Jerome Hass is a partner at Lightwater Partners. His focus is Canadian mid-large caps and short-long strategies.
We started shorting RET.A in August at $9.77 before the Q2 2013 earnings.
1. Brutal operational results. Q2, typically the strongest earnings quarter for Reitman’s got off to a horrible start with the company posting a same-store sales decline of -6.8 per cent was well short expectations, gross margins declined significantly, and adjusted EBITDA decline of 44 per cent.
2. Index exclusion. Reitman’s is the largest constituent in the S&P/TSX Dividend Aristocrats index. Their inclusion in this index is predicated on their ability to raise their dividend at least every two years, which is incredibly unlikely to happen before Nov. 30 (position review date for the index) given that the current payout ratio estimated between 150-200 per cent for this year. Reitman’s will likely be removed from the index in the first or second week of December. Aristocrat index funds hold approximately 62x the average daily volume of trading, so removal from this index could have significant downward pressure on the stock during the end of year tax-loss selling season.
3. Dividend cut is inevitable. Reitmans will dole out $5-million in dividends this year, the street is looking for the company to earn about $11-million net income this year. The dividend payout ratio of over 400 per cent this year, last year it was about 200 per cent. Reitmans has financed the deficit by drawing down on their cash reserves. This can only go on for so long (their cash position fell by $62-million over the past 4 quarters). Inevitably, a responsible board of directors will slash the dividend to preserve their cash. Some analysts are looking for a 75-per-cent cut to their dividend (from $0.80 to $0.20)
Long: Patient Home Monitoring
We have held PHM since June 2013 at $0.10
PHM is a small, profitable U.S. health-care services company that operates in a lucrative niche. PHM helps the patient monitor their health by an easy in-home blood test. Performing the test at home rather than in a hospital under medical supervision is a significant cost savings for medicare.
There are four million patients under medicare that could be eligible for this program; so far only 10 per cent of these patients have at-home testing.
The stock is a play on demographics in that patients are living longer but also more inclined to suffer cardiac and diabetic issues.
The company’s representatives speak to each patient on a weekly basis. Because they own this relationship, there is potential to cross-sell other complimentary services. Hence the stock can also be considered a health-care roll-up / consolidation player.
Two executive members of PHM bought large blocks of the stock at $0.21, a premium at the time when it was trading at $0.17.
Pair Trade: Long: Enercare; Short: Just Energy
Enercare is one of our more conservative names in the Lightwater Portfolio;
- 1. Enercare may be better known to views as the former Consumer Waterheater Income fund; it was re-named Enercare in January, 2011 when it converted from an income trust to a corporation. Enercare owns a portfolio of 1.3-million waterheaters (primarily in southern Ontario) that it rents out.
- 2. Enercare has been a long-term holding for us; we’ve held the stock since early 2010; our initial purchase cost is $5.03.
- 3.They also have an emerging business in sub-metering business which after five years of top line growth will start to translate into bottom line growth in 2014.
- 4. The yield is about 7.2 per cent; the dividend payout rate is about 80 per cent; the valuation is modest at 6.5x EV/EBITDA 2013.
It’s a safe, low maintenance stock that has a nice yield and long-term growth story.
Just Energy is another story:
- 1. Opaque accounting. Try as we might, we do not understand their accounting. Usually a big red warning flag for our Analysts.
- 2. Running to stand still. JE has to spend aggressively to attract new customers, as its customer retention rates are not high at contract expiry. These new customers are not as profitable as the ones they are replacing due to high ‘growth marketing’ spending.
- 3. Valuation unattractive. JE most optimistically trades at 12x EV/EBITDA in 2013 and 9x in 2014
- 4. High leverage. JE has about $900-million in debt which is about its market cap. Management is currently renegotiating its $370-million credit facility, which matures in December, 2013. There is another large debt payment due in September, 2014.
- 5. Unsustainable yield. The payout ratio is subject to considerable debate due to JE’s accounting but we estimate it to be in excess of 100 per cent. Remember: often it is not managements who opt to cut a dividend; their bankers make that decision for them.
Past Picks: July 16, 2013
Deltic Timber - Long
Total return: -0.54 per cent
Currency Exchange International - Long
Total return: +7.14 per cent
Total return: +15.02 per cent
Total return average: +7.20 per cent
We have none.
We are constantly asked our outlook for the market, for the Canadian dollar, the price of gold, or other questions about the direction of markets. There is a book which is entitled “A Random Walk Down Wall Street”, which for many years was mandatory reading for the Chartered Financial Analyst (CFA) program. The crux of the book is that in the short-term, the direction of the market is completely unpredictable and cannot be forecast on a consistent basis. It is what statisticians refer to as “a random walk”.
We don’t spend our time making market or commodity or foreign exchange forecasts as a result. We are stock-pickers or bottom-up fundamental investors. We prefer to spend our time analyzing individual companies especially those that are under-researched and under-owned by investors, as these stocks are most likely to be undervalued too. If our portfolio managers and analysts do our jobs, we believe this approach should be able to yield results regardless of the direction of markets.
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