Channeling Buffett Part 3: High Liner Foods

It’s been a while, huh guys? Yeah, sorry about that. I’ve been busy with other things. My cat is pretty high maintenance.

There hasn’t been much cheap stuff available in the market of late. I did take a close look at FreightCar America (NASDAQ:RAIL) back in the early part of November when it fell to $11 per share, but the rally after Trump’s election scared me off.

And that’s about it. I’ve been looking, especially after Directcash agreed to be acquired. I just can’t find much.

So instead I thought I’d talk about a high-quality business I feel is trading at an obscenely low multiple. That business is High Liner Foods (TSX:HLF), and I think I’m going to pull a Buffett on Monday and start buying this thing to hold for a long time.

The business

High Liner Foods is North America’s largest processor and marketer of value added seafood. Basically what they do is buy the fish, process it, turn it into fish sticks or whatnot, and sell it to grocery stores and restaurants.

It’s been a growth-by-acquisition story. Rather than listing it all, let me just post a screenshot from a recent investor presentation.

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73% of revenues comes from the United States (and Mexico), with 27% coming from Canada. 80% of revenue comes from High Liner brands, while 20% comes from generic brands. And value-added products have seen a decent uptick in the last few years, which has led to higher margins. An investment in better supply chain management has also helped margins.

Recent corporate activity included the sale of its Massachusetts-based scallops plant for $15 million. It was running at 41% utilization. That leaves four plants remaining, three in the U.S. and one in Canada.

The decrease in revenue is because demand is switching away from breaded fish sticks to healthier alternatives. Production is moving in that direction, but there’s increased competition. Grocery stores can easily create their own value-added fish products, and they can sell those products fresh instead of frozen.

Weakness in the Canadian Dollar isn’t helping either. High Liner reports in USD but it collects nearly 30% of revenue in Canadian Dollars.

The good news is thanks to cost cutting and the aforementioned supply chain improvements, profits are projected to grow versus last year. Raw material costs have also gone down.

Here’s a quick look at just how much revenues/earnings have grown over the last decade, courtesy of Morningstar.

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You can click to embiggen either of those if they’re not readable.

Basically, growth has been fantastic over the long-term and crappy in the short-term. Revenue has fallen over the past couple of years, but cash flow has remained pretty strong.

Valuation

High Liner has lots of free cash flow because it’s still has plenty of intangibles from former acquisitions to amortize.

It’s on pace to do about US$70 million in free cash flow in 2016, versus a market cap of C$567 million. When converting to constant currency, High Liner trades at just 6.1 times free cash flow. Or if earnings are more your thing, it trades at less than 14 times earnings.

Note that capex spending will likely be low in the next few years since High Liner’s four remaining factories all have quite a bit of excess capacity.

I was going to take the time to compare it to a bunch of other North American food companies, but I won’t bother. Because it’s not even close. High Liner trades at a much cheaper valuation than just about every other company in the industry. Investors tend to like good ol’ steady food companies, especially ones that dominate their sector. For whatever reason, they don’t really like High Liner.

Balance sheet

Debt is $270 million, versus total assets of $638 million. That is a little high for my liking.

But at least the debt is doing in the right direction. It owed $319 million a year ago, and the sale of the scallops plant should decrease the debt some more.

I think over time we’ll see High Liner slowly grow volumes, but not by much. Older people should slowly increase their fish consumption. I know we eat fish more often at my house than we used to, but we’re more inclined to buy the fresh stuff and eat it right away.

What that means is for High Liner to really grow, it needs to make acquisitions. There are targets out there; Clearwater Seafood in Canada is an obvious choice. But High Liner doesn’t really have the balance sheet strength to pull such an acquisition off. Look for it to keep paying off debt for at least another couple of years before going shopping again.

Dividend

Dividend growth has been fantastic. The annual dividend was a dime per share back in 2007. It’s $0.56 today after a recent increase. It’s still got a low payout ratio, and I’d be shocked if management didn’t increase dividends annually until at least it makes another big acquisition. The current yield is 2.95%, which is decent but not outstanding.

Conclusion

There are a lot of food companies that aren’t growing these days. Competition is fierce and economic growth is tepid. Most of these trade hands at 20 to 25 times earnings. High Liner trades at 13 times forward earnings and 14 times trailing earnings. It’s even cheaper on a P/FCF basis.

Give it a couple of years to pay down some debt and I think it goes fishing (heh) for another acquisition somewhere, maybe in Europe or Australia/New Zealand. If it manages to do that, investors will likely revalue it much higher. It’ll be a global growth story.

Or to put it much more simply, not a lot can go wrong when you buy an industry leader in a good business at six times free cash flow.

Disclosure: No position, but will likely start buying relatively soon

Crossroads Capital: Good on the Surface, But…

Let’s move away from Canada for this post to Crossroads Capital (NASDAQ:XRDC), a closed-end fund that invests in mostly privately held technology companies. Major investments include Zoosk, Tremor Video, Suniva, and a bunch of other tiny tech companies you’ve never heard of.

Crossroads was formed in 2008 to invest in tech companies that were big enough to attract venture capital attention but too small to go public. The company was originally called BDCA Venture Inc.

Shares were listed on the NASDAQ starting in 2011 at $8.70 each. They fell steadily through the next few years, finally hitting a low of $2 each earlier in 2016.

Business went along as usual until 2015 when Bulldog Investors got involved. The activist investor bought more than a million shares of the company, building up a stake of more than 10% of shares outstanding.

The board was convinced to stop making new investments and to begin the liquidation process. Shareholders approved this plan back in May. The company now plans to give up its listing on the NASDAQ and turn itself into a liquidating trust. There’s no deadline for liquidation.

At first glance, shares look to be a terrific value. As of March 31st, the fund’s net asset value was $4.25 per share, which included $1.40 per share in cash. Shares currently trade hands at $2.03 each, meaning investors are paying just $0.63 per share for investments that are worth $2.22 per share.

Even if the portfolio gets wrote down 50%, we’re still looking at a liquidation value of $2.51 per share, which represents pretty decent upside from today’s price. A 25% return with almost no risk is usually right up my alley.

Unfortunately, with Crossroads, it’s not quite that simple. Here’s why I’m avoiding this opportunity.

Timelines

One of the problems with Crossroads’s liquidation is the nature of its investments. Only one is publicly traded, and it’s only 1.3% of net asset value. The rest are private. Without intimate knowledge of these companies, we’re forced to trust the company’s estimate of fair value.

Additionally, management has already wrote off a significant chunk of value already, reducing NAV from $5.06 at the end of 2015 to $4.25 at the end of the first quarter. NAV the quarter before that was $5.63. I don’t like that trend.

Finally, there’s the issue of time. We don’t know how long it will take for this liquidation to take place. It could take at least a year or two to sell these assets at full value, assuming there’s even buyers out there for them at all. Money isn’t flowing to tech like it used to be.

Operating costs

The other troubling thing is the company’s operating costs. In the first quarter alone, the company had $621,912 in operating costs. Some of these costs will be reduced once the company is no longer listed on the NASDAQ, but the vast majority of costs are from operational and professional fees. These don’t look like they’ll go down much.

At $620,000 per quarter of operating costs, the net asset value will be reduced from $4.25 per share to $3.99 just from the company continuing to exist. Some of this will apparently be offset by cash being stuck in interest-paying accounts, but I still don’t like this cash burn.

If Crossroads was stuffed with assets I could easily value, it would be a screaming buy at today’s price. It would even be attractive with far less of a spread between the NAV and the current share price. But with the portfolio filled with assets I can’t value, I’m going to pass on this one.

Disclosure: no position

New Position: Aimia Preferred Shares

Geez, Nelson, are preferred shares the only thing you invest in now?

I was recently arguing with a friend about the state of the markets. He said everything was too damn expensive, and buying today would be a bad idea. I disagreed, arguing that the U.S. might be expensive, but there was plenty of value up here in Canada.

That was over a month ago and I still have some cash to put to work after the sale of Village Farms and from getting rid of Gamehost more prematurely than I originally thought.

At first, I didn’t think this would be so hard. But it has been. The TSX Composite has rallied  some 20% from lows in January, being led by some of the worst performers of the previous year. In other words, all the trash was leading the rally. And as a guy who likes to invest in trash, this made me happy.

But as I look lately, there isn’t much out there. Information Services Corp quickly got too expensive for me. At $17 per share I’ve relegated it to the “stocks I’d like to buy if they were 10% cheaper pile”, a pile that also includes Extendicare.

So, yeah, Jordan, you win. There sure isn’t much out there to buy.

But I did find one stock that’s pretty interesting, Aimia Inc. (TSX:AIM). Canadians know Aimia best as the operator of the Aeroplan frequent flyer program, which allows people to collect points for free Air Canada flights. People do this either through Aeroplan-branded credit cards (issued through either CIBC, TD, or American Express) or by buying gas at Esso, renting cars through Avis, staying at any number of hotels, or buying something online from places like Home Hardware, Hudson’s Bay, or the Gap. Over 150 different places give out Aeroplan miles.

About 60% of revenues come from the North American division, with the other 40% coming from the international division. Other notable partnerships include Air Miles Middle East, Nectar in the UK, and a deal with AirAsia and another partner.

There’s a nice moat around the Aeroplan program, but investors are concerned it’s starting to erode. New more aggressive credit cards are starting to steal some of Aeroplan’s thunder. Westjet’s frequent flyer program is a legitimate competitor. And consumer spending is down pretty much all across Canada. All of these factors have combined to bring the price of the common shares down from an early-2014 high of $19.50 per share to $8.93 today.

Management has been doing exactly what they should be, which is aggressively buying back shares. At the end of March 2015, the company had 170.2 million shares outstanding. At the end of March 2016, that number dropped all the way down to 152.7 million. That’s a 10.3% reduction in just over a year, a huge amount.

The balance sheet is fine too. There’s nearly $400 million in cash in the bank and $300 million invested in various long-term bonds, but these amounts are offset by various reserve requirements, just in case there’s a huge spike in customers redeeming their miles. It might remind you a lot of insurance float because it is a lot like insurance float.

Net cash is $140 million compared to close to $800 million in gross debt which includes preferred shares. All of the debt could be paid off in less than four years of free cash flow.

Speaking of free cash flow, Aimia is a free cash machine. Over its past five full years, it has posted an average free cash flow of $1.32 per share. Over the last decade average free cash flow has been $1.21 per share. The recent number of $0.84 per share in 2015 was the worst result since 2006.

Guidance for 2016 is much better, with free cash projected to come in between $1.24 and $1.44 per share (assuming no additional share buybacks). That puts the common shares at between 6.2 times and 7.2 times free cash flow, respectively.

The common shares also pay an $0.80 per share annual dividend, which works out to a yield of 9%. Normally when a yield gets that high management looks to cut, but Aimia’s management did the opposite, choosing to hike the payout 5% earlier this year.

Why the preferreds?

Here we have a stock with 50-100% upside, a free cash flow yield of between 13.9% and 16.1%, a succulent dividend, and management who make smart capital allocation decisions. Why would I buy the debt instead of the common shares?

This reminds me a lot of both the Dundee and Canaccord preferred shares. Both fell to double-digit yields even though there was very little chance of the underlying company going bankrupt. Locking in a 10-12% yield is attractive enough, but one with a 50% capital appreciation opportunity is even more attractive.

Aimia preferred shares are pretty similar. The Series 3 Prefs (AIM.PR.C) pay $0.390625 per quarter, a yield that works out to 11.2% annually. They reset at the five-year government of Canada bond plus 4.25% at the beginning of 2019, meaning I’m getting 2.5 years of 11.2% yields followed by five years of an 8.6% yield assuming rates stay the same as they’re at today.

Ultimately, I think the upside on the preferreds is pretty close to the upside on the common. Add in my concern with the valuation of the overall market, and I’m happy to collect a nice dividend hiding out a little higher up the capital structure.

Disclosure: Long Aimia Series 3 Preferred shares

Channeling Buffett, Part 2: Information Services Corp

I’m usually more of a Walter Schloss type of investor, trolling the 52-week low lists to find crap I think has fallen so far it can’t do anything but go up. It’s a tough existence, but somebody has to do it.

Every now and again I take a break from the world of turd mining to profile a company I feel is exactly the kind of thing Warren Buffett might own. I want a company that doesn’t use much capital, has a very clear moat, an obvious growth path, and one that preferably pays a dividend. Oh, and I want to buy it at a reasonable valuation, too.

Pizza Pizza was my first attempt at this, which has worked out relatively well. I first wrote about it on June 11th last year. Since then shares are down approximately 2.3%, handily beating the TSX, which is down 7.7% in the same time period. Pizza Pizza also paid me more than a 6% annualized dividend, while the yield from the TSX is closer to 3%. So I’m relatively happy with the buy even if the performance seems a little lackluster on the surface.

The only thing I wasn’t happy about with Pizza Pizza was the valuation. I paid approximately 16x earnings for the stock, something I still feel was expensive. I could have gotten a better entry point had I waited, but I figured Pizza Pizza was the kind of stock I wanted to own for a very long time. Thus, the entry point didn’t really matter. As long as I was paying a reasonable price, I was fine.

As much as I was excited about the business of pizza, I think I’m even more excited about the business of Information Services Corp. (TSX:ISV).

ISC is a true monopoly in a world where very few monopolies exist. It is the exclusive provider of land, personal property and corporate registry administration and management services to the Government of Saskatechewan under a 20-year agreement that was implemented in 2013. It’s a former crown corporation that has been recently privatized.

The business of processing land titles transactions is a good one. Revenue in 2015 was $78.32 million. Net income was $15.92 million. Those are succulent net profit margins of 20.3%. 2014 was even better, as increased activity in the oil patch gave the company $18.36 million in profits on $80.46 million in revenue, good enough for net margins of 22.8%.

If only every company could have net margins higher than 20% in a down year.

Revenue was down for a couple of reasons. There were fewer houses sold in Saskatchewan in 2015, a direct result of oil’s weakness. Saskatchewan isn’t getting hit nearly as hard as Alberta, but it’s still affecting the real estate market. The other hit to revenue was fewer oil companies buying mineral rights.

Free cash flow fell to $21.5 million in 2015 on these weaknesses. The company has a market cap of $262.85 million, which puts shares at 12.2 times free cash flow today.

I think free cash flow has the potential to improve in 2016. The company acquired ESC Corporate Services on October 1st, 2015, a company that assists law firms and financial institutions in accessing certain land title and corporate registry records. It paid $21 million for the company, plus a bonus payment up to $7 million.

In the company’s most recent quarter, revenue was up 14.2%, an increase directly attributed to the new division. Net profit margins stayed above 20%, coming in at $4.57 million.

Let’s be conservative and assume a 10% growth in free cash flow for 2016. That bumps free cash flow to $23.65 million, putting shares at 11.1 times free cash flow. That’s remarkably cheap for such a strong earner.

The balance sheet is pristine as well. Total debt comes in at $24.56 million while cash on hand is $36.57 million. The company pays out approximately 50-60% of its free cash flow in dividends, which works out to a yield of 5.3%.

Growth potential

Alberta has been openly musing about privatizing its land titles registry. Manitoba just sold its property registry to Ontario-based Taranet, which was acquired by OMERS back in 2008.

Alberta might be a prize too big, but Nova Scotia is certainly achievable. The Liberal government in that province has publicly stated that privatizing land registries there is on the table. I’m sure it’s something that’s been discussed in other provinces too.

One of two things can happen. Either ISC succeeds in acquiring additional businesses or it gets bought out by Teranet. Both of those outcomes are just fine for investors.

Risks

One of the biggest risks for ISC is Canada’s real estate bubble. If the bubble pops, transactions go down. That’s bad news for ISC.

The good news is Saskatchewan is still relatively affordable, at least compared to other places in Canada. The average house price in the province is still under $300,000. Prices in the province increased a bit year over year, but the number of transactions were down.

Oil’s continued weakness could also hurt the company, although the majority of its transactions are still regular real estate.

Conclusion

I think ISC is an amazing business going through a temporary tough time. It made it through a weak 2015 while still maintaining profit margins at north of 20%. Management seems to make good capital allocation decisions, and you’ve got to love having a bonafide monopoly in 2016.

I do not currently own Information Services Corp but I will likely be buying some in the next 24-72 hours.

Update: Sold Gamehost

Like the rest of Canada, I followed the Fort McMurray forest fire drama with a keen eye last night, but not just from a compassionate view. Gamehost, one of my largest holdings, has a casino in the city.

As far as I can tell, the casino is safe, at least for now. The fire appears to be at least a kilometer away, maybe two at the most. Officials are expecting today to be another challenging day, with the weather predicted to be warm and breezy. The neighborhoods of Beacon Hill and Abasand look to be the most affected, and Abasand is basically just across the highway from the downtown. We’re talking half a kilometer or so.

I’m not a fire expert. And, obviously, I’m hoping the firefighters can contain the blaze to just the areas affected now. So I’m not going to speculate about whether the casino will make it or not. All we need to know is it’s at risk.

Even if the damage is still relatively contained, I doubt going to the casino is going to be high on anyone’s priority list over the next few months. This will drive down earnings for the whole company. Fort McMurray will likely rebuild, and things will be fine in a few years. But this isn’t a stock I want to own in the meantime.

(And to be honest, from a purely business perspective, there’s certainly an argument for hoping the casino burns. The value of the insurance is likely worth more than the value of the building as it stands today. It could either rebuild a better facility at that point or just take the insurance money and run. I’m not sure if it’s possible to sell a casino license in the city without a casino attached to it, but that’s a possibility too.)

Essentially, it came down to this. I think earnings are affected by this for potentially a year or two to come. The company was barely covering the dividend as it is. A decline in earnings from Fort McMurray could be enough to really put the dividend in danger, causing further pressure to the downside. Plus, the stock was up nicely from when I bought it a few months ago.

So I sold this morning, getting $9.91 for my shares. That’s a profit of approximately $1.85 per share (including dividends) in just a few short months. I was hoping shares would go much higher when I bought it, setting a target price above $15. With business in Fort McMurray looking very bleak over the next few months to years, I think the timeline for a $15 target price just got too long for me.

Disclosure: No position in Gamehost

Senvest Capital: Own a 17% Compounder for 53% Off

There are no shortage of sum-of-the-parts financials in the Canadian market.

You all know how they work by now. A company owns certain investments in other companies. When you figure out the value of these parts, they’re worth anywhere from 10-50% more than the market value of the holding company. It’s exactly the formula I followed with Jaguar Financial, for instance.

Most of the time, there’s a big reason for this discount to true value. Take Jaguar as an example. The guy in charge of it paid himself a huge salary compared to the paltry value of the company’s total assets. He had been reprimanded by regulators at least once before. And Jaguar had squandered much of its shareholders money on foolish decisions. From May 2006 until May 2014, the TSX version of Jaguar lost 96% of its value before getting punted to the TSX Venture.

So it’s pretty obvious why Jaguar was as cheap as it was.

Looking at squarely the numbers, Senvest Capital (TSX:SEC) seems to be a lot like Jaguar. The company has a price of $128.90 per share compared to a book value of $275.28 (as of December 31st). Most of the company’s portfolio is held in marketable securities, via two hedge funds managed by the company. One is a U.S. value hedge fund focusing on small and medium-cap companies, while the other focuses on opportunities in Israel. A small portion of assets are privately held REITs and a fund investing in opportunities in Cyprus.

Let’s focus on the last ten years. At the end of 2006, book value was $56.66 per share, while shares traded hands at approximately $40 each. At the end of 2015 book value was $275.66. That’s a compound annual growth rate north of 17% over a decade. And yet, the discount to book actually grew during that time.

Here’s a table of price versus book value for the company at the end of each year over the last decade. See if you can spot the outliers.

Screen Shot 2016-05-03 at 4.38.48 PM

I’m the first to admit this isn’t terribly scientific. I just did a quick estimate for the price right around December 31st each year to establish some sort of range in book value. Normally, the company trades at about 65-70% of book, but has approached 80% of book in the past. This current price is the only time it has traded below 50% of book value in the last decade.

I’m not sure how book value will do this quarter. On the one hand, the Canadian Dollar has recovered compared to the U.S. Dollar, which brings down the value of the U.S.-based assets in the largest fund. But on the other hand a few of the largest holdings did have decent quarters. So it’s hard to say, but I don’t foresee a huge move either way.

The people running it have plenty of skin in the game, something else I like to see. Victor Mashaal, the Chairman and President, owns 41.4% of the company. His son Richard has been on the board since 2001, and has a 9.3% ownership stake. Victor runs the main hedge fund, collecting 40% of the total management fees from it for himself. 60% of fees go back to the company.

Now onto the bad stuff, which certainly exists. A common investor complaint against Senvest is the company’s poor disclosure practices. There’s no indication of what the company owns in its quarterly reports. It just reports the total value of the assets.

The company also has expenses some think are too high. It doesn’t earn enough from management fees to cover all its fixed expenses, which causes an operating cost each year. This operating deficit has been made up for by portfolio gains over time.

Remember, hedge funds pay 20% of profits to the fund manager when times are good. So during years where the funds did well the company pays big fees to the manager. These add up over time.

Finally, the company has traded at a discount to net asset value for years, and management has never done really done anything about it. Of course, the average volume is a whole 296 shares a day, which isn’t much liquidity.

I will look more closely at this in the next few days, but I do like Senvest at these levels. The plan would be to buy at a level close to 50% of book value and then sell when that discount decreases to 20% of book.

Quick Update: Sold Village Farms and Rona Preferred

A few weeks ago I wrote about the Rona preferred share arbitrage play.

The thesis was simple. Lowe’s had agreed to take over Rona, offering $24 per common share for the company. For some reason they only offered $20 for each preferred share even though the prefs were issued at $25.

Retail investors were up in arms about not getting the full $25 back. Many newspaper articles were written about it. I’m told many retail investors showed up at the special meeting on March 31st to let Rona and Lowe’s managers know how pissed off they were.

Common shareholders voted overwhelmingly to approve the deal. Preferred shareholders did not. This means the preferred shares would remain outstanding.

Shares dipped down below $19.50 on the news before recovering quickly back to just over $20 again. I still think another higher offer comes along for the preferred shares, but at the same time, they still represent cheap funding for the company. And I think these shares trade lower if we go weeks or months before getting a better offer.

So I sold at $20.30 each. I made a total of $0.05 per share in capital gains and $0.33 in dividends. Once I factor in trading costs my profit was 1.6% for a little less than a month. Annualized, that’s flirting with 20%. Not bad.

Village Farms

I’ve held Village Farms for approximately 15 months. The original write-up is here.

The thesis was 1) buying the company’s greenhouses for far less than replacement value and 2) hoping for a recovery on tomato prices. The latter sort of happened, but only enough to take a break-even company to a slightly profitable one.

Shares really didn’t do much for 14 of the 15 months I held them, bobbing between my purchase price of $0.83 and $1.10. But then a rival produce company announced it had bought almost 20% of total shares outstanding and all hell broke loose.

Management responded by adopting a shareholders rights plan, but people just kept on buying. Blocks of 50,000 and 100,000 shares were regularly changing hands and the price kept surging. In the last month alone shares were up 57.9%.

So I did what any sane person would do. I sold at $1.49 per share, locking in a return of 79.5% over approximately 15 months.

If only they all turned out so good.

Rona Merger Arbitrage: Heads I Win, Tails I Don’t Lose Much

After getting more rejected than me during high school during its 2012 quest to acquire the company, Lowe’s finally made an offer for Rona (TSX:RON) shareholders just couldn’t reject. It offered $24 per share for the Canadian retailer of building supplies, shrugging off any concerns of an eventual collapse in housing prices. Lowe’s is looking at this from a long-term perspective. Their management couldn’t care less what’s going to happen in the next few years.

A number of things changed since 2012. The U.S. Dollar strengthened significantly compared to the Canuck Buck, meaning the offer wasn’t really that much more than the $14.50 it offered back then in the same currency. The better offer meant the Quebec government was okay with the deal. And Lowe’s promised it wasn’t going to axe any jobs from Quebec in this updated offer, including vowing to put a French Canadian in charge of the whole Canadian operation.

The vote to approve the deal will take place on March 31st, and it’s widely expected the company will get the 2/3rd majority from shareholders needed to approve the deal. That’s why the common shares trade at $23.65 as I write this.

The potential for merger arbitrage for the common shares is somewhat interesting. $0.35 on $24 offer price is a return of 1.46%, less any brokerage fees you might have to pay. The deal will close in 3-4 months, making it an annualized return of 4.37% to 5.83%, depending on the timeline. That ain’t bad.

But it’s not nearly as attractive as the potential opportunity in the preferred shares.

The background

Rona issued 6.9 million preferred shares back in 2011 for $25 each. These shares paid a dividend of approximately $0.33 per share each quarter. These are rate reset preferreds, which means as of March 31st, they’d be paying a dividend of the five-year Government of Canada bond plus 2.65%. Or, if investors want, they can choose a floating rate option which is the 90-day T-bill yield plus 2.65%.

If investors take the fixed option, they’d be receiving dividends of about $0.20775 per quarter, because hey, you’re not accurate unless you’re five decimal places accurate.

Here’s where these preferred shares really get interesting. They have a $25 per share par value, but Lowe’s only offered $20 per share for reasons nobody really understands.

Right before the deal was announced the preferred shares were trading at about $12.60 each, which means investors got a huge premium compared to the current price. But for people who held since $25, $20 is a pretty poor offer. They want their capital back, and rightfully so.

There are a number of reasons why people suspect a higher bid for the preferred shares are coming. Rona’s investor relations department is reportedly swamped with emails and phone calls from pissed off retail investors making a big stink about the whole situation.

According to at least two different articles I’ve read, insiders with a close knowledge of the situation say the two companies are working on some sort of alternative plan to make things right with the preferred shareholders.

There are two separate votes that’ll take place on March 31st. The first, for the common shares, looks to be a slam dunk after all the big shareholders have already said they’re okay with the deal terms.

The vote for the preferred shares will be much more interesting. Remember, there needs to be a 2/3rds majority for the preferred shares to get acquired. If that doesn’t happen, the new Lowe’s/Rona combination would have to pay for the cost of maintaining a TSX listing and all the regulatory compliance that goes along with it.

And with just 6.9 million preferred shares outstanding, it would cost Lowe’s an extra $34.5 million to just offer the preferred holders the full $25 per share. That’s peanuts for an acquisition that’s already going to cost $3.2 billion. What’s an extra 1%?

The risk on this is minimal, and here’s why. There will be a preferred share dividend of $0.21 (screw it, I’m rounding up) on March 31st, and then Lowe’s is responsible for any accrued unpaid preferred dividends between then and the closing date. The shares go ex-dividend on Monday, so if you buy on Tuesday you can probably get in for a few cents cheaper.

Say the deal closes on April 30th. Investors who buy today at $20.25 would get approximately $0.28 in dividends between now and the closing date, which pushes their cost down to $19.97 per share. If shareholders agree to the $20, you get your money back.

But if a higher offer comes, there’s potential for a maximum of 25% upside. Even a 10% upside would be spectacular over a period of a few weeks. You could then hold until the transaction date, saving yourself the commission on selling. That’s not much these days, but hey, every few bucks helps.

The market is clearly pricing in a higher offer coming for the preferreds, or else they’d be trading at a slight discount like the common shares. I’ll gladly take a shot at a 25% upside with very little risk to the downside. Worse case scenario I can see is I just get my money back.

Disclosure: Long Rona preferred shares

Cannacord Genuity Preferred Shares

Canaccord Genuity (TSX:CF) made headlines on Friday, posting a $3.91 per share loss on what was mostly from a goodwill write-off. If you strip out the goodwill and an impairment in an investment in Canadian First Financial, the loss was a more manageable $0.25 per share.

Canaccord also whacked the dividend on the common shares, deciding the cash would be better used to shore up the balance sheet. Can’t say I disagree, they’re in need of some cost cutting, especially in the Canadian part of the business. These guys rode the commodity boom up to $12 per share back in 2014, and now that it’s over they really need to punt some of the dead weight. As part of earnings the company announced a reduction of something like 8% of its workforce, a nice step in the right direction.

Basically, the company has four divisions — Canada, U.S.A., Europe, and Asia/Australia. With the exception of Canada, which is down 11% YOY over the last nine months, the other parts of the company aren’t doing so bad.

I’m not especially excited about the common shares at this point. Much of the book value is still made up of intangible assets, something that doesn’t really excite me. Canaccord is still getting a decent share of new deals, so there’s clearly some sort of moat there. But competition is fierce in the capital markets business, and I don’t think it would be terribly difficult for one or two of the big players to aggressively crowd out Canaccord, especially in a soft market.

Although at the same time, the company has a history of crashing hard during bear markets. Shares were this cheap as recently as 2012, eventually increasing some 200% just two years later in 2014. Investors have done well riding the trends of this company before, and there’s no reason to think today would be any different.

Where Canaccord does become interesting (at least to me) in when you look at the preferred shares. There are two outstanding, the series A and the series C.

The As reset at the GoC five-year bond rate plus 3.21% on September 30th, 2016. They have a current yield of 17.5% (trading at $7.86 each), and have an implied yield of 12.1% for the next five years. You’re looking at a return of about 13% over the next six years, plus potential capital appreciation.

The Cs are similar. They yield 14.6%, paying out $0.36 per quarter, currently trading at $9.85 each. They reset on June 30th, 2017 at the GoC five-year rate plus 4.03%. The implied yield at the conversion date would be 11.8%. Add in the 14.6% you’d be getting for a year and a half, and you’re looking at the same sort of return as the As, just stretched out over a little longer time period.

There’s only one reason why these things would trade at such high yields, and that’s because investors are worried the company is going to zero. I’m not sure I understand the concern, since there’s $400 million in cash compared to just $15 million in corporate debt on the balance sheet. There are also some lease obligations, but these only total something like $60 million over the next decade. Very manageable.

I see very little risk of a 2008-type of event to really rock these investment bankers to their cores either. This is just a cyclical company which is experiencing a temporary downturn that investors think will last forever. Like the last time it happened. And the time before.

This looks a lot like my investment in Dundee’s preferred shares. As long as you think the company is strong enough to survive the downturn, these preferred shares are a screaming bargain. Once the company recovers and investors think these preferred shares deserve a 6% dividend again, the upside is easily 100%, and you get paid to wait.

I believe Canaccord can get itself to a break-even company with just a few more cuts. If that happens, these preferred shares are safe. And if not, the giant hoard of cash should be enough to ensure the preferred share dividends get paid.

Disclosure: No position, but I will likely initiate one this week. Long Dundee common shares and preferred shares.

Gamehost: Good Dividend, Solid Earnings, Depressed Shares. What’s Not To Like?

When energy first hit the crapper back in the latter part of 2014, I searched far and wide for what I thought would be the best stocks to buy when the commodity inevitably went back up. I settled on Penn West and Canadian Oil Sands.

Canadian Oil Sands wasn’t a great result (I’ve since sold for a small loss, I have no interest in the Suncor shares I’d get for the takeover), but at least it was better than the disaster which is Penn West. Maybe I’ll write an update to that one of these days.

I’m bullish on oil over the long-term. I firmly believe the equilibrium price for crude is somewhere between $70 and $90 a barrel. That allows producers a reasonable profit, and also ensures there won’t be a flood of new money heading into the sector. A mid-range is good for most industries, oil included.

The issue becomes *when*. Crude recovers at some point, that much is obvious. We just don’t know if that’ll happen in March, December, or 2019. That was my mistake, assuming  oil would rebound off the lows relatively quickly.

So I’ve changed my thinking. Rather than looking at oil companies, I’m looking at stocks with a lot of Alberta exposure. Think of these stocks as the innocent civilians when we drop a bomb on an ISIS base right next to a hospital.

(Does that even happen? I dunno. I’m not up on the latest in ISIS)

Dream Office REIT fits that mold. The company is pretty heathy with the exception of its exposure to Alberta. As long as you figure Alberta is worth something, Dream is pretty undervalued. I bought more shares at the $15 level based on that very thesis.

Gamehost (TSX:GH) is another such company. It owns three casinos, one in Grande Prairie, one in Fort McMurray, and a large one in Calgary, the Deerfoot Casino. Both Calgary and Grande Prairie have hotels attached, and the company owns a small strip mall area between the hotel and the casino in Grande Prairie which is currently leased to a restaurant.

Results are down, but not overly so. In the most recent quarter (ending Sept. 30th), revenue was $18.8 million compared to $20.2 million a year ago. Operating earnings were down too, falling from $8.4 million to $7.4 million. This is pretty much what you’d expect. It’s still quite profitable, with net income over the last year coming in at $0.96 per share. That compares to $0.95 per share in profit in 2014. Free cash flow is pretty strong too, coming in at around $0.90 over the last twelve months. At a current price of $8.20, the stock trades at 8.5 times earnings and 9.1 times free cash flow.

The balance sheet is fine. It has $21 million in debt, but that’s offset by $17 million in cash. Most of the assets are in the buildings themselves, which have been depreciated from $112 million to around $70 million.

It pays a succulent dividend of $0.0733 per share monthly, a payout it has sustained since its income trust days. I’m a little concerned about the future of the dividend, since the payout ratio is close to 100% of free cash flow. But there is cash in the bank, and the earnings are still there to cover it — barely.

Say Alberta takes an even bigger hit and earnings fall to $0.70 per share. To make up the difference between earnings and the dividend, we’d be depleting the cash reserve by about $4.5 million per year. So it could maintain the dividend for a few years even if things continue to decline. Again, not ideal, but certainly possible.

The risks

The big risk is a new casino opening in Gamehost’s turf. There’s very little chance of that happening in Fort McMurray or Grande Prairie anytime soon, since these are both only medium sized cities that can really only support one casino each. There was an application a few years ago to the Alberta Gaming and Lottery Commission to open another casino in Fort McMurray, and the government rejected it. With the economy the way it is, I doubt anyone is chomping at the bit to open up a new casino in Northern Alberta.

Calgary is a slightly different story. There’s a new racetrack opening up north of the city at Crossiron Mills, which will have slot machines. And the Grey Eagle Casino just off the outskirts of the city has recently completed a big expansion. (Vanessa and I used to eat there all the time when we lived in the city. Good buffet if you go on the cheap nights) Grey Eagle is a nice place.

The Deerfoot Casino is in the southeast corner of the city. Management says this gives them an advantage because it’s the only casino for miles. They have a point, take a look at this map:

Screen Shot 2016-02-05 at 3.04.44 PM

Deerfoot Casino is in the bottom right corner, just by Highway 2. The other two south of Highway 8 aren’t even casinos, they’re party companies that will organize fun casinos for your office party. The closest casino (Cash Casino, located where the two dots are together, north of Highway 8 and west of Highway 2) is about a 15 minute drive away. Grey Eagle (the three dots on the middle left) is about 20-25 minutes away.

The Will brothers (Darcy and David) own about 43% of the company, with the COO owning an additional 3% or so. I’m not a huge fan of the compensation packages the top three managers get, but at least they’re each running a casino. Altogether, they’re getting paid $2 million a year, or about 10% of profits. I’d be more concerned if they didn’t own a whack of shares.

Target

Gamehost is a simple business that will rebound with Alberta’s economy. I think earnings could easily hit $1.10 to $1.20 per share with that happens. At a 15x earnings multiple, my target price is $17.25 per share, representing potential upside of 109%. This excludes dividends, which, at 10.7%, has the potential to nicely top up any capital gain.

Disclosure: Long Gamehost