drop in 2006, which occurred around February after Bird converted from a corporation to an income trust. This income trust structure stayed in place until 2011, when the firm changed back to a corporation on January 1, 2011. As with many other firms, the firm also suffered a huge drop in value between 2008 and 2009 due to the financial crisis.
As discussed, Bird made a conversion to an income trust in 2006. This makes comparable numbers for dividends (during the corporate format pre-2006 and post-2010) and distributions (2006-2010) a little tricky. The conversion to an income trust in 2006 resulted in a drop in dividends (which technically became distributions). However, even during the income trust format, the firm continued to increase its distributions after the conversion; during the five-year period as an income trust, the distributions had compounded annual growth of 13.4%. This is not as strong as the 46.5% compound growth which occurred during the 2002-2005 period, but it is still impressive. For the period observed, dividend (distribution) growth was 20.77% compounded annually. In short, independent of the firm structure (dividend paying corporation vs. interest paying income trust), Bird has shown a consistent pattern of increasing the cash paid out to shareholders (i.e. unit holders 2006-2011). A point of concern however is the dividend payout ratio vis-à-vis the firm EPS. The payout ratio has remained high throughout the period observed, surpassing 100% in 2005. For the 2011 year (the first year as a dividend paying corporation) the payout ratio was 94%. Comparing dividends to free cash flow is another cause for concern, as observed by the 2011 payout ratio, which surpassed 300.0%.
Given the discussion above, based on P/E alone, the firm is attractively priced. Except for 2005, it has the market value of the firm relative to its underlying EPS has remained solid, breaking the 15.0 multiple for the first time in six years in 2011.
The current ratio is partially an area of concern, but more research as to the expectations of the industry is required before making a final call. Bird has kept its current ratio consistently at 1.20 or above, except in 2007. A conservative value investor normally targets a current ratio of at least 1.50. However, given Bird’s performance while maintaining its current ratio in the current range, may warrant a reevaluation of that particular metric when deciding if the firm is a worthwhile addition to an investor’s portfolio.
Note: For the 2008 and 2009 periods, the EPS seems flat. In the analysis I performed, I have been comparing net income as defined as comprehensive income and income from continuing operations. However, in 2009 Bird closed off its operations in Seattle Washington, which resulted in a loss of $3.9MM from discontinued operations. To provide a fair comparison, the net income used for 2009 was $60,795M, compared to the $56,913M listed in the 2009 financial statements; the 2010 annual report has a description of the discontinued operations.
With that said, EPS has been on the upswing, but took a hit in the 2010 fiscal year. This was to be expected; since projects are booked in advance, there was a hit on the backlog of projects in the 2009 year (2009 backlog ($901MM) was 18% less than the 2008 backlog ($1,105MM)), which affected the 2010 net total revenue.
One final note on the fundamental analysis. Reviewing Bird’s financial statements is a great exercise in investigating the ins and outs of changes to operations and accounting policies. The conversion in 2006 to an income trust, and the subsequent conversion back to a corporation in 2011, made it a little tougher to compare a firm whose corporate structure has remained constant over the period being reviewed. In addition to this, Bird converted to IFRS reporting in 2011 due to regulatory requirements in Canada. This resulted in a hit on the valuation of some items on the balance sheet and the income statement.
Based on the 2011 results, Bird is a solid firm, however it is overpriced. P/E is 16, P/BV is almost 3.0, and P/E × P/BV is 46.8. Ignoring the overpriced quality of the firm, while the business itself is easy enough to understand, I do have some other concerns:
- The dividend payout ratio as measured against EPS was 94.0% in 2011, and the dividend payout ratio as measured against free cash flow was over 300.0% in 2011. Exceeding free cash flow is a major read flag in my view, and doubly so when it exceeds 100% by a factor of three.
- While the country made it through he worst of the financial crisis years ago, due to the nature of Birds business it may be some time before the effects of the financial crisis are no longer affecting Bird’s bottom line.
There are some plusses for the company which I like:
- The ability of Bird’s management to maintain a constantly growing dividend is impressive, especially given the turmoil of the past few years. Their closing of operations in 2009 also speaks to their oversight in discontinuing operations which are not profitable or aligned with their corporate strategy.
- As of today (October 28, 2012), the dividend yield is an impressive 4.50%. With year over year growth of 20.8%, Bird would be a worthwhile addition to a dividend portfolio.
- Due to the nature of the business, they are part middle-person and part designer/builder. Their corporate strategy gives them the breadth to take on a wide variety of projects, and when the firm does not have the depth to undertake those projects on the design side, they are willing to subcontract that work out.
That said, I will definitely be revisiting Bird after the 2012 financial results have been published. The company, at least on paper, looks pretty solid. And except for some concerns due to the recent (i.e., past two years) financial conditions of the economy – but not necessarily the firm itself – I would be willing to jump in now.
Paraphrased from the 2011 Annual Report, CCL Industries Inc. is a world leader in the development of label solutions for global producers of consumer brands in the home and personal care, healthcare, durable goods, and specialty food and beverage sectors and a specialty supplier of aluminum containers and plastic tubes for the same customers in North America. Founded in 1951, the Company has been public under its current name since 1980. CCL’s corporate office is located in Toronto, Canada, with its operational leadership centres in Framingham, Massachusetts, United States. The company operates in three major operations: Label, Container, and Tube.
- CCL Label: CCL Label is the world’s largest converter of pressure sensitive and film materials and sells to leading global customers in the consumer, packaging, healthcare and consumer durable segments.
- CCL Container: CCL Container is a leading North American manufacturer of sustainable aluminum aerosol containers and bottles for premium brands in the home and personal care and food and beverage markets.
- CCL Tube: CCL Tube produces highly decorated extruded plastic tubes for premium brands in the personal care and cosmetics markets in North America.
When analyzing CCL I came up on some interesting challenges. CCL has two share classes, CCL-A.TO and CCL-B.TO. The Class A shares are voting shares, and receive a dividend that is $0.05 less than the Class B shares. Class A shares are convertible to Class B shares at any time. CCL’s annual statements use the number of Class B shares outstanding to calculate EPS and book value. Because Class A can be converted to Class B at any time, I felt it was more appropriate to use the sum of both classes when calculating ratios. That said, my analysis has focused on the combined total of all Class A and Class B shares, and as such my numbers are slightly off (they are actually lower than those published by CCL in their annual report). In later years (2010 onwards) CCL has listed which portion of net income is attributable to Class A and which portion is attributable to Class B, which allows one to calculate the individual EPS values for each class of share.
That said, let’s take a look at the initial evaluation:
|Number of most recent years of positive EPS||10.000||10||3||Min||YES|
|Number of consecutive years of negative EPS||0||1||Max||YES|
|Compound Annual Dividend Growth||$0.340||$0.700||7.488%||2.000%||Min||YES|
|Compound Annual Share Price Growth||$15.980||$30.810||6.785%||3.000%||Min||YES|
|Compound Annual EPS Growth||$0.654||$2.541||14.532%||3.000%||Min||YES|
|P/E × P/BV||24.671||24.671||22.5||Max|
Remember that for the P/E, P/BV, and P/E×P/BV values we want both P/E and P/BV to pass, or P/E×P/BV to pass. While the P/E×P/BV test fails, the P/E and P/BV values pass. Given that, CCL passes all of my initial tests. Here are the graphs for the stock:
The above represents the Class B share prices, and year over year, the share price of CCL has gone up steadily. Because CCL focuses on packaging for many of the larger firms that produce consumer goods, they were hit pretty hard with the 2008 financial crisis, which is evident in the share price drop during that period. However, since the fall-off-the-cliff, the company has been back on a steady rise to higher share prices.
The three graphs above illustrate an interesting story. In 2004, 2005, and 2007, CCL discontinued some operations which sent positive shocks to the EPS. When you adjust the EPS for these shocks, it remains at around a respectable $2.00. Notwithstanding EPS, the dividends have been raised consistently for the past decade, with 7.49% compounded annual growth.
Another point to note is the free cash flow. CCL invests a considerable amount of time in capital expenditures year over year. From a dividend standpoint, the ideal scenario is for dividends to be taken out of free cash, since this illustrates that dividends being paid to shareholders are coming directly from cash received from customers — in other words, cash is flowing directly from the customer to the shareholder. Except for 2005 and 2007, this was always the case.
Finally, free cash flow has been on a steady rise since 2005.
And of course, no analysis would be complete without taking a look at the P/E. P/E has remained consistently below 15 since 2003. When you combine this with the Price to Book ratio, and the P/E×P/BV multiple, CCL is very attractively priced.
In my opinion CCL is a great company to invest in. Dividends have been increased at a constant rate, and management has taken actions to eliminate parts of the business which do not add value.
Disclosure: No CCL as of 2012/10/08.
High Liner Foods holds a special place in my investing heart, because it was the first stock that I ever performed my own analysis on. Since purchasing it in 2010, it has soared over 50%, making it an incredibly valuable part of my portfolio. High Liner’s success is what really pushed me into the value investing sector, whereas before I was always trying to time the markets as a day/swing trader. High Liner’s share price growth has been impressive, showing an 8.57% compound annual rate of return from 2002-2011.
Fast forward two years, and things are even better. On September 20, 2012, High Liner Foods announced that they had been added to the S&P/TSX Small Cap Index, which was a major accomplishment. This addition brought about added exposure and liquidity to the stock as it is now traded in some of the S&P/TSX Small Cap ETFs such as iShares XCS.
Given all of these changes, I felt that High Liner warranted a refresh of my initial analysis. While I discussed my initial evaluation methodology previously, reviewing my original analysis reminded me of some of the fundamentals I should be looking for. That said, I’ll be expanding my initial evaluation methodology, starting with High liner. So, what do we have at first glance?
|Strong financial condition||Current Ratio||2.05||1.50||YES|
|Earnings Stability||Positive EPS over last 3 years||8.00||3.00||YES|
|Earnings Stability||Less than 2 consecutive negative years||0||2||YES|
|Dividend Growth||Dividend Growth||30.75%
|Share Price Growth||Minimum 3.00% compound growth over the past 10 years||9.82%||3.00%||YES|
|Moderate P/E Ratio||P/E||8.61||15.00||YES|
|Moderate P/BV Ratio||P/BV||1.09||1.50|
|Moderate P/E*P/BV Ratio||P/E * P/BV||9.38||22.50|
In the above, the one that needs a real explanation is the P/E, P/BV, and P/E×P/BV section. I consider a firm to be overpriced if its P/E is greater than 15, its P/BV is greater than 1.5, or if the combined value of both is greater than 22.5. This combination factor allows for some flexibility.
If the above looks familiar, it probably is. For the most part, this is a screen taken from Benjamin Graham’s The Intelligent Investor. The above values are based on the 2009 fiscal year, which is the data I originally used for selecting the stock. However, looking at 2011 data, we have a drastically different story:
|Strong financial condition||Current Ratio||1.31||1.50||NO|
|Earnings Stability||Positive EPS over last 3 years||10.00||3.00||YES|
|Earnings Stability||Less than 2 consecutive negative years||0||2||YES|
|Dividend Growth||Dividend Growth||28.03||2.00%||YES|
|Share Price Growth||Minimum 3.00% compound growth over the past 10 years||5.37%||3.00%||YES|
|Moderate P/E Ratio||P/E||13.59||15.00||YES|
|Moderate P/BV Ratio||P/BV||1.53||1.50|
|Moderate P/E*P/BV Ratio||P/E * P/BV||20.78||22.50|
While all of the initial tests passed, the price of HLF.TO is now incredibly high; the 2011 chart is based off of a $16.35 share price, but the stock is now trading at $23.94, which yields a P/E of 19.90, P/BV of 2.24, and P/E×P/BV of 44.55! (This is assuming we use the EPS of the fiscal year, with the October 1, 2012 share price). The stock would definitely not be on my radar at the moment because it is incredibly overpriced.
Initial screen aside, the other fundamentals look solid.
Observing the above, there has been consistent growth in the dividend over the past five years, and the dividend payout ratio has — except for 2005 — remained consistently below 50%. In adition to this, EPS has been inching slowly upwards since 2005. One may be a little wary of the huge EPS in 2003 which suddenly dropped by 2004, but the 2003 blip was a one time event “realized on [High Liner’s] exit from the harvesting and primary processing businesses,” as discussed in the 2003 annual statement.
While FCF has been a little week, overall High Liner has been a solid performer. Good management has seen the company shedding businesses that it no longer needs (such as food processing in 2003 and the Italian Village line in 2005), and making good acquisitions such as their purchase of Icelandic Group in 2011. All in all, the firm has strong fundamentals, a good management team which is focused on increasing the value of the business, and a solid (but well managed) history of increasing dividends.
Depending on what the fiscal 2012 results are, I would consider picking up HLF.TO on dips in 2013, provided the combined P/E×P/BV ratio was less than 25 (higher than my regular threshold, but I woudl be willing to give a little on an excellent company).
When looking for companies to invest in, as a dividend investor, the initial screen is to weed out any companies that do not pay a dividend. This has weeded out powerhouses such as Apple, Inc., which have experienced a considerable amount of capital appreciation over the years, but which are otherwise overlooked because they horde cash. (Up until recently of course, when Apple officially announced they would start paying a quarterly dividend). However, in the world of finance, if an investor wishes to invest in a company that does not pay a dividend outright, they can use homemade dividends to replicate the income stream of a dividend paying firm. A good definition of homemade dividends can be found at Investopedia:
A form of investment income that comes from the sale of a portion of shares held by a shareholder. This differs from dividends that shareholders receive from a company according to the number of shares the shareholder has.
So, how does this strategy work? The theory is, that if you require an income stream, you can sell off shares of the company that you own, replicating the dividend. This is a relatively simply operation, and easy to illustrate in Excel. For example’s sake, say we have the following information:
- The current stock price is $10.00
- We require a starting dividend payout of $0.15/year (yielding 1.5%, which not uncommon)
- We would like to see annualized dividend growth of 5%; this is in line with many dividend aristocrats
The above illustrates a common example: when doing research we usually know what the current price of a company is, and what our expectations of the dividend — and growth in that dividend — are. A homemade dividend would sell a partial amount of the share to replicate the dividend payout. So at the end of year one, if you require a dividend of $0.15/share, you would sell off 0.015 shares of the company, leaving you with 0.985 shares at the end of the year. With your required dividend growth of 5%, in year 2 you would require a dividend of $0.1575/share, and you would sell off an appropriate partial share to generate that cash flow. The following table summarizes 20 years of homemade dividends, using our example above:
|Year||Starting Shares||Share Price||Value of Holdings||Dividend||Effective Dividend Yield||Shares to Sell||Closing # of Shares|
Observing the above, we can see that as time goes on, the dollar amount of your investment is decreasing over time, and this is because we are assuming that there is no appreciation of the share price over time. Realistically we would want to see some share price growth. With that in mind, we can add in one more column which adjusts for share price growth. I will save you the derivation of the formula, but g was calculated from the following:
Where the i subscript are growth, dividend, and price, for year i. With this additional information, our example then becomes:
|Year||Starting Shares||Share Price||Value of Holdings||Dividend||Effective Dividend Yield||Shares to Sell||Closing # of Shares||Required Price Growth (g)|
The logic in the above is that we must maintain a share price which allows us to keep paying a dividend forever. Obviously, over time if we are selling partial shares, this number of shares that we have available to create our homemade dividend, thus we the price of the share must appreciate to compensate for the lower number of shares. Observing the table, growth rates of 1.52% in Year 1 up to 2.65% in Year 20 are actually pretty realistic; over a 20 year time period, the share price has actually gone up less than 50%, and has a CAGR of only 1.94%! So this annual required growth of the share price is not out of line with what we would expect to see for any well managed firm; in fact, we would expect to see the same for a regular dividend company anyways.
So, what are the challenges with using homemade dividends?
The obvious first challenge is that selling partial shares is not realistic; most brokerage houses will not allow you to buy or sell partial shares. In our example above, in year 1 we would have to sell 0.015 shares, which likely isn’t possible for the majority of retail investors.
The second challenge is related to cost. In a perfect world, there would be no transaction costs for a homemade dividend. Alas, we do not live in a perfect world. So the activities involved in selling the shares to create the homemade dividend would likely incur brokerage fees which far exceed the dividend itself. This compares to a traditional dividend where the firm pays us the dividend, so the transaction is virtually free for us: all we have to do is sit back, and wait for the dividend to arrive.
Third, we haven’t taken taxes into account. Dividends are taxed at a more favourable rate than capital gains, but by selling partial shares, we are triggering a capital gains tax. This results in more taxes being taken out over time.
Finally, the required growth price of the company, while realistic in terms of value (less than 2% CAGR in share price gives us an annualized dividend growth rate of 5%), having a constantly increasing g may not be realistic.
In theory, homemade dividends allow an investor to replicate the income stream from a conventional dividend paying firm. However, when you take into account brokerage fees, taxes, and the difficulty in selling partial shares, it becomes evident that for the average retail investor, homemade dividends are not as effective in practice as in theory.
In Canada, the CRA allows one to deduct interest expenses (Line 221 in the 2011 tax return) used for income producing investments from their net income, which results in lower taxes paid by an individual in any given tax year. I was curious as to whether or not borrowing to invest in dividend paying stocks would result in more income after taxes. To investigate this, I created a spreadsheet model to test a number of scenarios. The results I found were pretty interesting, and are summarized below:
|Scenario 1||Scenario 2||Scenario 3|
|Employment Credit Amount||$1065.00||$1065.00||$1065.00|
|Ontario Health Premium||$750.00||$750.00||$750.00|
|Loan for Investing||$0.00||$10,000.00||$10,000.00|
|Loan Annual Interest Rate||n/a||4.25%||4.25%|
|Income After Taxes||$72,695.44||$72,952.37||$73,040.15|
Some notes about the above. First, to keep things simple I used employment income of $100,000. I wish I made that much, but it makes things simpler for the model. $100,000 net income simplified the Ontario Health Premium, which was $750.00. I also assumed the maximum for CPP and EI. All of these numbers are based on the 2011 tax year for the Province of Ontario. And as one final check, I punched the same numbers into the Canadian Income Tax calculator found at Tax Tips and came up with identical results.
So, what do those results tell us? Scenario 1 is the control scenario, where we don’t borrow and don’t receive dividends. In that scenario, an individual pays out $27,304.56 in income taxes for the given year. Scenario 3 was a more realistic scenario: borrowing to invest in a company whose dividends were higher than the borrowing interest rate. Thanks to the tax credits one receives on dividend income, and the fact that interest income is deducted from your net employment income, the total taxes paid were less than in Scenario 1 by $64.71. What was surprising Scenario 2: borrowing to invest, and then purchasing shares in a dividend paying corporation with a dividend yield identical to the interest rate on the loan, yielded less overall taxes than Scenario 1 by $82.68! This means that borrowing to receive dividends where the net gain between interest payments and dividend income is $0.00 still yields lower taxes.
Of course, there are a couple of caveats to this approach. First off, when you borrow, you have to pay off the principal as well. However, if you are borrowing to invest in quality companies, then in theory the company’s share price should increase, so over time you could unload your position to pay back the principal of the loan. Also, most loans require you to pay both interest and principal. CRA rules only allow you to deduct the interest payments, not the principal payments; this means that your net income before taxes would be lower than in the model here, which assumes that you never pay down the principal. Finally, when you do go to sell the position, you will be hit by a capital gains tax.
Given the caveats, one, the extra cash in hand is less than $100 (which is less than 0.1% of $100,000 net income), two, the extra work involved, and three, the risks of the company’s share price dropping, this strategy may not be worth it. However, it was still an interesting exercise; no matter which way you cut it, you are still technically better off since you end up with more cash in pocket at the end of the day.
As you would expect from the company name, Calian Technologies is a Canadian based technology firm which operates in two industries: Systems Engineering and Business & Technology Services (BTS). The company has been in business for over a decade, but they only started issuing dividends in 2003. Even then, the company has managed to increase their dividend every year, along with a special dividend of $1.00/share in 2010. Year over year, their share price CAGR is 14.10% from 2003-2011.
Taking a look at a graph of dividend payouts vs. their dividend payout ratio, they have had consistent dividend increases since 2003. CAGR for dividends is 24.88%, which excludes the one time special dividend in 2010. Their dividend payout ratio has had a range of 17%-56% (highest was in 2011), but they have remained consistently below 60% since issuing a dividend. THe spike in 2010 relates to the special dividend and actually pushed their dividend payout ratio to 102%.
Compare the dividend payout ratio to EPS, and two things are clear: EPS is on a constant upward trend with slight dips, but even with these dips the dividend payotu ratio has stayed consistently low; this shows me that management has taken a measured approach to delivering a constantly growing dividend, but ensuring that the dividend growth does not outpace EPS growth.
Three other indicators I like to take a look at are the P/E ratio, and ROE, illustrated below. ROE CAGR has been 2.85%, which isn’t stellar, but it is still an upward trend. P/E ratio has remained consistently below 15, and while the P/BV has broken 1.5 a few times, the combined P/E×P/BV has still stayed below 25.0.
As of the 2011 fiscal year, Calian had a P/E ratio of 10.1554, P/BV ratio of 2.1275 giving a P/E×P/BV of 21.6056, which is within the range at which I would consider buying a position. However, those numbers are based on a share price of $17.35. Currently (closing of July 20, 2012) CTY.TO is trading at $20.73 on the TSX, which bumps P/E to 12.1338 and P/BV to 2.5420, pegging us at a combined value of 30.8437. This is a touch high; I do like the dividend yield which currently sits at 5.07%, but would prefer to jump in at the sub-$20 mark.
Disclosure: No CTY.TO. As of Sept 2012 I hold CTY.TO.