Streetwise: A solid business is key to holding on to ex-income trusts

Yellow Media Inc. CEO Marc Tellier poses for a photograph prior to the company's quarterly results meeting in Montreal. The former income trust’s restructuring has been painful for shareholders. (Graham Hughes/The Canadian Press)

As Yellow Media Inc. pleads with investors and creditors to allow a restructuring that will almost wipe out shareholders, two other onetime income trusts are showing just how it is possible to reshape a company on the fly and save a lot more value for equity investors.

There is plenty of short-term pain. But also there can be gain, as the stock charts of Superior Plus Corp. and Vicwest Inc. illustrate. The key decision both companies made was that even though investors owned the stocks for their dividends, and a cut would be painful and unpopular, payouts had to be reduced to keep the balance sheet strong.

Oakville, Ont.-based Vicwest, which makes building supplies, slashed its quarterly dividend by 37 per cent in November, 2011, to 15 cents a share from 27 cents. Why? Not because there was a pressing pile of debt maturities, as at Yellow Media, or because of problems with covenants, another issue at Yellow Media. Vicwest cut the dividend because the business was looking iffy and it made sense to husband cash. Vicwest’s shares dropped as low as $7.96 after the dividend reduction. But a strong balance sheet matters. On Monday, Vicwest closed at $10.75.

At Superior Plus, the monthly payout went from 13.5 cents in early 2011 to 10 cents in mid-2011 to 5 cents after another cut in late 2011. The Calgary-based company, with a portfolio of businesses ranging from propane sales to specialty chemicals, was struggling under a heavy debt load. The money was better used paying creditors than shareholders. The shares initially sagged, bottoming out at $5.36 in November. Since then, they have soared and finished Monday at $9.23.

The moral of the story bears repeating one more time. If you own a business that has a high payout ratio, do not be blinded by the yield. Consider getting out until the company has cleaned up, unless you are certain in the viability of the payout.

One that may be worth keeping an eye on is CML Healthcare, which provides medical imaging and laboratory services. Some analysts, such as those at Accountability Research, put the company’s payout ratio at about 100 per cent this year and next. RBC Dominion Securities has also said the ratio could top 100 per cent.

For those that stay in a company with a high payout ratio to keep collecting the cash payments, the best case could well be that you ride the stock down and all the way back up after a dividend cut. The worst case will be on display Tuesday when Yellow Media convenes a conference call with investors to try to drum up support for a restructuring that will leave shareholders with only a sliver of the company.

“When you have 100-per-cent payout ratios and levered balance sheets, sooner or later you are going to run into trouble,” said Blair Levinsky, a principal at hedge fund Waratah Advisors.

Waratah has a specialization in businesses that were once income trusts. Mr. Levinsky once ran the income-trust trading desk at TD Securities, while his parter at Waratah, Brad Dunkley, ran a top-performing hedge fund with a focus on trusts when at Gluskin Sheff.

Waratah will sell short former trusts with a big payout ratio and troublesome outlooks. (That means borrowing the shares and selling them, in hopes that they fall, enabling Waratah to buy them back later at a lower price, then return them and keep the profit.) But the firm will also purchase fallen stocks after their dividend cuts, knowing that a strong balance sheet will often enable them to return to favour.

Businesses that were taken public as income trusts, before the government disallowed that structure, were often low-growth businesses that could only find public market support by paying a high dividend. Over and over, the perils of that payout policy have been laid bare by downturns in business.

“These trusts were structured to run close to the edge,” Mr. Levinsky said.

CML has nowhere near the issues of Yellow Media, which was watching its main business of printing Yellow Pages directories fade away.

The business is still relatively steady. But there are risks. CML’s biggest customer is the Ontario government, which is desperately trying to cut health care costs. Next year, a key agreement with Ontario on payment levels is up for negotiation. What if it doesn’t go CML’s way? Ontario already trimmed fees for some CML services earlier this year, leading to a hit in earnings. Analysts say the company might have to borrow to pay dividends if the payout ratio does pass 100 per cent.

“The sustainability of that dividend is certainly in question,” Accountability’s analysts wrote in August.

So far, CML does not seem worried. The company’s new chief executive officer is readying a new plan for the company. Meanwhile, “we remain comfortable with our current dividend policy, and have the cash flow to maintain our monthly payment,” chief financial officer Tom Weber said earlier this month after CML released its quarterly results.

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Sherif Nathoo

Sherif Nathoo

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CENTURY 21 Leading Edge Realty Inc., Brokerage*
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