In This Issue


CONSERVATIVE PORTFOLIO ON TRACK

By Gordon Pape, Editor and Publisher

When stock markets start to soar

Low-risk investing is a bore.

But when markets are dark and grey

Conservative investing saves the day.

I received an e-mail last week from a reader who was considering investing in a three-year laddered GIC. I told him I thought that was a bad idea (see the Q&A section for more details as to why) and suggested he consider our IWB Very Conservative Portfolio instead.

Granted, it has slightly more risk than a GIC. But the potentially higher returns more than offset that in my view. Why settle for less than 2% a year when inflation is running at 2.1%? It’s a sure-fire way to lose money.

This portfolio was created in September 2011 in response to concerns from readers who were still suffering post-traumatic stress disorder stemming from the 2008-2009 stock market crash. They were unhappy with GIC yields at the time, which were even lower than they are today at 1.3% for a five-year term. In response, I assembled a portfolio that was designed to preserve capital while providing decent cash flow. The initial book value was $10,000 and the target return is two percentage points higher than the yield on a five-year GIC from the major banks. The current RBC rate is 2% so a gain in this portfolio of 4% per year would be right on the mark.

With that in mind, let’s look at our securities and see how they have performed in the six months since my last review in March. Prices are as of mid-day on Sept. 24.

iShares 1-5 Year Laddered Corporate Bond Fund (TSX: CBO). This short-term corporate bond ETF acts as one of the stabilizers in this portfolio. Because of the nature of the fund, it will never deliver a great return but neither does it come with a lot of risk. The trading price is gradually eroding – it’s down $0.28 a share from the last update in March. However, that capital loss was more than offset by distributions over the period of $0.48 per unit, giving us a small overall six-month gain. The total return over the three years since 2011 is 9.4%.

iShares DEX Short Term Corporate Universe + Maple Bond Index Fund (TSX: XSH). This is another short-term ETF. It was added to the portfolio in the fall of 2013 to provide some exposure to Maple Bonds, which are Canadian-dollar bonds from foreign issuers such as Bank of America, JPMorgan Chase, and Goldman Sachs. The unit price is down by $0.08 since March but we are receiving monthly distributions of about $0.05 per unit, which has more than covered that small loss. We’ve had a total return of 3.6% since we acquired this ETF, which is consistent with the low-risk nature of this fund.

iShares Advantaged U.S. High Yield Bond Index ETF(CDN-Hedged) (TSX: CHB). This ETF focuses on high-yield U.S. bonds (aka “junk bonds”), which are normally associated with higher risk. It was added in fall 2013 because at the time high-yield bonds were actually performing better than supposedly low risk government issues. That decision paid off in the first five months, with the ETF giving us a total return of 6.1%. However, the high-yield market has cooled since then. The units are down $0.73 since March. We’ve done slightly better than break-even thanks to total distributions of $0.77 but the time has come to change course on this one.

PIMCO Monthly Income Fund (PMO005). This is a global fixed-income mutual fund that is managed by one of the world’s most respected bond houses. It offers monthly cash flow and places a heavy emphasis on capital preservation. We added this fund in October 2013 and it has performed very well so far with a one-year return of 8.7%.

BCE Inc. (TSX, NYSE: BCE). Most of this portfolio is in various types of fixed-income funds. This allocation is consistent with the primary goal of capital preservation. The rest of the money has been spread among three conservative growth securities. All have performed well, which is not surprising given the strong market run we have experienced. There are signs this is slowing, however. BCE shares are down $0.56 since the last review in March. We still have a gain for the period, however, thanks to three dividend payments totaling $1.85 per share.

Enbridge (TSX, NYSE: ENB). Enbridge keeps powering along, boosting the returns in this portfolio. Over the past three years, the total return from this pipeline giant and natural gas distributor is 86.3%, proving that you don’t have to speculate on penny mines to earn a nice return. The shares have gained $5.28 since March and we have received dividends of $0.70 per share for a total return over the latest six-month period of 12.2%. This is now the top performer in the portfolio.

Brookfield Infrastructure Limited Partnership (TSX: BIP.UN, NYSE: BIP). This Bermuda-based limited partnership continues to perform well for us. The share price is up $1.62 since March and we received two distributions of US$0.48 each. The total return since inception is 84.1%, a shade behind that of Enbridge.

We received interest of $4.99 on the cash in the high-interest savings account.

Comments: The total value of the portfolio now stands at $12,551.30, including retained distributions. That’s a gain of 3.5% since the last review in March. That may not seem like much but it’s consistent with a low-risk portfolio of this type and comfortably in excess of our target. Since inception the total return is 25.5%, which works out to an average annual compound rate of return of 7.9%.

Changes: As mentioned, the iShares Advantaged U.S. High Yield Bond Index ETF looks more risky these days now that the spread between government and high yield issues has narrowed. Therefore we will sell the entire position, which will give us $1,102.18, including retained distributions.

Enbridge has done very well for us but portfolio drift has increased its share of total assets to more than 15%. Since this is a very conservative portfolio, we should reduce that. So we will sell 2.08 shares for $113.11, which will leave us with 30 shares.

We will replace CBH with the iShares Convertible Bond Index ETF (TSX: CVD). This invests in bonds that are exchangeable for common stock in the issuer at a predetermined price. This gives investors the best of both worlds: regular interest payments plus an opportunity to earn a capital gain if the price of the underlying stock rises.

CVD tracks the performance of the FTSE TMX Canada Convertible Bond Index. Only bonds traded on a Canadian exchange are eligible for inclusion and they must be denominated in Canadian dollars. The issuer must not be in default on either principal or interest and the bond must have a minimum outstanding amount of $50 million and trade in the $80 to $120 range. The largest holdings are issues from Boralex Inc., Morneau Shepell, Chartwell Retirement Residences, Element Financial Corp., and Superior Plus Corp. The fund gained 9.6% over the year to Aug. 31 and was showing a three-year average annual compound rate of return of 5.8% to that point. The management expense ratio is 0.49%. The current monthly distribution is about $0.08 per unit.

The units were trading on Sept. 24 at $19.55. We will buy 60 units for a cost of $1,173. After those transactions are completed, we will be left with an extra $42.29.

We will also use some of our accumulated distributions to add to existing positions as follows. Note that this is for modeling purposes only; I do not advise buying such small amounts in the real world because of brokerage commissions. Use dividend reinvestment plans (DRIPs) instead.

CBO – we will purchase 18.2 units at $19.53 for a cost of $355.45. This will bring our total position to 155 units with retained distributions reduced to $3.07.

BCE – we’ll buy 2.9 shares for $138.13. We now have 29 shares with $42.09 in retained dividends.

BIP.UN – we’ll add 3.41 shares at $43.63 for a cost of $148.78. Our new holding is 34 shares and we have $14.81 left over.

These transactions have enabled us to eliminate all the fractional positions in the portfolio. Here’s what the revised version looks like.

View IWB Very Conservative Portfolio details (revised Sept. 24/14)

We will leave the retained distributions and cash of $347.36 in a high interest savings account paying 1.3%. I’ll revisit this portfolio in March.

Gordon Pape’s new book, Retirement’s Harsh New Realities, is now on several best-seller lists. Save 38% by ordering your copy at http://astore.amazon.ca/buildicaquizm-20


RYAN IRVINE REVISITS FOUR STOCK PICKS

TOP

Contributing editor Ryan Irvine joins us this week from his base on Canada’s West Coast to update us on some of his previous stock selections. Ryan is one of the country’s leading experts on small-cap stocks and the CEO of KeyStone Financial (www.keystocks.com). Here is his report.

Ryan Irvine writes:

This month we have three updates and one upgrade for IWB readers. So let’s get right to it.

The Caldwell Partners International (TSX: CWL, OTC: CWLPF)

Originally recommended on Feb. 25/13 (#21308) at C$1.04. Closed Friday at C$1.38, US$1.34 (Sept. 19).

We introduced The Caldwell Partners in February 2013 when the stock traded at $1.04. Today, with the company recently releasing its third-quarter results for fiscal 2014, we review the numbers and update our rating on the stock.

Note that this is a true micro-cap stock and, as such, is not suited for all investors.

Founded in 1970, The Caldwell Partners International is an executive search consulting firm. The company, through a predecessor corporation, became the first retained consulting organization in Canada to specialize in representing employers in the recruitment of executives.

Today, Caldwell is one of North America’s premier providers of executive search. The company has built a solid reputation for providing successful searches for boards, chief and senior executives, and selected functional experts. Caldwell has offices in Vancouver, San Francisco, Los Angeles, Dallas, Calgary, Atlanta, Toronto, Stamford, New York City, and a strategic presence in London and Hong Kong.

Revenues for the third quarter rose 34% over the comparable period last year to $12.36 million from $9.22 million in 2013. U.S. revenues increased 48% (35% excluding a 13% favourable variance from exchange rate fluctuations) to $9.08 million. The improvement was driven primarily by increased search volumes and average fees, offset by fewer average partners during the current year. Canadian revenues increased 10% to $3.28 million on higher average fees and to a lesser extent higher search volumes, with a consistent number of partners.

Third-quarter net earnings were $639,000 ($0.032 per share) as compared to a net loss of $366,000 ($0.021 per share) in the comparable period a year earlier.

At just under 14 times trailing earnings, Caldwell appears neither extremely cheap nor expensive on first look. However, the company has about $14.8 million in cash and investments, or just over $0.70 per share. Stripping out the cash, the company trades at a more attractive seven times trailing earnings. We also expect reasonable growth in the upcoming fourth quarter.

Action now: Continue to Hold existing positions for a strong yield and decent growth potential. Expect the stock to be volatile due to the low public share float.

High Arctic Energy Inc. (TSX: HWO, OTC: HGHAF)

Originally recommended on Sept. 3/13 (#21332) at C$2.85, US$2.55. Closed Friday at C$4.85, US$4.44 (Sept. 24).

High Arctic Energy provides a solid energy services business in Western Canada, but remains a Buy due to the strong cash flow generated from its core business in Papua New Guinea (PNG). We introduced the stock just over a year ago when it was trading at $2.85. Today, with the stock closing at $4.85, we review the company’s recently released 2014 second-quarter financial results.

High Arctic Energy is an international oil and gas services company with operations in both Papua New Guinea and Western Canada. High Arctic’s substantial operation in PNG is comprised of contract drilling, specialized well completion services, and a rentals business, which includes rig matting, camps, and drilling support equipment. The Canadian operation is focused on the provision of snubbing services and the supply of nitrogen to a large number of oil and natural gas exploration and production companies operating in Western Canada.

For the second quarter, revenues rose 21% to $39.8 million from $32.9 million in the same period of 2013. Revenues increased from both the PNG and Canadian operations. The increases in PNG revenue were due to higher rental revenues and the benefit of a strong U.S. dollar.

Canadian activity levels were much higher in the first half of 2014 than the same period in 2013 for both snubbing and nitrogen services. As a result, adjusted EBITDA jumped 68% to $11.1 million from $6.6 million a year ago. Operating earnings increased 105% to $7.6 million from $3.7 million in the same period of 2013. Finally, net earnings rose 219% to $6.7 million ($0.13 per share) from $2.1 million ($0.04 per share) in the same period of the prior year.

Here are some more second quarter highlights:

  • In June, the appointments of a new CEO and President were announced; both individuals bring significant international drilling experience to High Arctic.
  • In April, High Arctic signed a two-year drilling services contract with a large oil and gas operator in PNG that commences with the spud of a first well, which is expected to occur in early 2015. In conjunction with the drilling commitment, High
  • Arctic completed the acquisition of two heli-portable drilling rigs on July 28.
  • High Arctic closed its previously announced bought deal financing of $25 million resulting in the issuance of 5,051,000 common shares at $4.95 in July.
  • The company increased its monthly dividend to $0.015 per share in March, a 20% increase from the previous monthly dividend amounts.
  • High Arctic continues to maintain a strong balance sheet with a trailing annual payout ratio of 19%.

We are adjusting our fair value assessment on High Arctic to account for the better-than-expected second quarter EBITDA and the multiple expansions that could be derived from the additional cash flow expected from the purchase and subsequent contracting of the two drill rigs. Essentially, the new contract and equipment introduces a new growth element.

The revised fair value assessment is $7 per share and is based only on a multiple of 7.25 times trailing adjusted EBITDA. We estimate the company could produce net income of $40 million ($0.70 per share) in 2015. A conservative justified price-to-earnings multiple of 10-12 times the estimate produces a 2015 target price of between $7 and $8.40 a share.

High Arctic has had little broad institutional (brokerage and funds) ownership. If the company begins to garner attention from institutional investors there is a potential for the market to apply a higher multiple.

Conclusion: Driven by solid demand in PNG and a rebound in its Canadian operations, High Arctic bested street estimates in the quarter by a significant margin and produced another strong quarter of growth in revenues, cash flow, and cash accumulation. The US$52 million investment into two drill rigs was a welcome surprise and times nicely with the completion of the previously discussed US$19 billion LNG processing facility, which has proceeded ahead of schedule in PNG. The new facility will produce 6.9 million tonnes of LNG per year for export to Asian markets and is likely a game changer in PNG, supporting strong demand for ongoing natural gas development in the region.

High Arctic has done a good job of signing lucrative contracts with customers, expanding its customer base, as well as growing its equipment rental business and expanding the service offering.

Subsequent to the end of the quarter, High Arctic paid off all debt and added approximately $25 million from a share offering. We estimate the company will have well over $65 million in cash prior to spending $52 million on the two new rigs. As such, subsequent to purchasing and commissioning the rigs in full, High Arctic will remain debt free with a significant net cash position well in excess of $15 million.

The stock is no longer as undervalued as it was a year ago but, despite excellent gains, remains very attractive given the dividend and new growth element,% which should come online in 2015. The long-term potential in PNG remains very strong and High Arctic is well positioned to benefit from the growth as the project comes on stream. Growth may be challenged in the near term (second half of 2014) given Rig 102 will be offline and the rental business will have some inventory out of the field, but a rebound in Canadian activities and new contract wins could help offset and near-term softness.

Action now: We maintain our Buy rating on High Arctic. Our fair value assessment has been upped to $7. In the near term, collect the solid 3.7% dividend and expect to hold for long-term growth catalysts over the next 1-3 years, despite the 70% gain to date.

McCoy Global Inc. (TSX: MCB)

Originally recommended on Dec. 5/11(#21143) at $2.95. Closed Friday at $5.59.

McCoy Global Inc. was originally recommended in December 2011 with a buying range of $2.80-$3.10. The shares are now trading in the $5.60 range.

McCoy provides innovative products and services to the global energy industry. It operates internationally through direct sales and distributors based out of Western Canada, the U.S. Gulf Coast, Europe, and Asia-Pacific. McCoy Global’s corporate office is located in Edmonton, with offices in Alberta, Louisiana, Texas, Aberdeen, Singapore, and Luxembourg.

As expected, McCoy’s second-quarter revenue was lower year-over-year at $27.9 million, compared to $29 million in 2013. Reported net earnings of $8.3 million compared to $3.1 million in 2013. This year’s earnings included a one-time gain on the sale of Mobile Solutions. Stripping that out, earnings from continuing operations were $2.3 million compared to $2.4 million in 2013. McCoy reported a backlog of $44.6 million as at June 30, a $100,000 increase from March 31.

In 2013, the company committed to a formal process to divest the last of its “non-strategic operations”. During the latest quarter, McCoy completed the sale of its Mobile Solutions business, achieving another step in its goal of becoming solely focused on providing technology and product support solutions to the global oil and gas industry. Further to this goal and subsequent to the end of its second quarter, on Sept. 16 McCoy announced that it has sold its Coatings and Hydraulics business, located in Edmonton, for approximately $9.3 million.

The company’s balance sheet remains strong with an estimated $28 million (approximately $1 per share) in cash. Buoyed by a recent financing and proceeds from the divestures, the capital structure is in place for organic growth initiatives as well as potential strategic acquisitions.

We view the strategic shift to concentrate on higher margin and potentially more stable technology-based products for the global energy industry as a good one. Having said this, business in this segment does not materialize overnight. While McCoy has solid offering in this arena and is profitable from continuing operations, with the stock trading at 20 times (17 times cash out) trailing earnings, we are currently being asked to pay for future growth.

We expect management to produce this growth, but it may take a year for this to materialize to a significant degree (acquisitions not factored in). As such, we see better value in the small-cap international energy service space in High Arctic.

Action now: Sell McCoy and look to re-enter when growth has returned in earnest. We will exit with a capital gain of 89.5%.

WiLAN Inc. (TSX: WIN, NDQ: WILN)

Originally recommended on April 8/11 (#21128) at C$6.99, US$7.15. Closed Friday at C$4.04, US$3.62.

Founded in 1992, WiLAN is an intellectual property (IP) licensing company that was originally created to develop and commercialize technology that made low-cost, high-speed wireless networking a reality. In its early years, WiLAN manufactured several generations of proprietary products and its inventions were also used in other products offered by the high-tech industry.

By 2005, WiLAN’s inventions were commercialized in millions of wireless networking devices worth many billions of dollars. Realizing the value that its intellectual property brought to the industry, in 2006 WiLAN focused its business on protecting and monetizing patented inventions. Today, some of the world’s largest technology companies license patents in WiLAN’s portfolio.

In mid-May, the company announced it had completed its strategic review. The Board determined that it is in the best interests of the company and shareholders to execute an updated business plan focused on diversification, licensing partnerships, improved profitability, and increasing the return of cash generated from operations to shareholders.

The four-part action plan is as follows:

1. Diversify the company’s revenue base by moving focus from licensing WiLAN’s entire portfolio to licensing smaller subsets of the portfolio. The company will also continue to add licensing programs in new market segments.

2. To reduce the risk in its business model, WiLAN will limit the outright purchases of patent portfolios it makes. Instead, the company will focus on attracting portfolios from companies seeking a licensing partner that are willing to share the risk of the success of the licensing program.

3. Focus on increasing the profitability of its business by ensuring that law firms working with WiLAN share in some of the risk of its licensing programs.

4. Consider selling some of the non-core patents in its portfolio to generate revenues and reduce the maintenance costs.

Incorporating these strategies, management has established a roadmap to increase GAAP earnings to at least $0.30 per share by 2018. This would be achieved by more than doubling revenues and increasing operating leverage. If these targets are met, the strong profitability of the company’s business will drive higher returns to shareholders through quarterly dividends that the board will strive to increase regularly.

The first increase, to $0.05 per quarter per share, represents a 25% hike and took effect with the second quarter declaration. At today’s share price, this represents a yield of approximately 5%.

The plan appears to be sound and with $140 million in cash in the bank ($1.17 per share) and zero debt, the company is in a position to execute on it. Consensus estimates are for WiLAN to earn $0.50 per share on an adjusted basis this year. With its strong balance sheet, this would leave WiLAN fundamentally undervalued in its current range.

Conclusion: WiLAN has a good deal of repair work to do within the investment industry after a couple years of disappointing results, but this also presents an opportunity. Since the company’s strategic review and reported growth plan, management has delivered two quarters with very strong revenues and GAAP earnings, signed a partnership deal with Panasonic that anchors several new semiconductor licensing programs which should begin generating revenue in the near term, entered licensing partnerships in the automotive, networking, and industrial products markets, and signed a significant partnership with an industry leading memory company.

Among other positive announcements, the U.S. Patent Office and U.S. District Court confirmed the validity of WiLAN’s 802 patent, which was at issue in the Apple case.

The announcements, and the results of the first two quarters, have put WiLAN back on the radar screen of many analysts.

From a valuation perspective, WiLAN again looks attractive. We estimate the company should earn $0.45 per share (with the potential to beat) on an adjusted basis in 2014. The company has an excellent balance sheet with $140 million in cash and zero debt.

If we remove the cash, the company is currently trading at a relatively low 6.5 times our estimated adjusted earnings for 2014. The valuation appears very attractive when compared to the multiple of 14 that a similar IP company, MOSAID Technologies Inc., was purchased at in 2011. Having said this, we do not expect WiLAN to trade at 14 times adjusted earnings as this was a takeover premium. A more appropriate multiple, if the company continues to deliver on adjusted earnings growth, would be in the range of 9-10. Applying a multiple of 9 times adjusted earnings (the low end of our range) and adding back the $1.17 per share in cash would give us a fair value in the range of $5.22.

Due to the nature of the company’s business, we expect quarterly adjusted earnings to be “lumpy” given the nature of the one-time up front revenues on signing many licenses and the increased level of cost associated with litigation if and when patent cases move to trial. We do believe the company’s new model, which includes the stipulation that law firms working with WiLAN share in some of the risk of its licensing programs, will help to lessen the impact of trial costs and thus smooth out what has in the past been a lumpy business.

Action now: We are upgrading our rating on WiLAN to Buy. We are looking for the company to execute on its growth plan over the next 3-5 years and looking for 15-25% share price growth with the current 5% dividend also providing a solid percentage of the total return. We expect WiLAN to be a dividend grower over time if management executes on the growth plan.

Disclosures: KeyStone and/or employees own shares in HWO and WIN.

– end Ryan Irvine


GORDON PAPE’S UPDATES

TOP


Andrew Peller Ltd. (TSX: ADW.A)

Originally recommended on July 22/13 (#21327) at $14.05. Closed Friday at $15.

Andrew Peller shares got a nice boost after the company released good results for the first quarter of its 2015 fiscal year (to June 30). Sales were up an impressive 9.3% to $79.5 million thanks to strong growth across all trade channels and the successful launch of some new products including the introduction of skinnygrape spritzers and Panama Jack cocktails. That’s a very good performance in what is basically a slow-growth industry.

Net earnings were $4.1 million ($0.30 per share) compared to $5.1 million ($0.37 per share) for the comparable prior year period. The reduction in net earnings was primarily due to the change in non-cash losses and gains on derivative financial instruments between the two fiscal year periods. The company recorded a non-cash loss in the quarter of approximately $1.1 million related to mark-to-market adjustments on an interest rate swap and foreign exchange contracts. That compared to a non-cash gain of $0.7 million in the same prior-year period.

Adjusted net earnings, which do not include unrealized losses and gains on derivative financial instruments and other expenses or income, were $5 million compared to $4.5 million last year.

Earlier, the company announced a 5% dividend increase to $0.42 a share annually, from $0.40. At the current price, the yield is 2.8%.

Andrew Peller is a producer of quality wines, with facilities in Ontario, British Columbia, and Nova Scotia. The company’s Peller Estates, located in Niagara-on-the-Lake, Ontario, was chosen as Canadian Winery of the Year for 2014 at the WineAlign National Wine Awards held in Penticton, B.C. in June.

Action now: The stock remains a Buy.


YOUR QUESTIONS

TOP

Escalating GIC

Q – I met my financial advisor and he told me to put my money in a non-registered, escalating rate GIC for three years. The first year interest rate is 1.6%, the second year is 1.8%, and the third year 2.2%. The other option is for one year at the rate for 1.6%. Do you think is a good idea? – George N.

A – No, I do not. Using the numbers you provide, the average annual compound rate of return over three years is 1.87%. The current inflation rate is 2.1%. If that continues, you will be losing money in the form of purchasing power every year. To make matters worse, this is non-registered money, which means the interest will be taxed. It you’re in a 40% marginal tax bracket, your after-tax first-year return will be 0.96%, the second year will be 1.08%, and the third will be 1.32%. This means your after-tax return for each $1,000 invested will be $41.34 over three years for an average after-tax compound rate of return of 1.36%. Let me put the question back to you. Do you think this is a good idea? – G.P.

Short-term investing

Q – How would you invest $275,000 short term (3 months)? I’ve sold my house and have the cash in hand but may not purchase a new house for two to three months. – Brian W.

A – Obviously, you don’t want to put your money at risk. You’re going to need it for that new house before long. So don’t be greedy. Put the money into a high interest savings account (or three of them at different financial institutions if you want to be fully protected by deposit insurance). You won’t make a lot of money but the principal will be safe.

According to highinterestsavings.ca, rates of between 1.3% and 1.95% are available from smaller financial institutions. However, you can sometimes find special promotions at the big banks. For example, CIBC is currently offering 2% until Sept. 30 on new deposits to an eAdvantage Savings Account when the balance is $5,000 or more. Check around for other offers that fit your time frame. – G.P.

 

That’s our story for this week. We’ll be back on Oct. 6.

 

Best regards,

Gordon Pape

In This Issue


CONSERVATIVE PORTFOLIO ON TRACK

By Gordon Pape, Editor and Publisher

When stock markets start to soar

Low-risk investing is a bore.

But when markets are dark and grey

Conservative investing saves the day.

I received an e-mail last week from a reader who was considering investing in a three-year laddered GIC. I told him I thought that was a bad idea (see the Q&A section for more details as to why) and suggested he consider our IWB Very Conservative Portfolio instead.

Granted, it has slightly more risk than a GIC. But the potentially higher returns more than offset that in my view. Why settle for less than 2% a year when inflation is running at 2.1%? It’s a sure-fire way to lose money.

This portfolio was created in September 2011 in response to concerns from readers who were still suffering post-traumatic stress disorder stemming from the 2008-2009 stock market crash. They were unhappy with GIC yields at the time, which were even lower than they are today at 1.3% for a five-year term. In response, I assembled a portfolio that was designed to preserve capital while providing decent cash flow. The initial book value was $10,000 and the target return is two percentage points higher than the yield on a five-year GIC from the major banks. The current RBC rate is 2% so a gain in this portfolio of 4% per year would be right on the mark.

With that in mind, let’s look at our securities and see how they have performed in the six months since my last review in March. Prices are as of mid-day on Sept. 24.

iShares 1-5 Year Laddered Corporate Bond Fund (TSX: CBO). This short-term corporate bond ETF acts as one of the stabilizers in this portfolio. Because of the nature of the fund, it will never deliver a great return but neither does it come with a lot of risk. The trading price is gradually eroding – it’s down $0.28 a share from the last update in March. However, that capital loss was more than offset by distributions over the period of $0.48 per unit, giving us a small overall six-month gain. The total return over the three years since 2011 is 9.4%.

iShares DEX Short Term Corporate Universe + Maple Bond Index Fund (TSX: XSH). This is another short-term ETF. It was added to the portfolio in the fall of 2013 to provide some exposure to Maple Bonds, which are Canadian-dollar bonds from foreign issuers such as Bank of America, JPMorgan Chase, and Goldman Sachs. The unit price is down by $0.08 since March but we are receiving monthly distributions of about $0.05 per unit, which has more than covered that small loss. We’ve had a total return of 3.6% since we acquired this ETF, which is consistent with the low-risk nature of this fund.

iShares Advantaged U.S. High Yield Bond Index ETF(CDN-Hedged) (TSX: CHB). This ETF focuses on high-yield U.S. bonds (aka “junk bonds”), which are normally associated with higher risk. It was added in fall 2013 because at the time high-yield bonds were actually performing better than supposedly low risk government issues. That decision paid off in the first five months, with the ETF giving us a total return of 6.1%. However, the high-yield market has cooled since then. The units are down $0.73 since March. We’ve done slightly better than break-even thanks to total distributions of $0.77 but the time has come to change course on this one.

PIMCO Monthly Income Fund (PMO005). This is a global fixed-income mutual fund that is managed by one of the world’s most respected bond houses. It offers monthly cash flow and places a heavy emphasis on capital preservation. We added this fund in October 2013 and it has performed very well so far with a one-year return of 8.7%.

BCE Inc. (TSX, NYSE: BCE). Most of this portfolio is in various types of fixed-income funds. This allocation is consistent with the primary goal of capital preservation. The rest of the money has been spread among three conservative growth securities. All have performed well, which is not surprising given the strong market run we have experienced. There are signs this is slowing, however. BCE shares are down $0.56 since the last review in March. We still have a gain for the period, however, thanks to three dividend payments totaling $1.85 per share.

Enbridge (TSX, NYSE: ENB). Enbridge keeps powering along, boosting the returns in this portfolio. Over the past three years, the total return from this pipeline giant and natural gas distributor is 86.3%, proving that you don’t have to speculate on penny mines to earn a nice return. The shares have gained $5.28 since March and we have received dividends of $0.70 per share for a total return over the latest six-month period of 12.2%. This is now the top performer in the portfolio.

Brookfield Infrastructure Limited Partnership (TSX: BIP.UN, NYSE: BIP). This Bermuda-based limited partnership continues to perform well for us. The share price is up $1.62 since March and we received two distributions of US$0.48 each. The total return since inception is 84.1%, a shade behind that of Enbridge.

We received interest of $4.99 on the cash in the high-interest savings account.

Comments: The total value of the portfolio now stands at $12,551.30, including retained distributions. That’s a gain of 3.5% since the last review in March. That may not seem like much but it’s consistent with a low-risk portfolio of this type and comfortably in excess of our target. Since inception the total return is 25.5%, which works out to an average annual compound rate of return of 7.9%.

Changes: As mentioned, the iShares Advantaged U.S. High Yield Bond Index ETF looks more risky these days now that the spread between government and high yield issues has narrowed. Therefore we will sell the entire position, which will give us $1,102.18, including retained distributions.

Enbridge has done very well for us but portfolio drift has increased its share of total assets to more than 15%. Since this is a very conservative portfolio, we should reduce that. So we will sell 2.08 shares for $113.11, which will leave us with 30 shares.

We will replace CBH with the iShares Convertible Bond Index ETF (TSX: CVD). This invests in bonds that are exchangeable for common stock in the issuer at a predetermined price. This gives investors the best of both worlds: regular interest payments plus an opportunity to earn a capital gain if the price of the underlying stock rises.

CVD tracks the performance of the FTSE TMX Canada Convertible Bond Index. Only bonds traded on a Canadian exchange are eligible for inclusion and they must be denominated in Canadian dollars. The issuer must not be in default on either principal or interest and the bond must have a minimum outstanding amount of $50 million and trade in the $80 to $120 range. The largest holdings are issues from Boralex Inc., Morneau Shepell, Chartwell Retirement Residences, Element Financial Corp., and Superior Plus Corp. The fund gained 9.6% over the year to Aug. 31 and was showing a three-year average annual compound rate of return of 5.8% to that point. The management expense ratio is 0.49%. The current monthly distribution is about $0.08 per unit.

The units were trading on Sept. 24 at $19.55. We will buy 60 units for a cost of $1,173. After those transactions are completed, we will be left with an extra $42.29.

We will also use some of our accumulated distributions to add to existing positions as follows. Note that this is for modeling purposes only; I do not advise buying such small amounts in the real world because of brokerage commissions. Use dividend reinvestment plans (DRIPs) instead.

CBO – we will purchase 18.2 units at $19.53 for a cost of $355.45. This will bring our total position to 155 units with retained distributions reduced to $3.07.

BCE – we’ll buy 2.9 shares for $138.13. We now have 29 shares with $42.09 in retained dividends.

BIP.UN – we’ll add 3.41 shares at $43.63 for a cost of $148.78. Our new holding is 34 shares and we have $14.81 left over.

These transactions have enabled us to eliminate all the fractional positions in the portfolio. Here’s what the revised version looks like.

View IWB Very Conservative Portfolio details (revised Sept. 24/14)

We will leave the retained distributions and cash of $347.36 in a high interest savings account paying 1.3%. I’ll revisit this portfolio in March.

Gordon Pape’s new book, Retirement’s Harsh New Realities, is now on several best-seller lists. Save 38% by ordering your copy at http://astore.amazon.ca/buildicaquizm-20


RYAN IRVINE REVISITS FOUR STOCK PICKS

Contributing editor Ryan Irvine joins us this week from his base on Canada’s West Coast to update us on some of his previous stock selections. Ryan is one of the country’s leading experts on small-cap stocks and the CEO of KeyStone Financial (www.keystocks.com). Here is his report.

Ryan Irvine writes:

This month we have three updates and one upgrade for IWB readers. So let’s get right to it.

The Caldwell Partners International (TSX: CWL, OTC: CWLPF)

Originally recommended on Feb. 25/13 (#21308) at C$1.04. Closed Friday at C$1.38, US$1.34 (Sept. 19).

We introduced The Caldwell Partners in February 2013 when the stock traded at $1.04. Today, with the company recently releasing its third-quarter results for fiscal 2014, we review the numbers and update our rating on the stock.

Note that this is a true micro-cap stock and, as such, is not suited for all investors.

Founded in 1970, The Caldwell Partners International is an executive search consulting firm. The company, through a predecessor corporation, became the first retained consulting organization in Canada to specialize in representing employers in the recruitment of executives.

Today, Caldwell is one of North America’s premier providers of executive search. The company has built a solid reputation for providing successful searches for boards, chief and senior executives, and selected functional experts. Caldwell has offices in Vancouver, San Francisco, Los Angeles, Dallas, Calgary, Atlanta, Toronto, Stamford, New York City, and a strategic presence in London and Hong Kong.

Revenues for the third quarter rose 34% over the comparable period last year to $12.36 million from $9.22 million in 2013. U.S. revenues increased 48% (35% excluding a 13% favourable variance from exchange rate fluctuations) to $9.08 million. The improvement was driven primarily by increased search volumes and average fees, offset by fewer average partners during the current year. Canadian revenues increased 10% to $3.28 million on higher average fees and to a lesser extent higher search volumes, with a consistent number of partners.

Third-quarter net earnings were $639,000 ($0.032 per share) as compared to a net loss of $366,000 ($0.021 per share) in the comparable period a year earlier.

At just under 14 times trailing earnings, Caldwell appears neither extremely cheap nor expensive on first look. However, the company has about $14.8 million in cash and investments, or just over $0.70 per share. Stripping out the cash, the company trades at a more attractive seven times trailing earnings. We also expect reasonable growth in the upcoming fourth quarter.

Action now: Continue to Hold existing positions for a strong yield and decent growth potential. Expect the stock to be volatile due to the low public share float.

High Arctic Energy Inc. (TSX: HWO, OTC: HGHAF)

Originally recommended on Sept. 3/13 (#21332) at C$2.85, US$2.55. Closed Friday at C$4.85, US$4.44 (Sept. 24).

High Arctic Energy provides a solid energy services business in Western Canada, but remains a Buy due to the strong cash flow generated from its core business in Papua New Guinea (PNG). We introduced the stock just over a year ago when it was trading at $2.85. Today, with the stock closing at $4.85, we review the company’s recently released 2014 second-quarter financial results.

High Arctic Energy is an international oil and gas services company with operations in both Papua New Guinea and Western Canada. High Arctic’s substantial operation in PNG is comprised of contract drilling, specialized well completion services, and a rentals business, which includes rig matting, camps, and drilling support equipment. The Canadian operation is focused on the provision of snubbing services and the supply of nitrogen to a large number of oil and natural gas exploration and production companies operating in Western Canada.

For the second quarter, revenues rose 21% to $39.8 million from $32.9 million in the same period of 2013. Revenues increased from both the PNG and Canadian operations. The increases in PNG revenue were due to higher rental revenues and the benefit of a strong U.S. dollar.

Canadian activity levels were much higher in the first half of 2014 than the same period in 2013 for both snubbing and nitrogen services. As a result, adjusted EBITDA jumped 68% to $11.1 million from $6.6 million a year ago. Operating earnings increased 105% to $7.6 million from $3.7 million in the same period of 2013. Finally, net earnings rose 219% to $6.7 million ($0.13 per share) from $2.1 million ($0.04 per share) in the same period of the prior year.

Here are some more second quarter highlights:

  • In June, the appointments of a new CEO and President were announced; both individuals bring significant international drilling experience to High Arctic.
  • In April, High Arctic signed a two-year drilling services contract with a large oil and gas operator in PNG that commences with the spud of a first well, which is expected to occur in early 2015. In conjunction with the drilling commitment, High
  • Arctic completed the acquisition of two heli-portable drilling rigs on July 28.
  • High Arctic closed its previously announced bought deal financing of $25 million resulting in the issuance of 5,051,000 common shares at $4.95 in July.
  • The company increased its monthly dividend to $0.015 per share in March, a 20% increase from the previous monthly dividend amounts.
  • High Arctic continues to maintain a strong balance sheet with a trailing annual payout ratio of 19%.

We are adjusting our fair value assessment on High Arctic to account for the better-than-expected second quarter EBITDA and the multiple expansions that could be derived from the additional cash flow expected from the purchase and subsequent contracting of the two drill rigs. Essentially, the new contract and equipment introduces a new growth element.

The revised fair value assessment is $7 per share and is based only on a multiple of 7.25 times trailing adjusted EBITDA. We estimate the company could produce net income of $40 million ($0.70 per share) in 2015. A conservative justified price-to-earnings multiple of 10-12 times the estimate produces a 2015 target price of between $7 and $8.40 a share.

High Arctic has had little broad institutional (brokerage and funds) ownership. If the company begins to garner attention from institutional investors there is a potential for the market to apply a higher multiple.

Conclusion: Driven by solid demand in PNG and a rebound in its Canadian operations, High Arctic bested street estimates in the quarter by a significant margin and produced another strong quarter of growth in revenues, cash flow, and cash accumulation. The US$52 million investment into two drill rigs was a welcome surprise and times nicely with the completion of the previously discussed US$19 billion LNG processing facility, which has proceeded ahead of schedule in PNG. The new facility will produce 6.9 million tonnes of LNG per year for export to Asian markets and is likely a game changer in PNG, supporting strong demand for ongoing natural gas development in the region.

High Arctic has done a good job of signing lucrative contracts with customers, expanding its customer base, as well as growing its equipment rental business and expanding the service offering.

Subsequent to the end of the quarter, High Arctic paid off all debt and added approximately $25 million from a share offering. We estimate the company will have well over $65 million in cash prior to spending $52 million on the two new rigs. As such, subsequent to purchasing and commissioning the rigs in full, High Arctic will remain debt free with a significant net cash position well in excess of $15 million.

The stock is no longer as undervalued as it was a year ago but, despite excellent gains, remains very attractive given the dividend and new growth element,% which should come online in 2015. The long-term potential in PNG remains very strong and High Arctic is well positioned to benefit from the growth as the project comes on stream. Growth may be challenged in the near term (second half of 2014) given Rig 102 will be offline and the rental business will have some inventory out of the field, but a rebound in Canadian activities and new contract wins could help offset and near-term softness.

Action now: We maintain our Buy rating on High Arctic. Our fair value assessment has been upped to $7. In the near term, collect the solid 3.7% dividend and expect to hold for long-term growth catalysts over the next 1-3 years, despite the 70% gain to date.

McCoy Global Inc. (TSX: MCB)

Originally recommended on Dec. 5/11(#21143) at $2.95. Closed Friday at $5.59.

McCoy Global Inc. was originally recommended in December 2011 with a buying range of $2.80-$3.10. The shares are now trading in the $5.60 range.

McCoy provides innovative products and services to the global energy industry. It operates internationally through direct sales and distributors based out of Western Canada, the U.S. Gulf Coast, Europe, and Asia-Pacific. McCoy Global’s corporate office is located in Edmonton, with offices in Alberta, Louisiana, Texas, Aberdeen, Singapore, and Luxembourg.

As expected, McCoy’s second-quarter revenue was lower year-over-year at $27.9 million, compared to $29 million in 2013. Reported net earnings of $8.3 million compared to $3.1 million in 2013. This year’s earnings included a one-time gain on the sale of Mobile Solutions. Stripping that out, earnings from continuing operations were $2.3 million compared to $2.4 million in 2013. McCoy reported a backlog of $44.6 million as at June 30, a $100,000 increase from March 31.

In 2013, the company committed to a formal process to divest the last of its “non-strategic operations”. During the latest quarter, McCoy completed the sale of its Mobile Solutions business, achieving another step in its goal of becoming solely focused on providing technology and product support solutions to the global oil and gas industry. Further to this goal and subsequent to the end of its second quarter, on Sept. 16 McCoy announced that it has sold its Coatings and Hydraulics business, located in Edmonton, for approximately $9.3 million.

The company’s balance sheet remains strong with an estimated $28 million (approximately $1 per share) in cash. Buoyed by a recent financing and proceeds from the divestures, the capital structure is in place for organic growth initiatives as well as potential strategic acquisitions.

We view the strategic shift to concentrate on higher margin and potentially more stable technology-based products for the global energy industry as a good one. Having said this, business in this segment does not materialize overnight. While McCoy has solid offering in this arena and is profitable from continuing operations, with the stock trading at 20 times (17 times cash out) trailing earnings, we are currently being asked to pay for future growth.

We expect management to produce this growth, but it may take a year for this to materialize to a significant degree (acquisitions not factored in). As such, we see better value in the small-cap international energy service space in High Arctic.

Action now: Sell McCoy and look to re-enter when growth has returned in earnest. We will exit with a capital gain of 89.5%.

WiLAN Inc. (TSX: WIN, NDQ: WILN)

Originally recommended on April 8/11 (#21128) at C$6.99, US$7.15. Closed Friday at C$4.04, US$3.62.

Founded in 1992, WiLAN is an intellectual property (IP) licensing company that was originally created to develop and commercialize technology that made low-cost, high-speed wireless networking a reality. In its early years, WiLAN manufactured several generations of proprietary products and its inventions were also used in other products offered by the high-tech industry.

By 2005, WiLAN’s inventions were commercialized in millions of wireless networking devices worth many billions of dollars. Realizing the value that its intellectual property brought to the industry, in 2006 WiLAN focused its business on protecting and monetizing patented inventions. Today, some of the world’s largest technology companies license patents in WiLAN’s portfolio.

In mid-May, the company announced it had completed its strategic review. The Board determined that it is in the best interests of the company and shareholders to execute an updated business plan focused on diversification, licensing partnerships, improved profitability, and increasing the return of cash generated from operations to shareholders.

The four-part action plan is as follows:

1. Diversify the company’s revenue base by moving focus from licensing WiLAN’s entire portfolio to licensing smaller subsets of the portfolio. The company will also continue to add licensing programs in new market segments.

2. To reduce the risk in its business model, WiLAN will limit the outright purchases of patent portfolios it makes. Instead, the company will focus on attracting portfolios from companies seeking a licensing partner that are willing to share the risk of the success of the licensing program.

3. Focus on increasing the profitability of its business by ensuring that law firms working with WiLAN share in some of the risk of its licensing programs.

4. Consider selling some of the non-core patents in its portfolio to generate revenues and reduce the maintenance costs.

Incorporating these strategies, management has established a roadmap to increase GAAP earnings to at least $0.30 per share by 2018. This would be achieved by more than doubling revenues and increasing operating leverage. If these targets are met, the strong profitability of the company’s business will drive higher returns to shareholders through quarterly dividends that the board will strive to increase regularly.

The first increase, to $0.05 per quarter per share, represents a 25% hike and took effect with the second quarter declaration. At today’s share price, this represents a yield of approximately 5%.

The plan appears to be sound and with $140 million in cash in the bank ($1.17 per share) and zero debt, the company is in a position to execute on it. Consensus estimates are for WiLAN to earn $0.50 per share on an adjusted basis this year. With its strong balance sheet, this would leave WiLAN fundamentally undervalued in its current range.

Conclusion: WiLAN has a good deal of repair work to do within the investment industry after a couple years of disappointing results, but this also presents an opportunity. Since the company’s strategic review and reported growth plan, management has delivered two quarters with very strong revenues and GAAP earnings, signed a partnership deal with Panasonic that anchors several new semiconductor licensing programs which should begin generating revenue in the near term, entered licensing partnerships in the automotive, networking, and industrial products markets, and signed a significant partnership with an industry leading memory company.

Among other positive announcements, the U.S. Patent Office and U.S. District Court confirmed the validity of WiLAN’s 802 patent, which was at issue in the Apple case.

The announcements, and the results of the first two quarters, have put WiLAN back on the radar screen of many analysts.

From a valuation perspective, WiLAN again looks attractive. We estimate the company should earn $0.45 per share (with the potential to beat) on an adjusted basis in 2014. The company has an excellent balance sheet with $140 million in cash and zero debt.

If we remove the cash, the company is currently trading at a relatively low 6.5 times our estimated adjusted earnings for 2014. The valuation appears very attractive when compared to the multiple of 14 that a similar IP company, MOSAID Technologies Inc., was purchased at in 2011. Having said this, we do not expect WiLAN to trade at 14 times adjusted earnings as this was a takeover premium. A more appropriate multiple, if the company continues to deliver on adjusted earnings growth, would be in the range of 9-10. Applying a multiple of 9 times adjusted earnings (the low end of our range) and adding back the $1.17 per share in cash would give us a fair value in the range of $5.22.

Due to the nature of the company’s business, we expect quarterly adjusted earnings to be “lumpy” given the nature of the one-time up front revenues on signing many licenses and the increased level of cost associated with litigation if and when patent cases move to trial. We do believe the company’s new model, which includes the stipulation that law firms working with WiLAN share in some of the risk of its licensing programs, will help to lessen the impact of trial costs and thus smooth out what has in the past been a lumpy business.

Action now: We are upgrading our rating on WiLAN to Buy. We are looking for the company to execute on its growth plan over the next 3-5 years and looking for 15-25% share price growth with the current 5% dividend also providing a solid percentage of the total return. We expect WiLAN to be a dividend grower over time if management executes on the growth plan.

Disclosures: KeyStone and/or employees own shares in HWO and WIN.

– end Ryan Irvine


GORDON PAPE’S UPDATES


Andrew Peller Ltd. (TSX: ADW.A)

Originally recommended on July 22/13 (#21327) at $14.05. Closed Friday at $15.

Andrew Peller shares got a nice boost after the company released good results for the first quarter of its 2015 fiscal year (to June 30). Sales were up an impressive 9.3% to $79.5 million thanks to strong growth across all trade channels and the successful launch of some new products including the introduction of skinnygrape spritzers and Panama Jack cocktails. That’s a very good performance in what is basically a slow-growth industry.

Net earnings were $4.1 million ($0.30 per share) compared to $5.1 million ($0.37 per share) for the comparable prior year period. The reduction in net earnings was primarily due to the change in non-cash losses and gains on derivative financial instruments between the two fiscal year periods. The company recorded a non-cash loss in the quarter of approximately $1.1 million related to mark-to-market adjustments on an interest rate swap and foreign exchange contracts. That compared to a non-cash gain of $0.7 million in the same prior-year period.

Adjusted net earnings, which do not include unrealized losses and gains on derivative financial instruments and other expenses or income, were $5 million compared to $4.5 million last year.

Earlier, the company announced a 5% dividend increase to $0.42 a share annually, from $0.40. At the current price, the yield is 2.8%.

Andrew Peller is a producer of quality wines, with facilities in Ontario, British Columbia, and Nova Scotia. The company’s Peller Estates, located in Niagara-on-the-Lake, Ontario, was chosen as Canadian Winery of the Year for 2014 at the WineAlign National Wine Awards held in Penticton, B.C. in June.

Action now: The stock remains a Buy.


YOUR QUESTIONS

Escalating GIC

Q – I met my financial advisor and he told me to put my money in a non-registered, escalating rate GIC for three years. The first year interest rate is 1.6%, the second year is 1.8%, and the third year 2.2%. The other option is for one year at the rate for 1.6%. Do you think is a good idea? – George N.

A – No, I do not. Using the numbers you provide, the average annual compound rate of return over three years is 1.87%. The current inflation rate is 2.1%. If that continues, you will be losing money in the form of purchasing power every year. To make matters worse, this is non-registered money, which means the interest will be taxed. It you’re in a 40% marginal tax bracket, your after-tax first-year return will be 0.96%, the second year will be 1.08%, and the third will be 1.32%. This means your after-tax return for each $1,000 invested will be $41.34 over three years for an average after-tax compound rate of return of 1.36%. Let me put the question back to you. Do you think this is a good idea? – G.P.

Short-term investing

Q – How would you invest $275,000 short term (3 months)? I’ve sold my house and have the cash in hand but may not purchase a new house for two to three months. – Brian W.

A – Obviously, you don’t want to put your money at risk. You’re going to need it for that new house before long. So don’t be greedy. Put the money into a high interest savings account (or three of them at different financial institutions if you want to be fully protected by deposit insurance). You won’t make a lot of money but the principal will be safe.

According to highinterestsavings.ca, rates of between 1.3% and 1.95% are available from smaller financial institutions. However, you can sometimes find special promotions at the big banks. For example, CIBC is currently offering 2% until Sept. 30 on new deposits to an eAdvantage Savings Account when the balance is $5,000 or more. Check around for other offers that fit your time frame. – G.P.

 

That’s our story for this week. We’ll be back on Oct. 6.

 

Best regards,

Gordon Pape