Report
Ceapro Inc. Report
Ceapro Inc.
Results had turned sharply downwards in 2017 and 2018 after a period of rapidly increasing revenues and especially earnings per share from 2013 to 2016. Revenue per share growth resumed in 2019. Earnings turned sharply higher in 2020, 2021 and 2022 But then revenues and especially earnings per sharp turned very sharply lower in the first nine months of 2023. The company is focused on investing in research and views its existing profitable base business which involves selling certain ingredients to the cosmetics industry as a way to fund its research into what it hopes will be more profitable products. The reason book value increased sharply back in 2016 but that was due to a share issuance at a price well above book value. To date its research has not panned out in anything commercial but it claims to have several promising irons in the fire. Now the company is proposing a merger with another company and this along with the revenue decline has very much clouded the outlook.
| Ceapro Inc. (CZO, Venture) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold shares |
| Based on financials from: | Dec ’22 Y.E. + Q3 ’23 |
| Last updated: | January 26, 2024 |
| Share Price At Date of Last Update: | $ 0.16 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Highly Speculative Buy / Hold at $0.16 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | No, it’s highly speculative |
| Has Wonderful Economics? | Uncertain |
| Has Excellent and Trustworthy Management? | Not certain |
| Likely to grow earnings per share at an attractive rate over the next decade? | Not certain |
| Positive near-term earnings outlook? | Unknown |
| Valuation? | Attractive but speculative |
| SUMMARY AND RATING: The graph for the past nine years shows a lot of volatility – earnings were sometimes negative. The value ratios have recently deteriorated badly and the only attractive ratio is the price to book value ratio. Management quality seems good in terms of the science but the ability to commercialise the science has been poor (non-existent). The insider trading signal is neutral. Executive compensation seems reasonable. The near term outlook is now very uncertain due a recent sharp sales decline and a proposed merger with another company. Possibly, something in the nature of a license deal to commercialise some of their research could occur in the medium term but that has failed to materialise for years. Cash generation in 2022 and 2021 was impressive and it then appeared that the existing products along with research grants, were generating more than enough cash to fund their research efforts. But cash flow will be negative in 2023. In the longer term, its research and product commercialization efforts may or may not result in attractive or even very attractive earnings. They have various irons in the research fire – one or more of which may be successful and could be licensed profitably – but all of which are difficult to negotiate and take time. All their efforts always seem to be a long way from commercialization. The wait for something to materialize from their research efforts grows tiresome. We consider this to be a higher risk investment based on the nature of its operations and also based on the low share price (It is a penny stock range where stock prices are usually quite volatile). On a positive note, the company has no debt and so is in strong financial shape. We rate this as a Highly Speculative Buy / Hold. It’s suitable for only a modest position as a highly speculative investment which may have potential. | |
| MACRO ENVIRONMENT: The macro environment such as interest rates and the state of the economy is probably not of much relevance to this company. | |
| LONG TERM VALUE CREATION: There has been a long-term value destruction based on the share price. The book value per share has grown only modestly since 2015. Overall, there has been no value creation for investors. | |
| DESCRIPTION OF BUSINESS: Ceapro Inc. is a small “growth stage biotechnology company”. Ceapro has a line of existing cosmetic ingredient products (which it extracts from oats) which are profitable on their own but believes that its real value and future lies in the products and processes it is researching and developing. Through scientific research, it develops products or extracts from plants (currently mostly oats). It currently produces two ingredients for the cosmetics industry on a commercial scale. Ceapro has developed (and/or purchased or licenced the rights to) certain proprietary and in some cases patented extraction and production technologies . Some of these are intended to produce commercially valuable methods to “deliver” a variety of drugs and treatments into the human body. They sell mostly (over 90%) through a single distributor and not by direct sales. The current products are used in the cosmetics and include an active ingredient in anti-aging skin creams. Brand names that contain Ceapro’s products include Neutrogena, Lubriderm, Aveeno, Jergens, Dove and others – We suspect Ceapro’s product is in one or a few but certainly not all or most of the products under these brand names. Ceapro indicates that it is the sole-source provider of ingredients in a number of products – but the purchasers can drive a hard bargain on price and the quantities needed are not large. Many or all of its newer products would require partnering with much larger companies. In 2021, geographically, sales were 66% in the U.S., 23% in Germany, 10% in China and with just 0.3% of sales in Canada. | |
| ECONOMICS OF THE BUSINESS: The economics of the existing products appears to be reasonably good. The base business is profitable even after expensing research efforts. But the research aspect is quite risky in terms of the need to spend on research which may never materialise as commercial products. To a large degree, this company is something of a lottery ticket. But the shares are not currently pricing in any value for the potential pay-off from the research. So it may be something of a free lottery ticket. | |
| RISKS: We suspect that the larger risks would relate to risk of spending money on developing products and processes that might never achieve therapeutic success or regulatory approvals or commercial success. There may also be risks due to product liability in spite of some insurance coverage. There may also be significant risks related to competition or to a reliance on just one key distributor (including possible bad-debt risk) and possibly on key end-use customers. | |
| INSIDER TRADING / INSIDER HOLDING: As of July 8, 2023 there has only been no insider trades in about four years! Therefore the insider trading signal is neutral. It’s disappointing that a couple of new directors and a new Revenue Officer have not bothered to buy any shares at all. The CEO did exercise 150,000 options at ten cents back in July 2022 (lucky him) and kept the acquired shares and now holds about 1.5 million shares. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (Fail, because most investors would have no familiarity with the company’s products or its risks), has favorable long-term economics due to cost advantages or superior brand power (marginal pass), apparently able and trustworthy management (marginal pass at best given some concerns about disclosure despite the credentials of management and the Board), a sensible price – below its intrinsic value (pass although it is difficult to know), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (fail) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) Overall, the company does poorly on these tenets. | |
| MOST RECENT EARNINGS AND SALES TREND: It should be noted that as a research-oriented company the current revenues and earnings may not be the most important indicators of value. In addition revenues have been somewhat volatile due to timing issues and earnings are quite volatile due to revenue timing plus varying levels of grant funding and FX impacts. For the full year 2022 revenues per share were up 10%. Unfortunately, revenues per share have recently plummeted. In the most recent four quarters starting with Q3 2023 and going back the decline has been 32%, 66%!, 43% and 6%. It may be that customers stocked in the first half of 2022. Earnings per share were up 31% in 2022 but earnings turned negative in the latest four quarters. In Q1 2023 earnings were negative partly due to a sharp increase in general and administration expenses due to some director stock options and a some unusual legal fees. In Q2 and Q3, lower revenues along with higher costs and unusually high legal fees led to losses. Earnings per share had been small and fluctuated around zero but did increase sharply in 2020 to a reasonably attractive level and increased an additional 19% in 2021 and were up 31% in 2022 but then turned negative in the past four quarters. Overall, the revenue and earnings trend is now extremely negative. | |
| COMPARABLE STORE SALES OR INDUSTRY SPECIFIC STATISTICS: Not applicable | |
| Earnings Growth Scenario and Justifiable P/E: With negative profits in the trailing year and plunging revenues earnings provide no guidance to valuation at this time. | |
| VALUE RATIOS: Analysed at a share price of $0.44. As a research oriented company, value ratios provide only limited guidance and in theory understate the value. After several years of GAAP losses, the company was nicely profitable in 2020 and again in 2021 and 2022 but has now reported losses in the last four quarters along with plunging revenues. It could be argued that (most of) its research and development expenses are actually creating valuable assets and therefore are more in the nature of investments than expenses – however that research never seems to payoff despite many years of promises. The P/E is now negative as is the ROE! The price to book value ratio is, in isolation, quite attractive at 0.42 particularly considering its cash which amounts to 15 cents per share or close to the current share price. There is no dividend. Overall the value ratios indicate a highly speculative company. The price to book value ratio is the only attractive ratio. | |
| TAXATION FOR SHARE OWNERS: Nothing unusual to note. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | CZO.V, Toronto Venture |
| Currency: | $ Canadian |
| Contact: | czo@jtcir.com |
| Web-site: | www.ceapro.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $11.3 |
| Latest four quarters annual earnings $ millions: | $(2.8) |
| P/E ratio based on latest four quarters earnings: | negative |
| Latest four quarters annual earnings, adjusted, $ millions: | $(1.7) |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Starting 2019 added back 75% of other income or expense which is mostly foreign exchange gains / losses Previously added back 75% (assumes 25% income tax) of plant relocations costs and foreign exchange losses or gains also deducted large periodic tax credits. Deducted a large income tax recovery in 2015. In 2018 adjusted for a gain on litigation settlement and gains on deferred taxes. Starting 2021 we are usually no longer making any adjustments because the earnings are inherently volatile and there is no real value to making adjustments. Unusual legal costs are added back in 2023. These were likely associated with a proposed merger. | |
| Quality of Earnings Measurement and Persistence: Adjusted earnings have been volatile and positive in 2022 but then turned negative in the latest four quarters. Earnings may be under-stated due to the expensing of research and development. Non-refundable government grants are in some ways equivalent to earnings but are mostly accounted for as a reduction of capital costs or a reduction of research expenses. Cash flows in the past exceeded the earnings due the amortization of equipment and leasehold improvements as well as due to deferred income taxes in 2022. | |
| P/E ratio based on latest four quarters earnings, adjusted | negative |
| Latest fiscal year annual earnings: | $4.4 |
| P/E ratio based on latest fiscal year earnings: | 2.8 |
| Fiscal earnings adjusted: | $4.4 |
| P/E ratio for fiscal earnings adjusted: | 2.8 |
| Latest four quarters profit as percent of sales | -14.9% |
| Dividend Yield: | 0.0% |
| Price / Sales Ratio | 1.11 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.42 |
| Balance Sheet: (as of Q1 2022) Assets are composed as follows: 53% is property and equipment (of which 36% is leasehold improvements and 37% is manufacturing equipment, 11% is equipment not available for use, and 14% is buildings but probably capitalised lease on buildings) , 27% cash, 13% receivables, 5% inventory, 1% prepaid expenses and 2% a longer term investment tax credit receivables. The assets are financed as follows: 90% by equity (of which 27% is retained earnings and 73% is equity raised by selling shares), 8% by capitalized lease liability, and 2% by accounts payable, 1% deferred taxes. This is a strong balance sheet with no debt which means that the company is very unlikely to be in any financial difficulty in the foreseeable future. | |
| Quality of Net Assets (Book Equity Value) With the company trading at 0.4 times book value (as of January 26, 2024) the quality of the assets or their realizable value could potentially provide support to the share price independently of earnings. Given the cash, receivables and inventory the assets do provide good support for the share price at this point. | |
| Number of Diluted common shares in millions: | 78.3 |
| Controlling Shareholder: No person or company owns as much as 10% of the shares and therefore the company is likely effectively controlled by management. | |
| Market Equity Capitalization (Value) $ millions: | $12.5 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 88.3% |
| Interest-bearing debt as a percentage of common equity | 0% |
| Current assets / current liabilities: | 11.0 |
| Liquidity and capital structure: Strong. The company now has no debt. And its cash position is strong. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | -5.4% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 14.8% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | -13.4% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 6.9% |
| Volatility of sales growth per share: | Volatile |
| 5 Years compounded growth in earnings/share | negative past earnings |
| 5 years compounded growth in adjusted earnings per share | 33.8% |
| Volatility of earnings growth: | Volatile |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | No |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 14.8% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 5.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 12.0% |
| OUTLOOK AND AMBITIONS FOR BUSINESS: The potential merger with Aeterna has clouded the outlook greatly. Also, the outlook for the existing base business which has been profitable has recently become quite clouded due to a huge revenue decline in the past three quarters. In the medium to longer term the company expects to benefit from new products under development. It also has patents on a processing technology that it could potentially license out. It’s not clear that revenue will flow from these efforts anytime soon. However, it is possible that they would generate cash through joint venturing on the developments in some cases. Overall the near-term the outlook is for continued modest profits unless some kind of licencing deal emerges to boost earnings. | |
| LONG TERM PREDICTABILITY: Given the technologies and development risks involved, this is not a predictable company. | |
| Estimated present value per share: As this is an early-stage growth company it does not seem appropriate to attempt to forecast earnings. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (pass due to the science required) No issues with powerful suppliers (pass). No issues with dependence on powerful customers (fail as sales are over 90% to one key wholesaler who then sells to dozens of customers), No potential for substitute products (marginal pass) No tendency to compete ruinously on price (pass). Overall this industry (the base business) appears to be attractive to a successful incumbent in the industry – although the huge reliance on one wholesale customer is a definite concern.. | |
| COMPETITIVE ADVANTAGE: Ceapro has certain proprietary processes and intellectual property, some or all of which are protected by patents. We had understood that in some or most of its products it is the sole commercial provider. That assumption has come into question give the revenue decline in 2023. | |
| COMPETITIVE POSITION: We did not see any information or discussion regarding its competitors or its market share. They have claimed they are the only supplier of some of their products. (Lately with their revenue plunge that is coming into question) | |
| RECENT EVENTS: In a VERY big development, the company is proposing a merger with TSX- and NASDAQ- listed Aerterna Zentaris. Ceapro would become a subsidiary of that company and existing Ceapro shareholders would own 50% of Aeterna. The company explored but abandoned some kind of significant business opportunity in Q1 of 2023 but it was not clear what this was. In Q3 they mentioned they had canceled an engagement with an international consulting firm and that may be what the referred to in Q1. It appears that they may no longer be receiving government grants. In late April 2023 they announced the hiring of a Senior V.P. technical Operations which was indicated to be in part in preparation for commercialization of some of the companies research efforts. In 2022 they appointed a chief revenue officer which could mean that some progress in terms of licencing revenue is more imminent. The company continues to work on various product development initiatives involving scientific research and clinical trials. Unfortunately despite several potential products, nothing appears to be imminent at all. In the 2021 Management Discussion and Analysis there was almost no discussion of the outlook for its various research efforts. As of Q1 2023 there is jargon-filled discussion of progress on various research fronts but no clarity on when any revenue will result which appears to be at least 18 months away unless a licencing deal occurs. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Overall the disclosure is quite poor. In Q3 2023 they gave what looked like an implausible reason for the big revenue decline blaming it on a lack of orders from a Chinese customer but only 9% of their sales are to China! They announced that the GM “of their subsidiary” had retired with no explanation of what part of the business they referred to. The company tends to use excessive jargon in its reports as opposed to even attempting to use plain language. Due to accounting rules and the nature of the business there are some complexities in the accounting which make the net earnings a less reliable figure than usual. On the one hand, earnings may be under-stated due to the expensing of research and development that is intended to benefit future earnings (it arguably creates an asset). We were impressed with the candid disclosure of government funding. However this government funding causes the asset values to be lower than their true cost and in our view lowers the book equity and increases the reported ROE (when there are profits). Grants are netted against the R&D expense which obscures the level of those expenses. The company should probably report in U.S. dollars since its revenues are largely in U.S. dollars. And the disclosure of the results and especially the potential of its various research efforts seems poor. | |
| COMMON SHARE STRUCTURE USED: Normal, one vote per share. | |
| MANAGEMENT QUALITY: Management appears to be high quality in terms of the science involved and also in terms of having built up cash and a strong balance sheet. Whether they have the skills to commercialise the science efforts remains to be seen and is looking increasingly doubtful. | |
| Capital Allocation Skills: This remains to be seen. The determining factor will be how its investments in research pay off. The 2017 acquisition of “Juvente” appears to be a mistake given that in Q4 2018 it wrote off approximately the entire amount it paid. The assets acquired were almost entirely intangible plus a small amount of inventory. Sales from the division since 2018 have been very modest. The company downplayed the write-off as “non-cash” – and still believes the subsidiary is valuable. Yet it indicated in 2021 that the division is immaterial. | |
| EXECUTIVE COMPENSATION: (Based on 2022 figures released in Spring of 2023) The CEO’s compensation is arguably relatively high at $0.56 million for the past two years. The CFO’s compensation is reasonable at $0.2 million for those years. The CEO’s salary was paid to his corporation as a consulting fee which is unusual and may have been an attempt to avoid or defer personal income tax. It is disturbing that the company would agree to this. There are only these two named executives. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. (Based on the Spring 2021 circular) The six directors appear to be highly educated including relevant technical education as well as financial education and knowledge. Two longer-standing directors own 1.1 to 1.7 million shares each. The other two long-standing directors hold 102,000 and 78,000 shares respectively. Two newer directors elected in 2022 have not bothered to purchase any shares. Overall this appears to be a strong Board of directors. However, they may not be aggressive enough in seeking better results for the company. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
| © Copyright: InvestorsFriend Inc. 1999 – 2024. All rights to format and content are reserved. | |
Melcor REIT report
Melcor Real Estate Investment Trust
The top line, in green is the book value per unit. Ignore the initial higher value in 2014, it is not correct due to reasons related to the start up of the REIT that year. Since 2014 the book value per share has been declining somewhat due to market value losses on buildings due to the past recession conditions in Alberta and partly due to issuing units below book value. The 2020 decline in market values and therefore book value is due to the virus situation which led to market value declines on buildings. More recently in 2022 and 2023 the higher interest rates caused a modest decline in the calculated value of their buildings and this could certainly get worse or could have been worse as it depends on assumptions. Also the very high payout ratios of REITs always limits growth in book value.
Revenue per unit (the red line) has been relatively stable. Adjusted earnings which uses management’s figure for adjusted funds from operations has declined due to a combination of slightly higher vacancy rates (now more stable) and lower lease rental rates on renewals, and higher tenant incentives, all due to the past recession conditions in Alberta and also perhaps partly due to issues of units on a non-accretive basis. The adjusted earnings decline in 2020 was due to bad debt and rent forgiveness related to the virus situation. This improved substantially in 2021 and there was an extra increase due to a large lease termination fee. Earnings per unit (adjusted AFFO)declined 14% in 2022 due to higher expenses for utilities, professional fees, normalized capital expenditures and normalized tenant incentives and leasing commissions. There was an additional 12% decline in earnings per unit (adjusted AFFO) in 2023 mostly due to higher tenant incentive & leasing costs and higher interest rates.
The blue GAAP earnings per share line is totally meaningless due to IFRS accounting that (among other problems) treats the estimated gain or loss in market values of buildings as a current income or expense item (unlike traditional accounting did).There are also other market value gains and losses that come into income including large impacts related to the unit price.
| Melcor Real Estate Investment Trust (MR.UN, Toronto) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) do hold shares |
| Based on financials from: | Dec ’23 Y.E. |
| Last updated: | March 6, 2024 |
| Share Price At Date of Last Update: | $ 2.60 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Speculative Buy at $2.60 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | No |
| Has Wonderful Economics? | No |
| Has Excellent and Trustworthy Management? | Marginal |
| Likely to grow earnings per share at an attractive rate over the next decade? | No |
| Positive near-term earnings outlook? | No |
| Valuation? | Attractive but risky |
| SUMMARY AND RATING: The graph shows a decline in adjusted earnings per share over the years. Revenues per unit have been flat which is problematic as some expenses rose. Book value per unit has declined somewhat. The Value ratios (based on past earnings and the balance sheet) would support a rating of Speculative Buy due to the units trading at just 28% of book value but tempered by the low 5.6% ROE. The near-term and medium-term outlook is quite negative in terms of earnings due to higher interest rates that will cause market value losses on buildings as well as higher interest payment costs. Other costs are also rising but occupancy stable. Related to that the Macro Environment for Real Estate in general is poor. Management quality appears to be fair at best and certainly not great. The problematic vacancy rates in Office as well as the sharply higher interest rates were external factors. The insider trading signal is neutral. The business of owning commercial real estate (in general and not specific to Alberta) should be a stable business with acceptable but relatively low returns in the long term. The 38 properties are a mix of attractive newer retail but also some older strip malls. Much of the office portfolio is old and higher vacancies are a possibility as leases come to an end although renewals have been strong to date. The distribution has been suspended while the REIT undertakes a strategic review. There’s no guarantee but I suspect the review will be either neutral or noticeable beneficial to the unit price (currently $2.60). Overall, we now rate this as a Speculative Buy at $2.60. | |
| MACRO ENVIRONMENT: The recent sharply higher interest rates are very problematic. As of Q4 2023 only relatively modest market value losses have been booked and there could be more coming. Real Estate in general is now unpopular with investors due to higher interest rates. The outlook for office properties remains weak. The Alberta economy appears to be relatively strong and has seen significant population growth due to immigration. | |
| LONG TERM VALUE CREATION: (Updated Q4 2023) This REIT began trading eleven years ago in the Spring of 2013 with an IPO price of $10. The timing was not ideal given the recession in Alberta caused by sharply lower oil prices starting in 2014. It had paid an attractive yield of 6.75% annually on the $10 investment (but the distribution was temporarily reduced to 3.6% of that $10 IPO price and then partly restored to 4.8% and now has been suspended). But the market value of the units at $2.60 is well below book value and the unit price is about 74% below the IPO price. Therefore, to date, the REIT has provided a negative and very poor return for the IPO unit holders considering the distributions received minus the huge capital loss in the unit value. | |
| DESCRIPTION OF BUSINESS: (As of end of 2023) This Real Estate Investment Trust represents a 45% minority equity ownership in 38 income-producing (office, retail and some industrial) properties. The gross leasable area is 3.15 million square feet. All management and staff is effectively contracted out (mostly or entirely to the related majority 55% equity owner, Melcor Developments). The entity has no employees other than it appears the CEO and the part-time CFO who is shared with Melcor Developments. The Net rental income (for 2023) is 30% from office properties (20 buildings of low to medium rise largely in Alberta and with a concentration in Edmonton, some or most of these buildings are quite dated), 60% from retail properties (14 properties including 6 newer multi-building power centers and seven older neighbourhood shopping centers and one large Staples store/distribution center), 7% from 3 industrial properties and 2.4% from a land lease community (trailer home park). The office properties are 49% of the square footage but only 30% of net revenue and this appears to be due mostly to lower rent but partly due to higher vacancy. Geographically, 57% of the properties by net rental income are in Northern Alberta (Edmonton area plus Red Deer and Grande Prairie), 35% are in Southern Alberta (Calgary area plus Lethbridge) and 8% in Kelowna and Regina (which are now for sale). The majority of the office properties are older and less desirable buildings. The largest tenant is the government of Alberta at 5.8% of rent including health services with 8 locations in total. Tenants include (3 Shoppers Drugmart locations, 4 Royal bank branches, 3 Staples, 2 Ronas, 4 Canadian Brewhouse locations and 2 Michaels. | |
| ECONOMICS OF THE BUSINESS: This business generally provides relatively low returns (even with the use of substantial debt leverage) but the return is generally reasonably stable and reliable. We will assume that Adjusted Funds From Operations is a fair representation of the adjusted or economic earnings. On that basis the return on equity is quite modest at 5.6% as of the end of 2023 and appears to be heading lower. That is not an attractive return given the recent returns available of fixed income which rose sharply since the start of 2022. The business is heavily tied to the strength of the commercial business conditions in Alberta including vacancy rates in competing properties and the valuation is heavily affected by interest rates. | |
| RISKS: The biggest risks as of March 2024 are the ability to renew debt and the significant impact of higher interest rates. Profit is also likely to be pressured by higher utility costs. Market value losses on buildings are a definite risk due to higher interest rates and profit will also be impacted by higher interest rates, as well as other cost increases. It’s always possible that REITs could become subject to income tax like other businesses at some point. Another big risk is the outcome of the strategic review. It was meant to improve unit holder value so the output seems likely to be neutral (nothing comes of it) to positive (something good comes of it). | |
| INSIDER TRADING / INSIDER HOLDING: (Based on March 1, 2023 to March 6, 2024) The senior V.P. of investment properties, Randy Ferguson bought added a modest 250 units in March 2023 at $5.25 to hold a modest 775 units. Guy Pelletier, a Melcor Developments V.P. sold units at $4.60 in May 2023 to hold none. He also has a history of selling Melcor Development shares. Overall the insider trading signal is weak and could be considered neutral with one buyer and one seller. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (pass as the ownership of commercial office and retail rental property is a simple business especially for this REIT which is a pure ownership vehicle with management contracted out) has favorable long-term economics due to cost advantages or superior brand power (marginal pass as it is affiliated with a developer of properties that it can purchase at a slight discount but this is fundamentally usually a low return business), apparently able and trustworthy management (pass given their long-term record at Melcor Developments), a sensible price – below its intrinsic value (pass), Other criteria that have been attributed to Buffett include: a low debt ratio (fail, the debt level is a concern), good recent profit history (fail) little chance of permanent loss of the investors capital (probable pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) | |
| MOST RECENT EARNINGS AND SALES TREND: Revenues per unit in the past four quarters starting with the most recent, being Q4 2023 have been very flat at down 1.6%, up 0.5%. down 0.2%,and up 0.2% and up 1.5%. In 2023 overall, revenues per unit were about unchanged. In 2022 overall, revenues per unit were unchanged. In 2021 overall, revenues per unit were down 0.4%. Adjusted earnings (AFFO) per unit in the past four quarters were up 1%, down 13%, down 6%, and down 25%. The figure for the full year 2023 was down 12% and for 2022 was down 14% and was up 11% in 2021 compared to the pandemic year of 2020 and assisted by a lease termination fee. The recent adjusted earnings trend (AFFO) is therefore quite negative primarily due higher tenant incentive and leasing costs, higher interest costs and higher normalized capital expenditures. | |
| INDUSTRY SPECIFIC STATISTICS: As of Q4 2023, the occupancy level is 87.6% down from 88.9 at Q3 and relatively flat in the past three years. This is significantly down from the 92.7% level of Q2 2017. Occupancy continues to be somewhat weak mostly due to a weak demand for its office space. But things are improving and the committed occupancy is 89% which is down from 91% indicated as of Q3.. | |
| Earnings Growth Scenario and Justifiable P/E: The trailing adjusted earnings P/E of 4.7 is apparently pricing in no growth but rather a decrease in earnings – which is very possible due to higher interest rates and inflation in other expenses. | |
| VALUE RATIOS: Based on a unit price of $2.60. Their is do yield as the distribution has been suspended due to a hopefully temporary cash crunch. The price to book value is calculated as just 0.28 and 0.72 on an enterprise (debt plus equity) basis. Our price to book value is calculated to include Melcor Development’s ownership. Note that the adjusted earnings is based on management’s view of adjusted funds from operations – which does appear to us to be a reasonable view of “true” earnings. The adjusted trailing P/E ratio appears very attractive (in isolation) at 5.0. The ROE is low and inadequate at 5.6%. The value ratios would support a Buy rating based on these trailing figures but note the concerns under outlook. | |
| TAXATION: With the distribution suspended only capital gains and loss tax impacts apply at this point. REITS do not qualify for the Canadian dividend tax credit. REIT distributions can be fully taxable as regular income or part of the distribution can be considered as a capital gain or as a return of capital. In the case of the MELCOR REIT, there has been a changing mix in how the distribution has been classified. On average more than half has been classified as return of capital. This creates some complexity for investors including tracking their adjusted cost basis. Holding these units in non-taxable accounts eliminates that complexity. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | MR.UN, Toronto |
| Currency: | $ Canadian |
| Contact: | ir@melcorreit.ca |
| Web-site: | www.melcorreit.ca |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $73.9 |
| Latest four quarters annual earnings $ millions: | $16.3 |
| P/E ratio based on latest four quarters earnings: | 4.6 |
| Latest four quarters annual earnings, adjusted, $ millions: | $15.2 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Uses management’s view of adjusted funds from operations. This appears somewhat conservative by deducting “straight line rent” accrual and possibly by deducting normalized capital expenditures which we understand are mostly recovered from tenants as part of recoverable operating expenses. | |
| Quality of Earnings Measurement and Persistence: The adjusted earnings figure appears to be reasonably measured. | |
| P/E ratio based on latest four quarters earnings, adjusted | 5.0 |
| Latest fiscal year annual earnings: | $16.3 |
| P/E ratio based on latest fiscal year earnings: | 4.6 |
| Fiscal earnings adjusted: | $15.2 |
| P/E ratio for fiscal earnings adjusted: | 5.0 |
| Latest four quarters profit as percent of sales | 20.5% |
| Dividend Yield: | 0.0% |
| Price / Sales Ratio | 1.02 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.28 |
| Balance Sheet: (As of Q4 2024) Assets consist largely (90%) of investment properties. Plus another 5% representing 3 properties held for sale. These assets are valued at their estimated and modeled market value which is based on the value of expected future cash flows discounted at a market-based capitalization rate. An additional 4% are investments in tenant inducements (free leasehold improvements) and investments in lower rents in the early stages of rental contracts. The remaining 1% is mostly cash and short-term receivables and pre-paid amounts. It is essential to note and understand that the investment properties have been “marked” to recent modeled market value based on (as we understand it) the rental income less operating costs multiplied by an assumed market multiple that is typically paid to acquire net rental revenue. Or based on a forecast of future net rents and a terminal value discounted to present value. It is important to understand that the calculated (estimated) value of the properties changes (at least) annually and is subject to possible significant decline if the rents decrease due to vacancy or the market multiples or discount rates change due to factors including higher interest rates. This modeled market value may be higher than the actual price which could be obtained in the market especially at short notice. The original costs to construct and later improve the properties is not disclosed. These assets are financed as follows: 58% by debt, 38% by equity and the remaining 4% by tenant deposits and other minor liabilities. This is a somewhat weak balance sheet although it is supported by relatively reliable cash flows. | |
| Quality of Net Assets (Book Equity Value) Measurement: For this owner of commercial properties, the book value per share is an important valuation number. The book value of equity is subject to the estimated value of the buildings which itself is subject to changes with market conditions including interest rates, vacancy rates on the properties and vacancy rates on competing properties (which affect market rental rates). Such changes are then amplified by debt that is 1.5 times larger than the equity level. Overall, the book value per share is likely somewhat exaggerated as market value losses due to the recent higher interest rates have probably not yet been fully reflected. | |
| Number of Diluted common shares in millions: | 29.1 |
| Controlling Shareholder: The REIT is controlled by Melcor Developments which, in substance, owns about 55% of the REIT units. Melcor in turn is controlled by the Melton family. | |
| Market Equity Capitalization (Value) $ millions: | $75.6 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 38.0% |
| Interest-bearing debt as a percentage of common equity | 153% |
| Current assets / current liabilities: | 0.3 |
| Liquidity and capital structure: Liquidity is very poor at this time. The REIT does not keep much cash on hand and so it is to a very good degree dependent on the kindness of its lenders. Melcor reports that lenders are cautious. A very significant amount of debt is due for renewal in the next two years. Management tells me that they CAN renew debt and the rates are not terrible. But they are unable to add to their debt even if needed. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 5.6% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 5.6% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 20.1% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 0.3% |
| Volatility of sales growth per share: | Stable |
| 5 Years compounded growth in earnings/share | -1.7% |
| 5 years compounded growth in adjusted earnings per share | -5.2% |
| Volatility of earnings growth: | Modest decline |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | No |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 5.6% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | -3.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 0.0% |
| OUTLOOK AND AMBITIONS FOR BUSINESS: There may be additional material market value losses on properties due to sharply higher interest rates. The average cap rate (which is a large determinant of building values) has increased only from 6.65% at the end of 2021 to 7.24% which could be a very inadequate increase given the sharp rise in interest rates. The outlook as of early March 2024 is for revenue per unit decreases as they sell assets to improve the balance sheet. The Alberta economy is relatively strong. But rent increases on retail properties could be offset by vacancies and/or lower rents on office properties plus the impacts of sold properties. Profit will be significantly impacted by higher interest rates on renewing debt in 2024 and recent renewals. Profit is also being negatively impacted by higher utility and admin costs. The normalized capex and tenant incentives have also increased in 2023 but may not increase any further in 2024. Overall, it seems very likely that adjusted earnings will decline further in 2024 . The outcome of the strategic review is very uncertain but could potentially lead to a higher unit price if the entire REIT is sold. The distribution may or may not be reinstated at some level by the end of 2024. | |
| LONG TERM PREDICTABILITY: For the next several years the predictability of cashflows appears to be threatened by higher interest rates. The predictability also depends to a large extent on the predictability of the Alberta commercial economy – but that appears to be strong. The REIT’s prospects also depend heavily on the level of surplus office and retail space that may develop near its buildings. There is some risk that older less desirable office space could face even higher vacancies as leases come to an end. The REIT believes it will eventually grow significantly due to purchasing buildings from Melcor Developments as Melcor constructs them (via contractors) and leases them up. But that prospect appears to be threatened now by the higher interest rates. | |
| Estimated present value per share: This calculation uses adjusted funds from operations (AFFO) per unit as the adjusted earnings figure. The future level of AFFO is very uncertain due to higher interest rates and higher costs. We calculate $2.56 if earnings per share (AFFO) shrink or 5 years at an average of 3% and the shares are then sold at a higher P/E of 8. And $4.46 if earnings per share (AFFO) remain flat and unchanged in 5 years and the shares are then sold at a P/E of 12. (This is not a share price prediction). In theory there should be growth if the distribution is not reinstated. This calculation assumes no distribution. Both estimates use a 7.0% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (marginal pass at best, there are few barriers to those wishing to purchase commercial rental property, however there may be little ability for anyone to construct new retail space at basically the same location as the REITs retail properties.). No issues with powerful suppliers (pass, as there are many buildings to be bought and many lenders). No issues with dependence on powerful customers (pass as there are many different tenants), No potential for substitute products (pass, space is needed – except that we have learned that office space may be replaced by work at home) No tendency to compete ruinously on price (fail as companies will tend to reduce rents very aggressively in times of surplus space given the fixed cost nature of the buildings). Overall this industry, based on these characteristics does not appear to be a particularly attractive industry even for established incumbents although it can be attractive when there is no surplus of rental space in the market. | |
| COMPETITIVE ADVANTAGE: Melcor REIT has the advantage of first access to properties developed by Melcor Developments. Because Melcor Developments avoids capital gains taxes on the sale to an affiliate and avoids real estate fees, it sells the properties to the REIT at a modest discount of 2 to 4%. It also has access to the economies of scale of Melcor Developments. This is not of any relevance as of 2023 and 2024 because the REIT is in no position to make any purchases. It likely has no particular advantages in attempting to market its space although it claims to provide superior service to tenants resulting in being a landlord of choice. | |
| COMPETITIVE POSITION: The Melcor REIT is a small player in a large and fragmented market. However, since property locations, especially retail locations, are not interchangeable, the REIT is not necessarily in a weak competitive position. But it has a weak balance sheet and a weak ability to access capital. And it is in a weaker position regarding Edmonton office properties (which are mostly in older buildings) since office tenants can move more easily than retail tenants. And the Edmonton office rental market is weak due to industry vacancies. | |
| RECENT EVENTS: The distribution has been suspended while the REIT undertakes a strategic review. Interest rates on debt have increased substantially and will continue to do so with upcoming debt renewals. Early in 2023 they renewed one mortgage at 5.69%. In Q3 renewed a small mortgage at 6.97% and three mortgages at (a hefty) 8.01%. There are significant renewals coming up in 2024 plus a large convertible bond due at the end of 2024. Tenant renewal incentives and leasing commissions have increased substantially. They currently have three strip mall centers for sale in Saskatchewan and are now looking to sell an office building in Kelowna and one in Lethbridge Alberta. They are doing this to reduce debt. In early 2023 they sold a building in Kelowna for $19.5 million and this was a market value gain of $4.3 million booked in 2022 and offsetting other market value losses. This was a good sign in terms of the true value of its assets but may have been very specific to Kelowna. In 2022 they recorded $16.3 million in modeled market value losses on other buildings for a net loss of $12 million. This was a modest loss given the interest rate hikes in 2022. The pandemic had led them to reduce the cash distribution per unit by 47% in 2020 in order to conserve cash. In early 2021 this was partly restored and then further restored in mid-2021 but the distribution remains 29% below the previous level. There was significant market value losses on properties in the past couple of years mostly due to more office space coming available in Edmonton which put some downward pressure on rental rates and also due to some increases in capitalization rates used in valuation. | |
| ACCOUNTING AND DISCLOSURE ISSUES: It appears that fair value changes on derivatives related to floating to fixed swaps and to the conversion option on debentures are now material adding to complexity. Accounting rules (which are no fault of the REIT) create some accounting complexities. The GAAP earnings figure is rendered completely meaningless due to the requirement to include the (modeled) market value changes of the properties in earnings, the lack of a depreciation expense, and the requirement to treat Melcor Development’s 55% ownership as a liability on the balance sheet and value the liability based on the unit price and to include the change in such valuation in GAAP earnings. In fact the GAAP earnings figure should be an embarrassment to the accounting regulator. Management appears to provide a reasonable figure to use as adjusted earnings which they refer to as adjusted funds from operations. This figure removes the impacts of changes in the market value of properties and the unit price and does include a deduction for normalized capital expenditures and normalized tenant incentives and leasing costs. The GAAP figure for book value per unit is also rendered meaningless by the accounting for Melcor’s ownership as a liability. We correct for this by treating that ownership as equity. In terms of disclosure we would like to see the age of the properties and the original dollars invested in each property since and including its construction or purchase by Melcor. Normally a REIT avoids income tax by distributing all of its taxable earnings. For 2022 the REIT had a gain for income tax purposes allocated to unit holders. For 2021, the REIT had a loss for income tax purposes probably due to Capital cost allowance. It appears there was a gain allocated to unit holders in 2020. Also a loss for income tax purposes each year back to 2017. There was a taxable income in 2016 and a large taxable loss in 2015. | |
| COMMON SHARE STRUCTURE USED: Generally normal, one vote per unit. But Melcor Developments the majority owner does have some special voting rights. | |
| MANAGEMENT QUALITY: Management appears to be somewhat weak. They may have been less than conservative through (arguably) an over-reliance on debt and lack of retained earnings although this is partly due to the rules by which REITs avoid income tax and partly due to investor expectations regarding REITs. | |
| Capital Allocation Skills: This remains to be seen. | |
| EXECUTIVE COMPENSATION: Technically, the REIT does not have any direct employees. The compensation for the two officers is from Melcor Developments and the REIT contributes to this indirectly through its management fee to Melcor Development. Compensation may be on the high side given the very weak performance. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. There are Seven Trustees. Three are Melcor Development appointees. All are well qualified. The independence of this Board has been improved in recent years. However, two Board members departed as of March 5 and replacements have not yet been named. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
| © Copyright: InvestorsFriend Inc. 1999 – 2024. All rights to format and content are reserved. | |
Royal Bank of Canada Stock Report
Royal Bank’s revenue per share (the red line) has grown at a relatively steady rate over the years, increasing at a compounded average of 5.8% per year in the period shown. Earnings per share (the blue line) increased at a higher compounded average of 7.0% per year. Book value per share has increased very steadily at a compounded average of 9.3% per year. These increases were achieved despite paying out roughly half of annual earnings in cash dividends. The earnings spike in 2021 was boosted by a reversal of expected loan losses booked in 2020 that did not materialize. But it’s also do to higher than normal business growth in 2021. Earnings growth in 2022 was only 1% because of the earnings spike in 2021. Earnings were flat in 2023 partly due to higher loan losses.
| Royal Bank of Canada (RY, Toronto and U.S.) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold shares |
| Based on financials from: | Oct. ’23 Y.E. +Q2 ’24 |
| Last updated: | June 8, 2024 |
| Share Price At Date of Last Update: | $ 146.35 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | (lower) Buy rated at $146.35 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Yes! |
| Has Wonderful Economics? | Yes |
| Has Excellent and Trustworthy Management? | Yes |
| Likely to grow earnings per share at an attractive rate over the next decade? | Yes |
| Positive near-term earnings outlook? | Probably not given loan losses and possible recession |
| Valuation? | Neutral |
| SUMMARY AND RATING: The graph of revenues per share (red line) shows strong and relatively steady historic growth but flat earnings in the past couple of years. The earnings per share line shows quite strong growth over the years but with an earnings decline in 2020 primarily due to estimated loan losses caused by the pandemic. The losses did not materialise and were reversed in 2021 causing the 2021 earnings to be artificially high but earnings were maintained at that level in 2022 and 2023. The Value ratios would support a rating of Buy to (higher) Buy. Management quality appears strong. The insider trading signal is neutral. Executive compensation is high but not a concern given the size of this bank. The outlook is uncertain given that the latest quarter was quite strong but loan losses are increasing and a recession seems probable. RBC has strong economics and some strong competitive advantages in terms of its scale and established market position. It appears to be a business that can reliably predicted to continue to grow over the years. RBC, however (like all banks) is highly leveraged and therefore there is some small risk of very major problems in certain scenarios. There are also potential risks associated with possible lower housing prices, recession and mark to market losses on some investments. Overall RBC is a consistent money maker but achieves this with high leverage which is managed through a finely tuned risk management system. Overall we would rate this as a (lower) Buy at this time. | |
| MACRO ENVIROMENT: The huge increase in interest rates has pushed up their interest income and their interest expense massively. But net interest margin is up more modestly. The impact of higher interest rates on loan losses remains to be seen. The projected 2023 mild recession is a headwind. | |
| LONG TERM VALUE CREATION: Royal Bank has created excellent value in the long term. | |
| DESCRIPTION OF BUSINESS: Last updated Q4, 2023 and Q2 2024 . Royal Bank of Canada is the country’s largest bank with assets of $2.03 trillion dollars, a common equity market cap of $207 billion dollars, 1247 bank branches, 4341 automated teller machines and 94,000 employees in 29 countries. Earnings by segment as of Q2 2024 were 53% from personal and commercial banking (in Canada, the U.S. and the Caribbean) [And 68% of the revenue in this personal & commercial segment is Canadian personal banking] , 28% from capital markets (includes equity and debt origination and distribution, and structuring and trading), 14% from wealth management – down from 20% in 2019 (mainly Canada, the U.S., the U.K, the channel islands and Asia), 5% from insurance (In Canada and reinsurance outside Canada). The return on equity for personal and commercial banking is reported at a stunningly profitable 28% and this high level has been sustained for years! (The high ROE is presumably due to massive leverage on CMHC mortgages as well as lucrative fees), 10% ROE for wealth management, 37% ROE for insurance (which seems extraordinarily high but might be explained by selling high margin insurance like life insurance on mortgages and by reinsurance which will likely occasionally have losses), and 15% ROE in capital markets (similar to the 13% of 2018). Overall corporate ROE was 14%. Based on 2017 figures Canada accounts for 61% of revenue, The U.S. accounts for 23% of revenue, International (37 countries) accounts for 17% of revenue. For 2019 (and 2018), 57% of revenue is from non-interest income (investment management fees, account service charges, foreign exchange fees and card fees, insurance, underwriting and trading) and 43% from net interest income. Interestingly, RBC has very little (only 5%) of its Personal and Commercial banking outside of Canada but its Wealth Management business in the U.S. is almost twice as large as its Canadian wealth management level. | |
| ECONOMICS OF THE BUSINESS: (Updated as of Q1 2023) RBC’s economics are strong. It does however like most banks depend on very high (even extraordinarily high) leverage. Its profit as a percent of revenue was recently 31%. However that translates into a profit on (ending) assets of only 0.83% as revenue is only 3% as large as the assets. This 0.83% return on ending assets was then leveraged up to 15.9% return on ending equity as ending common equity was only 524% as large as the assets (The common equity is extremely highly leveraged – which is typical for banks). The high ROE indicates that the economics of the business are very good but it is achieved through massive leverage which can be risky. The economics are also strong in that the business is of a recurring nature and the customers tend to be “sticky”. | |
| RISKS: See annual report for a full discussion of risks. Data breaches are a definite risk. New disruptive technologies are a possible risk. Banks always run the risk that borrowers will fail to pay their loans. This risk is increased by the very large leverage of most banks and of Royal Bank in particular. However, the bank has in place numerous and complex risk management strategies that are designed to prevent its risks from creating any major financial problems for the bank. Share owners must place their faith in management and its risk management abilities. RBC has operations in tax havens including the Caribbean, and (of more concern) the Channel islands and Luxemburg. It could face risks in that area if it is found to be helping customers evade income taxes. As of 2023 there are added risks in regard to bad loans due to borrowers struggling with higher interest rates and due to a projected mild recession. | |
| INSIDER TRADING / INSIDER HOLDING: Based on J April 1, 2022 to April 3, 2023: Insiders are shown buying fairly regularly “under a plan” but these purchases don’t give much of a signal since they are set up in advance. Four insiders, including the CEO, sold shares after exercising options. In two cases very substantial number of shares. Most insiders were holding and not selling (which is positive). Overall, the insider trading signal is about neutral. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (marginal pass because the various sectors and geographies make RBC more complex and particularly because it is very hard to judge the risk of this highly leveraged business), has favorable long-term economics due to cost advantages or superior brand power (pass due to scale and established history of high ROE achievement), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (marginal pass), Other criteria that have been attributed to Buffett include: a low debt ratio (arguably a fail given the massive leverage although that is not unusual in banking), good recent profit history (pass) little chance of permanent loss of the investors capital (pass – although with high leverage there is some risk) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass). | |
| MOST RECENT EARNINGS AND SALES TREND: The recent earnings growth is somewhat distorted by volatile swings in the allowance for credit losses which are NOT adjusted for in adjusted earnings. Banks strangely deduct interest expense in arriving at Revenue. Revenue per share growth in the past four quarters beginning with the most recent (Q2, 2024) was 12%, minus 1%, 0% and 7%. Adjusted earnings per share (affected by volatile estimates for credit losses) were up 9%, down 6.5%, down 5% and up 11%. In 2023, overall revenues per share were up 5% but adjusted earnings per share were unchanged. In 2022, overall revenues per share were flat while adjusted earnings per share were up just 1%. Overall, the recent earnings trend is very flat and it’s not year clear in the growth in the latest quarter will be sustained. Historic figures: In 2021 overall the earnings per share were up by a huge 42% but a large part of that was loan loss reversals and revenues per share were up 5.5%.. In 2020 overall, the earnings per share growth was a decline of 11% (mostly due to estimated pandemic loan losses) and revenue per share declined 2% partly due to lower interest margins. In 2019 overall, the earnings per share growth was 5% and revenue per share growth was 9%. In 2018 overall, the earnings per share growth was 13% (possibly boosted by the Trump tax cuts) and revenue per share growth was 6%. In 2017 overall, the earnings per share growth was 12% and revenue per share growth was 6%. | |
| INDUSTRY SPECIFIC STATISTICS: In Q2 2024, the provision form credit loss was 0.41%. For fiscal 2023, the provision for credit loss was 0.29%. For fiscal 2022, the provision for credit loss at 0.06% was abnormally low. For fiscal 2021 Provision for Credit Loss was negative 0.10% as they reversed loss estimates from 2020 which was a hefty 0.63% due to the pandemic and was sharp increase from 2019 at 0.31% and 2018 at 0.23%. Gross impaired loans at end of 2023 were 0.42% and as of Q2 2014 were 0.55% Gross Impaired Loans in 2022 were just 0.26% and in 2021 were 0.31% down from 0.47% in 2020 and 2019. Net interest margin in the personal and commercial sector in 2023 was 2.74%. Net Interest Margin on average earning assets was 1.50% in 2023 in 2022 was 1.48% and in 2021 was 1.28% down from 1.55% 2020 and continuing a downward trend as 2019 was 1.61% and 2018 was 1.64% on average earning assets. | |
| Earnings Growth Scenario and Justifiable P/E: With a dividend yield of 3.8%, and a P/E of 13.3% it is pricing in growth in the range of about 7%. | |
| VALUE RATIOS: Analysed at Canadian $146.35 (U.S. $106.39). The price to book value ratio at 1.85 is reasonably attractive considering the 14.6% ROE. The trailing P/E ratio is moderately attractive at 13.0. The dividend yield is reasonably attractive at 3.9% and amounts to a payout of 51% of earnings. The Return on equity is quite high at 14.6% BUT this is a decline from historic levels around 17%. Earnings per share have grown at a compounded average of 6.0% in the past five fiscal years and revenue per share has grown at a compounded average of 4.7% per year. This is good revenue growth considering that about half of earnings are paid out as dividends. We calculate the intrinsic value to be $124 per share if earnings can be expected to grow at 4% per year and the P/E declines to 10 and (more optimistically) $178 if earnings per share grow at 6% per year for five years and the P/E rises slightly to 14. These intrinsic value calculations use a required return of 7.0%. These value ratios support a rating of Buy to (higher) Buy. | |
| TAXATION: | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | Royal Bank of Canada |
| Currency: | $ Canadian |
| Contact: | invesrel@rbc.com |
| Web-site: | www.rbc.com/investorrelations |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $53,301.0 |
| Latest four quarters annual earnings $ millions: | $15,073.0 |
| P/E ratio based on latest four quarters earnings: | 13.6 |
| Latest four quarters annual earnings, adjusted, $ millions: | $15,784.0 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: For the most recent few periods we have used a new adjusted earnings figure provided by management. They likely started doing this because of an usual retroactive tax hit in Q1 2023. Prior to that we had not made any adjustments except for a gain on a sale in 2017 and 2016. Loan loss estimated can also be quite volatile but we did not adjust for that. | |
| Quality of Earnings Measurement and Persistence: Earnings measurement is probably of reasonably high quality but there are certainly some estimates involved such as for loan losses. Some mark to market changes in asset values flow to the net income. | |
| P/E ratio based on latest four quarters earnings, adjusted | 13.0 |
| Latest fiscal year annual earnings: | $14,369.0 |
| P/E ratio based on latest fiscal year earnings: | 14.3 |
| Fiscal earnings adjusted: | $15,586.0 |
| P/E ratio for fiscal earnings adjusted: | 13.2 |
| Latest four quarters profit as percent of sales | 29.6% |
| Dividend Yield: | 3.9% |
| Price / Sales Ratio | 3.86 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 1.85 |
| Balance Sheet: (Updated Q2, 2024) The composition of assets is as follows: 47% of assets are loans (of which 63% are categorized as retail and 37% as wholesale), 15% assets purchased under reverse repurchase agreements and securities borrowed (essentially short term secured lending and 93% of this is offset by assets sold under similar arrangements that appear to be like short-term deposits much of which are 1 to 6 month terms.), 20% securities – which would mostly pay a cash yield or interest so are like loans but highly liquid (42% of which are held for trading and 58% are held for investment), 6% derivatives (which appear to be mainly for risk management purposes and are fully offset by derivative liabilities), 5% “other” – which is mostly financial receivables and 5% cash and deposits with other banks, and less than 1% goodwill. Liabilities consist of 65% deposits (of which 38% are personal, 60% are business and government and 2% from other banks), 7% derivatives, 14% obligations for assets sold under repurchase agreements (essentially short-term borrowing or perhaps equivalent to a very short-term deposit where the “depositor” has security – the great majority of these are under 1 month.), 1.6% obligations related to securities sold short, 6% “other” – which is mostly financial payables of various kinds, 5.5% common equity, 0.7% subordinated debt and 0.5% preferred shares. In general the balance sheet shows some complexity in that loans are only 47% of assets (62% if assets purchased under repurchase agreements are treated as loans). Common equity at about 5.5% is very highly leveraged which is typical of banks. | |
| Quality of Net Assets (Book Equity Value) Measurement: It is difficult to judge the reliability of the net book value. Not all assets are marked to market and the leverage is so high that a small error in asset values could wipe out a large chunk of equity. On the other hand most of the assets are very liquid and a significant portion are marked to market. | |
| Number of Diluted common shares in millions: | 1,414.2 |
| Controlling Shareholder: No one is allowed to own more than 10% of the shares. | |
| Market Equity Capitalization (Value) $ millions: | $206,968.2 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 5.5% |
| Interest-bearing debt as a percentage of common equity | 12% |
| Current assets / current liabilities: | not revealed |
| Liquidity and capital structure: With common equity of only 5.2% of the asset level, the capital structure appears to be weak in that regard. But this is apparently typical for large banks. And, the assets are considered to be highly liquid and safe and credit rating agencies (S&P) rate the debt at A. On a risk-weighted basis and by bank standards it balance sheet is considered strong. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 14.6% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 14.8% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 7.6% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 4.7% |
| Volatility of sales growth per share: | strong, steady growth |
| 5 Years compounded growth in earnings/share | 4.3% |
| 5 years compounded growth in adjusted earnings per share | 6.0% |
| Volatility of earnings growth: | moderately volatile |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 7.3% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 4.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 6.0% |
| OUTLOOK AND AMBITIONS FOR BUSINESS: RBC’s earning assets have adjusted upwards very quickly with higher interest rates. The outlook is uncertain given that the latest quarter showed strong growth after two quarters of decline. Loan losses are still increasing and a recession seems likely. There is also possible headwinds in terms of mark to market losses on investments and loan losses on non-CHMC mortgages. The reinsurance business can occasionally lead to material losses. In general, the outlook for the near-term is uncertain. | |
| LONG TERM PREDICTABILITY: Royal Bank of Canada has been growing its assets and earnings per share for decades. It seems reasonable to assume that it can continue to grow with the economy. But it is possible though that newer technologies will disrupt banking leading to lower profits. Technology is allowing for big cost reductions as transactions become more and more digital and self-serve. | |
| Estimated present value per share: We calculate $106 if adjusted earnings per share grow for 5 years at the more conservative rate of 4% and the shares can then be sold at a P/E of 12 and $143 if adjusted earnings per share grow at the more optimistic rate of 8% for 5 years and the shares can then be sold at a HIGHER P/E of 14. An 8% growth might be quite doable since the 2020 base was depressed by the pandemic. Both estimates use a 6.0% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Pass, there are certainly barriers to achieving a large scale in banking since it is difficult to acquire customers although new entrants are emerging and could become a concern in future). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass), No potential for substitute products (pass) No tendency to compete ruinously on price (marginal pass – they may compete aggressively on some products but there are some parts of the business where there appears to be little price competition such as credit card rates and currency exchange rate fees.). Overall this industry appears to be attractive for an established large incumbent. | |
| COMPETITIVE ADVANTAGE: Size and scale are advantages. Customers find it inconvenient to switch banks and therefore having an established large market share is an advantage. They indicate that there are significant barriers to entry in the reinsurance part of their business. | |
| COMPETITIVE POSITION: Royal Bank is the largest Bank in Canada. In personal and commercial banking it is number 1 or 2 in all key product categories. It has a very strong competitive position in Canada and competes effectively in certain U.S. and European lines of business. | |
| RECENT EVENTS: Has just completed the $13.5 billion acquisition of HSBC Canada it’s largest acquisition ever (apparently bigger than the City National acquisition of several years ago). Also acquired a wealth management business in the U.K called Brewin Dolphin. Royal Bank, like the other big Canadian banks, rather suddenly has a significant 26% of mortgages with remaining amortizations over 35 years. This is due to floating rate mortgages with (temporarily) fixed payments and due to allowing customers to extend their mortgages to deal with higher rates. It appears (page 22 Q1 report) that most of these mortgages are uninsured. The recent huge increases in interest rates has led to a massive increase in their interest income and also a huge increase in interest expense. Provisions for credit losses became quite volatile with the pandemic and the recovery therefrom. Overall they continue to grow. | |
| ACCOUNTING AND DISCLOSURE ISSUES: The disclosure of large banks is voluminous. But we are always left with some questions. They measure revenue after deducting interest expense. In Q1 2023 we see mention that they have at least $95 billion in debt but we can’t find where it is on the balance sheet. They speak of trading revenues but it is often impossible to know if they refer to proprietary trading for their own account or merely collecting fees on customer trading activity, which is a vastly different thing. Net income is reported in a legal but misleading way. They fail to prominently show and focus the lower net income to common after deducting preferred share dividends and non-controlling interest. Accounting rules require gains on asset sales to be counted as revenue, which distorts the figure. Earnings are impacted by mark-to market changes in some assets and liabilities. Currency changes affect earnings. They did not show normalised earnings for the unusually high credit loss reserves in 2020 or the negative estimated loans losses in 2021 which would have been quite useful. | |
| COMMON SHARE STRUCTURE USED: Normal, one vote per share. | |
| MANAGEMENT QUALITY: Overall, the quality appears to be high. Listening to the CEO speak, he seemed to be a very able individual. He is very much focused on applying new technology to banking. Management indicates they are focused on Total Shareholder Return through performance over a 3 to 5 year period. This could be dangerous in that it could cause a focus on the share price rather than long-term earnings or could lead to excessive leverage in order to attempt to boost earnings. We do not have a strong opinion about management. We are somewhat concerned about why they were ever involved in Caribbean wealth management or (of more concern) operations in the Channel Islands and Luxemburg, which are known as tax havens but they do seem to be reducing their business in such tax havens. | |
| Capital Allocation Skills: Given the high ROEs in all of the various divisions of the Bank, capital allocation skills appear to be strong based on past results. | |
| EXECUTIVE COMPENSATION: Updated with April 2020 figures. Compensation is generous with the top five officers earning total compensation of $5 million to $14 million. Given the size of the bank and its earnings, this is not a concern. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. The Board members at RBC are well qualified. Most are independently relatively wealthy and hold more shares than the minimum target of $750k. A number of the members are quite recent and none have been in place since before 2005 and the average tenure is only about 5 years. We’d like to see a bit more continuity that that. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
| © Copyright: InvestorsFriend Inc. 1999 – 2024. All rights to format and content are reserved. | |
Utility Cost of Capital Presentation
PDF VersionClick the arrows on the presentation to move from slide to slide or click the PDF version.
This regulated (cost of service) utility cost of capital presentation is intended to be of use for:
Utility regulation Commission / Board panel members
Commission / Board staff members
Utility staff involved in regulated utility cost of capital matters
Customer representatives in utility rate cases
Question or comments can be sent to shawn@investorsfriend.com
Shawn Allen developed this presentation over a period of many years working in the field of regulated utility cost of capital.
The material in this presentation may be shared in any forum, with appropriate attribution to the source.
Topics include:
Definition of “capital” for regulated utilities and legal requirements for a fair return
How to determine the fair return on debt for regulated utilities
How to set the equity ratio for regulated utilities
How to set the fair return on equity for regulated cutilities
And additional topics
TFI International Stock Report
TFI International Inc.
This chart speaks for itself showing very strong growth.
| TFI International Inc. (TFII, Toronto) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold shares |
| Based on financials from: | Dec ’22 Y.E. +Q1 ’23 |
| Last updated: | May 9, 2023 |
| Share Price At Date of Last Update: | $ 141.57 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Buy at $141.57 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Yes |
| Has Wonderful Economics? | Yes, despite price competition |
| Has Excellent and Trustworthy Management? | Yes! |
| Likely to grow earnings per share at an attractive rate over the next decade? | Yes |
| Positive near-term earnings outlook? | No, due to current slow down |
| Valuation? | Attractively valued |
| SUMMARY AND RATING: The graph of revenues per share (red line) shows strong and steady growth. The adjusted earnings per share growth (purple line) has been very strong indeed. The Value ratios (looking backwards) would easily support a (higher)Buy rating. Management quality is very strong. The insider trading signal is neutral. Executive compensation does not seem excessive, although the CEO is very well compensated. The outlook for 2023 however is for an probable modest earnings decline due to a divestiture and weaker freight levels. The long-term outlook seems good. It does not appear to have strong competitive or cost advantages other than scale and its very excellent management ability. The economics of the business are strong despite being subject to stiff price competition. It is possible that Amazon’s move into trucking could harm their business somewhat. Overall we would rate this a Buy at $141.57. Due to the probable earnings decline in 2023 it would be best to accumulate this more slowly and not rush in. | |
| MACRO ENVIRONMENT: Sharply higher interest rates and a probable looming recession are headwinds. Volumes are down in the trucking industry in 2023 compared to 2022. | |
| LONG TERM VALUE CREATION: (Updated March 13, 2022) The long-term value creation is exceptionally strong. | |
| DESCRIPTION OF BUSINESS: (last updated Q3 and Q4 2021) TFI International is a trucking and delivery company with total annual revenues of over $9 billion dollars. TFI is focused on acquisitions as well as very efficiently managing its operations. Since 1998, the company has acquired more than 180 companies. Acquired companies continue to operate under their same names and management teams in a decentralised structure. It has the largest trucking fleet in Canada and a presence in the United States. It has 233 terminals/facilities in Canada and 316 in the United States and 12 terminals in Mexico. It has 28,900 employees and another 9,857 independent contractors (presumably mostly driver/owners of trucks). It owns 13,433 power units (tractors) and 48,612 trailers. The breakout of revenue by segment for 2021 was Package and Courier (which subject to check operates only in Canada) 9%, Less-Than-Truckload 37% , Truckload 29% , and Logistics and Last Mile 25%. Revenues in 2021 were 33% from Canada and 67% from the U.S and 0.3% from Mexico. TFI has become primarily a U.S. operator with its recent large UPS acquisition. | |
| ECONOMICS OF THE BUSINESS: The economics appear to be VERY strong. TFI’s success in managing costs contributes to its strong overall economics. | |
| RISKS: See annual report for a full discussion of risks. Earnings fluctuate with the state of the economy. Some of the important risks include accident liabilities, competition based on price and competition for drivers. | |
| INSIDER TRADING / INSIDER HOLDING: Checking insider trading from May 1, 2022 to May 9, 2023: The founder and CEO exercised options and sold several hundred thousand shares regularly most months but he maintained his ownership and increased slightly to 4.35 million shares. There were several insiders exercising options and selling and some outright share sales with one sale at $173. The company itself was buying back shares fairly regularly through the year ultimately paying as much as $159 (but mostly lower) which is a vote of confidence. Overall with a share price decline to about $142, the insider selling signal is neutral. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (pass given that trucking is relatively simple business) , has favorable long-term economics due to cost advantages or superior brand power (marginal pass – perhaps its high ROE is evidence of some advantage of scale), apparently able and trustworthy management (pass given the profit history and the general tone of its reports), a sensible price – below its intrinsic value (pass given its value ratios), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (marginal pass) | |
| MOST RECENT EARNINGS AND SALES TREND: The recent growth trend turned negative in the latest quarter after a long period of stellar gains. The adjusted earnings pers share gain in 2022 was 53% but revenue per share growth was just 6%. The adjusted earnings per share growth in 2021 was 59% and the revenue per share growth was 83%! | |
| INDUSTRY SPECIFIC STATISTICS: | |
| Earnings Growth Scenario and Justifiable P/E: With a dividend yield of 1.3% and a payout ratio of just 18% of adjusted earnings, the stock is pricing in growth of only about 5% annually at its current P/E of about 14. It’s historic growth has been far higher. | |
| VALUE Ratios: Analysed at a price of $118.33. The Price to book ratio appears somewhat high at 3.5 and note that the company itself has paid very significant premiums in acquisitions. But that may be well justified by the high ROE. Due to the relatively high price to book ratio, and the low 18% payout ratio, the dividend yield is quite modest at 1.3% despite recent dividend increases. The adjusted P/E ratio is neutral in attractiveness at 17.4. The ROE is exceptionally strong at 29% and that is in spite of the premiums paid in acquisitions and in spite of the impact of the pandemic. The adjusted earnings per share have grown at a compounded average rate of 40% in the past five calendar/fiscal years. Intrinsic value is calculated as $144 if earnings per share grow at 5% for five years and the P/ E remains at 14 (very conservative) and $208 if earnings grow at 9% annually and the P/E increases back to 17. Both estimates use a 7.0% required rate of return. Overall, the value ratios would easily support a rating of (higher) Buy – but note the potential for an earnings decline in 2023. | |
| TAXATION: Nothing Unusual. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | TFII, Toronto |
| Currency: | $ Canadian |
| Contact: | 647 729-4079 |
| Web-site: | www.tfiintl.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $11,289.7 |
| Latest four quarters annual earnings $ millions: | $1,072.2 |
| P/E ratio based on latest four quarters earnings: | 11.7 |
| Latest four quarters annual earnings, adjusted, $ millions: | $940.4 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: With a few exceptions we used managements figure for adjusted earnings from continuing operations. In 2020 we deducted the after-tax benefit of the Canada Emergency Wage Subsidy because there was no indication that the money was used to keep people working. It appears that in 2017 management had not adjusted for gains on asset sales but started to do so in 2018. For the calendar years prior to 2015, we did not have that figure but used management’s figure for adjusted earnings except that we deducted gains on dispositions (less a tax impact). | |
| Quality of Earnings Measurement and Persistence: The adjusted earnings seem relatively reliable. Depreciation is an estimated figure and is relatively large in relation to earnings and so the earnings are relying on the accuracy and sufficient conservatism of the depreciation amount. Depreciation does seem to be conservative as evidenced by the frequent sale of assets at a gain. Certain transition costs have not been added back in adjusted earnings. Overall the earnings and adjusted earnings appear to be conservatively stated. And we deducted the after-tax benefit of the Canada Emergency Wage Subsidy so that it would not inflate earnings. | |
| P/E ratio based on latest four quarters earnings, adjusted | 13.4 |
| Latest fiscal year annual earnings: | $1,121.0 |
| P/E ratio based on latest fiscal year earnings: | 11.2 |
| Fiscal earnings adjusted: | $996.3 |
| P/E ratio for fiscal earnings adjusted: | 12.6 |
| Latest four quarters profit as percent of sales | 8.3% |
| Dividend Yield: | 1.3% |
| Price / Sales Ratio | 1.11 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 3.56 |
| Balance Sheet: (last updated for Q3 2020). Assets are comprised as follows: 41% is purchased goodwill or the equivalent, 21% is rolling stock (trucks and trailers) 6% is land and buildings, 1% is equipment) and 22% is current working capital most of which is trade receivables and it currently has a large cash holding and 9% of assets are capitalised leases. The other side of the balance sheet which supports these assets is comprised as follows: 26% debt, 46% common equity, 11% current payables, 9% capitalised lease liabilities, 6% deferred income taxes, and 2% provisions and other liabilities. Overall, the balance sheet appears relatively strong assuming that the goodwill is solid which the 17% ROE indicates is very much the case. Debt is relatively modest in relation to earnings and cash flow. | |
| Quality of Net Assets (Book Equity Value) Measurement: (Updated Q3 2020) About 41% of the assets here are purchased intangible (goodwill and the equivalent). At the time of this analysis the shares were trading at about 2.7 times book value. The company is valued for its earnings not for the value of the assets. Based on earnings and frequent sales of assets at gains, the assets are worth more than book value. | |
| Number of Diluted common shares in millions: | 86.6 |
| Controlling Shareholder: As of Spring 2019, no one or no fund owned more than 10% of the shares . The long-time CEO owns about 5% of the shares. | |
| Market Equity Capitalization (Value) $ millions: | $12,257.4 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 46.0% |
| Interest-bearing debt as a percentage of common equity | 51% |
| Current assets / current liabilities: | 1.3 |
| Liquidity and capital structure: The debt level is relatively modest at 51% of the book equity level and in relation to earnings and cash flow. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 28.7% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 31.2% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 7.7% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 16.5% |
| Volatility of sales growth per share: | Steady Growth |
| 5 Years compounded growth in earnings/share | 49.1% |
| 5 years compounded growth in adjusted earnings per share | 40.0% |
| Volatility of earnings growth: | Steady Growth |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 25.8% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 5.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 9.0% |
| OUTLOOK AND AMBITIONS FOR BUSINESS: The outlook appears to be for a modest earnings decline in 2023 due to a divestiture made in 2022 and due to lower volumes in the trucking industry and a potential recession. | |
| LONG TERM PREDICTABILITY: It seems reasonable to predict that the company will continue to grow its earnings over the years however its earnings are subject to year to year volatility. | |
| Estimated present value per share: We calculate $144 if adjusted earnings per share grow for 5 years at the more (very?) conservative rate of 6% and the shares can then be sold at a P/E of 14 and $208 if adjusted earnings per share grow at the more optimistic rate of 9% for 5 years and the shares can then be sold at a P/E of 17. Note that these values assume that the P/E ratio increases from the current low level of 10. Both estimates use a 7.0% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Has barriers to entry (marginal pass as capital is likely the largest barrier but scale is also important). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass as the largest customer is less than 5% of revenue), No potential for substitute products (pass) No tendency to compete ruinously on price (marginal pass as the industry does compete on price). Overall this industry appears to be marginally attractive to an established large incumbent. It may be attractive for the lowest cost incumbents. | |
| COMPETITIVE ADVANTAGE: The company indicates that competitors compete primarily on price and reliable service. Therefore cost management and scale are presumably very important. It likely has some competitive advantage in Canada due to scale as it is the largest trucking company in Canada. It’s not clear that it would have any special advantages in the U.S. market. They do appear to be particularly well managed and are skilled in cutting costs when needed. | |
| COMPETITIVE POSITION: The company has the largest trucking fleet in Canada as well as a significant presence in the U.S. market. It is a fragmented industry. | |
| RECENT EVENTS: The company continues to make fairly numerous acquisitions for growth. | |
| ACCOUNTING AND DISCLOSURE ISSUES: A recent change to reporting in U.S. dollars was warranted but complicates comparisons to the past results. Some required accounting changes a few years ago to revenue recognition and lease accounting have affected the comparability of earnings. We found the disclosure to be reasonably good. However the practice of presenting adjusted earnings from continuing operations troubled us in that the numbers change retroactively when it sells a division. We would have preferred an adjusted earnings figure that was not subject to retroactive change. They may have been aggressive in not deducting the Canada Emergency Wage Subsidy in adjusted earnings given it may have amounted to a windfall. Frequent gains on sales of assets create a situation where adjusted earnings constantly differ from GAPP earnings. Certain derivatives and hedges impact earnings. The fact that about half of the earnings are from the U.S. contributes to earnings volatility as the exchange rate changes. Like most companies, they mix purchased customer relationships with software , and the amortization of, which are both intangibles but of a vastly different nature. They are conservative in not adding back certain acquisition transition costs to adjusted earnings. The income statements has the fuel expense in the same line item as subcontract expenses and since both of these items are large it would be preferable to show them separately. | |
| COMMON SHARE STRUCTURE USED: Normal, one vote per share. | |
| MANAGEMENT QUALITY: The chairman and CEO, Alain Bedard has led the company since 1996. Management quality appears to be extremely high. Listening to the conference call, the CEO is extremely open with his thoughts and is very knowledgeable. He knows his numbers. In addition, this management has shown excellent ability to trim costs when needed in response to revenue declines. And they have jettisoned less profitable business. It is a rare management that is willing at times to “fire” customers. It seems they don’t to waste time and energy and resources on customers that are insufficiently profitable. We were however surprised to hear that he would base getting into or out of certain leases on the accounting rules, when the underlying economics would be the same either way. | |
| Capital Allocation Skills: This skill is particularly important for TFI which has a stated major goal of adding value through acquisitions. It has a very strong track record. It may have made a very wise choice in divesting certain weaker lines of business several years ago. It has made some extremely good acquisitions and particularly the ground operations of UPS. Its aggressive share buy back program has apparently been a good use of capital even at a time when the company was also very active in making acquisitions. The move towards a more “asset light” approach appears to have been wise. | |
| EXECUTIVE COMPENSATION: In 2019 the CEO received total compensation of $10.8 million. The other four named officers were in the $1.1 to $1.1 million range. This level of compensation is arguably not excessive or a concern given the size and success of the company. It does, however look somewhat too heavily weighted to the CEO although the CEO as the only man on the conference call is a VERY hands on CEO. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. Here the Board consists of ten members, mostly retired executives (from banking, federal cabinet, industrial products distributor, food, and trucking) . There appears to a good level of business knowledge and the members are likely wealthy enough not to be unduly influenced by their compensation at TFI which is modest at about $120k per year. It is disappointing to see that five Board members (albeit four are very recent directors) could not be bothered to buy any shares. They all receive and hold deferred share units. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
| © Copyright: InvestorsFriend Inc. 1999 – 2023. All rights to format and content are reserved. | |
Valeant Pharmaceuticals
Valeant Pharmaceuticals International, Inc.
The chart here only starts in 2011. Although Valeant existed as Biovale prior to that, it effectively became a new company in the September 2010 when it came under new management merged with a company called Valeant and changed its name and also paid out a special dividend. Revenues per share have grown at a compounded rate of 47% annually in 2012 through 2014. Adjusted earnings (the pink line) grew at a compounded annual rate of 81%. The fact that GAAP earnings (the blue line) are always substantially below the adjusted earnings line and is absent (negative) in 2013 illustrates the fact that there are substantial adjustments to arrive at adjusted earnings. That makes the adjusted earnings less reliable as one can argue about the validity of the various adjustments.
| Valeant Pharmaceuticals International, Inc. (VRX, Toronto and U.S.) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold no shares |
| Based on financials from: | Dec ’14 Y.E. +Q2 ’15 |
| Last updated: | 30-Jul-15 |
| Share Price At Date of Last Update: | $253.91 |
| Currency: | $ U.S. |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Sell at $253.91 |
| SUMMARY AND RATING: The graph of revenues per share (red line) shows exceptional growth since new management took over and the company was effectively reborn through a significant merger in 2010. The adjusted earnings per share have also grown at an exceptionally strong rate in that period. The book value per share would have grown at a high rate if not for amortization and other expenses that have been added back in adjusted earnings. The Value ratios would indicate no better than a Hold rating given the strong growth but tempered considerably by the very high P/E ratio. Management quality appears strong but we are concerned about the trust factor given the apparently aggressive approach to adding back items in calculating their cash EPS figure and also given what appears to be aggressive measures to avoid income tax. The insider trading signal is moderately positive. Executive compensation seems excessive. The outlook for earnings growth seems good but may not justify the high P/E ratio. The economics of the business are strong in that it has patent and brand protection. We are concerned by the very high debt level which results in high interest rates on debt and a BB minus debt rating. We are perplexed as to how it was able to borrow so much money. Overall we would rate this as a Sell. | |
| DESCRIPTION OF BUSINESS: (Based on the 2014 annual report) Valeant is a large international pharmaceutical company that has recently grown at a rapid rate through acquisitions. Although headquartered in Canada, Valeant obtains 97% of its revenue outside Canada. While this company is Canadian in form it appears to be a U.S. company in substance. Valeant’s equity market value is U.S. $88 billion dollars (making it Canada’s highest valued company, the enterprise value after adding debt is U.S. $119 billion. On its balance sheet the total assets are U.S. $48 billion with equity of U.S. $6.6 billion and debt of U.S. $31 billion. As of early 2015, the company had 17,000 employees. 800 in R&D, 6200 in sales and marketing and 1600 in general and administrative and 8200 in production. An international drug and medical device developer, manufacturer and marketer. Its products include prescription drugs and over-the-counter (non-prescription) products. It markets directly or indirectly in over 100 companies. In developed countries it focuses on eye, skin and brain products. In non-developed countries it focuses on branded generic drugs, over-the-counter products and medical devices. Overall revenues are 43% from prescription drugs, 21% from over-the-counter products, 20% from medical devices, 15% from branded and other generics (drugs?) and 2% from other. The company relies on selling brand names rather than on patent protection. It focuses on products that are paid for directly by the user or the user’s drug plan rather than on products that government is paying for. It attempts to focus on products with large growth potential. Its R&D (800 employees) is focused on delivering new products through clinical trials as opposed to basic research. It attempts to focus on products that are easier to manufacture. The product portfolio consists of about 1600 products. Some of the major products for developed countries are Acne products (Solodyn . Rentin-A and others) Wellbutrin (for depression), various eye-care products, contact lenses, surgically implanted lenses, and skin tightening products. In addition the company has lists four generic products. In Emerging Market countries the products are mainly branded drugs and over the counter products and medical devices. Products include eye care, respiratory care, contact lenses, surgically implanted lenses and skin tightening products. Revenues are heavily concentrated in the U.S. at 54% of revenue. The next there important countries are Canada at 5%, Poland 3% and Russia 3%. Overall revenues are 75% from developed countries and 25% from emerging markets. Its largest two customers (presumably distributors) accounted for 17% and 10% of revenue. It has 40 manufacturing plants world-wide. In addition, some manufacturing is subcontracted. Half of its revenues come from products manufactured by others under ‘toll” agreements. The company lists about 251 subsidiaries in various countries. | |
| ECONOMICS OF THE BUSINESS: The economics of the drug and over-the-counter treatment business appear to be good in that there are tariff and brand protections. On an adjusted earnings basis, Valeant’s profit is 24% of revenue. In part, this high profit ratio is achieved by virtue of a very low tax rate. This is then leveraged down to a 4.6% return on assets as revenues are only 19% as large as the asset figure. This however, is leveraged back up to a 34.5% return on ending equity as ending equity is a slim 13.3% of assets. The leverage to equity is provided mainly by debt but also to some extent by deferred income taxes. The equity may be considered to be somewhat artificially lowered by the expensing of deferred taxes that may never be paid and by the expensing of the amortization of intangibles. | |
| RISKS: These risks are as to the earnings of the company, not the stock price which faces all of these risks plus the risk that the stock price is currently over-valued. A number of its products face generic competition. The company did not indicate the percentage of its revenues involved. The company is inherently subject to product litigation and liability issues. They are not insured against this but rather they self-insure. There are risks due to government regulatory actions. | |
| INSIDER TRADING / INSIDER HOLDING: Checking insider trading from January 1, 2015 to July 25, 2015: About four insiders had sold shares after exercising options. Sales prices were mostly $200 to $222 U.S. dollars. Two directors bought 500 shares each at about U.S. $200 to $230. One director also apparently bought 500 shares for a family member at U.S. $230. A senior officer bough 7500 shares at U.S. $235. Overall and given that selling on option exercise is to be expected the insider trading signal can be considered moderately positive. In terms of insider ownership, a good number of executives and directors own substantial shares. Directors and executives as a group own 8.62%. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (marginal pass at best due to complexity of regulations and R&D efforts), has favorable long-term economics due to cost advantages or superior brand power (pass due to patents and brands), apparently able and trustworthy management (marginal pass at best as we have some concerns about the cash EPS figure), a sensible price – below its intrinsic value (fail due to high P/E), Other criteria that have been attributed to Buffett include: a low debt ratio (fail due to very high debt ratio), good recent profit history (pass using adjusted earnings) little chance of permanent loss of the investors capital (marginal pass at best as the high leverage combined with product liabilities could cause a wipeout) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) | |
| MOST RECENT EARNINGS AND SALES TREND: | |
| COMPARABLE STORE SALES: Not applicable. The company did discuss organic growth versus acquisition but we did not see a clear disclosure of this on a percentage basis. | |
| Earnings Growth Scenario and Justifiable P/E: The adjusted P/E is high at somewhere between 22 and 40 depending on how one calculates adjusted earnings. It takes considerable growth to justify this level of P/E. | |
| VALUE RATIOS: The price to book value ratio is ostensibly very unattractively high at 13.6 particularly considering that the company’s assets are mostly intangibles. A very high P/B ratio can sometimes be justified but it requires a very high ROE to justify this P/B level. The price to book ratio would be more reasonable but still quite high at 7.5 if we added back the accumulated amortization of intangibles. And it might be reasonable to add back some of the deferred income taxes as well and perhaps some of Valeant’s other add-backs to income which would further lower the P/B ratio. There is no dividend. The P/E ratio using our more conservative view of adjusted earnings is unattractively high at 40. Using management’s view of 2015 expected so-called cash EPS the P/E is still somewhat high at 22. The ROE using our view of adjusted earnings is very strong at 37%, however, this is significantly overstated since equity has been reduced by amortization charges and restructuring charges that are added back for adjusted earnings (and would not have reduced equity if they were not expensed). Also it is achieved partly through high debt leverage. Growth in revenue per share in the past three calendar/fiscal years has been extremely strong at a compounded annual 47% and in adjusted earnings per share at 81%. Estimated present value per share: We estimate the intrinsic value per share at U.S. $141 if adjusted earnings per share grow for 5 years at the more conservative rate of 15% and the shares can then be sold at a P/E of 15 and $232 if adjusted earnings per share grow at the more optimistic rate of 20% for 5 years and the shares can then be sold at a P/E of 20.Both estimates use a 6.5% required rate of return. Keep in mind that these figures are highly dependent on the way that adjusted earnings are calculated as will as on the growth and P/E assumptions as well as the required return. Overall these value ratios suggest no better than a hold rating given the high growth but also given that it is effectively pricing in continued growth in the area of 20% annually. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | VRX, Toronto and U.S. |
| Currency: | $ Canadian |
| Contact: | ir@valeant.com |
| Web-site: | www.valeant.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $9,259.5 |
| Latest four quarters annual earnings $ millions: | $831.0 |
| P/E ratio based on latest four quarters earnings: | 104.7 |
| Latest four quarters annual earnings, adjusted, $ millions: | $2,188.7 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Rather than use management’s figure, which seems aggressive to us, we have added back 75% of the amortization of intangibles and 75% of restructuring and integration costs and items management identified as other income or gains (the 75% assumes that these expenses reduced income tax at a 25% rate on average). In Q2 2015 we added back 75% of the large expense of accelerated stock options since that appeared to be a cost of an acquisition. | |
| Quality of Earnings Measurement and Persistence: In 2014 the major components of expense were cost of goods sold at 27% of revenue, selling, general and admin at 25%, amortization and impairment of intangibles at 19%, and interest at 12%. | |
| P/E ratio based on latest four quarters earnings, adjusted | 39.8 |
| Latest fiscal year annual earnings: | $913.5 |
| P/E ratio based on latest fiscal year earnings: | 95.3 |
| Fiscal earnings adjusted: | $1,941.8 |
| P/E ratio for fiscal earnings adjusted: | 44.8 |
| Latest four quarters profit as percent of sales | 23.6% |
| Dividend Yield: | 0.0% |
| Price / Sales Ratio | 9.40 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 13.59 |
| Balance Sheet: (last updated for Q2, 2015) Assets consist of 2% cash, 11% other current assets (receivables, inventory, pre-paid and deferred tax assets) 3% property and equipment 36% goodwill and 48% intangible assets (which are very similar to goodwill as they consist largely of the purchased value of brands and product rights). These assets are supported on the liability and equity side of the balance sheet as follows: 1% accounts payable (which suggests that the company to a very large degree generates its products in house with few outside inputs) 6% accrued and other liabilities, 1% acquisition contingent consideration, 64% debt, 13% deferred income tax liabilities and 14% common equity. This appears to be a very weak balance sheet given the high level if debt and considering that the assets are largely purchased goodwill and equivalent. Most of the deferred tax liabilities arose in acquisitions. | |
| Quality of Net Assets (Book Equity Value) Measurement: This is irrelevant since the stock is trading at 14 times book value. Clearly the book equity is worth far more than its stated value however it is not at all clear that it is worth 14 times. In any case the company is clearly valued for its earnings and not its book assets. | |
| Number of Diluted common shares in millions: | 344.4 |
| Controlling Shareholder: There is no controlling shareholder as such but there are several large owners. Based on the 2015 management proxy circular; The Ruane, Cuniff & Goldfarb fund owns 10.2%, Perching Capital (Bill Ackman) owns 5.8%, Value Act Capital (owned by management) owns 5.6% and T. Rowe Price owns 5.3%. | |
| Market Equity Capitalization (Value) $ millions: | $87,446.6 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 13.3% |
| Interest-bearing debt as a percentage of common equity | 480% |
| Current assets / current liabilities: | 1.5 |
| Liquidity and capital structure: The balance sheet is weak due to a heavy debt load. The credit rating is weak at BB minus from Standard and poors which is several notches below investment grade. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 37.4% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 37.2% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 2.5% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 3 years compounded growth in sales/share | 47.4% |
| Volatility of sales growth per share: | $ – |
| 3 Years compounded growth in earnings/share | 76.2% |
| 3 years compounded growth in adjusted earnings per share | 80.6% |
| Volatility of earnings growth: | $ – |
| Projected current year earnings $millions: | $4,012.3 |
| Management projected price to earnings ratio: | 21.8 |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 37.2% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 15.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 20.0% |
| OUTLOOK FOR BUSINESS: The company lists a number of products in development. The company indicates that it has additional cost synergies that it will achieve. The company also continues to make acquisitions. Given the high debt levels its pace of acquisitions will likely have to slow. | |
| LONG TERM PREDICTABILITY: It is difficult to predict given the recent sharp growth by acquisition. | |
| Estimated present value per share: We calculate U.S. $143 if adjusted earnings per share grow for 5 years at the more conservative rate of 15% and the shares can then be sold at a P/E of 15 and $235 if adjusted earnings per share grow at the more optimistic rate of 15% for 5 years and the shares can then be sold at a P/E of 20. Both estimates use a 6.5% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (pass). No issues with powerful suppliers (pass although there are some sole-sourced input products). No issues with dependence on powerful customers (marginal pass as the top three customers account for over 30% of revenues), No potential for substitute products (pass) No tendency to compete ruinously on price (pass). Overall this industry appears to be attractive for an established incumbent. | |
| COMPETITIVE ADVANTAGE: Valeant indicates that it has lower selling, general and admin costs and that its decentralized structure is an advantage. However, it faces a disadvantage in the high interest rates that it is paying on its very high debt load. Their access to Wall Street investment banks for borrowing may be an advantage. | |
| COMPETITIVE POSITION: We are not aware of where it stands in the industry although it does appear to be large. | |
| RECENT EVENTS: In July 2015 announces a pending acquisition valued at U.S. $0.8 billion. In April 2015, acquired Salix Pharmaceuticals, a leader in gastrointestinal products at an enterprise value of U.S. $14.5 billion financed primarily with debt but it also issued $1.45 billion in shares at a price of U.S. $199. In 2013 the company became a B.C. registered company and stopped being a federally registered company. In seeking shareholder approval for this the company noted that the BC system was more modern and more flexible in regards to corporate transactions (mergers and acquisitions, and divestitures) and in particular did not require 25% of the directors to be Canadian. In 2014 acquired several businesses at a cost of $1.4 billion. In 2013 acquired Bausch and Lomb in a major transaction valued at U.S. $8.7 billion. Several other businesses were acquired in 2013 for a total of $0.9 billion. In 2012 acquired the shares of Medicis for $2.6 billion. Subsequent to certain relatively recent acquisitions the company undertook workforce reductions and closed duplicative facilities (R&D, sales offices and corporate locations). In 2014 divested certain product rights for $1.4 billion | |
| ACCOUNTING AND DISCLOSURE ISSUES: The company’s view of “cash earnings per share” as a form of adjusted earnings per share appears to be aggressive and to over-state earnings. In summary they appear to add back all non-cash expenses. Primarily this is stock compensation which they apparently are suggesting is not a “real” expense. Amortization of debt issue costs is added back presumably because it is non-cash, even though this is normally considered to be a deferred interest expense. Premiums paid to retire debt early were added back, perhaps on the basis that this is a one-time cost. Amortization of intangibles is by far the largest item added back and we would agree with this as long as the intangibles are likely to have indefinite lives which is likely for brand names but may or may not be the case for product rights. We would also reduce the add-back by a tax impact but it’s not cleat that Valeant has done so or, if they have it appears they used a very low tax rate. The other add backs appear to be added back on the basis that they should be treated as part of the capital cost of an acquisition, this includes accelerated stock options, and certain inventory costs, and acquisition-related contingent consideration and restructuring and integration costs (the basis of this last may be that it is in the nature of a one-time cost). These add-backs may be reasonable but we would be reluctant to add back all of these and again it did not appear that much of a tax impact was accounted for (these items were mostly deductible for tax purposes and if they were not expenses then the tax benefit would not be present). Overall, we are concerned that that the extent of these add-backs is too aggressive. Also we did not see an explanation for why each items was added back. In our own view of adjusted earnings we took a somewhat more conservative approach adding back 75% of amortization and restructuring charges and unusual gains or losses or other income gains and well as the accelerated stock option expense. The 75% assumes a 25% tax rate which is higher than they actually face. The company self-insures for product liability but it is not clear than any expense has been accrued for this. | |
| COMMON SHARE STRUCTURE USED: Normal, one vote per share. | |
| MANAGEMENT QUALITY: Overall, the quality of management appears to be good given the performance. However we do have deep concerns about the aggressiveness of the calculation of so-called “cash EPS” and also about the apparent aggressive measures to reduce income tax including use of subsidiaries in Luxemburg. The company indicates that it measures success through total shareholder returns but does focus on a three year period. In our view that is a dangerous goal as it can lead to management taking actions that push up the share price beyond a reasonable level however, the focus on a three year period does mitigate our concern. The company indicates that executives were required to purchase several; million dollars worth so shares with their own money and that several went beyond the required level. This is a positive indication. The decision to self-insure against product liability may expose the company to unnecessary risk. | |
| Capital Allocation Skills: The market has judged Valeant’s capital allocation skills to be exceedingly good. The share price has climbed over 600% mostly due to acquisitions. In terms of share buybacks Valeant did not buy back any shares in 2014 as the price rise and in 2013 had not bought at prices higher than U.S. $91. However in 2015 the company has bought back some shares at U.S. $223. We would question the wisdom of that purchase. | |
| EXECUTIVE COMPENSATION: We would describe executive compensation as being obese. In 2014, compensation for the five named officers ranged from US. $10 million to U.S. $51 million. Strangely, the CEO was the lowest among the five. Given the market valuation, the compensation is not the biggest concern but we do take it as a negative indicator. | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. The Valeant Board has 11 members. Two are from the investment capital industry (one of whom owns over 5% of the company. There are several with management consulting experience including pharmaceutical consulting experience, several pharmaceutical industry executives , two with CFO experience, and one with investment banking experience. The CEO is also chair of the Board. Overall it appears to be a good Board. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
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May 3, 2015
The report for Bank of America is updated and the stock is rated Speculative (higher) Buy at $16.11. The thesis for owning Bank of America is that its stock price could rise substantially once it is able to string together four quarters without a large litigation settlement to matters dating back to the financial crisis. Also it may soon announce an increase to the dividend. (It has to have permission from the Fed to do that and I am not sure where that stands.)
On Friday, the S&P 500 rose 1.1% and Toronto was up 0.8%.
Canadian National Rail was up 2.8%. The RioCan pref share rose 2.5% and the rate reset pref shares in general had a strong week.
Melcor Developments Ltd. Stock Report
Melcor’s revenue per share (red line) has mostly trended down since 2014 but is more recently increasing.
(Adjusted) earnings per share have been quite volatile but always positive on an annual basis but have mostly trended down since 2014 before increasing in recent years. The company is quite cyclical. Adjusted earnings fell sharply in 2019 due mostly to weaker housing starts. This weakness finally reversed in the later part of 2020 and has been relatively stronger since then but declined in 2022 with no lot sales in the US. There is an increase in 2023 as lots were sold in the U.S.
Book value per share has trended up over the years. Recently it was boosted by share buy backs at prices far below book value.
While book value per share has increased at an acceptable 5.4% compounded annually over the past ten years, overall it is certainly not an impressive chart.
| Melcor Developments Ltd. (MRD, Toronto) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | Author(s) hold shares |
| Based on financials from: | Dec ’23 Y.E. +Q2 ’24 |
| Last updated: | August 7, 2024 |
| Share Price At Date of Last Update: | $ 12.23 |
| Currency: | Canadian $ |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Buy at $12.23 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Yes but expect only modest and below market returns |
| Has Wonderful Economics? | No |
| Has Excellent and Trustworthy Management? | No |
| Likely to grow earnings per share at an attractive rate over the next decade? | Expect modest but not attractive growth |
| Positive near-term earnings outlook? | Yes, probably |
| Valuation? | Attractive |
| SUMMARY AND RATING: The graph of adjusted earnings per share demonstrates essentially no growth and some volatility going back ten years. Not impressive. Book value per share has grown at an average of 5.4% annually since 2013 including fair value gains (and since 2020 fair value losses) on its rental buildings. This together with the dividend that averaged about 2% of book value suggests an achieved average effective ROE of around 7.4%. In 2023, the adjusted ROE was once again weak at 5.6%. Overall the economics of the business have not been good as it appears that the gross profits on lot prices have not been high enough to reflect all the years that equity is tied up before the sale. With quite cyclical or volatile earnings, the earnings-related and other value ratios are somewhat unreliable but would currently suggest a (higher) Buy or higher rating based on the price to book ratio of 30% and the P/E of 5.2 but tempered by the weak ROE. The outlook for lot sales appears good as home starts are strong in Alberta. The outlook for the commercial rental building segment is for stability in revenue but lower earnings due to higher average interest rates. The Strategy review of the REIT subsidiary adds to uncertainty. Management quality is questionable at best. They appear to have little ambition to improve the ROE. The controlling family appears to have little regard for increasing the share price. The insider trading signal is moderately positive. It’s not entirely clear that they have any lasting competitive advantage although they have strong market knowledge and abilities in a field that is probably not that easy to enter for new competitors (but why would anyone want to enter?). The balance sheet is relatively strong. And interest expenses are relatively large as a percentage of earnings. Note the thin trading liquidity. Overall we rate this a Buy at this time based on the extremely low price to book value and the nature of the assets but tempered by the low ROE history and the apparent complacency of management. We acknowledge that it has been a poor investment for many years except when purchased after very steep price drops which occurred with the financial crisis in 2008 and with the pandemic in 2020 and which seemingly is occurring again at this time. In the longer term we would like to see a substantial share price gain which would be an opportunity to exit this apparently inherently low return business. A catalyst for aa price increase would be a resolution of debt renewal issues at the REIT allowing for a Melcor to return to a higher dividend level. | |
| MACRO ENVIRONMENT: Higher interest rates are a major headwind due to depressed home building, lower market value of land and buildings, higher interest costs and downward pressure on P/E ratios. Offsetting this, the Alberta economy remains very strong and the 3.7% population gain in 2022 and similar growth in 2023 is also quite beneficial. | |
| LONG TERM VALUE CREATION: On its books at least, Melcor has created significant long-term value given that 91% of its equity consists of retained earnings and the company has also paid out substantial dividends. However, the market has shaved off much of the accounting value as the shares trade at only about 30% of accounting book value whereas the vast majority of publicly traded companies trade at a higher price than book value. And it’s not clear that the ROE has been attractive at all in the long term. Recent value creation has been poor. | |
| DESCRIPTION OF BUSINESS: Updated March 2023 based on 2022 figures. The contributions of its various segments to revenue and earnings varies significantly from year to year. In 2022, 48% of revenue was as a residential (with some commercial) land developer. The land development business appears to be mainly done with joint venture partners. Also develops, retail and industrial buildings for transfer to its rental division (5% of revenue – the contribution of this segment varies greatly year to year) . Rents out office, retail and industrial buildings including some in a 55% owned REIT structure (43% of revenue which is however before deducting the share of the REIT owned by others). Also owns and operates three golf courses and has an interest in a fourth (4% of revenue). Operates mostly in or near the major cities of Alberta. Has some U.S. residential developments (Phoenix and Denver) and rental property (6.5% of revenue – low due to no US lot sales in 2022 – and 13% of assets, included in the segments above). The rental investment property portfolio totals about 62 buildings or properties and 4.80 million square feet (of which 39 properties or 3.67 million square feet are in the REIT which is 45% owned by the public unit holders and 55% by Melcor). Tenants include the Alberta government, Canadian Tire, Canadian Western Bank, Home Depot, Rexall Drugs, Rona, Royal Bank, Save-on Foods, Sobeys, Scotia Bank, Shoppers Drug Mart, Sport Chek, Staples, TD Canada Trust, Tim Hortons, Walmart and many others. Buildings include 476 residential apartment units and about 10 parking lots. The total assets are $2167 million. Melcor is not employee intensive as it contracts out the physical work of developing properties. 13% of the assets are in the U.S. and the great majority of the Canadian assets are in Alberta. The U.S. assets appear to be mostly represented by about six office buildings purchased from 2014 to 2016 as well as over 1000 acres of largely residential development lands in Arizona and Colorado. | |
| ECONOMICS OF THE BUSINESS: The largest business is residential (and some commercial) land development. In this business they buy (and hold for a long time) raw land typically on the edges of cities, mostly in Alberta but with some in Kelowna and some near Denver Colorado and other areas in the western U.S. In this business capital spending, unlike the case for most companies, goes directly into the product that is sold, so that capital is recycled although the process can easily take 10 years or more. Developing the land into residential building lots (and some multi-family and shopping areas) requires obtaining permits and installing infrastructure such as roads and utilities (which is done through contractors). Also there is substantial surveying and grading (which also is done by contractors). This business involves investing for a number of years before any lots can be sold (if ever). There is competition. The business can be highly cyclical and unpredictable. However gross margins on lots and land sales have been too low since 2015 and this has led to an inadequate overall company ROE in the 3 to 6% range. Due to long holding periods for land, a higher gross margin is required in order achieve a reasonable ROE on money invested over the years. Another portion of the business is to manage the construction (by contractors) of commercial, retail and industrial rental buildings. The economics have been such that Melcor has been able to make good profits on this business. The third major area of business is renting out the commercial and retail space. This portion of the business has generated modest but steady rental returns plus mostly increases in the market value of the rental properties as interest rates have declined – but in 2020 and since then building values declined due to higher vacancies. Overall it appears that Melcor’s business economics have been relatively poor since 2014. Unfortunately, there is not much reason to expect the ROE to reach double digits much less to be sustained at that level. | |
| RISKS: The primary risk is the state of the Alberta economy and the volatile demand for new housing (and potentially lower prices for building lots) and the demand and market rents for its office and retail space. There is some risk that demand for its office space has relatively permanently decreased due to the work from home phenomenon and due to an excess supply of office space on the market. Another risk is the risk from higher interest rates which, all else equal, will lower the market value of its buildings and land as well as lower reported earnings but as of Q2 2024 that risk is abating. There is some risk of bad debts from builders although apparently they retain title to building lots until they are paid for. See annual report for additional risks. Also, this public company has a majority controlling owner. In most cases this will benefit outside shareholders as compared to non-ownership type management. But there is a risk that the controlling shareholder will use his position to award large bonuses and stock option grants to himself and the family and not act strictly in the best interest of outsiders. The family may have little interest in the share price since they apparently have no intention of selling. The family may even prefer a lower share price to limit any capital gains tax in transferring the business to the next generation. This family control feature can tend to hold the share price down somewhat (perhaps significantly) since it seems to preclude any possibility of a take-over bid no matter how low the share price is. | |
| INSIDER TRADING / INSIDER HOLDING: Checking from August 1, 2023 to August 7, 2024. A number of insider received share rights on December 1, 2023 and sold about half of those shares at $11.12. Notably, the CEO Tim Melton but 20,000 shares in January at $11.30 and then 30,000 in June at $11.70 to hold 2.25 million shares personally in addition to his large holdings in the family holding company. But Graeme Melton continued his long-standing practice of selling shares and sold 2530 shares in May at $11.74 to hold 4,771. Overall the insider trading signal is at least moderately positive given Tim Melton’s purchases. Insiders hold substantial stock which is positive. A number of them hold significant amounts, such as $1 million, while a couple hold huge amounts well into the $ millions. However a number of executives own very modest amounts of shares which does not inspire much confidence. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand (marginal pass as the accounting is complex and the business very cyclical), has favorable long-term economics due to cost advantages or superior brand power (fail – it appears to be involved in an inherently low ROE businesses – its land development business appears to be both low return and high risk), apparently able and trustworthy management (fail given the weak recent performance and apparent lack of concern for the public share owners), a sensible price – below its intrinsic value (pass – low P/E and apparently selling well below market value of assets but tempered by the low ROE), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (fail) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) | |
| MOST RECENT EARNINGS AND SALES TREND: This company has volatile and cyclic earnings and various accounting issues that make the adjusted earnings highly variable. Revenues per share in the past four quarters starting with the most recent (Q2 2023) were up 9%, 41%, 71% and up 53%. In the same four quarters, adjusted earnings per share were down 1%, up 336%, 70%, and up 51%. In 2023 overall, revenues per share were up 37% and adjusted earnings per share were up 28%. In 2022 revenues per share were down 22% and adjusted earnings per share were down 15%. In 2021, revenues per share and adjusted earnings were up substantially but that is in comparison to a very weak 2020. The graph shows a negative trend in revenues and earnings per share dating back to 2014 (when oil prices fell). However, the most recent quarters have featured strong growth. | |
| INDUSTRY SPECIFIC STATISTICS: In the first half of 2024, residential lot sales in Canada were up 67% and average lot prices were up 4% to and $181,000. There were no lot sales in the U.S. Residential lot sales in Canada in 2023 were up by 8% driven by a surge in lot sales in Q4. And, overall counting U.S. lot sales the increase was 30%. Canadian lot prices in 2023 were up 10% to $170,000. (This can very based on lot sizes and the percent of estate lots) Lot prices on average in 2022 were up 6% to $154,000. Lot prices on average were about flat in 2021 at $145,000 but in Q4 2021 the average was a disappointing $116,000 attributed to smaller lot sizes. In 2022 there were no lot sales in the U.S. In 2021 the number of developed lots sold in the U.S. was up 16% but the average price per lot was down to $102k from $141k Canadian dollars – the lower price was attributed to smaller average lot sizes. In addition in 2021, in the U.S., it sold 595 undeveloped lots that it had taken through the municipal approval process plus 155 acres of land. | |
| Earnings Growth Scenario and Justifiable P/E: The trailing P/E is generally not a reliable indicator for this cyclic company but at 5.2 it is certainly not pricing in much if any growth. | |
| VALUE RATIOS: Analysed at a price of $12.23. The Price to book value ratio appears extremely attractive indeed at 0.30 (30 cents on the dollar!) especially considering the “hard” and tangible nature of its assets. However note that the shares have a history of usually trading somewhat (though usually not this much) under book value. It also seems possible that Melcor will continue to earn a low ROE on its land investments due to the may years that investments are tied up before selling the developed land. And its rental buildings could continue to suffer market value losses due to the higher interest rates and vacancies in the office buildings. And we also have to consider the poor (adjusted earnings) ROE at 6.0% and that it has been consistently quite poor since 2014. Under IFRS accounting, investment properties have been marked to (modeled) market value but land (other than under rental buildings) remains valued at cost (including costs of improvements and capitalised interest) unless there is an impairment which has not occurred in recent decades. The dividend yield is reasonably attractive(despite the cut) at 3.6%. The payout ratio is just 19% of trailing adjusted earnings. The interim adjusted P/E appears highly attractive at 5.2 but is not very meaningful given the cyclical nature of the business. Earnings will vary significantly with lot and other land sales in Alberta and the U.S. Book value per share is $40.81. Overall the value ratios (in isolation) easily support a Buy or even Strong Buy rating on the basis of buying dollar bills (the book value) for about 30 cents although the very low ROE and the poor recent history offsets that. (It may be that the book value is stuck in an inherently poor ROE business with weak management.) On an enterprise basis if the company were acquired including its debt the price appears to represent buying assets at 54 cents on the dollar of book value. | |
| TAXATION: Nothing unusual. The dividend qualifies for the Canadian dividend tax credit. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | MRD, Toronto |
| Currency: | Canadian $ |
| Contact: | ir@melcor.ca |
| Web-site: | www.melcor.ca |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $333.4 |
| Latest four quarters annual earnings $ millions: | $75.3 |
| P/E ratio based on latest four quarters earnings: | 5.0 |
| Latest four quarters annual earnings, adjusted, $ millions: | $72.2 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: We have removed the after tax gains (and more recently losses) on market value of buildings that the company must report under International Financial Accounting Standards. Also adjusted for the changes in the value of the REIT units which flow into earnings, and unusual income tax items. Note that earnings are cyclical and heavily dependent on economic activity. There have been some unusual gains on asset sales but we have generally not adjusted for these due to the overall cyclical nature of the company and the difficulty of obtaining a normalized view of earnings. | |
| Quality of Earnings Measurement and Persistence: Lower measurement quality and lower persistence quality. Earnings result from sales of developed residential building lots and some commercial lots at a profit, value added in developing rental buildings, rental income, and from the mark to market gains (or losses) on investment properties and occasional sale of rental property (though we adjust for the market value gains or losses). Builders often have about 1 year to pay for the lots and there is some risk of bad debt although that receivable is secured by the lots sold. Earnings are quite cyclic so they are not very predictable. However we removed the mark to market gains for adjusted earnings and so adjusted earnings are of reasonably good measurement quality but remain cyclically volatile. | |
| P/E ratio based on latest four quarters earnings, adjusted | 5.2 |
| Latest fiscal year annual earnings: | $63.0 |
| P/E ratio based on latest fiscal year earnings: | 6.0 |
| Fiscal earnings adjusted: | $66.3 |
| P/E ratio for fiscal earnings adjusted: | 5.7 |
| Latest four quarters profit as percent of sales | 21.7% |
| Dividend Yield: | 3.6% |
| Price / Sales Ratio | 1.13 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.30 |
| Balance Sheet: (Last updated Q3 ’23). Assets are comprised as follows: 52% of the assets are investment properties which are marked to (modeled) market (and a further 3% are mostly tenant incentives and similar). 36% of the assets are represented by the land inventory (which would be land cost plus subsequent costs of developing the land and plus capitalized interest – this is not marked to market). 4% of assets is largely a large and somewhat longer term secured receivable from builders who apparently pay for lots only after one year and in some cases longer. Melcor retains title to the lots until payment is received. No interest applies until one year passes and then prime plus 2% interest applies. 3% of assets is cash. Property and equipment accounts for less than 1% of assets which illustrates the fact that this is a company that manages land development by contracting out that work. On the liability side of the balance sheet, 56% of the assets are supported by common equity, 33% by debt, 3% by a provision for land development costs, (Only) 3% by the minority interest of the REIT (the publicly traded share of the REIT) 3% by deferred income taxes and 3% by accounts payable. 91% of the common equity is retained earnings which proves that it has a history of making profits especially considering that substantial additional earnings were dividend out over the years. (However, the market is discounting the equity by 71% as if the earnings were not “real”). There is no purchased goodwill. Deferred income taxes owing can be considered a softer liability in that it may continue to grow and be deferred for years (even as deferred taxes are paid, new deferred taxes may take their place in which case there is no net cash paid out on deferred taxes). Overall, this appears to be a very strong balance sheet with hard and valuable assets financed with relatively modest debt. However, with the market discounting the book equity by 71% and the enterprise value by 45% there comes a point where we have to question if the book asset values are realistic. | |
| Quality of Net Assets and Book Value Measurement: This should be high although real estate assets are subject to possibly significant market value fluctuation. See our comments about the balance sheet. As of August 7, 2024 the shares traded at just 30% of book value. Investment properties have been marked up to (modeled) market value (and since 2020 marked down somewhat). The land inventory remains valued at cost (including development costs and capitalized interest) and it seems likely that land market values are somewhat above book value, but the actual ratio is unknown and subject to change including declines. The company attested that as of December 31, 2023 the (UNDISCOUNTED) realizable value of its land inventory was higher than its carrying value such that no provision for impairment was required. But that does not mean that the market value is higher than cost. There is also presumably value in the going concern aspect of the business beyond its asset value. Overall the quality of the assets and the book value measurement seems high. However, it may be that the land assets in particular are trapped in a low return business and that the investment properties may be over-valued on the books in light of higher interest rates. | |
| Number of Diluted common shares in millions: | 30.7 |
| Controlling Shareholder: (Updated May 2022) Tim C. Melton, the chairman of the company, together with his family, controls about 55% of the shares. A former CEO and current board member owns another 4% and other directors/officers total about 1%. It appears that about 40% of the shares are available to trade however there are some other large holders as well. | |
| Market Equity Capitalization (Value) $ millions: | $375.6 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 59.6% |
| Interest-bearing debt as a percentage of common equity | 53% |
| Current assets / current liabilities: | not available |
| Liquidity and capital structure: Apparently reasonably good liquidity but they are dependent on continued access to bank credit, the company does use debt to finance their investment properties and (to a very limited degree) raw and developed land but the debt is probably not excessive and was recently 53% of the book value equity amount which is relatively low leverage. However with the equity trading at309% of book value, debt is significantly higher than the market value of equity. It does have debt maturities coming up but these are mostly secured against individual buildings or land with no recourse to Melcor. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 5.9% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 5.6% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 19.2% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 4.8% |
| Volatility of sales growth per share: | Good long term growth with significant volatility. |
| 5 Years compounded growth in earnings/share | 1.0% |
| 5 years compounded growth in adjusted earnings per share | 3.3% |
| Volatility of earnings growth: | Highly volatile but always positive each year |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | no |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 4.5% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 0.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 8.0% |
| GROWTH OUTLOOK AND AMBITIONS: It appears that profits and cashflows will be strong in Q3 and A4 based on the strong Alberta housing market. Their current lot inventory is low but presumably will be refreshed through current development activities. They have a focus of harvesting their existing excessive land position. Their ambition is more to protect investment and they are not ambitious for rapid growth that could be risky. They believe there is upward momentum in the Alberta economy. They have brought on new communities in the Calgary area and lot sale were strong in Q4 2023 and this should continue in 2024. As of Q2 2024 the lot inventory was very low and they appear to be developing existing communities but not initiating new ones – although that could change in Q3 and Q4. Results in its rental property buildings appear set to be relatively stable but higher interest rates are a definite headwind to earnings . The current strategic review of the REIT contributes to uncertainty and adds to costs. | |
| LONG TERM PREDICTABILITY: While earnings are highly unpredictable in the short term, it seems safe to assume the company will continue to grow over the decades. The question is whether this will be at a good or even adequate return on equity. Currently the return on equity is unacceptably low although the return on market value of equity (the depressed share price) is quite good. In the very near-term higher interest rates and vacancies in their office buildings may cause further market value losses on investment (rental) properties although interest rates are now starting to decline. | |
| Estimated present value per share: This company is quite cyclical is therefore difficult to value based on earnings. It seems clear that the intrinsic value is somewhat higher than the recent $12.23 share price. Consider that book value is $40.81 per share. Even if book value over-states the true intrinsic value, there would appear to be a large margin of safety here. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. The development industry probably has limited barriers to entry – although scale, financing and industry knowledge may provide some barrier (marginal pass). There are no known issues with powerful suppliers although governments may play a restricting role and they may be dependent on key contractors though we have no information on this (pass). No issues with excessive dependence on powerful customers (pass although there may be some vulnerability to a few key home builders), No viable substitute products (pass), Probably at least some tendency to compete excessively on the basis of price (marginal pass). Overall this industry appears to be only neutral at best in attractiveness. | |
| COMPETITIVE ADVANTAGE: Established presence in the market place and knowledge. Relationships with contractors who build its buildings and do the physical development of land. Has an existing inventory of land which overall was probably purchased on average at prices somewhat below the recent market value, although we may be wrong on that as market values may have decreased. Based on the low ROE it does not appear that they truly have any competitive advantages. | |
| COMPETITIVE POSITION: Its not clear what market share Melcor Developments has but it is a fragmented market and they likely have well under a 10% share for the Province. | |
| RECENT EVENTS: In 2024 they sold one small REIT building to raise cash. In March 2024, with the 2024 earnings release, they rather inexplicably cut the dividend by 31% from 16 cents to 11 cents while providing no discussion on the reasons for this but it apparently relates to the suspension of the REIT distribution. In February 2024 its REIT subsidiary suspended its distribution and announced it will undertake a strategic review. Several REIT buildings are listed for sale in order to raise cash. In 2024 to date they sold one small building in Kelowna. In 2023 they sold two buildings to raise cash and they have continued to buy back shares. For Q1, 2023 the dividend was increased by 7% to 16 cents per quarter. The dividend had then been increased 5 times in the past two years after having been cut in 2016, 2017 and 2020 due to the recession in Alberta and then the pandemic. The CFO / Executive V.P. has been promoted to Chief Operating Officer. They sold 117 residential home units in the U.S. in Q4 2022 for $35 million that had been purchased between 2010 and 2013 for $11.9 million. It appears that almost all of this gain was booked in Q4 (as a fair value gain) even though the building was theoretically carried at market value. A notable event is that the company has recently completed several sizeable block share repurchases that have reduced the share count by 5%. The former dividend increases and the share repurchases had been an indication of management’s confidence but the 2024 dividend cut seems to be the opposite. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Book value per share may over-state the true market value of its assets. Land is valued at cost but may not be worth cost if a discounted future cashflow analysis is used. Under IFRS accounting, the company (paradoxically) reports a gain when the value of the units in its separately-traded REIT decline. This is preposterous and we add it back. The company also adds it back to concentrate on Funds From Operations. Also under IFRS its gains and losses on the (modeled) market value of its rental buildings flow directly into earnings. We adjust for that. With the stock trading well below book value it is important to understand the assets and their accounting value. The capitalized interest included in its raw land costs would be a useful figure but does not appear to be disclosed. The accumulated mark-to market gains on its rental buildings would be useful but are not disclosed. The age of all its buildings would be useful but is not disclosed. Under IFRS the value of its investment properties have been written up to market (and more recently written down) but the development land inventory remains stated at cost and the market value of the land does not appear to be disclosed. The past writing up of the buildings to market value pushes up book value and pushes down the ROE. There is not much explanation of the nature of operating lease incentives or straight line rent adjustments. Other complexities include the nature of the provision for future development costs and the nature of the deferred income taxes and whether that might be expected to reverse. Overall it appears that “the market” has a difficult time understanding the accounting and economics of the company. | |
| COMMON SHARE STRUCTURE USED: Normal, 1 vote per share | |
| MANAGEMENT QUALITY: Management quality does not appear to be good – the recent level of profitability has been inadequate and, what’s worse, management seems relatively unconcerned by the situation. The Chairman claims that most aspects of its profitability are outside of its control and that there is no point in providing more incentive for top management to increase profits. And based on their responses to questions it is not clear that they even understand that their gross margin on land sales has been too low. There are some indications that they are not good at controlling the costs of land development. And we do have some concerns that the disclosure could be improved in terms of clarity. And there is a total lack of guidance on outlook. The CEOs historically have been promoted from within which is a sign of good management. Management has seemed completely unconcerned about the fact that the share price has been for several years trading at significantly less than half (and more recently less than one-third) of book value. Their role of stewards of the capital invested by public share owners seems questionable. They are protecting that capital but not earning an attractive or even reasonable or adequate return on it. | |
| Capital Allocation Skills: Based on accounting results, this is now very questionable given the poor ROE in recent years. Results about 15 years ago were far better. On occasion it has bought back shares at good prices. The creation of the REIT in 2013 appeared to have been a prudent move. However the stock market for the past few years seems to disagree that the capital investments were wise given that it is valuing the equity at now just 30% of book value! It is now questionable as to whether their investments in land have in fact been a good allocation of capital. They likely invested too much in land that would not be developed for many years or even decades. | |
| EXECUTIVE COMPENSATION: Updated from the Spring 2024 circular with 2023 compensation: The CEO who is also the chair and the senior member of the controlling family was compensated was compensated at about $1.3 million relatively similar to the prior two years. The CFO/Chief Operating Officer was compensated at $1.2 million, relatively similar to the prior two years. The remaining three executives were compensated at $0.45 to $0.5 million. The compensation for the top two could be considered excessive for such a low ROE company that had adjusted earnings of $66 million 2023 and FFO of $84 million. We also note that in comparing total executive compensation to performance the company focuses on asset and book value growth and dividends per share but not return on assets or return on equity or total shareholder return (They did show the share performance was below the TSX and TSX real Estate index. | |
| BOARD OF DIRECTORS: (Updated from Spring 2023 circular) A small with board with 8 members. Several key members own large stock holdings which aligns their interests with that of outside shareholders. Three members are from the controlling owner Melton family. We understand that unfortunately 4 of the other 5 can be described as friends of the family. Three of the outside directors own very few shares. Therefore this is a weak Board when it comes to the interests of the public share owners. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
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| Canadian ETF name: | Trailing P/E (Click for update) | Dividend Yield % (Click for update) | ETF Stock Symbol and Price as at September 23, ’19 | Comments |
| HIGHER YIELDING DIVIDEND CANADIAN EQUITY STOCK ETFs – (updated February 7, 2024) Note that the cash distributions on equity ETFs can be surprisingly volatile. The past year’s dividends can be found on Yahoo Finance under historical data, dividends only or in some cases by clicking the links here to the ETF provider. | ||||
| iShares S&P/TSX Capped Financials Index ETF and double bull ETF and double bear ETF | P/E 13.7 and P/B = 1.41
Calculated ROE 10.3% |
4.7% yield
0% HFU, HFD |
XFN $47.49 (0.61% MER)
HFU $19.78 (1.15% MER) 2 times bull HFD $10.01 (1.15% MER) 2 times bear |
27 companies in the ETF dominated by the big banks and life insurance companies. XFN looks very attractive. |
| iShares S&P/TSX Capped Utilities Index ETF | P/E 21.0 and P/B = 1.52
Calculated ROE 7.2% |
4.0% yield | XUT $25.22 (0.62% MER) | 16 companies. Heavily weighted to Fortis, Brookfield Infrastructure, Emera and Hydro One. This is reasonably attractive. |
| Vanguard FTSE Canadian Capped REIT Index ETF | P/E 20.7 PB 1.0 ROE 8.5%Calculated ROE 4.8% |
2.65% yield | VRE $30.09 (0.39% MER) | 18 REITs, well diversified. P/E and ROE may be completely unreliable due to IFRS mark to market valuations of properties held by REITs. Neutral in attractiveness |
| Vanguard FTSE Canada High Dividend Yield Index ETF | P/E 14.0 P/B 1.6 ROE 12.4%Calculated ROE 11.4% |
4.6% yield | VDY $41.66 (0.22% MER) | Note the low MER
About 52 companies 56% weighting to financials and 27% to oil and gas. Looks attractive. |
| iShares Canadian Select Dividend Yield Index ETF | P/E 11.9 and P/B = 1.39
Calculated ROE 11.7% |
5.3% yield |
XDV $27.32 (0.55% MER) | Appears quite attractive. About 30 companies in the ETF. This dividend ETF is far more evenly weighted by company than the one above but is still 56% financials. Appears quite attractive. |
| iShares Canadian Value Index ETF | P/E 13.4 and P/B = 1.48
Calculated ROE 11.0% |
4.1% yield | XCV $32.86 (0.55% MER) | 38 companies. There is a heavy weighting in the banks and a total of 56% in financials 26% in Energy Appears attractive. |
| iShares S&P/TSX Canadian Dividend Aristocrats Index ETF | P/E 13.5 and P/B = 1.39
Calculated ROE 10.3% |
4.0% yield | CDZ $31.04 (0.67% MER) | 91companies. None of the companies are heavily weighted. Financials 29%, Energy 11%. This appears reasonably attractive. |
| S&P/TSX Preferred Share Index | not Applicable to Preferred | 5.8% yield | CPD $11.34 (0.50% MER) | About 170 preferred share issues. (Subject to check) 82% are rate reset issues, 14% are perpetual fixed, the remainder are floating rate. This is quite attractive for the yield. |
| TSX Segment Index | Trailing P/E (Click for update) | Dividend Yield % (Click for update) | ETF Stock Symbol, (Click for updated price) | Comment |
| CANADIAN EQUITY ETFs (February 7, 2024) Note that the cash distributions on equity ETFs can be surprisingly volatile. The past year’s dividends can be found on Yahoo Finance under historical data, dividends only or in some cases by clicking the links here to the ETF provider. | ||||
| iShares S&P/TSX Capped Composite index ETF | P/E 14.6 and P/B = 1.86
Calculated ROE 12.7% |
3.0% yield | XIC $33.43 (0.06% MER) | 226 companies. Appears neutral in attractiveness. 31% Financials, 17% energy, 14% Industrials, 10% Materials, 9%, I.T, 19% in six smaller sectors. Incredibly low management fee. |
| iShares S&P/TSX 60 (Large Cap) Index ETF and TSX 60 bull and bear ETFs | P/E 15.5 and P/B = 1.96
Calculated ROE 12.6% |
3.2% yield
No dividend on HXU, HIX or HXD |
XIU $32.07 (0.18% MER)
HXU $20.10 (1.15% MER) 2 times bull |
60 large companies. 34% Financials, 17% Energy, 13% Industrials, 10% I.T., 8% Materials and 18% in five smaller categories. This allows broad exposure to the Canadian large cap stock market at a low fee. Appears neutral in attractiveness. |
| S&P/TSX Mid and Small Cap Index (Completion Index) and TSX mid-cap ETF | P/E 11.5 and P/B = 1.51
Calculated ROE 13.1% |
1.9% yield | XMD $31.46 (0.61% MER) | This ETF is more diversified. 19% Industrials, 18% Materials, 17% Energy, 16% Financials. Looks reasonably attractive but the lower P/E may reflect lower ROE sectors 165 companies. |
| S&P/TSX Small Cap Index and TSX small cap ETF | P/E 8.0 and P/B = 1.17
Calculated ROE 14.6% |
2.8% yield | XCS $17.77 (0.61% MER) | Looks attractive on P/E but note the weighting to mining. 28% Materials (mining) 18% Energy, 14% Industrials. 249 companies. |
| iShares S&P/TSX Capped Consumer Staples Index ETF | P/E 18.5 and P/B = 2.88
Calculated ROE 15.6% |
0.8% yield | XST $90.71 (0.61% MER) | Appears neutral in attractiveness but note the high quality companies which justify a higher P/E. Only 11 companies mostly Couche-Tard and grocery stores. |
| iShares S&P/TSX Capped Energy Index ETF and TSX Energy double bull ETF and TSX Energy double bear ETF | P/E 5.9 and P/B = 1.5
Calculated ROE 25% |
4.4% yield
No dividend on HEU or HED |
XEG $15.02 (0.62% MER) | 31 companies. Looks extremely attractive but that depends on oil and gas prices. Huge 48% weighting to CNRL and Suncor another 12% in Cenovus |
| iShares S&P/TSX Capped Information technology Index ETF | P/E 44.2 and P/B = 5.74
Calculated ROE 13.0% |
0.0% yield | XIT $55.46 (0.61% MER) | Appears unattractive on valuation but includes high growth companies – about 24 companies in this ETF. Extremely concentrated in Constellation Software, CGI and Shopify totalling 70%. |
| iShares S&P/TSX Capped Materials Index TSX Materials ETF | P/E 11.4 and P/B = 1.29
Calculated ROE 11.3% |
1.3% yield | XMA $16.24 (0.61% MER) | 52 companies, with 57% weighting to gold companies, looks reasonably attractive based on trailing earnings but this can change rapidly |
| iShares Canadian Growth Index ETF | P/E 19.4 and P/B = 3.03
Calculated ROE 15.6% |
1.0% yield | XCG $48.31 (0.55% MER) | 44 companies not particularly attractive although growth and the high ROE may offset the high P/E. Fairly good diversification. |
| CANADIAN FIXED INCOME BOND ETFs (dated February 7, 2024) For all bond ETFs be aware that the yield to maturity and NOT the cash yield is the best estimate of return, assuming interest rates remain unchanged or assuming a long holding period mimicking holding individual bonds to maturity. See also our comments below. | ||||
| Bond Type (Click for updated yield to maturity and to see the individual bonds in the index) | Average Term of Bonds in Years | Average Yield to Maturity before MER on index and cash yield on ETF | ETF Stock Symbol, (Click for updated price) | Comment (Bonds and Bond ETFs are more suitable to tax-sheltered accounts than taxable) The attractiveness of these bond funds depends heavily on the future direction of interest rates. |
| ishares Core Canadian Universe Bond Index ETF (Mostly Government and some Corporate) | 9.6 years | 4.25% YTM
3.1% cash yield |
XBB $27.53 (0.19% MER) | Appears reasonably attractive assuming interest rates will decline. |
| Vanguard Canadian Corporate Bond Index ETF | 7.1 years
See fact sheet |
4.7% YTM
3.9% cash yield |
VCB $23.28 (0.17% MER) | A reasonably attractive yield. |
| Vanguard Canadian Government Index ETF | 11.1 years
See fact sheet |
3.7% YTM
3.1% cash yield |
VGV $22.00 (0.17 MER) | Appears unattractive but has no credit risk |
| ishares Core Canadian Long Term Bond Index ETF (mix of mostly government and some corporate) | 22.7 years | 4.3% YTM | XLB $19.13 (0.20% MER) | Not a very attractive yield but will offer capital gains if long-term interest rates decline materially. |
| iShares Canadian Real Return Bond Index ETF | 13.0 years | Real yield 1.8% | XRB $21.70 (0.39% MER)
This is a confusing investment it did very poorly with the recent inflation that it was supposed to protect against |
Real return bonds (in theory) protect against inflation but pay modest yields and do not at all protect against a rise in the real (before inflation) interest rates. High MER. |
| Vanguard Canadian Short-Term Corporate Bond Index ETF | 2.9 years
See fact sheet |
4.65% YTM
3.5% cash yield |
VSC $23.21 (0.11% MER ) | 4.65% YTM minus the MER is at least higher than (most) bank account interest. Note the low MER. |
| General comments on Bonds and Bond ETFs: Bond interest is taxed more heavily than share dividends or capital gains. Therefore they are more suitable for tax-sheltered savings accounts. (RRSP, RESP, Tax Free Savings Account). Bonds, and especially longer term bonds fall in price when interest rates rise. Long-term interest rates are currently near record lows and therefore there is a high risk that interest rates will rise and that bond prices will fall. The real return bond partly protects against that risk. Corporate Bonds fall in price when corporate profits fall and or whenever corporations are viewed as more risky or when interest rates rise in general. Bond and Bond ETF cash yields can be higher than the underlying yield to maturity – don’t be misled – the offset would be an expected capital loss as the bonds are trading at a premium to their maturity price. Most of almost all Bond ETF are currently holding bonds that on average trade above their maturity value and they WILL suffer capital losses on those holdings. Bond ETF cash distributions are surprisingly volatile. Investors should review the cash distributions in the past year to get a better understanding of the yield. See also our articles on bond investing. | ||||
| GOLD AND COMMODITY ETFs (updated February 8, 2024) | ||||
| Commodity Type | P/E Ratio | Yield | ETF Stock Symbol, (Click for updated price | Comment |
| iShares S&P/TSX Global Gold Index ETF | P/E 26.3 and P/B =1.52
Calculated ROE 5.8% |
1.6% yield
erratic dividend No dividends on the bear/bull ETFs |
XGD $15.93 (0.61% MER) | 41 Global gold companies. My experience has been that gold companies tend to be often over-priced due to a “lottery ticket” mentality.
P/E is unattractively high at this time but that can change quickly |
| Horizons GOLD Futures Contract Index ETF (HUG) | not applicable | not applicable | HUG $16.08 MER 0.35% | Gold price in Canadian dollars and hedged to remove currency risk. Endeavors to correspond to the performance of the Solactive Gold Front Month MD Rolling Futures Index ER. It does not own physical gold
|
| iShares Gold Bullion Trust | not applicable | not applicable | CGL $16.25 MER = 0.55% | This is gold itself as a commodity. This Trust owns physical Gold. Hedged to the Canadian dollar. |
| iShares Silver Bullion Fund | not applicable | not applicable | SVR $10.96 MER = 0.66% | This is silver itself as a commodity. Trades in Canadian dollars and it is hedged. This Trust owns physical Silver. |
| Horizons Silver Futures Contract Index ETF (HUZ) | not applicable | not applicable | HUZ $10.16 MER 0.65% | Silver Price ETF in Canadian dollars and hedged to remove currency risk. Endeavors to correspond to the performance of the Solactive Silver Front Month MD Rolling Futures ER. It does not own physical silver. |
| Horizons Crude Oil ETF (HUC) | not applicable | not applicable | HUC $21.09 MER 0.75% | Emulates December contract for light sweet Crude. Priced in Canadian dollars and Hedged. This should go up if the Winter futures price for oil rises. And the reverse. |
| Horizons Betapro Crude Oil 2x Bull ETF | not applicable | not applicable | HOU $12.78 MER 1.15% | 2x Bull Attempts to emulate a 200% continuous exposure to the next month’s oil futures contract, 2x Bear Attempts to emulate a 200% continuous exposure to selling the next month oil futures contract. Hedged to Canadian dollars. |
| Horizons NATURAL GAS ETF (HUN) | not applicable | not applicable | HUN $7.47 MER 0.75% | Emulates Winter contract for Natural Gas. Priced in Canadian dollars and Hedged. This ETF should go up if the January natural gas price rises. And the reverse. |
| Horizons Betapro Natural Gas 2x Bull ETF | not applicable | not applicable | HNU $5.06 MER 1.15% | 2x Bull Attempts to emulate a 200% exposure to the next month Natural gas future. 2x Bear Attempts to emulate a 200% exposure to selling the next month Natural gas future contract. Hedged to Canadian dollars. |
We provide the P/E and dividend yields as of early February 2024 and other comments. But we also provide links so that you can check the latest P/E, P/B, dividend yield and the ETF prices. Therefore this Canadian ETF reference article can be used at any date, not just near the date it was last updated.
Keep in mind that P/E ratios P/B ratios and yields (and the resulting valuation comments) are based on the earnings and dividend information available at a point in time. For example the figures here updated in early February, 2023 would generally reflect Q3 2023 trailing year earnings and financials. Ratios are always subject to change as financial results change and as the ETF prices change. You can click to see the updated P/E and dividend yield as earnings get reported and as the ETF prices change. You can also click the price and then click to see the short and long-term price history. Some are abysmal.
If the earnings are expected to rise or fall substantially compared to the earnings in the most recent four quarters reported, then the most recent P/E ratio would not be reliable as a valuation indicator. Nevertheless, the trailing P/E ratios are what they are, and investors should find value in being aware of them. It appears that the exchange traded funds report P/Es that they have often adjusted in some way, presumably to make them more representative. iShares uses the weighted average harmonic mean P/Es of the constituent companies. We understand that such P/Es tend to be lower (and therefore look more attractive) than simply the total earnings of the index divided by its price. But we understand that the harmonic mean P/E is appropriate for use.
Keep in mind that stocks are volatile and a segment that looks attractive on trailing earnings may not be attractive if earnings fall sharply, but the opposite applies if earnings start to rise rapidly.
Please note the special and dangerous nature of leveraged ETFs (2 or three times bull or bear). They are known to perform as expected for very short-term holding periods but may not perform as expected over longer holding periods. Click on the leveraged ETF symbols below to see a graph that illustrates the problem. In general they are meant for pure speculation rather than investment. We include commodity ETFs and these too are much more for speculation than investment.
Note also that the P/E, P/B and dividend yields have been taken from the ETF fund web sites.
Also note that a number of the ETFs are called “capped” but in fact the weighting of the largest company is as high as 25% in some cases.
For those interested in Canadian ETFs this should be an excellent reference article. You can bookmark it and also join our free newsletter list to be advised of periodic updates to this table.
These Canadian ETFs trade just like stocks on the Toronto Stock Exchange and the trading symbol is provided. Buying the Exchange Traded Fund gives convenient exposure to the segment or commodity.
With the information above, investors can make a judgment as to the desirability of various segments of the Canadian market and we provide the trading symbol under which each can be purchased.
This can help you decide which sectors are most (or least) attractive. (Financial, Energy, Real Estate etc.)
While it can be very difficult to interpret whether a particular P/E , or P/B ratio is attractive or not, it is useful to be aware of these ratios. In theory the P/E ratio of an index should be more meaningful than the P/E for an individual stock since the group of companies that make up an index are less prone to unusual gains and losses since these tend to average out. But in some cases they do not average out and an index P/E could be affected by large unusual gains or losses at individual companies or something unusual that is affecting the entire sector.
In buying or selling any of these Canadian ETFs be cautious about the trading volume and the bid/ask spread. Higher volume ETFs are preferred, all else being equal.
In buying any of these, be careful to double check the Canadian ETF trading symbol with other sources. I believe the symbols above are correct, but please double check. A wrong symbol could lead to to the wrong investment. Also check the latest P/E ratios and dividend yield by clicking the links above. When clicking links check that it goes to the Canadian ETF name that you expect.
Investors may wish to consider the expected growth or contraction of the earnings that are driving the P/E for a particular segment. High growth can justify a high P/E and low or negative growth leads to lower P/E ratios. Also for some industries like mining and real estate, the GAAP earnings may arguably understate sustainable free cash flow therefore justifying a higher P/E. For more on this see our articles on understanding P/E ratios. Possibly, some segments, which may not have a lot of companies in the sector, are affected by one or two companies within the sector having unusual losses or gains.
END
Shawn Allen, CFA, CMA, MBA, P.Eng.
President
InvestorsFriend Inc.
Last updated: February 8, 2024
This reference article was first published on September 24, 2004 with nine ETFs and has been updated many times since then and also greatly expanded. In all that time, I have never seen any other published list of Canadian ETFs include the P/E ratios.
Global ETFs Stock Report
Global / International Exchange Traded Funds (Updated April 24, 2023 – – but links are provided for current prices, yields and P/E ratios)
InvestorsFriend’s one-stop Global / International ETF reference Site provides:
- Selected Global / International Exchange Traded Funds (ETFs) and trading symbols (this includes emerging market ETFs)
- Fundamental data for each selected Global / International ETF (P/E ratio and dividend yield and price to book ratio)
- Links to updated P/E ratio, dividend and other info for each Global / International ETF
- Links to Yahoo Finance for each Global / International ETF for an updated price and news items
- Four bond Exchange Traded Funds are included
- The Management Expense Ratio (MER) of each selected International ETF.
This article provides a list of selected Global / International Exchange Traded Funds (ETFs). It also provides the available fundamentals (P/E ratio, dividend yield, and price to book value ratio) and the Management Expense Ratio (MER) of each ETF. The intention is to provide a relatively broad list of ETFs covering major countries including emerging markets. This list is not intended to cover various industry segments but rather to cover countries. We provide the latest available P/E and dividend yields as of the date indicated at the end of this report. And we also provide links so that you can check the latest P/E, dividend yield, price to book ratio and the ETF prices. Therefore this Global / International Exchange Traded Fund (ETF) reference article can be used at any date, not just near the date it was last updated. See also our analysis of Canadian ETFs and Market segments. We have also provided a basic low-fee ETF portfolio using Canadian and global ETFs.
Further Information on interpreting our ETF table is provided below.
| The Following global ETFs Trade in the U.S. Most of these subject investors to currency risk between their country and the currency in the country of the index. Canadian investors should note that some of the distributions (usually 15% except in RRSP accounts) may be withheld for U.S. income tax. Be aware that the net asset value of the underlying entities can differ from the price of the ETF. This can be checked under the links to the index provider, usually ishares.com in the first column below. We don’t claim to predict the future here. That is, we claim no particular knowledge of the economic outlook in all these various countries or areas or the political or the currency risks. Any comments here are simply based on the P/E ratio, yield and price to book ratio. (If a country ETF looks like a bargain we will say so) The P/E ratios often appear to use some form of adjusted earnings (omitting unusual gains and losses). Be sure to click the links below for updated P/Es and yields before you buy. Note that even the updated P/E ratios that you click to will often be based on the ETF price at the end of the previous month. Also many are based on earnings from the previous fiscal year as opposed the the latest four quarters. That could be mis-leading if the ETF price or earnings has meanwhile changed significantly. | |||||
| Global ETF Click the links for ishares.com info. | Trailing P/E (adjusted earnings) | Dividend Yield % (trailing 12 months) | Price to Book ratio (from ishares.com | ETF | Comment |
| U.S. S&P 500 ETF | 20.5 | 1.6% | 3.8 | IVV $413.89 (MER 0.04%) Canadians can buy XSP $43.86 on Toronto, hedged in Canadian dollars (MER 0.11%)
You can also get double leverage or “bear” versions. See warning! 2 times bull (MER 0.89%) SSO $50.68 2 times bear (MER 0.90%) SDS $39.66 1 times bear (MER 0.89%) SH $14.95 |
500 of the largest U.S. companies. . This seems neutral to moderately expensive . It’s a good choice for diversification.
WARNING: Double leverage funds lose money if the market bumps up and down with no trend. |
| Dow Jones Industrial Average ETF | 20.3 | 2.2% | 3.9 | DIA $338.11 (MER 0.17%) | Appears neutral to somewhat unattractive |
| ishares Europe, Australia and Far East EFF | 14.2 | 2.5% | 1.6 | EFA $73.63 (MER 0.33%) or XIN $31.83 on Toronto, hedged in Canadian dollars (MER 0.50%) | Gives broad exposure to Europe, Australia and the Far East. Appears attractive. |
| Vanguard all cap developed world ex USA and Canada | 12.9 | 2.7% | 1.5 | VIU Toronto $31.44(MER 0.23) Also VI Toronto $34.40 which is hedged in Canadian dollars | Appears attractive |
| ishares Global 100 ETF | 17.6 | 1.8% | 3.2 | IOO $71.77 (MER 0.40%) | Note that this is 72% weighted to the United States. Appears to be attractive. |
| Europe 350 ETF | 14.5 | 2.8% | 2.0 | IEV $52.12 (MER 0.60% | Appears to be attractive. |
| China 25 Index ETF (Tracks the largest Chinese companies on the Hong Kong Exchange) | 11.5 | 2.5% | 1.4 | FXI $28.40 (MER 0.74%) | Appears attractive especially considering the high growth in China but China is also considered risky. |
| Japan ETF | 13.4 | 1.4% | 1.4 | EWJ $59.01 (MER 0.48%) | Appears attractive |
| United Kingdom ETF | 12.7 | 3.3% |
1.8
|
EWU $33.79 (MER 0.48%) | Appears attractive |
| Australia ETF | 12.1 | 5.1% | 2.2 | EWA $23.25 (MER 0.48%) | Appears attractive |
| Hong Kong ETF | 19.5 | 3.0% | 1.0 | EWH $20.61 (MER 0.48%) | Moderately attractive given price to book value. Heavily weighted in two large companies. |
| Brazil ETF | 4.7 | 12.9% | 1.9 | EWZ $27.70 (MER 0.63%) | Appears very attractive but this may indicate higher risk. |
| BRIC Countries ETF (China 64%, Brazil 10%, India 26% Russia 0% | 12.1 | 2.0% | 1.8 | BKF $34.01 (MER 0.72%) | Appears attractive (Russia no longer included) |
| Italy ETF | 9.4 | 4.1% | 1.3 | EWI $31.69 (MER 0.48%) | Appears attractive |
| South Korea ETF | 9.2 | 1.1% | 1.0 | EWY $61.56 (MER 0.64%) | Appears attractive |
| 20+ Year U.S. Treasury 25.5 years average bond maturity 17.5 years effective duration | 3.89% yield to maturity, average coupon 2.44% indicating that these bonds now trade under par on average. | TLT $105.29 (MER 0.15%) | No Credit risk. Appears somewhat unattractive due to the still low yield on these long-term bonds. This ETF can be used to speculate on U.S. interest rates. It will fall in price if long-term interest rates rise and rise in price if interest rates fall. | ||
| Ultra-SHORT bet 7-10-year Treasury by ProShares | PST $21.04 (MER 0.95%) | Can use this to speculate (gamble) that U.S. long-term Treasury bond interest rates will rise. | |||
| U.S. Investment-Grade corporate Bond fund ETF Average maturity 13.0 years. Effective duration 8.5 years. | Average Yield to maturity 5.15%
(With a distribution yield lower at 3.9%, it appears that these bonds trade under par on average) |
LQD $109.32 (MER 0.15%) | Looks moderately attractive. The weighted average maturity is 13 years. This fund may fall in price if long-term interest rates rise. Also it exposes investors to credit risk. | ||
| U.S. high yield corporate bond fund ETF
Average maturity 5.0 years |
Yield to maturity 8.13% (assumes no defaults)
Trailing yield 5.65% – the average bond here trades below par |
HYG $75.01 (MER 0.49%) | Possibly attractive but consider interest rate and credit risk The weighted average maturity is about 5.0 years. This fund could fall in price somewhat if mid-term interest rates rise. Also it exposes investors to considerable credit risk. The full yield to maturity will not likely be realized due to some of the bonds defaulting. | ||
The above table is an excellent reference for investors interesting in gaining global and emerging market stock and bond exposure through ETFs. You can bookmark this page or join our free newsletter list to be notified of updates. Additional Emerging Market Countries include: India INDA Malaysia EWM Chile ECH Indonesia EIDO Mexico EWW Peru EPU Philippines EPHE Taiwan EWT Thailand THD Turkey TUR Russia ERUS For many more international Exchange Traded Funds and countries see www.ishares.com and www.proshares.com With this P/E ratio and yield information, investors can make a better judgment as to the desirability of various Country ETFs and we also provide the trading symbol under which each can be purchased. (Or sold short for that matter).
While it can be very difficult to interpret whether a particular P/E ratio is attractive or not, it is useful to be aware of these ratios. In most cases the P/E ratios are apparently not the raw trailing P/Es but may be massaged to remove extraordinary items. Keep in mind that P/E ratios and yields are based on the earnings and dividend information available at a point in time. Ratios are always subject to change as financial results change and as the ETF prices change. If you click through to see the latest P/E and yields for these global / international ETFs note that some of them are not updated daily but are based on a previous month end prices and the P/E is often calculated with the most recent calendar year earnings.
In buying or selling any of these Global / International ETFs be cautious about the trading volume and the bid/ask spread. Higher volume ETFs are preferred, all else being equal. In buying any of these, be careful to double check the trading symbol with other sources. I believe the symbols below are correct, but please double check. A wrong symbol could lead to to the wrong investment. Investors may wish to consider the expected growth or contraction of the earnings that are driving the P/E for a particular country. High growth can justify a high P/E and low or negative growth leads to lower P/E ratios. Note that the price charts of Global / International ETFs that trade in the U. S. are in effect distorted by currency movements. The graph typically does not show just the movement of the country index, but rather the country index in U.S. dollars.
END
Shawn Allen, CFA, CPA, MBA, P.Eng.
President InvestorsFriend Inc.
April 24, 2023
2005 Sino-Forest Report
March 30, 2012
Update Sino-Forest entered bankruptcy protection today. As documented below I expressed deep concern about this company way back in 2005. Scroll to the bottom here to see what I was saying about this company since 2005.
September 3, 2011
This is a re-creation of our November 13, 2005 report on Sino-Forest. Given all the controversy about Sino-Forest we wanted to post again what we were saying about the company in 2005. We said in essence that the company looked like quite good value but that we had some concerns.
In particular, see my comments below this report where I document that I had lost trust in management in late 2005 and even speculated that it might be a fraud. Apparently I was six years ahead of my time on this one.
The report below was re-created from our November 2005 database. All the words in the report are exact, unchanged as they appeared in our November 13, 2005 report. I have however highlighted below the areas where I expressed particular concern. Concerns that now seem highly relevant. The yellow high lighting was not there in the original report.
Sino-Forest
(TRE, Toronto)RESEARCH
SUMMARYReport Author(s): InvestorsFriend
Inc. Analyst(s)Author(s)’ disclosure of share ownership: We
hold sharesBased on financials from: Dec
04 Y.E. +Q3 ’05Last updated: 13-Nov-05 Share Price At Date of Last Update: $3.90 Currency: $
CanadianCurrent Rating (Company Rating does not consider the
circumstances of any individual investor and is therefore not a
recommendation and is not Investment Advice):(Highly)
Speculative Buy rated at $3.45DESCRIPTION OF BUSINESS: Manages, operates and invests in tree plantations in China and produces wood chips which are sold to pulp mills and engineered wood producers. Also produces some lumber products and engages in wood products trading. Also sells standing
trees, which recently has been the fastest growing and most profitable business activity. Purchases trees and arranges for the trees to be made into wood chips and then resold for pulp and paper purposes.RATING: At the recent price of $3.45 the value ratios are compelling and point to a Speculative (higher) Strong Buy. Does reasonably well on Buffett’s tenets. It does have
potential for strong growth and provides some exposure to China. Negative factors include the risks of operating in China. Note the recent bond issue has an interest rate of 9.125% and a credit rating of only BB minus which is indicative of higher risk.
I expect continued price volatility. I generally consider this to be a poor industry but that may not be the case in China. I believe that there could be strong potential upside here of perhaps a 100% gain within one year if the company continues its recent earnings momentum. Some analysts have pointed out that they continue to raise money to grow and there is a risk of not obtaining financing. I don’t view the growth as a bad thing given the earnings. I would think the 2008 Olympics and continued strong growth in China would bode well for the company. I worry that the story is too good to be true. I worry that the company seems to have changed its business plan several times in the past few years. I am wary to become over-exposed. Note
that Jennings Capital has an unfavourable outlook on the stock. Note also that management has in the past been less than forthcoming with information. In summary,
the value looks great, but there are many risk factors and
investing in this stock will require patience and tolerance of
volatility. I rate this a (highly) Speculative Buy. See
comments under management quality. I feel that I am overexposed and so
will sell most of may shares to take profit and reduce my position
from 4.2% down to under 1%.RISKS:
The price to earnings ratio of this stock seems almost too good
to be true. Combine that with a lack of detailed disclosure by the
company and the location in China and there is always the potential
that assets and / or earnings are over-stated. Faces
currency risks since costs and sales are in Chinese currency. Risk of
asset seizures by communist Chinese government. I consider there to be
added risks due to location in China. May face risks of write-offs on
certain production facilities. Faces commodity price risks and risks
regarding the quality of its trees. For additional risks see annual
report.INSIDER
TRADING: checking since January 1, 2005, there is no insider trading
shown (other than “conversions” and “changes in the
nature of ownership”). Three insiders are shown to own
substantial shares (800,000 to
2.8 million shares). It’s comforting that insiders are not selling,
but neither are they buying despite a slide in the share price (since
recovered) . I take no signal from this lack of activity.WARREN BUFFETT’s TENETS: Seems to pass most of Buffett’s tenets
(see Robert Hagstrom’s book) – not simple to understand due to
location in China and somewhat complex financing (fail), good profit
history (pass), moderately favourable prospects for above average
returns due to cost advantages of fast growing tree climate and
established position in a fast-growing market (pass), probably
ethical management although in the past they have been almost
secretive (marginal pass), a good ROE (pass), high profits on
sales (pass) ,a reasonably low debt ratio (marginal pass) and probably
selling at a significant discount to a intrinsic value (pass).RECENT EARNINGS TREND: Strong earnings growth in latest few
quarters and year. Earnings are made more volatile by sales of
standing timber. Strong
earnings have been made by purchasing and then reselling standing
timber (I am not clear why they are able to make large profits that
way without any apparent value added). Earnings and
particularly sales on their own planted trees seem disappointingly
very low. Margins on standing timber were lower in Q2 and Q3 but they
explain this by indicating more pine trees were sold versus eucalyptus
trees.VALUE AND GROWTH RATIOS: Price to book value is very attractive
at 0.93 based on diluted number of shares.
P/E is very attractive at 5.2, Return on equity was very strong
at 17.1% in 2004. 16.3% net profit on sales in last 12 months, fair to
good financial liquidity with substantial but not excessive net debt
level. Growth in revenue and earnings per share are uncertain due to
difficulties in calculating the diluted number of shares each year due
to impacts of convertible debt (which no longer exists). Revenue has
grown strongly while earnings per share are more volatile. I calculate
a present value per share of $5.80 using what I believe to be
conservative assumptions and $9.05 using a moderately more optimistic
projection. This implies a good Price to Value Ratio of 60% to 38%.
However the profit growth and therefore the intrinsic value are
uncertain. These ratios point to a Speculative (higher) Strong Buy.SUPPORTING
RESEARCH AND ANALYSISSymbol and Exchange: TRE,
TorontoCurrency: Canadian
$Category: Growth Contact: info@sinoforest.com Web-site: www.sinoforest.com INCOME
AND PRICE / EARNINGS RATIO ANALYSISLatest four quarters annual sales $ millions: $539.9 Latest four quarters annual earnings $ millions: $88.4 P/E ratio based on latest four quarters earnings: 5.9 Latest four quarters annual earnings, adjusted, $ millions: $88.4 BASIS
OR SOURCE OF ADJUSTED EARNINGS: No adjustments made.Quality of Earnings Measurement and Persistence: Seems fairly
reliable but not necessarily persistent, the net income is largely
realized in cash. A
possible concern is whether or not cash can be taken out of China. All
cash plus additional borrowings are being re-invested in tree and mill
assets. Recently there was a large expense for stock-based
compensation but this was much-reduced in Q3 2005. The recent amounts
seem arbitrary based on a chosen vesting period, it could have been
much higher, this reduces earnings quality. Income taxes are expensed
and shown as payable but are not paid and may not be legally due, this
increases earnings quality if the income tax will never be payable.P/E ratio based on latest four quarters earnings, adjusted 5.9 Latest fiscal year annual earnings: $62.8 P/E ratio based on latest fiscal year earnings: 8.3 Fiscal earnings adjusted: $62.8 P/E ratio for fiscal earnings adjusted: 8.3 Latest four quarters profit as percent of sales 16.4% Dividend Yield: 0.0% Price / Sales Ratio 0.97 BALANCE
SHEET ITEMSPrice to (diluted) book value ratio:
1.05Quality of Net Assets and Book Value Measurement: Apparently good
reliability, assets consist largely of standing trees. The assets are
tangible with very little goodwill, and sales of standing timber
appear to indicate that the standing tree assets are worth at least
50% more than book value. An independent report valued the trees at a
57% premium to book value. However, some investments in wood product
plants may be at risk of further write-offs.Number of Diluted common shares in millions:
137.8Controlling
Shareholder: Fidelity
(mutual funds) owned 10.3% at Mar 31, 2005. Management appears to own
less than 10% of the company.Market Capitalization $ millions: $537.6 Percentage of assets supported by common equity: (remainder is
debt or other liabilities)51% Interest-bearing debt as a percentage of common equity 77% Current assets / current liabilities: 2.5 Liquidity
and capital structure: reasonable liquidity, with cash on hand.
Although debt has recently increased.
I understand the credit rating is BB minus. This is considered several
notches below investment grade. So it is indicative of higher risk.RETURN ON
EQUITY AND ON MARKET VALUELatest four quarters adjusted
(if applicable) net income return on ending equity:17.3% Latest fiscal year adjusted
(if applicable) net income return on average equity:17.1% Adjusted (if applicable) latest four quarters
return on market capitalization:16.5% GROWTH
RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE5 years compounded growth in sales/share 12.1% Volatility of sales growth per share: strong
growth with some volatility5 years compounded growth in earnings/share 7.3% 5 years compounded growth in adjusted earnings per share n.a. Volatility of earnings growth: strong
growth, but some volatilityProjected current year earnings $millions: not
availableProjected price to earnings ratio: not
availableOver the last five years, has this been a truly excellent
company exhibiting strong and steady growth in revenues per share and
in earnings per share?Yes,
although volatileExpected growth in EPS based on adjusted fiscal Return on equity
times percent of earnings retained:17.1% More conservative estimate of compounded growth in earnings per
share over the forecast period:10.0% More optimistic estimate of compounded growth in earnings per
share over the forecast period:15.0% OUTLOOK FOR BUSINESS: Company
plans to continue its aggressive growth through investments in tree
plantations. In the past results have been volatile and this may
continue. Given recent and pending investments in tree plantations,
the near-term outlook seems quite positive. They may need to issue
additional shares to fund growth and that would dampen the share price
growth somewhat.Estimated present value per share:
$5.80 if earnings per share grow for 5 years at 8% compounded
each year and the shares can be sold at a higher P/E of 8 after five
years. $9.05 if earnings per share grow at 15% each year and the share
can then be sold at a higher P/E of 10 after five years. Both
estimates use a required rate of return of 8%. This is not a share
price prediction.ADDITIONAL
COMMENTSINDUSTRY ATTRACTIVENESS: (These comments reflect the industry
rather than any particular company.)
Michael Porter of Harvard argues that an attractive industry is
one where firms are somewhat protected from competition.
Wood chips, trees and wood products are commodities which tend
to compete strictly on price (although the company indicates
competition is low). The industry is not subject to powerful suppliers
or customers who could usurp the industry profit. The industry has
substitute products (which is a negative). The industry tends to be
cyclical following construction cycles. The industry is subject to
protests from environmentalists. Overall, this is an unattractive
industry. However, the competitive environment for Sino-Forest may be
much better than for the industry generally.COMPETITIVE ADVANTAGE: Compared to certain other regions of the
world, the trees grow remarkably fast in China. This company has the
long-term use of plantation lands in China. They appear to be a low
cost producer there appear to be barriers to entry due to (perhaps)
limited plantation land available and due to high capital investments
needed. However the more recent business is that of buying existing
plantations and it is less clear what competitive advantage they have
there although it may be their connections and relationships. The
company cites relationships and strategic locations near population as
well as expertise, and research and development.RECENT EVENTS: Borrowed U.S. $300 million at 9.125% by issuing
bonds (rated BB) to replace existing International Finance Corporation
debt and for capital spending.ACCOUNTING AND DISCLOSURE ISSUES:
I use diluted number of shares (calculated as earnings divided
by diluted EPS) and this is volatile due to impacts of convertible
debt (since retired). Earnings have been poured into tree plantations
and more recently into mills to process wood. Disclosure
in the past has been opaque. This is improved now but raises questions
as to why they waited so long to become better at disclosure.COMMON
SHARE STRUCTURE USED: Recently converted the multiple voting shares to
single voting shares. This was a very positive development.MANAGEMENT
QUALITY AND ETHICS: Management are of Chinese heritage, are major
shareholders and have a good track record. Previously
I was wary to trust this management given their past lack of
disclosure and high executive compensation. However, disclosure and
governance has now improved substantially. The company has been
listed on the stock exchange for many years. To
some degree I am placing my confidence in the regulators and
accountants that everything is above board here. I
am concerned that most profits now appear to come from buying land
with standing trees and then reselling the trees (not clear why this
would be profitable). Also most of the traditional wood chip
business seems to be outsourced. The
hoped for sale of the companies own planted fast-growing trees has
essentially not materialised even after 12 years. Talked about
revenues and profits on wood mills also seems not to have materialised.
This causes me concern about the management quality and
forthrightness.EXECUTIVE COMPENSATION: Recently management were rewarded with
stock-based compensation that of total value of over $10 million
although only $2.7 million was vested and expensed in Q2 2004. There
appears to be a danger here of excessive compensation. In Q3 2004 it
was reported that management was paid $12 million for rights to
acquire shares in a subsidiary of the company. $7.8 million will be
treated as compensation expense over a vesting period. This
seems rather strange and is worrying, however it may be a one-time
event.BOARD OF DIRECTORS: (2005 annual meeting
info) Six of the eight directors, including the CEO, are
significant shareholders. This tends to align their interests with
those of other shareholders. 5 of the directors are independent after
recently adding two independent directors to improve corporate
governance.Basis and Limitations of Analysis: The following applies to all
the companies rated. Conclusions are based largely on achieved
earnings, balance sheet strength, earnings growth trend and industry
attractiveness. I undertake a relatively detailed
analysis of the published financial statements including growth
per share trends and my general view of the industry attractiveness
and the companies growth prospects. Despite this diligence my analysis
is subject to limitations including the following examples. I have not
met with management or discussed the long term earnings growth
prospects with management. I have not reviewed all press releases. I
typically have no special expertise or knowledge of the industry.DISCLAIMER: All stock ratings presented are “generic”
in nature and do not take into account the unique circumstances and
risk tolerance of any individual. The information presented is not a
recommendation for any individual to buy or sell any security. The
author is not a registered investment advisor and the information
presented is not to be considered investment advice. The reader should
consult a registered investment advisor or registered dealer prior to
making any investment decision. For ease of writing style the
newsletter and articles are written in the first person. But, legally
speaking, all information and opinions are provided by InvestorsFriend
Inc. and not by the author as an individual. InvestorsFriend Inc.
itself does not have a position in any of the indicated securities
while the author may have a position.©
Copyright: InvestorsFriend
Inc. 1999 – 2005 All
rights to format and content are reserved.OLDER REPORTS
Our report from August 28, 2000. contained the following:
COMMON SHARE STRUCTURE USED: Poor structure. The shares that trade are subordinate voting common shares, there also exists 6 million multiple-voting common shares with five votes per share. The company founders could thus control the company even though outside investors might have more shares. In our opinion, subordinate voting shares are far less attractive than normal voting shares and are a strong negative indicator. Could prevent future take-overs or replacement of management if they become incompetent.
The company has paid significant amounts to service companies controlled by the founders.Our report from November 20, 2003 contained the following:
MANAGEMENT QUALITY AND ETHICS: Management are Chinese, are major shareholders and have a good track record. The company appears to have arranged its affairs so as to pay zero income taxes despite reporting profits. No income taxes appear to be payable in Canada.
One could perhaps question the ethics of this type of tax
avoidance... but maybe they are just being smart managers. Some insider trading was reported late and this is not a good sign.
By November 26, 2004 we added a sentence at the end:
MANAGEMENT QUALITY AND ETHICS: Management are Chinese, are major shareholders and have a good track record. The company appears to have arranged its affairs so as to pay zero income taxes despite reporting profits. No income taxes appear to be payable in Canada.
One could perhaps question the ethics of this type of tax avoidance…
but maybe they are just being smart managers. Some insider trading was reported late and this is not a good sign. Executive compensation seems high.
Overall I do not particularly trust this management.
OTHER COMMENTS WE MADE
When the November 13, 2005 report reproduced above was issued, we added some comments to our daily
blog provided to our customers. Also I show here some comments made prior to
November 2005. These are as follows, again with some
highlites that were not there in the original:April 13, 2005
Sino Forest last rated Speculative Strong Buy at $3.50 has seen weakness
and traded down to $3.14 today. I note no insider selling or trading in 2005
(which I am glad to see). They recently announced a transaction to invest in
another Chinese forestry company. See press release http://ca.us.biz.yahoo.com/ccn/050407/2b489d0853d73
c4ac8d19b1e63d45dff.html?.v=1
This may have been viewed as overly complex. Also
they recently changed auditors also they indicate this was not about
arguments over the accounting. See pres release. http://ca.us.biz.yahoo.com/bw/050407/75352.html?.v=1
Overall these factors increase the risk, but certainly the value looks quite
attractive.
November 13, 2005
Sino-Forest is updated and rated (highly) Speculative Buy at $3.45. Based
on the value ratios this would seem to be a very good buy that could easily
soon double. However, I have some
nagging concerns. The company that has all its assets in China and it
must be difficult for auditors to confirm the existence of the stated amount
of trees. Recently the earnings have been driven by the purchase and re-sale
of standing trees. It’s hard to understand why that would be a high margin
business. For quite a few years now I have expected to see the company start
to sell from its own planted tree plantations. In Q3 only a tiny 391
hectares were sold from plantations and these were at the low price of
$1,217 per hectare. Several years ago the company built a number of mills to
process wood, there were were start-up delays and then ultimately little
seems to be said about those mills. It seems like management has
changed the business plan a few times. Overall, this may be a wonderful
investment but I am concerned about the risks
and I plan to reduce my
holdings from 4.2% of my portfolio down to probably less than 1%.
November 14, 2005
I sold 4/5ths of my Sino- Forest today. Again, the numbers would say buy
more, but there is something about
the long-time lack of clear disclosure and the changes in business plans
that makes me uncomfortable. I also just made a note on the model
portfolio page that I will notionally sell half the position at tomorrow’s
opening price. I have sent an email to them and they have responded
partially and another person from Sino invited me to call to talk further,
so maybe I will change my mind but for now I am comfortable with a smaller
position in Sino-Forest.
Update – I have now spoken with the company by phone, perhaps I am
needlessly nervous. If everything is as they say it is these shares are a
definite Buy. But the company
was unable to explain to my satisfaction why we do not see much higher
revenues from their own planted lands. I remain skeptical at this time.
December
14, 2005
As of yesterday, I was at a
definite new peak return for the year. Gave some back today… Today I
sold the last of my Sino-Forest. See my previous comments on the company.
The numbers still look good on the stock. But
I was just no longer comfortable with the company in terms of really
understanding what they and what the risks are.
In addition here is an email I sent to one our customers on November 13, 2005
Please don’t share this with others, such as
stockhouse board. But what if Sino
just possibly is some kind of fraud or is hiding something,? Asking
them will not reveal it. I am just saying I am nervous here. I have
been holding Sino since maybe 1999 and have generally been a big fan
Page 5 of annual report says Eucalyptus trees mature in 5 years. Yet I
don’t see any indication they sold any of their planted trees in Q3, they
did say 391 hectares from plantation but was that planted trees or just the
older growth? I have been waiting 5 years to see expected big profits when
they started selling these planted trees. I mean I expected some way back
and where are they?
I have now emailed them.
Regards,
Shawn
Allen
InvestorsFriend
Inc.
I next mentioned Sino-Forest in my daily comments
to my paid subscribers on September 12, 2006 saying:
I noticed today a stock I used to cover, Sino-forest
is down to $3.70 from highs around $7. Based on earnings it would look quite
cheap. Also there has been some insider buying. So that seems tempting. But
as I said earlier about this company I was just not comfortable with it due
to past changes in strategy and seeming inconsistencies in their story.
Warren Buffett teaches us to not invest unless we are comfortable with
management. For whatever reason I am
just not comfortable. Therefore I think it is best if I just stay
away from this stock. Maybe I will miss out on something here. But the fact
is that there are thousands of companies to choose from and I prefer to put
money into companies where I don’t have any nagging doubts about whether I
quite trust management. So, I think I will continue to ignore Sino-Forest.
I next mentioned Sino-Forest in the daily comments
on May 21, 2009 saying:
I notice Sino-Forest is issuing shares at $11.00. I no longer follow it.
It often seemed to be reporting strong profits but I
was uncomfortable with changes in its business plan. (First the
profit was supposed to be in planted trees that would grow in seven years or
even five, last I checked that profit never materialized but they started
making a lot of money by selling trees on the stump that they had bought but
not grown themselves – curious why there would be big profit in that. At one
time they were supposed to have a bunch of mills to make lumber and that
never worked out. At one time their reports implied that they had mills to
chip wood, later it seemed to be revealed that the chip mills were not
owned, they paid to have logs chipped. For
a variety of such reasons I simply felt I personally was not willing to
trust them. On the other hand they had an S&P debt rating and so one
would think they could be trusted.
I would make the point that they are supposed to be a high profit company
yet they have never paid a dividend and now they need cash. Sure they are
growing but when will cash stream out of the company?
I did not again mention Sino-Forest until this Spring of 2011 when the
allegations of fraud finally arose.
Conclusion:
Above I document that I had certain suspicions
in late 2005, even speculating that it might possibly be a fraud but I had certainly
not concluded it was a fraud. In fact I said it looked like a Buy although a
highly speculative one. As far back as 2004 I indicated I did not
particularly trust this management.
It appears I did not mention in my notes that Sino had changed
auditors in April 2005 From Ernst and Young and then back to Ernst and Young
in August 2007. I was aware of this both times, I recollect.In
both cases the following (probably standard wording) was used:there have been no reservations contained in the auditors
reports on the annual financialstatements
of the Corporation for the two most recently completed fiscal years immediately
preceding the date of this notice nor for any period subsequent to the most
recently completed period for which
an audit report was issued
It
seems odd to me that they don’t just say there were no reservations for the
subsequent period, why use the proviso “for which an audit report was
issued”. The wording seemed a little cute to me at the time but perhaps
it is just the standard wording.
InvestorsFriend.com Sample Report – Canadian National Railway
THIS IS AN EXAMPLE ANALYSIS AND IS NOW OUT OF DATE
This Sample Shows you the content of the reports and you can see there is a lot of analysis and thought that goes into our ratings.
Our analysis includes a graph of earnings per share growth and revenue per share growth. Most analysts only graph stock price growth. Our philosophy is that if a company can take care to grow its earnings per share, the stock price will tend to take care of itself. We use a logarithmic scale on graphs. Log scales are the only honest way to present this information. On a normal arithmetic scale (which almost everyone else uses) a tiny growth can be made to look like a huge growth.
The chart of the revenue per share growth for CN (red line) shows a decline in 1998, recovery in ’99 and modest growth in the early 2000’s followed by quite strong growth since 2003. The earnings per share (adjusted for unusual items) (pink line) has grown substantially faster than revenues and notably has stalled to no growth in 2007. CN is likely facing little or no earnings growth in 2008 although management does project mid to high single digits based on its forecast of a slow-down (not recession) in 2008. Beyond 2008, it seems reasonable to assume that this well-run company with its duopoly position in Canada can continue to grow earnings per share at perhaps 7 to 10% per year. Note that the graph here is updated to 2009 while the original report had a graph that ended at 2007.
| Canadian National Railway Company (CNR, Toronto CNI, New York) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | Author(s) hold shares |
| Based on financials from: | Dec ’07 Y.E. |
| Last updated: | 2-Feb-08 |
| Share Price At Date of Last Update: | $51.86 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice ): | THIS IS AN EXAMPLE ONLY AND IS NOW OUT OF DATE(lower) Buy rated at $51.86 |
| DESCRIPTION OF BUSINESS: Railroad, operating coast to coast in Canada and includes Illinois Central Railway which extends the reach south to the Gulf of Mexico. | |
| SUMMARY AND RATING: The graph illustrates that this is a “great company” with strong (adjusted) earnings per share growth. ROE is very strong and overall the value ratios indicate a Buy. This management seems to be very aggressively focused on growth in shareholder value. Arguably passes all of the Buffett tenets. Very recent earnings growth has stalled to about 0%. The near-term outlook is for flat to slightly lower earnings due to the high Canadian dollar and lower forestry volumes and possible U.S. recession. Growth should resume after 2008. Significant share buy backs add support to the price. Overall we rate it a (lower) Buy due to the strong management, the earnings history, the reasonable P/E and the long-term sustainable advantage of owning tracks that likely cannot be duplicated by competitors, and the current value premiums being paid for cash generating assets, this is offset by a relatively poor outlook for the next year. | |
| RISKS: The company notes environmental and casualty liability risks. Also labour trouble is a large risk. Rising pension costs. Some regulatory and environmental risks. See annual report for more risks. | |
| INSIDER TRADING / INSIDER HOLDING: Checking insider trading from July 1, 2007 to December 10, 2007. About 7 insider exercised options and sold shares but generally continued to hold many shares so this is not considered more than a very modestly negative signal. 1 insider sold 400 shares at $54. One insider exercised options but held most of the shares and then bought 1000 when it dipped to $46. The CEO bought 21,000 shares at about $47. One director bought shares at $57 and $51. The company itself is buying back lots of shares but we take no signal from that – after all they are using shareholder money to do that. Updating from Dec 11 to Feb 1, several insider exercised options and sold around $50. Subsequent to the recent earnings release 1 insider exercised options and sold at $48.55. Overall, the insider trading / insider holding signal seems about neutral at a $52 share price. | |
| WARREN BUFFETT’s TENETS: Arguably passes all of Buffett’s tenets (see Robert Hagstrom’s book) – simple to understand (pass), good profit history (pass), reasonably favourable prospects due to strong management and low costs (pass), rational-candid-ethical management (pass), high ROE (pass), high profits on sales (pass), a reasonably low debt ratio (pass) and arguably selling at a reasonable discount to intrinsic value (marginal pass). | |
| MOST RECENT EARNINGS AND SALES TREND: Adjusted Earnings per share were unchanged in 2007 versus 2006. In Q1 2007 earnings per share dropped 5% due to disruptions of service caused by weather problems and labour problems. In Q2 2007 adjusted EPS roses 7%. In Q3 2007 adjusted EPS declined by 1%. In Q4 adjusted EPS were the same as Q4 2006. Therefore the trend had been very strong but it appears that earnings growth has now stalled. Earnings per share growth has gone to 0% due to the higher Canadian dollar and due to much lower shipments of forestry products to the U.S. – caused by the housing recession there. | |
| VALUE RATIOS: Analysed at $51.86. Price to book value ratio at 2.5 is neutral in attractiveness and mathematically reflects the high ROE and modest P/E. Price to book would be lower (more attractive) at about 1.7 if deferred taxes were removed or fully discounted as a liability. The P/E (adjusted to remove unusual gains) is 15.3 which seems somewhat attractive. Dividend yield is modest at 1.8%, but the dividend has been increasing substantially. Return On Equity (adjusted to remove gains) was quite strong at 17.2%. Sales per share have grown at an average 9.1% in the past 5 years. Adjusted EPS growth over 5 years has averaged a very strong 14.5% but was 0% in 2007. As detailed below, we calculate the intrinsic value to be $53.09 to $64.41, assuming five-year growth of 7% to (a perhaps quite optimistic) 10% and a P/E in five years of 15 to 16 respectively. This indicates an estimated Price to Value ratio of between 98% and 81% respectively. In order to return 15% annually over 5 years (to shareholders buying now at $51.86) growth would need to average 11.9% assuming a P/E of 16, such growth is quite optimistic. Overall these ratios, in isolation, indicate a Buy rating assuming growth of at least 7%. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | CNR, Toronto (and CNI, New York) |
| Currency: | $ Canadian |
| Category: | Mature with moderate growth potential |
| Contact: | mark.wallace@cn.ca |
| Web-site: | www.cn.ca |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $7,897.0 |
| Latest four quarters annual earnings $ millions: | $2,158.0 |
| P/E ratio based on latest four quarters earnings: | 12.2 |
| Latest four quarters annual earnings, adjusted, $ millions: |
$1,725.0 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: One time gains and losses identified by management are removed for the adjusted earnings figure. | |
| Quality of Earnings Measurement and Persistence: The reported Earnings seem “real”. But, the company notes that the depreciation charges are insufficient to replace the equipment after inflation. This seems to be the case given that capital expenditures are markedly higher than the depreciation expense. Until 2005 the company was paying little cash taxes which added to earnings quality, but cash taxes appear to equal accounting taxes in 2006. Pension expenses have been very much under-stated due to an unrealistic assumption of 8% return on plan assets in 2004 (9% prior to 2003). The company reported just $22 million pension expense while putting in $165 in 2004!. We calculate free cash flow closely approximates the net income in 2005 adding back deferred taxes. But free cash flow lagged earnings in 2006 as there was no deferred taxes. Overall, the quality of earnings is probably good, but the quality has declined in 2006 versus prior years. | |
| P/E ratio based on latest four quarters earnings, adjusted | 15.3 |
| Latest fiscal year annual earnings: | $2,158.0 |
| P/E ratio based on latest fiscal year earnings: | 12.2 |
| Fiscal earnings adjusted: | $1,725.0 |
| P/E ratio for fiscal earnings adjusted: | 15.3 |
| Latest four quarters profit as percent of sales | 21.8% |
| Dividend Yield: | 1.8% |
| Price / Sales Ratio | 3.34 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 2.53 |
| Quality of Net Assets and Book Value Measurement: With little or no intangible assets, the assets appear to be very strong. The value of the equity overall appears to be conservatively stated. There is a large and growing deferred income tax liability which will likely not be paid for many years. (Witness the $250 million gain due to lower tax rates recognised in Q2 2006). The present cash value of this liability is therefore likely much lower than the book liability and this tends to add to the true economic value of equity and create a stronger, higher quality balance sheet. | |
| Number of Diluted common shares in millions: | 495.9 |
| Controlling Shareholder: none, partly due to a ridiculous 15% ownership restriction imposed by government | |
| Market Equity Capitalization (Value) $ millions: | $25,717.4 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 43% |
| Interest-bearing debt as a percentage of common equity | 55% |
| Current assets / current liabilities: | 0.7 |
| Liquidity and capital structure: Very Good | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 17.2% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 17.2% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 6.7% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 9.1% |
| Volatility of sales growth per share: | stable with good growth and recently accelerating |
| 5 years compounded growth in earnings/share | 26.4% |
| 5 years compounded growth in adjusted earnings per share | 14.5% |
| Volatility of earnings growth: | strong steady growth but recent flattening |
| Projected current year earnings $millions: | not available |
| Projected price to earnings ratio: | not available |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 12.7% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 7.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 10.0% |
| OUTLOOK FOR BUSINESS: 2008 could see an earnings decline due to low forestry volumes and the high Canadian dollar. Appears set for continued growth but earnings would fall temporarily if the economy slumps. The company projects 10 to 15% earnings per share growth longer term but now indicates mid to high single digits for 2008 given the impacts of higher Canadian dollar, low forestry volumes. With a possible recession looming in North America there is a risk of an earnings decline in 2008. It seems to us that they are well positioned for the long term as North America continues to import ever-more goods from Asia. Therefore growth will be slow in 2008 but resume at perhaps 7 to 10% thereafter. | |
| Estimated present value per share: We calculate $56.82 if earnings per share grow for 5 years at an average compounded 9% and the shares can then be sold at a P/E of 15. And $68.83 if earnings per share grow at a compounded 12% for 5 years and the shares can then be sold at a P/E of 16 (approximately the current P/E). Both estimates use an 8% required rate of return. This is not a share price prediction./td> | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. This industry has very strong barriers to entry in terms of rail rights of way (pass). Not subject to dependency on powerful customers (pass). No dependency on powerful suppliers (pass), The industry as a whole is subject to trucking as substitute product (fail), Probably limited tendency to compete excessively on the basis of price due to competitive advantage over trucks in many cases but tempered by commodity nature of products and presence of fixed cost structure (marginal pass). Overall, appear to be a somewhat attractive industry. | |
| COMPETITIVE ADVANTAGE: Strong management with a focus on simple fundamentals like moving the trains faster and minimizing investments in assets. Acknowledged as the best managed railroad in North America. Appears to have some “pricing power” as evidenced by the ability impose fuel surcharges without affecting volumes. Presumably the tracks that they own are an advantage because their are likely few or no other rail service options available to many of their customers. (Although in some U.S. markets they compete with barges on the Mississippi river). | |
| RECENT EVENTS: Recently completed two relatively smaller acquisitions and a small divestiture of a European investment. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Uses U.S. GAAP. Generally exceptionally good disclosure. Excellent disclosure of freight moved (number of rail cars, ton-miles etc.) and revenue sources and results for different freight types. However, disclosure could be improved by including a 5 year summary in the annual report and by including net income, adjusted net income and average number of basic and fully diluted shares in the 5 year summary. There are some complexities involved in understanding the pension liability. | |
| COMMON SHARE STRUCTURE USED: Normal common shares, 1 vote per share. | |
| MANAGEMENT QUALITY: Excellent management. It appears that these people definitely know how to run a railroad. Their focus on asset utilization such as moving the trains faster (limiting idle time) seems very logical. The excellent level of disclosure in the annual report is a sign of a management that respects the shareholders. | |
| EXECUTIVE COMPENSATION: Long-term incentive payouts were very high in 2005 with two officers receiving U.S. $5 million and the CEO at U.S. $17 million. But the in the prior year the CEO received only $1.6 million. It’s not clear to us if the big 2005 payouts should be treated as annual amounts. The CEO salary and bonus in 2005 was generous but not excessive at about $5 million. The other four big executives received only about $1 million which is really not that high for the top executives of such a large company. Overall, given the size and profitability of this company, we are not concerned about executive compensation at this time. | |
| BOARD OF DIRECTORS: A prestigious board with a number of representatives from the investment community. A typical outside board member has substantial shares (several $million worth) and this insures that their interests are aligned with other shareholders. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend Inc. itself does not have a position in any of the indicated securities while the authors may have a position, as disclosed in each report. The Authors’ positions may subsequently change without notice.
© Copyright InvestorsFriend Inc. 1999 – 2008 All rights to format and content are reserved.
InvestorsFriend.com Sample Report – Telus
Telus (T, Toronto)
THIS IS AN EXAMPLE REPORT FROM LATE 2004 – We rated TELUS a Speculative Buy at that time.
This Sample Shows you the content of the reports and you can see there is a lot of analysis and thought that goes into our ratings.
RESEARCH SUMMARY – EXAMPLE ONLY – NOW OUT OF DATE
| Report Author: | Shawn Allen |
| Author’s disclosure of share ownership: | I hold no shares |
| Based on financials from: | Dec 03 Y.E. + Q2 ’04 |
| Last updated: | 6-Oct-04 |
| Share Price At Date of Last Update: | $28.00 |
| Currency: | $ Canadian |
| Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice): | THIS OLD SPECULATIVE BUY RATING FROM 2004 IS FOR EXAMPLE ONLY AS IT IS NOW COMPLETELY OUT OF DATE. The rating per this old report was Speculative Buy |
| DESCRIPTION OF BUSINESS: Incumbent local exchange and long distance provider in Alberta, BC and a part of Quebec. Has strong market share in those areas for local, long distance, internet and mobile. As non-incumbent is achieving good penetration in Ontario and Quebec in mobile and internet access service. | |
| RATING: The value ratios would suggest a hold. However, Telus appears to be trending up to significantly higher earnings. Past investments in building a huge cell-phone and internet subscriber base are materializing in rising cash flows. Continues to add significantly to customer base. Has industry-leading low churn rate. This is a company where the value is not yet apparent in the earnings. However, I believe earnings will rise sharply and that it is therefore a good but Speculative pick at this time. I rate it a Speculative Buy. | |
| RISKS: Aggressive competition and competing technologies are the major risk factors. Competition seems much less intense in long distance than it was a few years ago. Competition in wireless phones and internet access is unfortunately intense. There is a risk of further union problems. | |
| INSIDER TRADING: Checking transactions since April 1, there is not a lot of activity, some “purchases under a plan”, 3 executives exercised options and sold, although the CEO kept about one third of the stock acquired on option. Overall no clear signal emerges here. | |
| WARREN BUFFETT’s TENETS: (See Robert Hagstrom’s book – The Warren Buffett Way) – Not simple to understand due to accounting and technology issues (fail), poor recent profit history, but recently improving sharply (marginal pass), Some prospects for above average returns as cash flows from customer base materialize (pass), apparently candid ethical management, but I don’t like the focus on non-GAAP EBITDA (marginal pass), not a high ROE recently (fail), reasonable high profits on sales, particularly high gross profit (pass) , not a low debt ratio (fail), little chance of permanent loss of capital (pass) probably low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) and arguably selling at a discount to intrinsic value (pass). | |
| VALUE AND GROWTH RATIOS: Price to book value appears attractive at 1.5. But price to tangible book value is negative. Dividend yield is moderate at 2.1%. The P/E ratio based on interim earnings does not seem excessive, given the earnings growth trend, at 22.9. Revenue per share has declined in recent yeas due to share issues. Return on equity based on core earnings is unacceptably poor at about 6.5% but is now improving rapidly. Overall I find that these ratios, in isolation point to Hold. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | T, TO |
| Currency: | Canadian $ |
| Category: | Growth |
| Contact: | ir@telus.com |
| Web-site: | www.telus.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $7,301.2 |
| Latest four quarters annual earnings $ millions: | $435.5 |
| P/E ratio based on latest four quarters earnings: | 22.9 |
| Latest four quarters annual earnings, adjusted, $ millions: | $435.5 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Management sometimes reports “cash or core earnings” before amortization of goodwill, restructuring costs and any extraordinary items. However, given the plethora of confusing adjustments, prefer to focus on GAAP earnings at this time. | |
| Quality of Earnings Measurement and Persistence: It’s hard to know if the depreciation expense (on a net present value basis) is a good approximation of the need to replace assets as they wear out and become obsolescent. Depreciation may be over-stated as it recently exceeds capital spending, this adds to earnings quality. Currently the company is expensing mobile phone customer acquisition costs of $381 per customer. On an after tax basis this adds perhaps $100 million to expenses compared to amortizing these costs (from this year and previous years). Pension expenses appear to be under-stated. | |
| P/E ratio based on latest four quarters earnings, adjusted | 22.9 |
| Latest fiscal year annual earnings: | $320.9 |
| P/E ratio based on latest fiscal year earnings: | 31.1 |
| Fiscal earnings adjusted: | $320.9 |
| P/E ratio for fiscal earnings adjusted: | 31.1 |
| Latest four quarters profit as percent of sales | 6.0% |
| Dividend Yield: | 2.1% |
| Price / Sales Ratio | 1.37 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 1.51 |
| Quality of Assets and Book Value Measurement: Poor, book value cannot be trusted because it would be negative if intangibles and goodwill are removed. Also the market value of the debt significantly exceeds the book value of debt. | |
| Number of Diluted common shares in millions: | 360.1 |
| CONTROLLING SHAREHOLDER: | |
| Market Capitalization $ millions: | $10,082.8 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 38% |
| Current assets / current liabilities: | 0.9 |
| Liquidity and capital structure: Only fair with a significant debt level, but recently improving rapidly. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on ending equity: | 6.5% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 5.1% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 4.3% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | -3.8% |
| Volatility of sales growth per share: | Recently negative |
| 5 Years compounded growth in earnings/share | 27.8% |
| 5 years compounded growth in adjusted earnings per share | -13.1% |
| Volatility of earnings growth: | Volatile |
| Projected current year earnings $millions: | $504.1 |
| Projected price to earnings ratio: | 20.0 |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | No |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 2.6% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | No prediction |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | No prediction |
| OUTLOOK FOR BUSINESS: It appears that profits will rise in future due to continued strong growth in the subscriber base. Gross margins on wireless appear quite high and that will lead to higher profits as customer acquisition costs become a lower percentage of revenue, due to growth. There is a loss of earnings in long distance and a slow erosion of traditional land lines. Overall, I expect cash flows and earnings to increase as new customer spending becomes a smaller portion of the customer base. | |
| Estimated present value per share: Given recent volatility and low, albeit improving, earnings, it is impossible for me to value the company based on an earnings growth projection. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that attractive industries are those that are relatively protected from competition based on 5 key tests or forces. Has at least moderate barriers to entry since all competitors require extensive high cost networks. There are no issues with powerful suppliers or customers who could usurp industry profits. There is no issue with substitute products for the industry as a whole. (though phone competes with cable and satellite). Unfortunately high cost infrastructure businesses often suffer from severe price competition. It is a high growth industry. It is also high risk. New technologies can quickly lead to write-offs in the old technology. Once acquired, customers tend to represent ongoing monthly revenue. This is a very positive feature of the industry. Overall, the industry is moderately attractive but is risky. | |
| COMPETITIVE ADVANTAGE: Near -monopoly position in regulated local service. The incumbent position in Alberta and B.C. gives it an advantage in selling internet access lines. Has build up a huge base of cellular customers. | |
| RECENT EVENTS: | |
| ACCOUNTING AND DISCLOSURE ISSUES: Disclosure is in most ways exceptionally good. I very much liked that the company discloses its future earnings estimate. I also very much like that the company discloses earnings per share before unusual in the six year statistics. (Annoyingly the practice of giving adjusted earnings seems to have stopped). The quarterly report is exceedingly detailed but I find that it is all chopped up into detailed parts and I can’t easily see the overall earnings adjusted for all the unusual items discussed. | |
| COMMON SHARE STRUCTURE USED: Normal, 1 vote per common share. There is also a class of participating non-voting “common shares” which are included as common shares in our analysis. | |
| MANAGEMENT QUALITY: This management frustrates me. In general management is able to execute its operating strategy. But, this company focuses on revenue and EBITDA growth, rather than on net earnings or adjusted earnings per share. Measuring performance before interest, taxes and depreciation makes little sense to me. Their mistake in over-paying for spectrum license became apparent in write-offs, but they don’t admit their mistakes. The outlook has improved significantly lately. | |
| EXECUTIVE COMPENSATION: | |
| BOARD OF DIRECTORS: | |
DISCLAIMER: The information presented is not a recommendation to buy or sell any security. The author is not a registered investment advisor and the information presented is not to be considered investment advice. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision.
© Copyright: InvestorsFriend inc. 1999 – 2004 All rights to format and content are reserved.
InvestorsFriend.com Sample Report – Melcor
THIS IS AN EXAMPLE REPORT FROM 2003 – We rated MELCOR a Speculative Strong Buy at that time.
This Sample Shows you the content of the reports and you can see there is a lot of analysis and thought that goes into our ratings.
| MELCOR DEVELOPMENTS LTD. (MRD, Toronto) | |
| RESEARCH SUMMARY – EXAMPLE ONLY – NOW OUT OF DATE | |
| Report Author: | Shawn Allen |
| Author’s disclosure of share ownership: | I hold shares |
| Based on financials from: | Dec ’02 Y.E. +Q2 |
| Last updated: | 15-Aug-03 |
| Share Price At Date of Last Update: | $37.75 |
| Currency: | Canadian $ |
| Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice): | THIS RATING IS FOR EXAMPLE ONLY AS IT IS NOW COMPLETELY OUT OF DATE. Rating per this old report was: Speculative Strong Buy |
| DESCRIPTION OF BUSINESS: Primarily a residential land developer. Also develops some commercial properties. Owns and leases some commercial property. Owns and operates two golf courses. Operates almost exclusively in or near the major cities of Alberta. | |
| RATING: Here we have a company with a long history of profit and growth and it is selling slightly under book value. The assets consist of receivables, land and buildings , which means that the book value is quite real (unless the economy turned down very sharply driving down land prices). Profit is expected to decline in 2003 after an exceptional 2002. But the stock price seems to assume that profit will not recover. Their history suggests that profits will grow over the long term. Based on the strong value ratios and the strong history, I rate this a Strong Buy. It is somewhat speculative particularly in the short term due to cyclic nature. Trading liquidity is unfortunately quite thin, with a wide bid-ask spread. Therefore the stock is not suitable for fast trading and caution should be exercised in buying and selling due to the wide spread. Overall Rating – Speculative Strong Buy. | |
| RISKS: The primary risk is the state of the Alberta economy and the demand for new housing. also, this public company has a majority controlling owner. In most cases this will benefit outside shareholders as compared to hired-help type management. But there is a risk that the controlling shareholder will use his position to award large bonuses and stock option grants to himself and the family and not act strictly in the best interest of out-siders. To date, this may not have occurred and outside shareholders have done very well. This family control feature does tend to hold the share price down some-what. | |
| INSIDER TRADING: I have no convenient access to this information, but as a family controlled company it seems unlikely that insiders would be selling. | |
| WARREN BUFFETT’s TENETS: Seems to arguably pass all of Buffett’s tenets (see Robert Hagstrom’s book – The Warren Buffett Way) – simple to understand (pass),good profit history (pass), favorable prospects for above average returns (marginal pass), apparently candid ethical management (pass), reasonably high ROE (pass), high profits on sales (pass) , low debt ratio (pass), little chance of permanent loss of capital (pass) low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) and arguably selling at a discount to intrinsic value (pass). | |
| VALUE AND GROWTH RATIOS: The Price to book value ratio is very attractive at 0.92. (However, note that the company has a history of trading at an average 76% of book value). The dividend yield is fair at 2.9% and is indicative of a more mature operation. The P/E based on the latest 12 months earnings is highly attractive at 5.1. But 2003 earnings are expected to drop, the 2001 level however the P/E based on 2001 earnings is also very attractive at about 7.5. Return on Equity is recently exceptional at 20% but has historically been closer to 14%. The 5 year compounded growth in revenue per share is strong at 17%. The 5 year compounded growth in earnings per share is strong at 23%. The share price is currently implicitly assuming that earnings will fall to the 2001 level and grow very slowly from there. If earnings grow at 8% from 2001 level, the intrinsic value is calculated as $54.82. Overall these value ratios (in isolation) point to a Strong Buy. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | MRD, Toronto |
| Currency: | Canadian $ |
| Category: | Growth with income |
| Contact: | general@melcor.ca |
| Web-site: | www.melcor.ca |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $95.8 |
| Latest four quarters annual earnings $ millions: | $20.4 |
| P/E ratio based on latest four quarters earnings: | 5.8 |
| Latest four quarters annual earnings, adjusted, $ millions: | $20.4 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: No adjustments made, but note that earnings are cyclical and heavily dependent on economic activity. | |
| Quality of Earnings Measurement: High, Earnings result mostly from sale of developed lots at a profit. There is little in the way of estimated costs such as depreciation. Builders often have 1 year to pay for the lots and so there is some risk of bad debt. However earnings are cyclic and expected to decline in 2003 so they are not very predictable. | |
| P/E ratio based on latest four quarters earnings, adjusted | 5.8 |
| Latest fiscal year annual earnings: | $23.1 |
| P/E ratio based on latest fiscal year earnings: | 5.1 |
| Fiscal earnings adjusted: | $23.1 |
| P/E ratio for fiscal earnings adjusted: | 5.1 |
| Latest four quarters profit as percent of sales | 21.3% |
| Dividend Yield: | 2.9% |
| Price / Sales Ratio | 1.23 |
| BALANCE SHEET ITEMS | |
| Price to book value ratio: | 0.92 |
| Quality of assets measurement: Very high, and this is particularly important in this case since the shares trade near book value. Assets consist primarily of receivables, land and buildings. While a recession could lower their values, there is no reason at this time to believe that these assets are not worth the book value amount, net of liabilities. | |
| Number of Diluted common shares in millions: | 3.2 |
| Controlling Shareholder: T.C Melton, the executive chairman of the company, together with his family, controls just over 50% of the shares. | |
| Market Capitalization $ millions: | $119.2 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 58% |
| Current assets / current liabilities: | not available |
| Liquidity and capital structure: Good liquidity, the company does use debt to finance their lands and buildings but the debt is not excessive and was 66% of the equity at the end of 2001. The debt ratio has been declining in recent years. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on ending equity: | 15.7% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 19.8% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 17.1% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 17.4% |
| Volatility of sales growth per share: | Strong growth with some volatility. Expect higher volatility in future |
| 5 Years compounded growth in earnings/share | 22.6% |
| 5 years compounded growth in adjusted earnings per share | 22.6% |
| Volatility of earnings growth: | Strong growth with some volatility. Expect higher volatility in future |
| Projected current year earnings $millions: | $16.3 |
| Projected price to earnings ratio: | 7.3 |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | Yes, it appears to be, but volatility is expected in the long run |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 16.8% |
| Conservative estimate of compounded growth in earnings per share over the forecast period: | 4.0% |
| Optimistic estimate of compounded growth in earnings per share over the forecast period: | 8.0% |
| GROWTH OUTLOOK: The Alberta economy continues to be strong. The company should continue to grow through profits on its larger asset base. However any recession in Alberta could lead to lower earnings. Kyoto is a concern. | |
| Estimated present value per share: I calculate $37.56 if adjusted earnings per share grow for 5 years at the more conservative rate of 5% per year and the shares are then sold at a P/E of 8 and $54.82 if earnings per share grow at the more optimistic rate of 8% for 5 years and the shares are then sold at a P/E of 10. Both estimates use a 9% required rate of return. This company is quite cyclical and therefore the growth is unpredictable. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. The development industry has limited barriers to entry (fail). There are no issues with powerful suppliers (pass). No issues with excessive dependence on powerful customers (pass), No viable substitute products(pass), Probably at least some tendency to compete excessively on the basis of price (pass). Overall this industry appears to be only neutral in attractiveness. | |
| COMPETITIVE ADVANTAGE: Established presence in the market place and knowledge. | |
| RECENT EVENTS: Sales and earnings in 2003 are running well below 2002 levels as predicted by management. Earnings are expected to approximate the 2001 level. The dividend was recently increased by 10%. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Good disclosure. Candid discussion of the risks and the high dependency on the state of the economy in Alberta. See comments under quality of earnings and quality of assets. | |
| COMMON SHARE STRUCTURE USED: Normal, 1 vote per share | |
| MANAGEMENT QUALITY: High quality with a long record of profitability. I am disappointed by their choice of not directly expensing stock options. | |
| EXECUTIVE COMPENSATION: Salaries are not at all excessive. Bonuses were quite huge in 2002 but presumably would be cut well back in lean years. I am a little bothered by the 80,000 stock options granted to the Chairman. He is not the CEO and I can’t understand why he needed to be granted such a huge number of options. Furthermore, I believe that the pro-forma calculation of options compensation that is provided grossly under-states the true impact of this option grant. (But I have no doubt that their calculation follows the letter of the law). | |
| BOARD OF DIRECTORS: A strong small board. Key members own large stock holdings which aligns their interests with that of outside shareholders. It is however disappointing that several members own no or very few shares. | |
DISCLAIMER: The information presented is not a recommendation to buy or sell any security. The author is not a registered investment advisor and the information presented is not to be considered investment advice. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision.
© Copyright: investorsfriend.com 1999 – 2003 All rights to format and content are reserved.
InvestorsFriend.com Sample Report – Stantec
Stantec Historic Report. We first rated Stantec in 1999 as a Strong Buy at a price of $10.00. ($1.25 adjusted for subsequent splits. This old report is many years out of date but it just illustrates the long-term success of our analysis methods.
As of June 2, 2013, Stantec was trading at $34.72, an increase of a remarkable 2,678% since our first rating of Strong Buy at $1.25 (split adjusted).
The format of this report is somewhat old, our reports today are in in the same basic format but contain more written comments.
| COMPANY IDENTIFICATION SECTION | |
| Stantec Inc. | |
| Based on financials from: | Dec 98 + Q2 99 |
| Symbol and Exchange: | STN, Toronto |
| Currency: | Canadian $ |
| Category: | Growth |
| Description of business: | Primarily a consulting engineering firm. Substantial investment in newer businesses of Technology and IT has not yet resulted in significant revenue or profit. |
| Contact: | corp@stantec.com |
| Web-site: | www.stantec.com |
| INVESTMENT-PICK’S RECOMMENDATION | |
| LAST UPDATED: | 24-Sep-99 |
| Current Price: | $10.05 |
| Current Recommendation: | Strong Buy |
| Price when first featured: | $10.00 |
| Date first featured: | 3-Sep-99 |
| Recommendation when first featured: | Strong Buy |
| Price increase since first featured: | 0.5% |
| LATEST YEAR INCOME AND PRICE / EARNINGS RATIO | |
| Latest four quarters annual sales $ millions: | $148.9 |
| Latest four quarters annual earnings $ millions: | not available |
| P/E ratio based on latest four quarters earnings: | not available |
| Latest fiscal year annual earnings: | $7.2 |
| P/E ratio based on latest fiscal year earnings: | 10.0 |
| Fiscal earnings adjusted for unusual gains/losses: | $7.2 |
| P/E ratio for fiscal earnings adjusted for gains/losses: | 10.0 |
| Dividend Yield: | 0.0% |
| Latest fiscal year annual cash flow $ per share: | $1.67 |
| Price to cashflow ratio: | 6.0 |
| Latest fiscal year operating earnings (before interest, depreciation, taxes and unusual gains or losses) $ millions: | $13.4 |
| Operating income as a percent of sales: | 9.0% |
| Latest Balance Sheet and Liquidity Ratios | |
| Price to book value ratio: | 1.22 |
| Actual value of assets versus book value: | Likely lower |
| Number of common shares in millions: | 7.146 |
| Market Capitalization $ millions: | $71.8 |
| Latest four quarters return on book equity: | 12.2% |
| Latest four quarters return on market capitalization: | 10.0% |
| Debt (and equivalent) to common equity ratio: | 1.0 |
| Current assets / current liabilities: | 1.7 |
| Liquidity: | Good liquidity |
| GROWTH RATIOS AND OUTLOOK | |
| 4 years compounded growth in sales/share | 18.5% |
| Volatility of sales growth: | steady growth |
| 4 years compounded growth in earnings/share | 11.1% |
| Volatility of earnings growth: | steady growth |
| 4 years comp. growth in operating earnings/share | not available |
| Projected current year earnings $millions: | not available |
| Projected price to earnings ratio: | not available |
| COMMENT SECTION | |
| VALUE AND GROWTH RATIOS: Selling at only a small premium to book value. Low P/E. Strong growth. | |
| OUTLOOK FOR BUSINESS: Outlook is positive given strong Alberta economy and the company’s plans for further expansion by acquisition. | |
| ACCOUNTING ISSUES: No opinion | |
| SHARE STRUCTURE USED: Normal common shares, 1 vote per share | |
| MANAGEMENT QUALITY: No opinion | |
| GENERAL COMMENTS: An opportunity to invest in an established growth company at very reasonable valuation ratios. | |
| RISKS: May tend to be cyclic with sales related to industrial activity. Engineering design involves risks that are difficult or impossible to quantify in advance and therefore may not be entirely covered by insurance. Investments in Technology businesses. do not appear to be profitable and may be a drain on resouces and money. | |
| RECOMMENDATION: A strong buy based on ratios and growth. | |
| DISCLAIMER: Use this site at your own risk. Errors may inadvertently occur. Opinions may not always be valid. Check other sources. We hereby deny all responsibility for all use of any information or advice posted here. We usually hold positions in the investments featured here. | |
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