It's no secret that our population is aging, or that investing along demographic lines has been popular for two decades. So why are shares of Extendicare Inc., a big operator of nursing homes, withering away?
There are a couple of reasons, in my opinion, and both are temporary, making the stock a buy for both potential capital gains and generous income, with a current yield of 7.5 per cent.
Extendicare is one of the bigger publicly listed owners and operators of senior care centres, with a market capitalization of about $568-million.
The company has had its share of ups and downs, including a foray into the United States that didn't go that well and from which the company has almost exited.
That exit – a sale of the U.S. business that should close in the second quarter – will bring in a lot of cash but also remove a distraction for management, as the U.S. business was plagued by legal problems.
Extendicare agreed to sell its U.S. division late last year, with an expected closing date in the next few months. Net proceeds from the sale will amount to more than $220-million (U.S.), which will be put to work expanding and improving the Canadian business. Extendicare has also announced a big share buyback, so some of the money may be used for that as well.
The first reason the stock is down is likely that it had attracted a lot of "hot" money – hedge funds and other traders hoping the sale of the U.S. business would bring a quick buck in the form of a special dividend.
The sale price ended up being on the low end of the expected range, which frustrated these traders. But worse, in their eyes, was that the company plans to re-invest the proceeds rather than paying out a big fat dividend.
It didn't take long for the acrimony to start flowing, with irate investors calling out management for supposedly poor decision-making. On paper, their arguments are plausible. The U.S. operations are bigger than the Canadian business, so it's easy to believe arguments that the dividend is at risk because once you take out the U.S. division there's not enough cash flow coverage for the current dividend.
But that's a false argument because it assumes the $220-million net proceeds from the sale can't be put to work to generate more cash to support the existing dividend – and perhaps increase it.
By way of example, Extendicare just acquired the home health care division of Revera, a smaller competitor, for $83-million. That values the assets at 6.5 times projected earnings before interest, taxes, depreciation and amortization, a good multiple.
Analyst Doug Loe at Euro Pacific Canada likes the deal, noting it's a good bolt-on acquisition for Extendicare's existing home-care operations and that home care is increasingly touted by experts as a way to reduce the overall cost of health care in Canada.
Mr. Loe also believes that this acquisition goes some way to reduce the risk to the dividend. While the U.S. operations are strained by compressing margins and rising insurance costs, Extendicare still generates more than half its cash flow from south of the border.
But this accretive acquisition adds about 10 cents of cash flow per share. The dividend is 48 cents, so assuming half the funds for the dividend are coming from the United States, the company has already replaced a good proportion of it with an investment of $80-million. It has another roughly $200-million to deploy so it appears that the fears of a dividend cut are overblown as long as the company can deploy funds in a reasonable way, whether by acquisition or re-investment in its existing operations to increase revenue and profits.
I have to think that with an aging population and growing demand for such services, Extendicare should not have much difficulty making judicious decisions with its cash and I'm happy to collect a nice dividend while I wait to see what they do with that big war chest of cash.
Fabrice Taylor, CFA, publishes the President's Club investment letter, for which he and The Globe and Mail have a distribution agreement. He holds shares of Extendicare.