In this issue:

Published June 6, 2012

Next issue: June 20

THE BIG HIT

By Gordon Pape, Editor and Publisher

It’s not often that high-yield pipeline companies take a big hit. But it happened last week to three of our recommendations: Veresen, Inter Pipeline, and Pembina Pipeline Corp.

Between May 28 and June 1, Pembina shares lost $2.20 or 7.6% of their value. Over the same period, Veresen fell $1.51 (10.8%) while Inter gave back $2.16 per unit (11%).

These are big drops for Pembina and Inter, two securities whose track records up to now have shown consistent growth. Veresen has been more erratic but the decline nonetheless came as a shock to some shareholders.

So what happened? In two words: frac spread. This represents the difference in the price for natural gas liquids (NGL) such as propane and butane and the cost of the dry natural gas from which the NGL is extracted. The greater the frac spread, the more profitable NGL becomes.

While dry natural gas has been in the doldrums, NGL has been strong, with prices comparable to oil. That has enhanced the bottom line of companies that derive a portion of their income from NGL sales, which include the three we’re looking at here. The sharp drop in the value of oil has pulled down NGL prices with it, leaving investors worried the result will be a squeeze on future profitability. That’s the main reason for the sell-off.

Is it justified? To a degree, yes. However, it appears investors may have overshot the mark, at least as far as Pembina and Inter are concerned. Here’s a quick update on the stocks.

Inter Pipeline (TSX: IPL.UN, OTC: IPPLF) Inter Pipeline is a major petroleum transportation, bulk liquid storage, and NGL extraction business based in Calgary. It was originally recommended as a “survivor trust” on Oct. 21/09 at C$9.99, US$9.62 and has performed very well for us. The shares were trading on the TSX on Tuesday morning at C$18.15 (there have been no trades on the U.S. over-the-counter market since May 30).

The limited partnership had a good first quarter with funds from operations (FFO) up 8% year-over-year to $108 million. Net income increased to $80 million, up $15 million or 23% over first quarter 2011 results. The units pay a monthly distribution of $0.0875 per unit ($1.05) annually. The first-quarter payout ratio, including sustaining capital expenses of $6.3 million, was a low 68.7%, which indicates the distribution is safe. At the current price, the shares yield a very attractive 5.8%.

Action now: Take advantage of the pull-back and Buy.

Pembina Pipeline (TSX: PPL, OTC: PBNPF) This is another “survivor trust), having been first recommended on June 24/09 at C$14.77. The stock was trading on Tuesday at $27.45, down almost 12% from its 52-week high of $31.15.

The company also reported a decent first quarter although it was not as strong as Inter Pipeline. Cash flow from operations was $65.3 million ($0.39 per share) compared to $74.5 million ($0.45 per share) during the first quarter of 2011. Stripping out non-recurring items, adjusted cash flow was $98.8 million ($0.59 per share) compared to $75.9 million ($0.45 per share) for the same period last year. Earnings were $32.6 million ($0.19 per share), down from $42.5 million ($0.25 per share) for the same period in 2011. Excluding expenses related to the acquisition of Provident Energy, earnings were $48.4 million ($0.29 per share) for the first quarter of 2012.

Pembina owns an NGL infrastructure and logistics business but most of its revenue comes from its pipelines so the shares did not take as big a hit as those of Inter and Veresen. The company recently announced its first dividend increase since 2008, raising the monthly payout by 3.8% to $0.135 per share or $1.62 a year. At that rate the yield is 5.9%.

Action now: I’m changing the guidance from Hold to Buy.

Veresen Inc. (TSX: VSN, OTC: FCGYF) Veresen was first recommended as Fort Chicago Limited Partnership on Aug. 25/10 at C$11.20, US$10.62. As with many other partnerships and trusts, it converted to a corporation before the implementation of the SIFT tax in 2011 and changed its name in the process. The company’s main businesses consist of pipelines, NGL extraction and processing, and power generation.

This is the weakest of the three companies under review with the price of natural gas liquid being a significant contributor to the bottom line. On a per share basis, first-quarter distributable cash was $0.23, unchanged from the same period a year ago. That was less than the dividend paid out, which is currently $0.0833 a month ($1 per year).

With the shares trading on Tuesday at C$12.73, the stock yields 7.9%. That suggests the market see a lot more risk in this one than in either Inter or Pembina. Moreover, the trend is down and the shares are trading at well below their 50-day and 200-day moving averages.

Action now: Sell. The pattern is worrisome and there could be more downside here. I suggest you exit this stock with a capital gain of 13.7% plus dividends and reallocate the money to either Inter or Pembina.

 

Gordon Pape’s new book, Retirement’s Harsh New Realities, can be purchased through our on-line Best Books store, which is associated with Amazon: http://astore.amazon.ca/buildicaquizm-20. It is also available in e-book formats for Kindle, Kobo, and other readers.

Return to the table of contents…

UPDATE ON INTACT FINANCIAL

Intact Financial (TSX: IFC, OTC: IFCZF)

Type: Common stock
Trading symbol: IFC, IFCZF
Exchange: TSX, Pink Sheets
Current price: C$62.69, US$62.14 (May 29)
Originally recommended: April 20/11 at C$49.98, US$52.34
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.intactfc.com

Comments: I am reiterating my Buy recommendation for Intact as a result of another accretive acquisition. The company is purchasing specialist property and casualty (P&C) insurer Jevco for $530 million from the Westaim group in a deal set to close in the fall.

Jevco specializes in higher risk lines of business. It is Canada’s largest motorcycle insurer, as well as insuring taxis, tow-trucks, ATVs, snowmobiles, driver training cars, and drivers with bad driving or payment histories. With the riskier nature of this business come higher claims but also higher premiums. Charles Brindamour, Intact’s CEO, is confident that its claims-management experience will improve Jevco’s performance as well as expanding the range of business that Intact can insure.

Jevco had revenues of $350 million in 2011 and was the 23rd largest P&C insurance company in Canada. Dominion Bond Rating Service (DBRS) estimates that Jevco will represent 6%-7% of Intact’s earnings and add $1 billion to its $12 billion of invested assets. Intact will fund the deal with $205 million in debt, existing excess capital, and a $237.5 million equity issue at $62.75 a share.

The price to book ratio for Jevco is 1.3 times and the price/earnings is 13 times. It will add 2.6% to Intact’s book value, leaving its minimum regulatory capital at over 200%. It will generate an internal rate of return over 20% and Intact’s debt to capital ratio will remain below 20%.

Following its $2.6 billion acquisition of AXA Canada last year, Intact will now have 17% of the Canadian P&C insurance market, more than twice the market share of the next two largest players, Aviva at 8.3% and Royal Sun Alliance at 6.2%. Mr. Brindamour anticipates further consolidation in the Canadian insurance industry as financial constraints lead other international companies to dispose of their Canadian operations.
 
Intact reported net operating income for the quarter ending March 31 of $177 million ($1.43 per share). That was up 47% from $102 million last year. Revenue was $1.4 billion, up 49%. Net income increased from $155 million ($1.43 per share) to $177 million ($1.59 per share) while the combined ratio (expenses as a percentage of premiums) was down to 92.3%, reflecting the exceptionally mild winter. Book value, probably the most important measure for such a volatile business as P&C insurance, was up 13% at $30.40.

Intact anticipates that the P&C industry will enjoy modest growth in 2012, with low single digit increases in commercial premiums, mid single digit increases in personal auto premiums, helped by the Ontario government’s crackdown on insurance fraud, and high single digit increases for personal property premiums, due to higher water related losses and more frequent storms.

Action now: Intact remains a Buy. The stock is up 25% from the original recommended price plus we have received $1.20 in dividends. – G.G.

 

Return to the table of contents…

That?s all for this issue of Update Edition. Look for your next regular issue of The Income Investor on June 20.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Published June 6, 2012

Next issue: June 20

THE BIG HIT

By Gordon Pape, Editor and Publisher

It’s not often that high-yield pipeline companies take a big hit. But it happened last week to three of our recommendations: Veresen, Inter Pipeline, and Pembina Pipeline Corp.

Between May 28 and June 1, Pembina shares lost $2.20 or 7.6% of their value. Over the same period, Veresen fell $1.51 (10.8%) while Inter gave back $2.16 per unit (11%).

These are big drops for Pembina and Inter, two securities whose track records up to now have shown consistent growth. Veresen has been more erratic but the decline nonetheless came as a shock to some shareholders.

So what happened? In two words: frac spread. This represents the difference in the price for natural gas liquids (NGL) such as propane and butane and the cost of the dry natural gas from which the NGL is extracted. The greater the frac spread, the more profitable NGL becomes.

While dry natural gas has been in the doldrums, NGL has been strong, with prices comparable to oil. That has enhanced the bottom line of companies that derive a portion of their income from NGL sales, which include the three we’re looking at here. The sharp drop in the value of oil has pulled down NGL prices with it, leaving investors worried the result will be a squeeze on future profitability. That’s the main reason for the sell-off.

Is it justified? To a degree, yes. However, it appears investors may have overshot the mark, at least as far as Pembina and Inter are concerned. Here’s a quick update on the stocks.

Inter Pipeline (TSX: IPL.UN, OTC: IPPLF) Inter Pipeline is a major petroleum transportation, bulk liquid storage, and NGL extraction business based in Calgary. It was originally recommended as a “survivor trust” on Oct. 21/09 at C$9.99, US$9.62 and has performed very well for us. The shares were trading on the TSX on Tuesday morning at C$18.15 (there have been no trades on the U.S. over-the-counter market since May 30).

The limited partnership had a good first quarter with funds from operations (FFO) up 8% year-over-year to $108 million. Net income increased to $80 million, up $15 million or 23% over first quarter 2011 results. The units pay a monthly distribution of $0.0875 per unit ($1.05) annually. The first-quarter payout ratio, including sustaining capital expenses of $6.3 million, was a low 68.7%, which indicates the distribution is safe. At the current price, the shares yield a very attractive 5.8%.

Action now: Take advantage of the pull-back and Buy.

Pembina Pipeline (TSX: PPL, OTC: PBNPF) This is another “survivor trust), having been first recommended on June 24/09 at C$14.77. The stock was trading on Tuesday at $27.45, down almost 12% from its 52-week high of $31.15.

The company also reported a decent first quarter although it was not as strong as Inter Pipeline. Cash flow from operations was $65.3 million ($0.39 per share) compared to $74.5 million ($0.45 per share) during the first quarter of 2011. Stripping out non-recurring items, adjusted cash flow was $98.8 million ($0.59 per share) compared to $75.9 million ($0.45 per share) for the same period last year. Earnings were $32.6 million ($0.19 per share), down from $42.5 million ($0.25 per share) for the same period in 2011. Excluding expenses related to the acquisition of Provident Energy, earnings were $48.4 million ($0.29 per share) for the first quarter of 2012.

Pembina owns an NGL infrastructure and logistics business but most of its revenue comes from its pipelines so the shares did not take as big a hit as those of Inter and Veresen. The company recently announced its first dividend increase since 2008, raising the monthly payout by 3.8% to $0.135 per share or $1.62 a year. At that rate the yield is 5.9%.

Action now: I’m changing the guidance from Hold to Buy.

Veresen Inc. (TSX: VSN, OTC: FCGYF) Veresen was first recommended as Fort Chicago Limited Partnership on Aug. 25/10 at C$11.20, US$10.62. As with many other partnerships and trusts, it converted to a corporation before the implementation of the SIFT tax in 2011 and changed its name in the process. The company’s main businesses consist of pipelines, NGL extraction and processing, and power generation.

This is the weakest of the three companies under review with the price of natural gas liquid being a significant contributor to the bottom line. On a per share basis, first-quarter distributable cash was $0.23, unchanged from the same period a year ago. That was less than the dividend paid out, which is currently $0.0833 a month ($1 per year).

With the shares trading on Tuesday at C$12.73, the stock yields 7.9%. That suggests the market see a lot more risk in this one than in either Inter or Pembina. Moreover, the trend is down and the shares are trading at well below their 50-day and 200-day moving averages.

Action now: Sell. The pattern is worrisome and there could be more downside here. I suggest you exit this stock with a capital gain of 13.7% plus dividends and reallocate the money to either Inter or Pembina.

 

Gordon Pape’s new book, Retirement’s Harsh New Realities, can be purchased through our on-line Best Books store, which is associated with Amazon: http://astore.amazon.ca/buildicaquizm-20. It is also available in e-book formats for Kindle, Kobo, and other readers.

Return to the table of contents…

UPDATE ON INTACT FINANCIAL

Intact Financial (TSX: IFC, OTC: IFCZF)

Type: Common stock
Trading symbol: IFC, IFCZF
Exchange: TSX, Pink Sheets
Current price: C$62.69, US$62.14 (May 29)
Originally recommended: April 20/11 at C$49.98, US$52.34
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.intactfc.com

Comments: I am reiterating my Buy recommendation for Intact as a result of another accretive acquisition. The company is purchasing specialist property and casualty (P&C) insurer Jevco for $530 million from the Westaim group in a deal set to close in the fall.

Jevco specializes in higher risk lines of business. It is Canada’s largest motorcycle insurer, as well as insuring taxis, tow-trucks, ATVs, snowmobiles, driver training cars, and drivers with bad driving or payment histories. With the riskier nature of this business come higher claims but also higher premiums. Charles Brindamour, Intact’s CEO, is confident that its claims-management experience will improve Jevco’s performance as well as expanding the range of business that Intact can insure.

Jevco had revenues of $350 million in 2011 and was the 23rd largest P&C insurance company in Canada. Dominion Bond Rating Service (DBRS) estimates that Jevco will represent 6%-7% of Intact’s earnings and add $1 billion to its $12 billion of invested assets. Intact will fund the deal with $205 million in debt, existing excess capital, and a $237.5 million equity issue at $62.75 a share.

The price to book ratio for Jevco is 1.3 times and the price/earnings is 13 times. It will add 2.6% to Intact’s book value, leaving its minimum regulatory capital at over 200%. It will generate an internal rate of return over 20% and Intact’s debt to capital ratio will remain below 20%.

Following its $2.6 billion acquisition of AXA Canada last year, Intact will now have 17% of the Canadian P&C insurance market, more than twice the market share of the next two largest players, Aviva at 8.3% and Royal Sun Alliance at 6.2%. Mr. Brindamour anticipates further consolidation in the Canadian insurance industry as financial constraints lead other international companies to dispose of their Canadian operations.
 
Intact reported net operating income for the quarter ending March 31 of $177 million ($1.43 per share). That was up 47% from $102 million last year. Revenue was $1.4 billion, up 49%. Net income increased from $155 million ($1.43 per share) to $177 million ($1.59 per share) while the combined ratio (expenses as a percentage of premiums) was down to 92.3%, reflecting the exceptionally mild winter. Book value, probably the most important measure for such a volatile business as P&C insurance, was up 13% at $30.40.

Intact anticipates that the P&C industry will enjoy modest growth in 2012, with low single digit increases in commercial premiums, mid single digit increases in personal auto premiums, helped by the Ontario government’s crackdown on insurance fraud, and high single digit increases for personal property premiums, due to higher water related losses and more frequent storms.

Action now: Intact remains a Buy. The stock is up 25% from the original recommended price plus we have received $1.20 in dividends. – G.G.

 

Return to the table of contents…

That?s all for this issue of Update Edition. Look for your next regular issue of The Income Investor on June 20.

Best regards,
Gordon Pape, editor-in-chief