In this issue:

Next issue: October 24

A NEW GROWTH STOCK

By Gordon Pape, Editor and Publisher

There are two key themes I believe are important for income investors at this time. The first is to own some securities that offer growth potential as well as cash flow. The second is to have some exposure to the U.S. and global markets.

My new recommendation meets both criteria. The company is FLY Leasing Ltd., an international leader in commercial aircraft leasing. It is based in Dublin, Ireland and trades on the New York Stock Exchange under the symbol FLY. Here are the details.

Type: American Depository Receipts (ADRs)
Trading symbol: FLY
Exchange: NYSE
Current price: US$13.40
Entry level: Current price
Annual payout: US$0.88
Yield: 6.6%
Risk rating: Higher risk
Recommended by: Gordon Pape
Website: www.flyleasing.com

The business: FLY Leasing is a leading global lessor of modern, high-demand and fuel-efficient commercial jet aircraft. The company has been in business for more than 20 years and currently has a fleet of 107 aircraft that it leases under multi-year contracts to 55 airlines in 32 countries. The fleet is constantly growing, with the addition of seven Boeing 737-800 aircraft this year valued at $425 million. (All dollar figures in this article are in U.S. currency.)

The security: FLY trades as an American Depository Receipt (ADR) on the New York Stock Exchange. As such, it is not considered to be a U.S. stock for purposes of the Canada-U.S. Tax Treaty. See the section on Tax Implications for more details.

Why we like it: We’ve seen the negative effect that rising interest rates can have on low-growth dividend securities. Therefore, we need to search out companies that offer growth potential as well as a decent yield. Demand for FLY’s leasing services is expected to expand as the global economy improves. RBC Capital Markets initiated coverage of the company in August with a target price of $18 a share.

Financial highlights: Second-quarter financial results (to June 30) weren’t very good. Total revenue fell about $20 million from the year before, to $90.6 million. The main reason was a decline in operating lease revenue. Net income also fell sharply, from $25.7 million ($0.99 a share, fully diluted) in 2012 to $5.9 million ($020 a share) this year.

For the first half of the fiscal year, net income was $38.8 million ($1.35 a share) compared to $46.1 million ($1.77 per share) a year ago. Despite the drop, the dividend is still well covered.

Investors had anticipated the fall-off and had been selling down the stock since early July, when it was trading at over $17. Also contributing to the decline was a new share offering in mid-July at $14. The stock got as low as $12.63 in mid-August but has recovered slightly since.

As of June 30, the company’s total assets were valued at $3 billion. As you might expect from the nature of the business, FLY is heavily leveraged with a 3.3 ratio of net debt to shareholders’ equity.

RBC estimates that the company’s book value at the end of the third quarter was about $18 a share. So at the current price, the stock is trading at 0.74 of book.

Risks: The financial results make it clear that this is a higher risk stock. Airplane leasing is an economically sensitive business and FLY’s revenue and profit would be adversely affected by any slowdown in world growth. Conversely, the company should do well if the economic recovery gathers momentum.

Distribution policy: The current quarterly dividend is $0.22 a share ($0.88 annually). Payments are made in February, May, August and November.

Tax implications: This is where it gets a little messy. Since FLY is an Irish-based company, the dividends are subject to Irish withholding tax of 20%. However, the tax may be waived where an exemption is permitted by legislation or treaty if the taxpayer provides a certificate of proof from tax authorities that he/she is a resident of the country for tax purposes prior to the payment of the dividend. For more information, see www.flyleasing.com/wp-content/uploads/2012/09/Irish-Dividend-Withholding-Tax-QA-2010.pdf. It’s worth noting that even if the withholding tax is applied, the yield is still an attractive 5.3%.

Who it’s for: This security is only suitable for investors who can handle above-average risk. It offers a good yield and capital gains potential but don’t invest if you cannot afford a loss of any kind.

How to buy: The shares trade on the NYSE. Average daily volume is over 600,000 so you should have no problem being filled.

Summing up: Growth stocks, by their nature, carry more risk than the traditional dividend stocks we have favoured in the past. But if the projections are correct for strengthening economic expansion in 2014, this one should do well.

Action now: FLY is a Buy for more aggressive investors. – G.P.

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

 

Return to the table of contents…

OCTOBER UPDATES

Here are the updates for this issue. All prices are as of the close of trading on Monday, Oct. 7 unless otherwise indicated.

Blue Ribbon Income Fund (TSX: RBN.UN, OTC: BLUBF)

Type: Closed-end fund
Trading symbol: RBN.UN, BLUBF
Exchange: TSX, Grey Market
Current price: C$10.70, US$10.48 (Sept. 30)
Originally recommended: Feb. 23/11 at C$11.12, US$11.34
Annual Payout: $0.84
Yield: 7.8%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.bromptongroup.com

Comments: A significant portion of this fund (15% as of June 30) is invested in real estate investment trusts (REITs). The REIT sector as a whole is down 13.5% so far this year. Another large chunk (21%) is in pipelines, power, utilities, and infrastructure. The S&P/TSX Capped Utilities Index is off 10.6% for 2013. If you’re wondering why the price of these units has fallen from a 52-week high of $11.96 in February to the current level, most of the answer is right there.

Although there are some exceptions, on the whole this is a slow-growth portfolio that is designed to generate good cash flow ($0.07 a month) using traditional dividend-paying securities. As a result, it was hit by the ripple effect of the sudden jump in interest rates last spring and it will be vulnerable to further increases down the road.

That’s why, although the yield is an attractive 7.8%, I’m going to recommend selling your units at this point. The risk of capital loss in the current environment has increased, which is why I have raised the risk rating on this fund from Moderate to Higher.

Action now: Sell. – G.P.

 

Return to the table of contents…

Student Transportation Inc. (TSX, NDQ: STB)

Type: Common stock
Trading symbol: STB
Exchange: TSX, Nasdaq
Current price: C$6.40, US$6.20
Originally recommended: Jan. 24/07 at C$10.59, US$9.28
Annual payout: $0.56
Yield: 8.7%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.rideSTBus.com

Comments: Student Transportation reported good fourth-quarter and year-end results in mid-September. For the 2013 fiscal year (to June 30), the school bus company which operates in both Canada and the U.S. reported revenue of $423.7 million, a 15% improvement over the fiscal 2012 total of $369 million (note that the company reports in U.S. dollars). Basic net income increased to $3.7 million ($0.05 a share) from $2.2 million ($0.03 a share) the previous year. CEO Denis Gallagher said in a conference call that the 2012 results were skewed by a one-time write-up in the value of assets acquired in an acquisition.

Mr. Gallagher said that payout ratio for the year was 79%, based on free cash flow, and that it is the company’s goal to reduce that further in fiscal 2014.

My concern with Student Transportation over the years has always been the same – the low profitability. Based purely on earnings, the company’s dividend appears to be much too high and unsustainable, which helps to explain the high yield. However, the reality is that STB has a good record for maintaining dividend stability although investors should not expect an increase any time soon. The dividend has been stuck at the current level since 2010.

If you like the yield and are comfortable with a payout ratio based on cash flow, then continue to hold the shares for income. But keep in mind the stock has limited upside potential nor is a dividend increase likely for the foreseeable future.

Action now: Hold. – G.P.

 

Return to the table of contents…

TransCanada Corp. (TSX, NYSE: TRP)

Type: Common stock
Trading symbol: TRP
Exchange: TSX, NYSE
Current price: C$44.18, US$42.84
Originally recommended: July 24/03 at C$25.25, US$17.87
Annual payout: $1.84
Yield: 4.2%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.transcanada.com

Comments: TransCanada stock was one of the many that suffered collateral damage from the sudden jump in interest rates last spring. On May 22 the shares closed at an all-time high of C$51.21, which meant the yield was down to 3.6% based on an annualized dividend of $1.84. The spike in bond yields had the effect of driving down the market price of many dividend stocks, and today the shares are off 14% from their high.

That’s not good news for current investors but it offers an opportunity for those who don’t own shares. The lower price has pushed the yield back up to 4.2%, a more attractive, and more realistic, level.

The company reported strong second-quarter financial results with earnings of $357 million ($0.51 per share) compared to $300 million ($43 per share) a year ago. Revenue increased to just over $2 billion from $1.8 billion in 2012.

However, there are still two major uncertainties hovering over TransCanada. One is, of course, the Keystone XL pipeline, approval of which is still bogged down in the Washington bureaucracy. At this stage, there is no predicting when President Obama will make up his mind on whether to give the go-ahead, despite strong and consistent pressure from Canada.

The other is the ambitious Energy East project, which would transport output from the oil sands all the way to Quebec City and possibly Saint John, New Brunswick. TransCanada had been expected to push ahead quickly with the $12 billion plan but a senior official said earlier this month that it will be 2014 before the company is ready to submit a formal application to the National Energy Board.

Action now: Despite the uncertainties, TransCanada shares appear to be good value at this level and a dividend increase is very likely for next year which would push the yield higher. – G.P.

 

Return to the table of contents…

Sentry Global Balanced Income Fund Series X (NCE1047)

Type: Mutual fund
Code: NCE1047
Current price: $21.25 (Oct. 4)
Originally recommended: Nov. 24/03 at $25
Annual payout: $0.85
Yield: 4%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.sentry.ca

Comments: This is the old Diversified Preferred Share Trust but you’d never know to look at it today. The original trust was a closed-end fund that traded on the TSX; this is an open-ended mutual fund. The original was a proxy for the Canadian preferred share market; this one doesn’t have a whiff of preferred shares about it.

Following a shareholder vote, Sentry announced in May that it was winding up Diversified Preferred Share and exchanging the units for the new X series of this fund, which invests in an international portfolio of stocks and bonds. The fund hasn’t performed badly since the conversion but it bears no resemblance to what investors originally bought.

If you’re comfortable with this radical change, keep your units. But since this is no longer the fund I recommended, I am dropping coverage.

Action now: Sell. – G.P.

 

Return to the table of contents…

YOUR QUESTIONS

Thoughts on Innergest Series C

Q – Tom Slee has written extensively about preferred shares. What do you think about the Innergest Renewable Energy Series C Preferred Shares?

A – The Innergest Renewable Energy Series C Preferred Shares (TSX: INE.PR.C) are not currently on our Buy list. As I have mentioned before, however, these perpetual shares, with their respectable DBRS rating of Pdf 3, are an alternative to the Fortis Series F that I mentioned last month. But INE.PR.C shares are better suited for investors who can incur slightly more risk. Trading at a depressed $19.13 and paying a $1.4375 dividend, they yield 7.51%, which provides a well-above-average return even for registered accounts. The company can redeem them at $26 on Jan. 15 2018 and after that at descending prices. – T.S.

 

Return to the table of contents…

YOUR COMMENTS

For U.S. readers

Comment: I live in the U.S. and invest in Canadian stocks. I just read your piece on Premium Brands (TSX: PBH, OTC: PRBZF), which I bought last week.

The safe, easy way for U.S. investors to buy lightly-traded Canadian stocks is on the U.S. Grey Market. Here’s how. Get the latest price on the Toronto Stock Exchange and convert it to the U.S. dollar equivalent. Place a buy or sell limit order at that price. If it doesn’t execute, move it a penny or two and enter again. Continue this as long as you’re comfortable with the price. If you want to buy a large amount, say 5% of the average TSX daily volume, make your first order a smaller one, then wait a while before you place another. – Henry T.

Response: You can check out prices on the U.S. Grey Market and Pink Sheets by going to www.otcmarkets.com. – G.P.

 

Return to the table of contents…

MONEY SHOW REMINDER

Don’t forget to register for the upcoming World Money Show in Toronto from Oct. 24-26 by going to https://secure.moneyshow.com/msc/toms/registration.asp?sid=toms13&scode=032599.

I’ll be speaking on Oct. 25 at 9:30 a.m. on the subject Canada in 2014: Rebound or Retreat? See you there. – G.P.

 

That’s all for this issue of Update Edition. Look for your next regular issue of The Income Investor on Oct. 24.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Next issue: October 24

A NEW GROWTH STOCK

By Gordon Pape, Editor and Publisher

There are two key themes I believe are important for income investors at this time. The first is to own some securities that offer growth potential as well as cash flow. The second is to have some exposure to the U.S. and global markets.

My new recommendation meets both criteria. The company is FLY Leasing Ltd., an international leader in commercial aircraft leasing. It is based in Dublin, Ireland and trades on the New York Stock Exchange under the symbol FLY. Here are the details.

Type: American Depository Receipts (ADRs)
Trading symbol: FLY
Exchange: NYSE
Current price: US$13.40
Entry level: Current price
Annual payout: US$0.88
Yield: 6.6%
Risk rating: Higher risk
Recommended by: Gordon Pape
Website: www.flyleasing.com

The business: FLY Leasing is a leading global lessor of modern, high-demand and fuel-efficient commercial jet aircraft. The company has been in business for more than 20 years and currently has a fleet of 107 aircraft that it leases under multi-year contracts to 55 airlines in 32 countries. The fleet is constantly growing, with the addition of seven Boeing 737-800 aircraft this year valued at $425 million. (All dollar figures in this article are in U.S. currency.)

The security: FLY trades as an American Depository Receipt (ADR) on the New York Stock Exchange. As such, it is not considered to be a U.S. stock for purposes of the Canada-U.S. Tax Treaty. See the section on Tax Implications for more details.

Why we like it: We’ve seen the negative effect that rising interest rates can have on low-growth dividend securities. Therefore, we need to search out companies that offer growth potential as well as a decent yield. Demand for FLY’s leasing services is expected to expand as the global economy improves. RBC Capital Markets initiated coverage of the company in August with a target price of $18 a share.

Financial highlights: Second-quarter financial results (to June 30) weren’t very good. Total revenue fell about $20 million from the year before, to $90.6 million. The main reason was a decline in operating lease revenue. Net income also fell sharply, from $25.7 million ($0.99 a share, fully diluted) in 2012 to $5.9 million ($020 a share) this year.

For the first half of the fiscal year, net income was $38.8 million ($1.35 a share) compared to $46.1 million ($1.77 per share) a year ago. Despite the drop, the dividend is still well covered.

Investors had anticipated the fall-off and had been selling down the stock since early July, when it was trading at over $17. Also contributing to the decline was a new share offering in mid-July at $14. The stock got as low as $12.63 in mid-August but has recovered slightly since.

As of June 30, the company’s total assets were valued at $3 billion. As you might expect from the nature of the business, FLY is heavily leveraged with a 3.3 ratio of net debt to shareholders’ equity.

RBC estimates that the company’s book value at the end of the third quarter was about $18 a share. So at the current price, the stock is trading at 0.74 of book.

Risks: The financial results make it clear that this is a higher risk stock. Airplane leasing is an economically sensitive business and FLY’s revenue and profit would be adversely affected by any slowdown in world growth. Conversely, the company should do well if the economic recovery gathers momentum.

Distribution policy: The current quarterly dividend is $0.22 a share ($0.88 annually). Payments are made in February, May, August and November.

Tax implications: This is where it gets a little messy. Since FLY is an Irish-based company, the dividends are subject to Irish withholding tax of 20%. However, the tax may be waived where an exemption is permitted by legislation or treaty if the taxpayer provides a certificate of proof from tax authorities that he/she is a resident of the country for tax purposes prior to the payment of the dividend. For more information, see www.flyleasing.com/wp-content/uploads/2012/09/Irish-Dividend-Withholding-Tax-QA-2010.pdf. It’s worth noting that even if the withholding tax is applied, the yield is still an attractive 5.3%.

Who it’s for: This security is only suitable for investors who can handle above-average risk. It offers a good yield and capital gains potential but don’t invest if you cannot afford a loss of any kind.

How to buy: The shares trade on the NYSE. Average daily volume is over 600,000 so you should have no problem being filled.

Summing up: Growth stocks, by their nature, carry more risk than the traditional dividend stocks we have favoured in the past. But if the projections are correct for strengthening economic expansion in 2014, this one should do well.

Action now: FLY is a Buy for more aggressive investors. – G.P.

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

 

Return to the table of contents…

OCTOBER UPDATES

Here are the updates for this issue. All prices are as of the close of trading on Monday, Oct. 7 unless otherwise indicated.

Blue Ribbon Income Fund (TSX: RBN.UN, OTC: BLUBF)

Type: Closed-end fund
Trading symbol: RBN.UN, BLUBF
Exchange: TSX, Grey Market
Current price: C$10.70, US$10.48 (Sept. 30)
Originally recommended: Feb. 23/11 at C$11.12, US$11.34
Annual Payout: $0.84
Yield: 7.8%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.bromptongroup.com

Comments: A significant portion of this fund (15% as of June 30) is invested in real estate investment trusts (REITs). The REIT sector as a whole is down 13.5% so far this year. Another large chunk (21%) is in pipelines, power, utilities, and infrastructure. The S&P/TSX Capped Utilities Index is off 10.6% for 2013. If you’re wondering why the price of these units has fallen from a 52-week high of $11.96 in February to the current level, most of the answer is right there.

Although there are some exceptions, on the whole this is a slow-growth portfolio that is designed to generate good cash flow ($0.07 a month) using traditional dividend-paying securities. As a result, it was hit by the ripple effect of the sudden jump in interest rates last spring and it will be vulnerable to further increases down the road.

That’s why, although the yield is an attractive 7.8%, I’m going to recommend selling your units at this point. The risk of capital loss in the current environment has increased, which is why I have raised the risk rating on this fund from Moderate to Higher.

Action now: Sell. – G.P.

 

Return to the table of contents…

Student Transportation Inc. (TSX, NDQ: STB)

Type: Common stock
Trading symbol: STB
Exchange: TSX, Nasdaq
Current price: C$6.40, US$6.20
Originally recommended: Jan. 24/07 at C$10.59, US$9.28
Annual payout: $0.56
Yield: 8.7%
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.rideSTBus.com

Comments: Student Transportation reported good fourth-quarter and year-end results in mid-September. For the 2013 fiscal year (to June 30), the school bus company which operates in both Canada and the U.S. reported revenue of $423.7 million, a 15% improvement over the fiscal 2012 total of $369 million (note that the company reports in U.S. dollars). Basic net income increased to $3.7 million ($0.05 a share) from $2.2 million ($0.03 a share) the previous year. CEO Denis Gallagher said in a conference call that the 2012 results were skewed by a one-time write-up in the value of assets acquired in an acquisition.

Mr. Gallagher said that payout ratio for the year was 79%, based on free cash flow, and that it is the company’s goal to reduce that further in fiscal 2014.

My concern with Student Transportation over the years has always been the same – the low profitability. Based purely on earnings, the company’s dividend appears to be much too high and unsustainable, which helps to explain the high yield. However, the reality is that STB has a good record for maintaining dividend stability although investors should not expect an increase any time soon. The dividend has been stuck at the current level since 2010.

If you like the yield and are comfortable with a payout ratio based on cash flow, then continue to hold the shares for income. But keep in mind the stock has limited upside potential nor is a dividend increase likely for the foreseeable future.

Action now: Hold. – G.P.

 

Return to the table of contents…

TransCanada Corp. (TSX, NYSE: TRP)

Type: Common stock
Trading symbol: TRP
Exchange: TSX, NYSE
Current price: C$44.18, US$42.84
Originally recommended: July 24/03 at C$25.25, US$17.87
Annual payout: $1.84
Yield: 4.2%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.transcanada.com

Comments: TransCanada stock was one of the many that suffered collateral damage from the sudden jump in interest rates last spring. On May 22 the shares closed at an all-time high of C$51.21, which meant the yield was down to 3.6% based on an annualized dividend of $1.84. The spike in bond yields had the effect of driving down the market price of many dividend stocks, and today the shares are off 14% from their high.

That’s not good news for current investors but it offers an opportunity for those who don’t own shares. The lower price has pushed the yield back up to 4.2%, a more attractive, and more realistic, level.

The company reported strong second-quarter financial results with earnings of $357 million ($0.51 per share) compared to $300 million ($43 per share) a year ago. Revenue increased to just over $2 billion from $1.8 billion in 2012.

However, there are still two major uncertainties hovering over TransCanada. One is, of course, the Keystone XL pipeline, approval of which is still bogged down in the Washington bureaucracy. At this stage, there is no predicting when President Obama will make up his mind on whether to give the go-ahead, despite strong and consistent pressure from Canada.

The other is the ambitious Energy East project, which would transport output from the oil sands all the way to Quebec City and possibly Saint John, New Brunswick. TransCanada had been expected to push ahead quickly with the $12 billion plan but a senior official said earlier this month that it will be 2014 before the company is ready to submit a formal application to the National Energy Board.

Action now: Despite the uncertainties, TransCanada shares appear to be good value at this level and a dividend increase is very likely for next year which would push the yield higher. – G.P.

 

Return to the table of contents…

Sentry Global Balanced Income Fund Series X (NCE1047)

Type: Mutual fund
Code: NCE1047
Current price: $21.25 (Oct. 4)
Originally recommended: Nov. 24/03 at $25
Annual payout: $0.85
Yield: 4%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.sentry.ca

Comments: This is the old Diversified Preferred Share Trust but you’d never know to look at it today. The original trust was a closed-end fund that traded on the TSX; this is an open-ended mutual fund. The original was a proxy for the Canadian preferred share market; this one doesn’t have a whiff of preferred shares about it.

Following a shareholder vote, Sentry announced in May that it was winding up Diversified Preferred Share and exchanging the units for the new X series of this fund, which invests in an international portfolio of stocks and bonds. The fund hasn’t performed badly since the conversion but it bears no resemblance to what investors originally bought.

If you’re comfortable with this radical change, keep your units. But since this is no longer the fund I recommended, I am dropping coverage.

Action now: Sell. – G.P.

 

Return to the table of contents…

YOUR QUESTIONS

Thoughts on Innergest Series C

Q – Tom Slee has written extensively about preferred shares. What do you think about the Innergest Renewable Energy Series C Preferred Shares?

A – The Innergest Renewable Energy Series C Preferred Shares (TSX: INE.PR.C) are not currently on our Buy list. As I have mentioned before, however, these perpetual shares, with their respectable DBRS rating of Pdf 3, are an alternative to the Fortis Series F that I mentioned last month. But INE.PR.C shares are better suited for investors who can incur slightly more risk. Trading at a depressed $19.13 and paying a $1.4375 dividend, they yield 7.51%, which provides a well-above-average return even for registered accounts. The company can redeem them at $26 on Jan. 15 2018 and after that at descending prices. – T.S.

 

Return to the table of contents…

YOUR COMMENTS

For U.S. readers

Comment: I live in the U.S. and invest in Canadian stocks. I just read your piece on Premium Brands (TSX: PBH, OTC: PRBZF), which I bought last week.

The safe, easy way for U.S. investors to buy lightly-traded Canadian stocks is on the U.S. Grey Market. Here’s how. Get the latest price on the Toronto Stock Exchange and convert it to the U.S. dollar equivalent. Place a buy or sell limit order at that price. If it doesn’t execute, move it a penny or two and enter again. Continue this as long as you’re comfortable with the price. If you want to buy a large amount, say 5% of the average TSX daily volume, make your first order a smaller one, then wait a while before you place another. – Henry T.

Response: You can check out prices on the U.S. Grey Market and Pink Sheets by going to www.otcmarkets.com. – G.P.

 

Return to the table of contents…

MONEY SHOW REMINDER

Don’t forget to register for the upcoming World Money Show in Toronto from Oct. 24-26 by going to https://secure.moneyshow.com/msc/toms/registration.asp?sid=toms13&scode=032599.

I’ll be speaking on Oct. 25 at 9:30 a.m. on the subject Canada in 2014: Rebound or Retreat? See you there. – G.P.

 

That’s all for this issue of Update Edition. Look for your next regular issue of The Income Investor on Oct. 24.

Best regards,
Gordon Pape, editor-in-chief