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Shareholders can be excused for reaching for a drink after consuming the latest report from Liquor Stores N.A. Ltd. The alcohol retailer delivered a giant quarterly loss this week and followed it up by cutting its dividend to one-third of its former level.
The Edmonton-based company pointed to the economic downturn in Alberta as a reason for turning down the dividend tap. But clear-eyed observers spotted problems at the firm years ago.
Liquor Stores was put under the microscope during the final round of the Ben Graham Centre International Stock Picking Competition in early 2014, when three teams of students examined it from top to bottom. All of them recommended taking a pass on the stock. Among other concerns, the students figured that the company lacked the financial flexibility to fund its growth plans while maintaining its hefty dividend.
This week Stephen Bebis, the chief executive officer of Liquor Stores, appears to have come to a similar conclusion. "In order to invest in our seven-point plan and grow the company with store acquisitions, new store development and renovations, we need to invest capital and maintain a strong balance sheet. As a result, the board of directors has decided to change the dividend to allocate about $18-million annually to finance the company's growth plans," he said.
While the dividend cut was overdue, it also marked the second time the firm slashed its payments to investors this decade. The first reduction occurred in 2011, when Liquor Stores converted from an income trust to a corporation, and the payments fell from an annual rate of $1.62 per unit to $1.08 a share. The post-conversion annual dividend rate was maintained until this week when the company reduced it to 36 cents a share.
It was clear almost from the beginning that the post-conversion dividend rate was aggressive. After all, the firm barely covered its dividend in 2011 when it earned $1.08 a share. It then went on to earn much less in the following years. The company generated a total of $2.93 in earnings per share from 2011 through 2014, and paid $4.32 per share in dividends over the same period. It compounded matters in 2015 by losing $3.64 a share, thanks, in part, to large goodwill writedowns.
The earnings decline, and dividend reduction, hit Liquor Stores' stock hard. It started 2011 at just over $15 a share, climbed briefly above $20 in the summer of 2012, and then tumbled to about $12 a share when the students examined it in 2014. The shares perked up to just over $16 last year before tumbling again. The dividend cut was announced after trading on Wednesday and the stock fell almost 7 per cent on Thursday to end the day at $7.54 a share.
Liquor Stores dashed the hopes of investors who were lured in by an indicated dividend yield that exceeded 10 per cent prior to the cut. Its recent decline represents a painful lesson that stocks with extreme yields often come with more than a few risks.
Mind you, the firm still provides a hefty dividend yield of 4.8 per cent based on its new dividend rate and much lower share price.
On the upside, the company managed to boost its quarterly sales by 8.9 per cent on a year-over-year basis. The firm also reported "adjusted" earnings of 57 cents a share for 2015, which excludes items like the large goodwill writedown. That puts its price-to-adjusted-earnings ratio at a relatively modest 13.2. However, it's not overly cheap from a value perspective and the list of earnings adjustments makes for interesting reading.
Overall, Liquor Stores should be able to weather the current economic storm and its new dividend appears to be sustainable. But, at least in the short term, I'd rather buy the firm's products than its shares.
Norman Rothery is the value investor for Strategy Lab. Globe Unlimited subscribers can read more in the series at tgam.ca/strategy-lab.
Norman Rothery