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(Ron Chapple/(C) 2005 Thinkstock)
(Ron Chapple/(C) 2005 Thinkstock)

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Prognosis looking up for pure-play CML HealthCare Add to ...

Buy shares in a company that’s had no permanent CEO for more than six months? Doesn’t seem like such a good idea, at first glance.

Except, perhaps, in the case of CML HealthCare Inc., a Mississauga company that operates diagnostic labs and medical imaging centres. The absence in the company’s top spot seems to be the last major issue holding back the company’s shares – and creating, for now, a dividend yield that tops 7 per cent.

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CML HealthCare’s two top executives departed in May in what was viewed by analysts as a high-level disagreement about strategy and the company’s struggling U.S. operations, which have been posting an EBITDA (earnings before interest, taxes, depreciation and amortization) margin in the single digits, versus the 30-per-cent-plus margin of the Canadian business. (The company had to take a $51-million non-cash impairment charge at the end of 2010 to reflect the U.S. business’s diminished value.)

Under chairman and interim CEO Patrice Merrin, CML HealthCare put the U.S. operations on the block and struck a deal earlier this month to sell them. That will leave the company a pure-play Canadian health concern, with 118 lab centres in Ontario and 105 imaging centres in Ontario, Alberta and British Columbia.

“In retrospect,” says Raymond James analyst Jamil Murji, “we view CML’s 2008 entrance south of the border as a mistake: Not only did it add volatility to an otherwise stable, steady and easily predictable business, it cost CML’s CEO and [chief operating officer]their jobs, and lowered the stock’s multiple by two to three points.”

The company, formerly an income trust, pays a monthly dividend of 6.29 cents, or just over 75 cents per year. At Monday's close of $10.02, that's a yield of 7.5 per cent.

Often, a yield that high is more of a red flag than a buying green light. Sometimes, the market is saying the dividend payments aren’t sustainable.

Analysts who follow the company disagree, however. Neil Maruoka of Canaccord Genuity says CML HealthCare’s adjusted funds from continuing operations, or AFFO, should come in this year at about 95 cents per share, well above the 75-cent dividend. And despite the reduction in revenue and cash flow from the U.S. divestiture, CML HealthCare can maintain that roughly 80 per cent payout rate in coming years, he believes.

Mr. Murji of Raymond James says the key is CML HealthCare’s Ontario lab testing business, which he calls a “cash cow … which can almost be thought of as a utility given its stable revenues and profitability, representing nearly 85 per cent of annual EBITDA.”

CML HealthCare struck a new deal in October with the Ontario Ministry of Health and Long-Term Care that locks in cost levels and payment for services through March, 2013; the agreement removed another uncertainty that may have weighed on the company’s stock through the summer.

That leaves the empty CEO slot – which Mr. Maruoka of Canaccord Genuity calls “the final overhang” that’s creating a “cloud of uncertainty.” For now, CML HealthCare’s shares trade about halfway between their 52-week low, set in August, and the high set last January.

They are not at bargain-basement levels; on a price-to-earnings basis, they trade at about 14 times forward earnings (and a much higher trailing multiple, given the 2010 fourth quarter’s impairment-driven loss.)

Indeed, a number of the analysts are cautious, hesitating before forecasting significant price appreciation. Mr. Maruoka rates the shares a “hold” with a $10 target price, based on a discounted cash flow model. Douglas Loe of Byron Capital Markets Ltd. has a $10.25 target price and “hold” rating on the stock. Mr. Murji recently raised his target price to $11.25, meriting an “outperform” rating.

If CML HealthCare shares are fairly valued rather than overvalued, as these calls suggest, they may now have less downside risk. If CML HealthCare removes that “final overhang” and boosts its stock price by picking a new CEO, though, the shares’ dividend yield may drop by a point or two. It may be best for investors to buy into this “cloud of uncertainty.”

 
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