They operate in very different businesses but they have one important thing in common: No one loves them.
What I mean is that the list of income trusts orphaned by Bay Street gets longer by the week. Five years ago almost every dealer had at least one and as many as three trust analysts. Today many firms have none. According to Bloomberg, 29 business income trusts have no analysts watching them. Another 25 or so have two or less. Analyst coverage generally leads to higher stock prices; our thesis is that no coverage yields better values for investors.
But it's still a tricky business. In many cases there are excellent reasons for analyst indifference: the business is dead or dying.
Yet I think there are good reasons to use the lack of coverage as a starting point in the search for bargains. To a stock dealer, research is expensive and so coverage is still tied to underwriting. The more business you give them, the more coverage you get.
But the irony is that the best businesses don't need money. They make lots of cash selling whatever it is they make. (In fact, far from needing to sell fresh shares, they sometimes buy stock back, often reducing their market float. This makes them harder to trade and gives brokerage firms another reason not to bother analyzing the companies.)
Consider Big Rock Brewing , one of the names on the list of unloved trusts. This is a Calgary-based beer maker with very good management, building brands and a P&L that looks like a work of art.
In the first quarter, by way of example, sales by volume were up 25 per cent year over year. Net sales, in dollars, were up 29 per cent. Net income per unit rose 17 per cent. Distributions were higher too. Return on equity was north of 20 per cent.
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All of this is reflected in the unit price trajectory. Big Rock has delivered gains of 86.76 per cent in the past year, including distributions.
But the yield, at 7.5 per cent (the trust distributes pretty much all its free cash) is arguably low given the healthy balance sheet, solid returns and revenue growth. It works out to about 13 times earnings. Yes, you have to factor in the specified investment flow-through (SIFT) tax rules, but even then I wouldn't call it expensive, especially given the fate of successful brewery startups in this country. They are usually bought by Molson or Labatt, and for much bigger multiples than that.
Another idea is Pizza Pizza . The name says it all. The trust invaded the West a couple of years ago through an acquisition of a fast-growing pizza chain, but the West is hurting results now. Revenue dipped slightly in the most recent quarter. This is not a growth story, but the franchises have been around for a long time and pizza isn't going out of style. The trust's payout ratio is north of 100 per cent, which is not good news. But thanks to an historically conservative payout ratio, Pizza Pizza has reserves to draw on to make distributions. A recovery in Western Canada would go a long way to turning this around. The yield is 13 per cent, which isn't bad (again, the SIFT changes will have an impact on that number).
Menu Foods , meanwhile, is well into its turnaround. Readers will remember that it was the subject of a controversy about tainted pet food that killed numerous pets and continues to cost it business. Yet the units are on the mend, up sharply over the past three years.
The trust posted a profitable 2009 and, while warning that sales volumes would be down this year, added that it had won new business. Private-label pet food is growing nicely too.
This one has some hair on it to be sure, but had you bought it a year ago you'd have more than doubled your money by now. What's changed since then besides a higher price? Profits, as mentioned. Favourable trends. And the company has hired an adviser to explore a sale of the business or some of its assets.
Given the paltry valuation, I would think an offer could come in higher than the current bid.
You should check out these ideas yourself because I didn't spend a lot of time on them. They're only ideas. And there are other names on the list that might appeal to you more if you care to dig into them. But the bottom line is that is that neglected companies look cheap for a while, maybe a long while, but value eventually surfaces.
Three to check out
Big Rock Brewing
Why buy it? High-return business, growing revenue and market share, decent distribution yield, excellent management and likely takeover target
Pizza Pizza Why buy it? Good franchise with a strong market position, relatively insensitive to the economy, handling stiff headwinds reasonably well
Menu Foods
Why buy it? Turnaround running at a high pitch after recall nightmare, sales and profits improving steadily, stock looks cheap