In this issue:

Next issue: July 27

THE ARMTEC DEBACLE

By Gordon Pape, Contributing Editor

Armtec Infrastructure (TSX: ARF, OTC: AIIFF) stunned investors in early June by suddenly announcing that it was suspending its dividend entirely after a big first-quarter loss. CEO Charles Phillips told The Globe and Mail in an interview that the move was necessitated by bondholder covenants that restrict the company’s freedom to pay dividends if its earnings fall below a certain level.

The news was especially shocking because only two months before Armtec had raised $58 million by selling 3.6 million new shares at a price of $16.20 in a deal led by Scotia Capital, TD Securities, and BMO Nesbitt Burns. The Globe quoted the CEO as saying that at the time of the share issue the company believed the dividend was safe. "It wasn’t until really recently that it became clear that we had to review our dividend policy," he said.

It is difficult to understand how management could not have been aware of the magnitude of the first-quarter disaster by the time the new share issue closed on April 13. The quarterly results, to March 31, showed a net loss of almost $13.3 million ($0.65 a share) compared to a loss of $10.6 million ($0.52 a share) in the same period of 2010.

The company blamed the big loss on several factors including squeezed margins, bad weather, and a slow rebound from the recession. "CIA (construction and infrastructure applications) revenues are very sensitive to weather conditions," management said. "Construction activity tapers off with the onset of winter weather conditions and typically remains at low levels through the first quarter. The comparative volumes from 2010 reflected the impact of an unusually mild winter coupled with government incentives to accelerate construction activity. 

"The 2011 season has started with a typical cold Canadian winter and weather continues to be a factor with near record precipitation in many areas of the country. As a result, second quarter CIA volumes are expected to be affected significantly and to a far greater degree than previously anticipated. In particular, the spring agricultural installation season is almost complete with little ability to access the fields in the Eastern and Central regions.

"Based on the current outlook, management does not anticipate improvement in the ES (engineered solutions) business until the end of 2011. ES gross margin levels, anticipated to improve over time, are not expected to fully rebound to pre-recession levels during 2011."

In other words, don’t expect any significant improvement soon. This will be a long grind.

Investors and analysts responded predictably. The stock, which ended May at $14.40, was trading below $4 by June 10. Meanwhile, analysts were slashing their estimates and advising clients to dump the shares. Canaccord set a target price of $2.50 on the shares while Raymond James analyst Frederic Bastien was quoted in The Globe as saying to avoid the stock entirely.

It’s worth noting that the share price began its sharp drop on June 6, on unusually heavy volume (324,000 shares compared to about 75,000 on June 3). However, the first-quarter results and the announcement of the dividend suspension did not come until the night of June 8. Either some investors were remarkably prescient or the news was leaked in advance, although Mr. Phillips said he was "not aware" of any leaks during his interview with The Globe. He suggested it was simply a case of some investors looking at the overall situation and "triangulating on all those facts."

Whatever the reason, the stock continued to drop, falling all the way to $2.52 in intra-day trading on June 22 before rallying as bargain hunters moved in.

In the latest development, the company announced on July 3 that it had obtained $125 million in financing from Brookfield Asset Management. The interest rate was not disclosed nor was there any indication as to whether there are limits on Armtec’s ability to resume dividends. The term of the credit line is two years, extendable by six months at Armtec’s option. The company said that $90 million will become available as soon as the paperwork is complete. The balance of $35 million will depend on "the satisfaction of certain additional due diligence conditions".

Armtec said this will enable it to repay its current lenders in full in the third or fourth quarter of this year. Any balance will be available for general corporate purposes. 

As part of the deal, Brookfield gets a warrant to buy 4.56 million shares of Armtec (about 15% of the number of currently outstanding shares, calculated on a fully diluted basis). The exercise price "has a premium of 25% to the current market price of the common shares, subject to regulatory approval". This means investors can expect further dilution.

Mr. Phillips said the company is "very pleased to have entered into a new relationship with a strong financial partner like Brookfield." They should be; the stock jumped $1.18 (34%) in the first two days of trading after the announcement, closing on Tuesday at $4.62 (US$4.90).

I suggest investors take this opportunity to get out. The company’s business prospects do not look promising for at least the rest of this year and resumption of dividends is unlikely until Armtec gets comfortably back into the black. I see little capital gains potential from here and with no income to reward us for being patient there seems to be little reason to hang in.

Action now: Sell.

 

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

Return to the table of contents…

UPDATES

Here are the updates for this issue. All prices are as of the close of trading on Tuesday, July 5 unless otherwise indicated.

Brookfield Renewable Power Fund (TSX: BRC.UN, OTC: BRPFF)

Type: Income trust
Trading symbol: BRC.UN, BRPFF
Exchange: TSX, Grey Market
Current price: C$23.09, US$24.05
Originally recommended: July 22/09 at C$16.62, US$15.10
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.brookfieldpower.com

Comments: Brookfield was one of the few income trusts not to convert to corporate status, basically because management could find no compelling reason to do so. So it is being taxed at the new trust rate. However, it has not cut its distributions although it has moved to a quarterly payout schedule of $0.32499 per unit.

First-quarter revenue came in at $84.1 million, down from $95.2 million last year. Management said this was due largely to a drop of 5% in hydroelectricity generation "due to lower inflows in Ontario". Net operating cash flow was $45.9 million ($0.44 per unit), down from $52 million ($0.52 a unit) in 2010. Actual distributions in the first quarter of this year were $0.33 a unit.

The share price moved as high as $23.95 in May before pulling back. It closed on Tuesday at $23.09. The projected 12-month yield based on the current level of distributions is 5.6%.

Action now: Buy. The yield is still attractive. – G.P.

 

Return to the table of contents…

Firm Capital Mortgage Investment Corp. (TSX: FC)

Type: Mortgage investment corporation
Trading symbol: FC
Exchange: TSX
Current price: $12.55
Originally recommended: Jan. 16/04 at C$11.30
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.firmcapital.com

Comments: This continues to be a great choice for income investors. It’s a conservatively-managed mortgage lending company that consistently produces good results. Yes, it’s a boring business but the 7.5% yield is reason enough to put it in your portfolio and sit on it.

First-quarter profit came in at $3.55 million, up slightly from $3.31 million in the same period of 2010 when Firm was still an income trust. Profit exceeded dividends paid out by $165,284 or $0.012 per share.

The portfolio is top-quality with conventional mortgages with loans representing less than 75% of property values comprising 93% of the total. The largest concentration is in Ontario (81%).

The shares pay monthly dividends of $0.078 (about $0.94 a year). The largest risk is a major crash in housing prices similar to what happened in the U.S. That’s not impossible but it appears unlikely.

Action now: Buy. There’s not much capital gains potential but the cash flow is great. – G.P.

 

That’s this issue of Update Edition. Look for your next regular issue of The Income Investor on July 27.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Next issue: July 27

THE ARMTEC DEBACLE

By Gordon Pape, Contributing Editor

Armtec Infrastructure (TSX: ARF, OTC: AIIFF) stunned investors in early June by suddenly announcing that it was suspending its dividend entirely after a big first-quarter loss. CEO Charles Phillips told The Globe and Mail in an interview that the move was necessitated by bondholder covenants that restrict the company’s freedom to pay dividends if its earnings fall below a certain level.

The news was especially shocking because only two months before Armtec had raised $58 million by selling 3.6 million new shares at a price of $16.20 in a deal led by Scotia Capital, TD Securities, and BMO Nesbitt Burns. The Globe quoted the CEO as saying that at the time of the share issue the company believed the dividend was safe. "It wasn’t until really recently that it became clear that we had to review our dividend policy," he said.

It is difficult to understand how management could not have been aware of the magnitude of the first-quarter disaster by the time the new share issue closed on April 13. The quarterly results, to March 31, showed a net loss of almost $13.3 million ($0.65 a share) compared to a loss of $10.6 million ($0.52 a share) in the same period of 2010.

The company blamed the big loss on several factors including squeezed margins, bad weather, and a slow rebound from the recession. "CIA (construction and infrastructure applications) revenues are very sensitive to weather conditions," management said. "Construction activity tapers off with the onset of winter weather conditions and typically remains at low levels through the first quarter. The comparative volumes from 2010 reflected the impact of an unusually mild winter coupled with government incentives to accelerate construction activity. 

"The 2011 season has started with a typical cold Canadian winter and weather continues to be a factor with near record precipitation in many areas of the country. As a result, second quarter CIA volumes are expected to be affected significantly and to a far greater degree than previously anticipated. In particular, the spring agricultural installation season is almost complete with little ability to access the fields in the Eastern and Central regions.

"Based on the current outlook, management does not anticipate improvement in the ES (engineered solutions) business until the end of 2011. ES gross margin levels, anticipated to improve over time, are not expected to fully rebound to pre-recession levels during 2011."

In other words, don’t expect any significant improvement soon. This will be a long grind.

Investors and analysts responded predictably. The stock, which ended May at $14.40, was trading below $4 by June 10. Meanwhile, analysts were slashing their estimates and advising clients to dump the shares. Canaccord set a target price of $2.50 on the shares while Raymond James analyst Frederic Bastien was quoted in The Globe as saying to avoid the stock entirely.

It’s worth noting that the share price began its sharp drop on June 6, on unusually heavy volume (324,000 shares compared to about 75,000 on June 3). However, the first-quarter results and the announcement of the dividend suspension did not come until the night of June 8. Either some investors were remarkably prescient or the news was leaked in advance, although Mr. Phillips said he was "not aware" of any leaks during his interview with The Globe. He suggested it was simply a case of some investors looking at the overall situation and "triangulating on all those facts."

Whatever the reason, the stock continued to drop, falling all the way to $2.52 in intra-day trading on June 22 before rallying as bargain hunters moved in.

In the latest development, the company announced on July 3 that it had obtained $125 million in financing from Brookfield Asset Management. The interest rate was not disclosed nor was there any indication as to whether there are limits on Armtec’s ability to resume dividends. The term of the credit line is two years, extendable by six months at Armtec’s option. The company said that $90 million will become available as soon as the paperwork is complete. The balance of $35 million will depend on "the satisfaction of certain additional due diligence conditions".

Armtec said this will enable it to repay its current lenders in full in the third or fourth quarter of this year. Any balance will be available for general corporate purposes. 

As part of the deal, Brookfield gets a warrant to buy 4.56 million shares of Armtec (about 15% of the number of currently outstanding shares, calculated on a fully diluted basis). The exercise price "has a premium of 25% to the current market price of the common shares, subject to regulatory approval". This means investors can expect further dilution.

Mr. Phillips said the company is "very pleased to have entered into a new relationship with a strong financial partner like Brookfield." They should be; the stock jumped $1.18 (34%) in the first two days of trading after the announcement, closing on Tuesday at $4.62 (US$4.90).

I suggest investors take this opportunity to get out. The company’s business prospects do not look promising for at least the rest of this year and resumption of dividends is unlikely until Armtec gets comfortably back into the black. I see little capital gains potential from here and with no income to reward us for being patient there seems to be little reason to hang in.

Action now: Sell.

 

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

Return to the table of contents…

UPDATES

Here are the updates for this issue. All prices are as of the close of trading on Tuesday, July 5 unless otherwise indicated.

Brookfield Renewable Power Fund (TSX: BRC.UN, OTC: BRPFF)

Type: Income trust
Trading symbol: BRC.UN, BRPFF
Exchange: TSX, Grey Market
Current price: C$23.09, US$24.05
Originally recommended: July 22/09 at C$16.62, US$15.10
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.brookfieldpower.com

Comments: Brookfield was one of the few income trusts not to convert to corporate status, basically because management could find no compelling reason to do so. So it is being taxed at the new trust rate. However, it has not cut its distributions although it has moved to a quarterly payout schedule of $0.32499 per unit.

First-quarter revenue came in at $84.1 million, down from $95.2 million last year. Management said this was due largely to a drop of 5% in hydroelectricity generation "due to lower inflows in Ontario". Net operating cash flow was $45.9 million ($0.44 per unit), down from $52 million ($0.52 a unit) in 2010. Actual distributions in the first quarter of this year were $0.33 a unit.

The share price moved as high as $23.95 in May before pulling back. It closed on Tuesday at $23.09. The projected 12-month yield based on the current level of distributions is 5.6%.

Action now: Buy. The yield is still attractive. – G.P.

 

Return to the table of contents…

Firm Capital Mortgage Investment Corp. (TSX: FC)

Type: Mortgage investment corporation
Trading symbol: FC
Exchange: TSX
Current price: $12.55
Originally recommended: Jan. 16/04 at C$11.30
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.firmcapital.com

Comments: This continues to be a great choice for income investors. It’s a conservatively-managed mortgage lending company that consistently produces good results. Yes, it’s a boring business but the 7.5% yield is reason enough to put it in your portfolio and sit on it.

First-quarter profit came in at $3.55 million, up slightly from $3.31 million in the same period of 2010 when Firm was still an income trust. Profit exceeded dividends paid out by $165,284 or $0.012 per share.

The portfolio is top-quality with conventional mortgages with loans representing less than 75% of property values comprising 93% of the total. The largest concentration is in Ontario (81%).

The shares pay monthly dividends of $0.078 (about $0.94 a year). The largest risk is a major crash in housing prices similar to what happened in the U.S. That’s not impossible but it appears unlikely.

Action now: Buy. There’s not much capital gains potential but the cash flow is great. – G.P.

 

That’s this issue of Update Edition. Look for your next regular issue of The Income Investor on July 27.

Best regards,
Gordon Pape, editor-in-chief