by Travis Johnson, Stock Gumshoe | March 12, 2010 1:56 pm
I continue to hear from many readers that dividends are of big interest lately — the market’s surge over the past year has made a lot of folks very nervous about the future, given fairly high valuations on most stocks and the outperformance of “junkier” stocks (small caps, unprofitable growth companies, etc.). I’ll admit to being pretty interested in stability and dividends at the moment myself, so the latest teaser from Bryan Perry caught my eye.
Bryan Perry runs the 25% Cash Machine, a newsletter that had very weak ratings from my readers last Spring but that has seen some more friendly comments in more recent months — perhaps because of this general refocusing on “safety” and dividends, who knows, but for whatever reason it’s now in the top ten on the list of income letters at Stock Gumshoe Reviews.
He spent a lot of the past year or two touting a closed-end fund, Alpine Total Dynamic Dividend (AOD), a fund which essentially tries to double up on income by trading in and out of dividend-paying stocks — and that one still continues to pay a nice dividend, though it has also seen a pretty horrific collapse in its net asset value over the last couple years, this one is definitely built to churn out the dividend income, not to maintain or grow the asset value — over the past year, with awesome performance from the markets, the net asset value of the shares has stayed fairly steady between $6-7, so it’s clear that much of the market’s performance was effectively put into shareholders pockets with the monthly dividend (.12 per month, so 1.44/year). That’s not surprising for a fund that trades in and out of its positions so heavily, with turnover at something like 600%.
AOD has proven that they can keep generating the income pretty well, though it scares me to see funds like this trade at huge premiums to the net asset value — right now AOD trades at over $9, which means you’re paying a premium of close to 35% to buy the shares … or, put it another way, that you’re prepaying for what you expect will be two more years of those dividends when you buy the shares. Might happen, but you need to hope that their dividend capture trading continues to work, especially if it’s a flat or down market and their trading in and out around dividend dates generates capital losses instead of the gains they would have seen over the last year.
But that’s just my high-horse commentary about AOD — I know several fans of the fund, given its ability to churn out income, I just think it’s risky.
That’s not today’s pick by Bryan Perry, though, today he’s going up to Canada for a fund that also trades with a good dividend, 14% in this case. We should know that nothing trades at a yield like that without a reason, with the reason often being a withering or asset-depleting business or high leverage, but let’s look into it to see if there’s anything to his idea.
Here’s how Perry pitches it:
“Bryan Perry here, and this must be one of the biggest and safest paydays I’ve seen in years.
“One of Canada’s finest income trusts is set to go ex-dividend on Friday, March 26. This fund pays out 14% annually and has a long-term track record for continuous payments. Best of all, it pays that 14% to you in monthly installments, and the next one is right around the corner.
“Trust me—you’ll want to add it to your holdings today.”
OK, so leaving aside the fact that a fund that pays monthly gives you plenty of time to be patient — there’s no reason to jump in just in time to catch the next dividend and convert some of your capital instantly into taxable income, which fund is he talking about?
He tells us that this is one of his favorite kinds of investments, a Canadian trust that’s in the process (as many of them are) of converting to a corporation to better cope with the new tax laws next year.
“… my newest Canadian income trust is set to shell out — it pays a sleep-safely-at-night, rock-solid 14% annual dividend in dependable monthly installments.
“How can this be?
“Well, this Canadian income trust is able to deliver a 14% annual yield by betting on an industry that’s far from ‘sexy’ — printed and online telephone directories. But this hasn’t stopped the fund from growing nearly 20% annually and rewarding investors nicely with an annual 80-cent per share dividend.
“You see, boring old directories are fantastic cash cows. Their listing fees, plus the revenue they’re raking in from advertising ventures, are as dependable as the sun rising in the east. New initiatives like iPhone and Google applications are growing like wildfire for this fund, and they ensure that the revenues will be steady and reliable.
“And reliable revenue streams means management can pay a dividend that is big, and still growing.
“So it’s no surprise that the fund is up 43% in the past year. Throw in the annual 14% yield, and you can quickly see why investors are moseying up to this Canadian income trust.”
So who is this? Well, it probably won’t come as a huge surprise — this is a fund we’ve looked at before, the Yellow Pages Income Trust (YLO.UN in Canada, YLWPF on the pink sheets).
I wrote about this when Roger Conrad was touting it back in early 2009 as a “Google partner” which is technically true (and in the same way but on a far smaller scale, I host Google ads on StockGumshoe.com so I’m also a “Google partner”).
Yellow pages is indeed a directory publishing company, with the core business being printed phone directories, a business that I would argue is clearly dying (though at an undetermined speed), and with other businesses including the free “auto trader” publications you see on most city street corners and in convenience stores, and an online directory business that’s providing some growth.
So why does the stock trade at a 14% yield? And what’s going to happen when they become a corporation (or at least start getting taxed like one?).
Well, the dividend for the last three quarters of 2009 was 20 cents (they do pay monthly, like most trusts, so it’s 6.7 cents per month), and the “distributable cash” was 34 cents, so they’re paying out less than they theoretically could — which is probably a good thing, since they also carry a lot of debt and they’d probably be best off maintaining some flexibility with the conversion to a corporation upcoming. The shares are trading at C$6 right now, so that comes in at just a bit above 13% if they maintain their payout levels (the dividend is down by about a third from the peak it was at a year ago, they cut it last Spring).
And we no longer have really good comparison companies to throw up against these guys — since the dominant “pure play” directory companies in the US, Idearc and R.H. Donnelley, are essentially no more as public firms (both went bankrupt). The reason for the bankruptcies wasn’t just that they were in a declining business, though I think almost everyone would describe the traditional yellow pages directory business as doing more poorly than just “declining”, but also that the growing online presence and online directory and advertising businesses that helped to give them some sign of hope couldn’t generate the kind of cash flow they needed to cover their massive debt loads (in Idearc’s case, at least, a debt load that was cheerfully offloaded by Verizon when they spun off the directory company — at a pretty smart time, it appears).
And if you’re thinking, “hey, that sounds kind of like the newspaper business” … well, I wouldn’t argue with you. Going from a monopoly producer of something that almost everyone in a community uses, to a provider of online advertising and directory services in a much more jumbled and competitive market where any competitor can get instant distribution and you have much less pricing power, has to give you heartburn.
So how is it working so much better for the Yellow Pages folks up in Canada than it is for the US companies that foundered? Well, bankruptcy hasn’t been as imminent a threat because Yellow Pages Income Fund doesn’t carry the same outrageous kind of debt levels as Idearc did, so that’s a positive.
Yellow Pages Income, as of their last quarter, has about C$2.25 billion in debt, most of it in “medium term notes” and about 33 million preferred shares (at par those are $25 each, and they’re entitled to dividends, but they’re not really debt and are mostly eventually convertible into shares), so there are senior claims on the company of a little under C$3 billion. They have successfully rolled over some debt in the past year, with new bond offerings in the neighborhood of 7% yields, and their debt appears to be pretty well spread over the coming four or five years (a couple are longer term), for the most part, without any specific maturities for big hunks that would cause a huge shock.
There are about 510 million “units” (shares) outstanding, (or you can count it as 610 if you include the series 1 and 2 preferreds as equity). That gives a market capitalization of at least $3 billion, so you can see that in effect they’re pretty close to a half equity/half debt capital structure, which sounds an awful lot better than the massive leverage that dragged down Idearc and R.H. Donnelley.
So how do they pay for that? The company does make a profit, though the profit is far lower in 2009 than it was in 2008. If we just look at revenues for the last quarter, they came in at about C$406 million, with C$345 million from the directories and C$60 million from the “vertical media” (that’s the AutoTrader publications and websites, and similar employment and real estate publications and sites). That’s a drop in earnings from 2008’s 4Q, with both segments being about C$10 million lower. Online revenues are included in those numbers, but have also been the one part that is growing organically, pulling in C$82.6 million in the quarter (growth from just under C$70 million a year ago).
So the optimist looks at this and sees the online revenues growing at almost 20%, real organic growth. The pessimist looks at this and says that the online segment is so small, and so much less profitable, that even with 20% growth from that segment the revenue still fell almost 5%, and the earnings fell even a bit more. Earnings are arguably not what Yellow Pages really cares about, since they’re looking at cash flow that they can distribute to earnings, so for 2009, for example, the main reason why the accounting earnings fell by C$300 million was that they recorded a C$314 million impairment of goodwill, which isn’t a cash expense. So they were able to generate C$750 million in cash flow, and they only lost $735 million in financing and investing, so they add a few more million to the cash pile, though it’s not exactly a lot of cash sitting there for their use — they end up with C$36 million in cash at the end of 2009, which is pretty close to the amount that they have to pay out just to unitholders each month.
So the good? Yellow Pages does indeed have some reasonably steady cash flow, a still fairly robust local directory business, and a small but growing online business.
The bad? You have to make some kind of judgment about how quickly their traditional directories are going to decline, and how fast the traditionally lower margin online directories, local advertising services, and verticals will have to grow to make up for that decline.
So if we assume that Yellow Pages will be unable to grow out of this business by acquiring additional companies or otherwise expanding outside this core sphere, this ends up working quite similarly to a closed-end trust like the ones that are depleting a set oil reserve: For how long will we enjoy heavy cash flow that can be returned to unitholders? And is it long enough that the current distribution payment of 80 cents a year makes it worth it to buy a C$6 stock?
Personally, since I believe the only real assets that they have are the traditional directories and their sales force that sells directory and online ads, and I don’t think they’re likely to keep a competitive advantage in that business as the traditional yellow pages die out, I’m not willing to pay this much for them — if you do not reinvest your dividends, it would take about seven and a half years to get back your investment in the form of distributions, and I’m afraid that the fund might not be able to keep the distribution going at this level or better for that long.
That’s just me, if you have a rosier picture of the directory business and think they can maintain their margins or grow them, or if you believe that their local sales force will end up creating a much more lucrative online ad sales and management business, then this could easily be a fine income investment for years to come — it just seems to me that with the cash flow cutting in quite close to what they’ve promised in distributions, and with continuing costs from new preferred shares, and from their debt, there’s more chance that they’d further decrease the distributions than that they’d raise them. Their debt has been well received and is well rated so far, so this is not nearly the risk that Idearc was, but it still looks to me like it’s fairly risky, and I think my cash would be better treated elsewhere.
Never forget that it’s not just the income you get from the dividends, it’s also the investment that you’re putting at risk in exchange for those dividends — it could be that they’re cheap enough now, but investors who held Yellow Pages Income Fund as a safe, reliable business in 2007, even after the “Halloween surprise” that hurt all Trusts, have since seen the distributions cut, and the shares cut by more than half. The charts indicate that buying pressure for these units starts to bubble up once they get down to C$5 or so, but that’s likely just because an indicated dividend yield can only get so high before folks start buying it no matter what the condition of the business may be.
Disclosure: I continue to own shares of Verizon and Google but do not own any other investment mentioned above, my personal stock holdings are listed here and I will not trade in any stock I write about for at least three days.
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