When we last covered Alaris Royalty (OTC:ALARF), we were a tad possessive of our gains and suggested investors take the money and run.
Alaris turned out to be one of those rare companies that had priced in the dividend cut. It rallied over 30% since the announcement, bewildering shorts who thought they had a sure shot. Alaris, though, deserves a farewell at this point. The trade worked out superbly, but we don’t believe the write-downs are done. Tangible book value will move below $13 within 2-3 quarters, in our opinion, and we would not rule out another dividend cut.
The stock has moved a bit lower since then, in contrast to the broader indices.
Alaris also released its Q2-2020 results in the interim. Based on that, we decided to see if this would once again fall into our buy list.
As expected, Alaris had lower revenues and normalized EBITDA in its Q2-2020 results. The revenue declines were a bit worse than what one would have anticipated based on their Q1-2020 earnings update. Revenue per share decreased 24.0% due to the deferral of distributions during the quarter from Body Contours Centers, LLC (“BCC”) and PF Growth Partners (“PFGP”).
Source: Alaris Q2-2020 press release
Investors can notice the lower share counts, driven by Alaris’ aggressive buyback strategy.
The company’s earnings coverage heat map was quite positive in general with partners maintaining or improving coverage in general. Body Contour Centers was shut for a good part of the quarter, and hence, the drop was expected.
Source: Q2-2020 presentation
Kimco’s update was also surprisingly positive.
In June, Kimco entered into a new credit agreement with a senior lender. The agreement provides additional flexibility, capacity and favourable covenants compared to their previous lending agreement. Kimco has paid all accrued interest to Alaris for the six months ending June 30, 2020 with no interruptions expected moving forward. Additionally, due to the improvement in financial results and outlook, Kimco has restarted distributions on their preferred equity beginning in July 2020, in the amount US$1.2 million on an annual basis (US$0.1 million paid monthly).
Source: Q2-2020 financials
Alaris increased the fair value of its portfolio slightly in this quarter citing that it had overestimated COVID-19 impact. This might be true to some extent, but fair values have improved on all risky assets due to compressing spreads versus the risk-free rates. The company also completed its first investment in 2020.
The Corporation completed an initial investment into Carey Electric Contracting LLC (“Carey Electric”) for US$17.0 million, consisting of US$16.1 million of preferred equity and a US$0.9 million investment in exchange for a minority ownership of their common equity. Alaris will initially receive US$2.4 million of preferred distributions and is expecting to receive dividends on its common equity investment on an annual basis, as Carey Electric’s cash flows permit.
Source: Q2-2020 financials
This was a good time to make investments as companies were ready for generous terms in return for capital. That said, the royalty rate appears to be in line with what Alaris has got historically.
Alaris continues to show a great deal of confusion in how it is treating its dividend. Last year, it increased the dividend slightly, even though in any rational world, maintaining a small buffer (its payout ratio was already very high) would make sense. It then cut its dividend in 2020 and switched to a quarterly schedule. Now, it again is increasing it ever so slightly as it converts to an Income trust.
In connection with the Arrangement, the Corporation further announced an expected increase to its annual distribution of $0.08 per trust unit (from $1.16 per share to $1.24 per trust unit on an annual basis). If the Arrangement is approved by shareholders on August 31, 2020, the next quarterly trust distribution would be declared in September 2020 and payable on or about October 15, 2020 to unitholders of record as of September 30, 2020 and is expected to be $0.31 per trust unit.
Source: Alaris Q2-2020 press release
While it may appear that Alaris is trying to pay the most out to its shareholders, such a haphazard policy is hardly useful to anyone. We think most corporations would build up the buffer having cut the dividends already and then increase them when they have perfect visibility. Yes, the conversion to an income trust likely complicates how much they can retain, but even there, a year-end special distribution would make more sense than this constant tinkering. As always, we do opine on the future safety of the current dividends, and based on all the information, Alaris shows a moderate level of danger (15-33% probability of a dividend cut in the next 12 months) on our proprietary Kenny Loggins Scale.
At 0.8X price to tangible book, Alaris is certainly not expensive.
It perhaps is discounting a little more than it needs to, considering management’s errors over the last two years. But the discount also reflects the general disdain towards smaller companies and smaller company loans. Even the US VanEck Vectors BDC Income ETF (NYSEARCA:BIZD) sports a rather weak total return over the last 5 years.
But that also underscores our tactical stance on this one that it is not a “buy and hold” but rather a “trade and fade”. The trades we recommended on this would have returned over 100% in the last 3 years versus a buy and hold strategy.
With the bulk of its revenues coming from the US, Alaris remains vulnerable to a rapidly depreciating US dollar. It does have good hedges for the next 12 months, but if the current trend of Loonie strength continues, its coverage will start to get impacted. Current FX rate is already 5% lower than the Q2-2020 average.
Alaris can likely maintain this new distribution if the worst related to COVID-19 is behind us. BAA bond yields continue to stay rather low, and by our own benchmark of requiring a 600 basis yield spread, Alaris barely makes the cut (it yields about 10% on the current price).
Investors have long urged us to take the cash flow yield and not the distribution yield for Alaris, but we rather use the lower number as we want a higher margin of safety dealing with this company. We continue to rate this as neutral, but it is close to our buy point.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ALARF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.