Gamehost: A High-Yielding Canadian Stock With a Catalyst

Gamehost Inc. (TSE:GH)Â is an operator of hospitality and gaming properties in the Alberta province of Canada. The company operates four properties:

• Boomtown Casino.
• Great Northern Casino.
• Service Plus Inns and Suites.
• Deerfoot Inn & Casino.

The company derives revenues from:

• Gaming –Â Segment includes Boomtown, Deerfoot and Great Northern casinos. They offer slot machines, VLT, lottery machines and table games.
• Hotel Rooms –Â Includes both guest and meeting room sales at hotels.
• Food & Beverage – Located within the casinos and hotels and is a complement to the segments.

(click to enlarge)Gamehost Price Chart (Source: Yahoo Finance)

The stock peaked in August 2014 at $17 and is yet to find a bottom. The company is directly exposed to the Alberta economy which slumped along with crude oil prices as the majority of Canada's oil sands and oil reserves are located in Alberta. Real estate prices and economic activity are heavily dependent on the price of oil.

Fiscal 2015 revenue for the Gaming segment is down 1%, Hotel segment is down 16%, and Food and Beverage segment is down 12%. Gaming accounts for 52% of the revenue, which is why total revenue for Fiscal 2015 has declined by just 6% so far. We saw a companywide revenue decline in the last recession – 2007 to 2009. It's also no secret that Canada's housing market is a bubble. A renowned economist, Jesse Colombo, succinctly lays out the case here.

So, why buy a company in the property biz?

Alberta's economy is more correlated to oil than the rest of Canada

While Canada is clearly dependent on oil, as it is its largest export, Alberta is even more dependent on oil than the rest of Canada. Canada oil sands and reserves are primarily located in Alberta, with the rest in the Saskatchewan and Newfoundland provinces. Alberta, Saskatchewan and Newfoundland have been hit with higher unemployment rates as a result of the oil rout.

Canada Seasonally Adjusted Unemployment Rate (Source:Government of Canada)

Housing prices in Canada have defied the force of gravity over the past few years, but last year Alberta's actually declined while the prices around the country went up 10%. Alberta's months of inventory has also taken off and sits at heights not seen since 2009:

(click to enlarge)

Calgary, Alberta is also the wealthiest metropolitan area in Canada. According to the Canadian Real Estate Association (CREA):

Nationally, home sales activity rose 10% from year-ago levels in December 2015. For 2015 as a whole, provincial home sales numbered 56,477, down 21.3% from a near-record level in 2014. The provincial average price for homes sold in December 2015 was $389,486, edging down 0.3% from a year earlier. The national average price, by comparison, rose 12% on a year-over-year basis to $454,342.

(Source: CREA)

The MLS Index covers the 11 metropolitan areas listed above. Now, to put those prices into perspective, we are going to compare them to the median family income from the Government of Canada's database. The incomes are as of 2013, and the median income in Calgary has likely declined as a result of the oil rout. My guess, though, is that incomes rose going into 2014. When oil rebounds, the median incomes should rebound as well.

As of December 2015, Benchmark price to median household income for Calgary, Alberta, in 2015 was 4.38 ($443,900/$101,260). Looks fairly modest compared to Toronto's 7.87 ($573,500/$72,830) and Vancouver's 10.35 ($760,900/$73,390). The Globe and Mail lays it out here in a tabular format (note that the numbers are as of September 2015). Canada's average price to family income was 5.2, whereas Calgary's was 4.2. Vancouver and Toronto are clearly the outliers. The housing markets in Seattle, New York and San Francisco, for example, look more like Vancouver and Toronto than Calgary. So while the markets as a whole are overvalued, Calgary is moderately priced and will have a softer landing than Vancouver and Toronto when the Canadian housing bubble does indeed burst.

Dividend, dividend, dividend

At these prices, the company pays a 10.7% dividend. Yes, you read that right, 10.7%. Revenues for the first nine months of 2015 fell 6.1%; the temporary business decline has placed pressures on the 7.33 cents monthly dividend the company pays, as the company has paid out 100% of cash flows so far this year. Last recession, revenues fell 18% from peak to through, net income fell 28% from $11.45 million in 2008 to $8.16 million in 2009 and subsequently recovered to $14 million in 2010.

Though they have not mentioned any intent of cutting the dividend, a modest 20% dividend cut would result in a yield of 8.56%, which is still extraordinarily high. David Will and Darcy Will, president/CEO and VP, own a combined 39% of the company; it's clear that they love their dividend income. If you look at the price chart above, the blue "D" at the bottom indicates dividend payment, showing how consistent the company has been. Also, per the quarterly report ended September 2015:

It is the company's intent to continue a policy of consistent and regular monthly "eligible" dividends to shareholders of 7.33 cents per common share. ... If and when economic conditions and the financial performance of the company dictate that an increase to the dividend rate is prudent and would not jeopardize future sustainability of the regular dividend rate, an increase or special dividend may be considered by the company's board of directors. (Source:Sedar, Nov. 13 MD&A)

Profitability and low cost structure

The company has been profitable for 15 straight years (as far as I could go back). Net Income fell during 2008 but was still positive. Capex spending is minimal and has hovered at <1% of revenues for the past six years; management sticks to what works and is not itchy to grow the empire. The high insider ownership and shareholder-friendly policies will likely keep activist investors away.

The company also does not just generate revenues from Oil & Gas customers; it also has customers in the local population. This is why, even though crude prices fell by 50%, we saw the Sept. 30, 2015, quarter's revenues drop by only 7% as oil companies have canceled contracts with the company. Although I expect revenue to trend lower from where it is in the short term, oil and gas recovery should drive the company back into a growth trajectory.

The elephant in the room: Crude prices

Anyone reading today knows that I've been bullish on crude oil since December. In fact, my entire Reitman's thesis depends on higher crude prices, and Reitman's makes up 10.5% of my portfolio. When I wrote my Reitman's long thesis, WTI stood at $37 per barrel. As of this writing, we are looking at $26.73. We are going to see crude bottom by early 2017; the signs are evermore apparent.

Big Oil is cutting capex – Shell (RDS.A, Financial)(RDS.B, Financial) announced that it was going to cut its 2016 capex budget by 30%, Chevron (CVX, Financial) will be cutting capex by 24%, Brazil's own Petrobras (PBR, Financial) is cutting capex spending by 25% over the next five years, and Consol ENERGY (CNX, Financial) is cutting by 41%. The list goes on.

All of these will lead to a drop in production, as the capital expenditures fund both upstream and midstream. These companies are likely going to hold back capex investments until the price of crude stabilizes.

Hedges – Hedging is widely used in every commodity industry. Companies hedge their inputs or outputs against price increases or declines. Two years ago, in February 2014 when WTI Crude Oil hovered around $100 per barrel, shorting a futures contract that guaranteed a sale price of $80 per barrel was feasible. That is no longer the case. Most companies do not hedge their exposure past two to three years because if they do and their competitors do not, and they are wrong, the competitors will price them out of the market, and they'll go bankrupt. The longer-dated contracts come with uncertainty, and that is always reflected in the lower prices. As these hedges expire in 2016 and 2017, these companies will be forced to sell crude at spot price. This will accelerate the bankruptcies, and that will naturally curb production.

Debt deflation -– What we are witnessing today in oil and gas is debt deflation. Crude prices are falling because the industry is so leveraged, and companies are not cutting production because they do not have a choice. These companies took out debt when oil was flying high, and they are now unable to curb production because they have to pay off debt. They are going to produce until they run out of money. The hedging phenomenon I explained above will accelerate this. Debt and equity markets for oil and gas are basically frozen at this point, so they will not be able to raise more money. This should send crude prices higher.

I mentioned that I purchased the stock, and it made up 5% of the portfolio. I ended up buying more for $8.21. The average cost of purchase is now $8.19, and it makes up 6.5% of the total portfolio. Given that a 10.71% or even 8% dividend yield is rare in today's markets, a modest 50% upside within two years is warranted.

Note 1: I published this article on my website on Feb. 11. Any dates or days in the article refer to that date or before.

Note 2: Purchasing is possible in U.S. dollars (USD) on OTC Markets (GHIFF), or on the Toronto Stock Exchange (TSE) in Canadian dollars (CAD). For liquidity purposes, I will be buying in Canadian dollars on the TSE. So, all figures listed are in Canadian dollars unless otherwise noted. Current USD price is $5.89, and CAD price is $8.16 (Feb. 9).