A general rule of investing is the higher the potential rate of return, the greater the degree of risk. One way that this relationship expresses itself is when people chase yield. We did exactly that with our purchase of Hartco Corp. at prices from $3.02 to $3.46 over the past year or so.
With a monthly distribution of 5 cents, Hartco represented an annual income stream of better than 17 per cent at these prices. That's a huge premium to a safe guaranteed investment certificate. The question was and remains, is this nickel sustainable? If it is not, the trust unit's price will drop faster than the speed of a racing cyclist kicking steroids.
Prior to becoming an income trust, Hartco was one of those regular, boring corporations. One could say this company was more honest compared to many others that converted to the trust model. While many enterprises foisted overpriced units on feckless investors while management ran away with the spoils, in 2005 Hartco simply swapped common stock for units on a one-for-one basis.
Hartco is in the information technology business, providing computer solutions through its 60+ Metafore, MicroAge, Microserve and ZingPC locations. It also operates the Telephone Booth communications stores and, until recently, CompuSmart, a national network of digital technology locations.
The latter has been a problem. Profitability has been elusive the past few years accompanied by a cash drain of almost $14-million in 2006, so in May a decision was made to divest this division. Since then, all of the stores have either been closed or sold, although Hartco still has to get out of some of the leases.
For the year 2006, Hartco lost $3-million, which works out to 22 cents a share. Revenue slipped slightly from the year before to the $577.7-million level. First-quarter 2007 results will be out shortly, at which point virtually all of the CompuSmart issues should be behind the company.
Harry Hart, the chairman and chief executive officer, owns about 60 per cent of the business. He might want to pony up for the rest and take the corporation private. An alternative, given his advanced age, might be to sell the whole outfit, lock, stock and barrel.
Recently, the trading volume of the stock has swelled. There is no indication that insiders are buying or selling but there is definitely renewed interest in the company that has sent the unit price to around $4. Might there be an acquisitor on the hunt? Though this is strictly speculation, the volumes do lead us to wonder just what the heck is going on.
In a conversation with Carl Gavreau, vice-president and chief financial officer, he said: "We are growing in Ontario, which has about 40 per cent of the Canadian market. But while we have to grow, it is not at all costs. Plus, the business-to-business model does not have big margins, so we have to be on the ball."
At this point, with the distribution working out to more than 15 per cent, we remain happy to hold. It appears that this organization remains cheap relative to risk-reward, especially when the possible increase in the unit price is added to this value. While the major danger is that the distribution could be cut, the overall upside potential clearly supersedes the downside.
This column first appeared on GlobeinvestorGOLD.com.