Contributing editor Irwin Michael joins us for his monthly visit today. As one of Canada's most successful value investors, he continues to look for bargains in a volatile market and has found one in Western Canada. Irwin is the founder and president of the ABC Funds. Here is his report.
Irwin Michael writes:
Despite the worsening debt problems of Greece, Portugal, and Spain and their downgraded credit ratings by the influential Standard & Poor's rating agency, the North American stock markets have continued to climb the proverbial wall of worry.
The solid stock market advance is fascinating on a number of counts. These include the relative despair of 12 months earlier, the continuing tug-of-war between the bullish and bearish stock market camps, the extraordinary expansive monetary and fiscal policies of worldwide governments and monetary authorities, and, ultimately, the significant market advance already experienced since the price lows of March 2009.
In actuality, rising share prices are largely due to comparatively low interest rates, generally good corporate earnings results, and the significant cash pools sitting on the sidelines impatiently awaiting opportunities to enter the marketplace.
Nonetheless, stock selection remains very challenging and tricky as we enter the month of May. On the one hand, the bullish view argues that there are meaningful investor cash reserves earning less than 0.25% per annum in Canada Treasury bills. On the other hand, the pessimists, aside from proclaiming "sell in May and go away", believe that there are few equities that are dirt cheap at present. While we are generally optimistic, our view is that investors must remain very value-disciplined in an increasingly emotional marketplace given that many stocks are fully pricing in a revenue and earnings recovery this year.
Overall, we expect equity prices to remain very volatile for the balance of 2010 with periodic positive and negative surprises. We believe that we are in a stock picker's market whereby discerning stock selection will be all-important for superior 2010 investment returns. Furthermore, we expect 2010 to remain a trader's market such that occasional market opportunities will be presented to the alert investor.
We believe we have found one such opportunity and it is our recommendation for this month.
Flint Energy Services Limited (TSX: FES, OTC: FESVF)
Flint Energy Services provides a range of integrated products and services for the energy industry. With a history dating back over 100 years, the company's 10,000 employees cover the full cycle of oil and gas exploration and production from 60 locations in North America. Listed from early to late stage, the company offers oilfield services, production services, facility infrastructure, and maintenance services. Significant contracts related to oil sands construction activity include Suncor's Firebag 3, Shell's Albian Sands, and Statoil's Leismer Project. Maintenance contracts with Suncor, Canadian Natural Resources, and Royal Dutch Shell generate stable, recurring cash flow.
Flint Energy Services is relatively unusual when compared to traditional oil and gas services companies. Although Flint has significant conventional operations, a much greater proportion of its business is related to oil sands facility construction and ongoing maintenance than its peers. Importantly, oil sands capital spending is expected to rebound 30% in 2010 and 20% in 2011, after falling approximately 40% in 2009. To better understand the story, we need to examine each of the company's operating segments. It will make it easier for us to describe our investment thesis and explain why we believe that the stock is cheap.
Flint's oilfield services segment includes drill rig moving, service rig moving, off road transportation, pressure and vacuum services, and fluid hauling. In 2009, this segment generated $212.4 million of revenue and $16.3 million of EBITDA. In terms of percentages, oilfield services represented 11.3% of total revenue and 10.9% of total EBITDA at a 7.7% margin. Unfortunately, we believe that the company's entry into the rig moving business several years ago has never been well-received by investors.
The next segment, production services, focuses on conventional oil and gas production in addition to shale gas, heavy oil, and oil sands. Production services include well tie-ins and pipelines, field and mechanical construction, safety services, equipment manufacturing, and tubular management. In the most recent fiscal year, the segment generated $792 million of revenue and $45.7 million of EBITDA or 42.2% and 30.6% of the respective totals implying a 5.8% margin. This is the weakest segment from a margin perspective, well below historic levels due to the collapse of drilling in 2009. Hopefully, margins will rebound along with drilling activity in 2010 and 2011.
Moving to the facility infrastructure segment, we finally get to the heart of our investment thesis. In 2009, the segment generated $592.5 million in revenue and $70.8 million of EBITDA. Although facility infrastructure accounted for only 31.6% of revenue, with a company-leading 11.9% margin the segment produced 47.4% of the Flint's total EBITDA. Importantly, Flint has a backlog of approximately $200 million related to various oil sands projects in Fort McMurray including the aforementioned Suncor's Firebag 3, Shell's Albian Sands, and Statoil's Leismer projects. With oil sands capital spending expected to rebound from $11 billion in 2009 to $15 billion in 2010 to 2011, we expect that this segment will continue to drive the company's financial performance.
Finally, Flint's maintenance services segment could almost be considered "the gravy" on the story. Flint's operates this segment as a 50/50 joint venture with Transfield Services, an Australian-based, infrastructure services provider. As opposed to the other three segments that are cyclical, the maintenance division is a source of relatively stable cash flow. In the latest fiscal year, the segment generated $279.6 million of revenue and $16.5 million of EBITDA or 14.9% and 11.1% of the respective totals. Although the margin was lower than the company average, at 5.9%, the stable nature of the cash flow should be highly prized by investors. Major contracts include a five-year rolling contract with Suncor Energy covering oil sands projects and the Sarnia refinery, a three-year contract with Canadian Natural Resources related to the Horizon Oil Sands Project, and a two-year contract with Royal Dutch Shell on the Scotford Complex. Thankfully, this stable cash flow stream protected the company's balance sheet through the downturn.
The company's book value is $11.32 and the closing price on Friday was $13.41, so readers are able to buy in at a small premium to book. The shares have underperformed both engineering and construction and oil and gas services stocks for a non-fundamental reason. It had become known that Flint's largest shareholder, SCF Partners, had filed to sell its large block of stock. Once the shares were placed with fundamental-based investors, the stock was able to lift quite nicely.
We believe that additional upside could come from three main drivers. First, the ramp-up in oil sands capital expenditures could translate into growing cash flow and multiple-expansion. Second, the clean balance sheet with $160.9 million of cash and cash equivalents (or approximately $3.60 per share) and the stable cash flow from the maintenance division could be used to initiate an annual dividend in the range of 20c to 24c per share. This would yield 1.5% to 1.8% at current price levels and would open the stock to a new class of investors. Finally, there is the slim possibility that Transfield Services could make a bid for either the maintenance services division or even the entire company. This option may not be as far-fetched as it sounds since Transfield is publicly listed in Australia and trades at almost twice Flint's valuation.
We believe that Flint Energy is a misunderstood growth stock trading at value multiples. Further, if one of the three potential catalysts fails to materialize, we believe that the company could continue to be active with its normal course issuer bid, which would support the shares. For the year ended Dec. 31, 2009 the company purchased 688,300 common shares at an average cost of $7.94 per share. Although the share price is significantly higher, the normal course issuer bid was renewed on March 2 for up to a maximum of 2,379,689 common shares, representing 5% of the total issued and outstanding common shares. In any event, we believe that patient shareholders will be rewarded through the balance of 2010 and into 2011.
The shares trade mainly on the TSX although they can also be purchased on the over-the-counter Grey Market in the U.S. where the symbol is FESVF. The closing price there on Friday was US$13.50.
Action now: Buy below $14.
IRWIN MICHAEL'S UPDATES
Danier Leather Inc. (TSX: DL)
Originally recommended July 7/03 (IWB #2324) at $10.49. Closed Friday at $8.20.
Danier Leather has released the results of its substantial issuer bid. Readers will recall that the company offered to purchase and cancel up to $7 million in value of its subordinate voting shares at a price of not less than $6.10 per share and not more than $6.45 per share. A total of 1,845,592 shares were validly deposited and, pursuant to the terms of the offer, Danier determined the purchase price to be $6.25 per share. Since the value of shares deposited exceeded the $7 million cap on the buyback, a pro-rata factor of 0.6088 was applied to each deposited share. In effect, the company bought back and cancelled 1,120,000 shares at $6.25 per share. These shares represented 23.88% of the total subordinate shares issued and outstanding prior to the offer. Following the cancellation of these shares, approximately 3,569,940 of the subordinate voting shares remain outstanding. If we include the 1.2 million multiple voting shares, approximately 4.8 million total shares are currently outstanding.
We did not tender any of our shares to the offer since it was nicely accretive. Due to the issuer bid, book value per share increased from $10.48 at Dec. 26, 2009 to $11.97 at the end of the third quarter of fiscal 2010.
The most recent quarterly report for the period ended March 27 showed excellent results. Danier earned $2.8 million or 48c per fully diluted share compared to a loss of $1 million or 37c per fully diluted share in the comparable period a year ago. Even after deducting the cash used in the buyback, cash and cash equivalents on the balance sheet now totals $32.3 million or $6.74 per share. Admittedly, the company will deploy some of this cash to build inventory in advance of the important winter season. However, with the stock currently trading at $8.20, we believe that shareholders could still see some upside from today's levels. Eventually, we expect Danier to be taken private by its controlling shareholders.
Action now: Hold.
Equitable Group Inc. (TSX: ETC)
Originally recommended Aug. 11/08 (IWB #2828) at $21.04. Closed Friday at $24.30.
Equitable has continued its impressive operating and financial performance. Since reporting its fourth quarter and fiscal 2009 results, the stock has rallied approximately 20%. Investors were appreciative of the improvement of almost every single operating and financial metric on a year-over-year basis.
In fiscal 2009, net income grew 33.2% to $51.4 million or $3.36 per share from $38.6 million or $2.78 per share a year ago. This implied a return on equity of 17% compared to 16.6% in 2008. Note that the earnings growth did not compromise the balance sheet as the total capital ratio improved to 17.6% versus 13.5% a year ago. Book value per share grew 23% to $21.83 from $17.75 at the end of fiscal 2008. Importantly, these impressive results were generated without relaxing underwriting standards, evidenced by the improvement in mortgages in arrears 90 days or more to 0.64% of total principal outstanding from 1.57% at Dec. 31, 2008.
Based on analysis of the results and the company's outlook, we believe that that Equitable Group should trade at a greater premium to its book value than the current multiple of 1.16 times. From regression analysis of several financial service companies, we believe that 1.5 to 1.6 times book value would not be an unrealistic expectation as the path to economic recovery becomes clearer. As Andrew Moor, president and CEO, stated: "Given our well-capitalized balance sheet, quality mortgage portfolio, and focused risk management processes, we are confident in Equitable's ability to translate opportunity into value in 2010 for our shareholders".
We are extremely heartened by these comments by the CEO. As a result, we remain very comfortable continuing to hold Equitable Group as we patiently await its true valuation to be recognized by the marketplace.
Action now: Hold.
- end Irwin Michael
Irwin Michael writes:
Despite the worsening debt problems of Greece, Portugal, and Spain and their downgraded credit ratings by the influential Standard & Poor's rating agency, the North American stock markets have continued to climb the proverbial wall of worry.
The solid stock market advance is fascinating on a number of counts. These include the relative despair of 12 months earlier, the continuing tug-of-war between the bullish and bearish stock market camps, the extraordinary expansive monetary and fiscal policies of worldwide governments and monetary authorities, and, ultimately, the significant market advance already experienced since the price lows of March 2009.
In actuality, rising share prices are largely due to comparatively low interest rates, generally good corporate earnings results, and the significant cash pools sitting on the sidelines impatiently awaiting opportunities to enter the marketplace.
Nonetheless, stock selection remains very challenging and tricky as we enter the month of May. On the one hand, the bullish view argues that there are meaningful investor cash reserves earning less than 0.25% per annum in Canada Treasury bills. On the other hand, the pessimists, aside from proclaiming "sell in May and go away", believe that there are few equities that are dirt cheap at present. While we are generally optimistic, our view is that investors must remain very value-disciplined in an increasingly emotional marketplace given that many stocks are fully pricing in a revenue and earnings recovery this year.
Overall, we expect equity prices to remain very volatile for the balance of 2010 with periodic positive and negative surprises. We believe that we are in a stock picker's market whereby discerning stock selection will be all-important for superior 2010 investment returns. Furthermore, we expect 2010 to remain a trader's market such that occasional market opportunities will be presented to the alert investor.
We believe we have found one such opportunity and it is our recommendation for this month.
Flint Energy Services Limited (TSX: FES, OTC: FESVF)
Flint Energy Services provides a range of integrated products and services for the energy industry. With a history dating back over 100 years, the company's 10,000 employees cover the full cycle of oil and gas exploration and production from 60 locations in North America. Listed from early to late stage, the company offers oilfield services, production services, facility infrastructure, and maintenance services. Significant contracts related to oil sands construction activity include Suncor's Firebag 3, Shell's Albian Sands, and Statoil's Leismer Project. Maintenance contracts with Suncor, Canadian Natural Resources, and Royal Dutch Shell generate stable, recurring cash flow.
Flint Energy Services is relatively unusual when compared to traditional oil and gas services companies. Although Flint has significant conventional operations, a much greater proportion of its business is related to oil sands facility construction and ongoing maintenance than its peers. Importantly, oil sands capital spending is expected to rebound 30% in 2010 and 20% in 2011, after falling approximately 40% in 2009. To better understand the story, we need to examine each of the company's operating segments. It will make it easier for us to describe our investment thesis and explain why we believe that the stock is cheap.
Flint's oilfield services segment includes drill rig moving, service rig moving, off road transportation, pressure and vacuum services, and fluid hauling. In 2009, this segment generated $212.4 million of revenue and $16.3 million of EBITDA. In terms of percentages, oilfield services represented 11.3% of total revenue and 10.9% of total EBITDA at a 7.7% margin. Unfortunately, we believe that the company's entry into the rig moving business several years ago has never been well-received by investors.
The next segment, production services, focuses on conventional oil and gas production in addition to shale gas, heavy oil, and oil sands. Production services include well tie-ins and pipelines, field and mechanical construction, safety services, equipment manufacturing, and tubular management. In the most recent fiscal year, the segment generated $792 million of revenue and $45.7 million of EBITDA or 42.2% and 30.6% of the respective totals implying a 5.8% margin. This is the weakest segment from a margin perspective, well below historic levels due to the collapse of drilling in 2009. Hopefully, margins will rebound along with drilling activity in 2010 and 2011.
Moving to the facility infrastructure segment, we finally get to the heart of our investment thesis. In 2009, the segment generated $592.5 million in revenue and $70.8 million of EBITDA. Although facility infrastructure accounted for only 31.6% of revenue, with a company-leading 11.9% margin the segment produced 47.4% of the Flint's total EBITDA. Importantly, Flint has a backlog of approximately $200 million related to various oil sands projects in Fort McMurray including the aforementioned Suncor's Firebag 3, Shell's Albian Sands, and Statoil's Leismer projects. With oil sands capital spending expected to rebound from $11 billion in 2009 to $15 billion in 2010 to 2011, we expect that this segment will continue to drive the company's financial performance.
Finally, Flint's maintenance services segment could almost be considered "the gravy" on the story. Flint's operates this segment as a 50/50 joint venture with Transfield Services, an Australian-based, infrastructure services provider. As opposed to the other three segments that are cyclical, the maintenance division is a source of relatively stable cash flow. In the latest fiscal year, the segment generated $279.6 million of revenue and $16.5 million of EBITDA or 14.9% and 11.1% of the respective totals. Although the margin was lower than the company average, at 5.9%, the stable nature of the cash flow should be highly prized by investors. Major contracts include a five-year rolling contract with Suncor Energy covering oil sands projects and the Sarnia refinery, a three-year contract with Canadian Natural Resources related to the Horizon Oil Sands Project, and a two-year contract with Royal Dutch Shell on the Scotford Complex. Thankfully, this stable cash flow stream protected the company's balance sheet through the downturn.
The company's book value is $11.32 and the closing price on Friday was $13.41, so readers are able to buy in at a small premium to book. The shares have underperformed both engineering and construction and oil and gas services stocks for a non-fundamental reason. It had become known that Flint's largest shareholder, SCF Partners, had filed to sell its large block of stock. Once the shares were placed with fundamental-based investors, the stock was able to lift quite nicely.
We believe that additional upside could come from three main drivers. First, the ramp-up in oil sands capital expenditures could translate into growing cash flow and multiple-expansion. Second, the clean balance sheet with $160.9 million of cash and cash equivalents (or approximately $3.60 per share) and the stable cash flow from the maintenance division could be used to initiate an annual dividend in the range of 20c to 24c per share. This would yield 1.5% to 1.8% at current price levels and would open the stock to a new class of investors. Finally, there is the slim possibility that Transfield Services could make a bid for either the maintenance services division or even the entire company. This option may not be as far-fetched as it sounds since Transfield is publicly listed in Australia and trades at almost twice Flint's valuation.
We believe that Flint Energy is a misunderstood growth stock trading at value multiples. Further, if one of the three potential catalysts fails to materialize, we believe that the company could continue to be active with its normal course issuer bid, which would support the shares. For the year ended Dec. 31, 2009 the company purchased 688,300 common shares at an average cost of $7.94 per share. Although the share price is significantly higher, the normal course issuer bid was renewed on March 2 for up to a maximum of 2,379,689 common shares, representing 5% of the total issued and outstanding common shares. In any event, we believe that patient shareholders will be rewarded through the balance of 2010 and into 2011.
The shares trade mainly on the TSX although they can also be purchased on the over-the-counter Grey Market in the U.S. where the symbol is FESVF. The closing price there on Friday was US$13.50.
Action now: Buy below $14.
IRWIN MICHAEL'S UPDATES
Danier Leather Inc. (TSX: DL)
Originally recommended July 7/03 (IWB #2324) at $10.49. Closed Friday at $8.20.
Danier Leather has released the results of its substantial issuer bid. Readers will recall that the company offered to purchase and cancel up to $7 million in value of its subordinate voting shares at a price of not less than $6.10 per share and not more than $6.45 per share. A total of 1,845,592 shares were validly deposited and, pursuant to the terms of the offer, Danier determined the purchase price to be $6.25 per share. Since the value of shares deposited exceeded the $7 million cap on the buyback, a pro-rata factor of 0.6088 was applied to each deposited share. In effect, the company bought back and cancelled 1,120,000 shares at $6.25 per share. These shares represented 23.88% of the total subordinate shares issued and outstanding prior to the offer. Following the cancellation of these shares, approximately 3,569,940 of the subordinate voting shares remain outstanding. If we include the 1.2 million multiple voting shares, approximately 4.8 million total shares are currently outstanding.
We did not tender any of our shares to the offer since it was nicely accretive. Due to the issuer bid, book value per share increased from $10.48 at Dec. 26, 2009 to $11.97 at the end of the third quarter of fiscal 2010.
The most recent quarterly report for the period ended March 27 showed excellent results. Danier earned $2.8 million or 48c per fully diluted share compared to a loss of $1 million or 37c per fully diluted share in the comparable period a year ago. Even after deducting the cash used in the buyback, cash and cash equivalents on the balance sheet now totals $32.3 million or $6.74 per share. Admittedly, the company will deploy some of this cash to build inventory in advance of the important winter season. However, with the stock currently trading at $8.20, we believe that shareholders could still see some upside from today's levels. Eventually, we expect Danier to be taken private by its controlling shareholders.
Action now: Hold.
Equitable Group Inc. (TSX: ETC)
Originally recommended Aug. 11/08 (IWB #2828) at $21.04. Closed Friday at $24.30.
Equitable has continued its impressive operating and financial performance. Since reporting its fourth quarter and fiscal 2009 results, the stock has rallied approximately 20%. Investors were appreciative of the improvement of almost every single operating and financial metric on a year-over-year basis.
In fiscal 2009, net income grew 33.2% to $51.4 million or $3.36 per share from $38.6 million or $2.78 per share a year ago. This implied a return on equity of 17% compared to 16.6% in 2008. Note that the earnings growth did not compromise the balance sheet as the total capital ratio improved to 17.6% versus 13.5% a year ago. Book value per share grew 23% to $21.83 from $17.75 at the end of fiscal 2008. Importantly, these impressive results were generated without relaxing underwriting standards, evidenced by the improvement in mortgages in arrears 90 days or more to 0.64% of total principal outstanding from 1.57% at Dec. 31, 2008.
Based on analysis of the results and the company's outlook, we believe that that Equitable Group should trade at a greater premium to its book value than the current multiple of 1.16 times. From regression analysis of several financial service companies, we believe that 1.5 to 1.6 times book value would not be an unrealistic expectation as the path to economic recovery becomes clearer. As Andrew Moor, president and CEO, stated: "Given our well-capitalized balance sheet, quality mortgage portfolio, and focused risk management processes, we are confident in Equitable's ability to translate opportunity into value in 2010 for our shareholders".
We are extremely heartened by these comments by the CEO. As a result, we remain very comfortable continuing to hold Equitable Group as we patiently await its true valuation to be recognized by the marketplace.
Action now: Hold.
- end Irwin Michael
