Colabor: Shares Of Canadian Food Wholesaler Pricing In Too Much Dividend Risk

Dec.20.11 | About: Colabor Group (COLFF)

Investors’ aversion to risk in dividend-paying stocks is, of course, part and parcel of a global effort to cut risk this year. The catalyst continues to be the threat to eurozone economies, spawned by the erosion in creditworthiness of sovereign debt and its impact on the Continent’s banking system. That, in turn, has increased fear of tighter credit spreading worldwide, triggering a slide into a global recession.

On days when the situation in Europe seems to stabilize, yield premiums required to buy perceived riskier fare diminish, and stocks rally. On days when the news turns negative, the premiums widen and stocks fall. And given there’s no silver bullet to settle Europe’s woes quickly, it’s likely we’ll continue to see this kind of action for some months yet.

The bad days, however, haven’t stopped some dividend-paying Canadian stocks, such as Colabor (OTCPK:COLFF), from rallying by reducing investors’ perceptions of dividend risk.

Colabor has never reduced its dividend. That includes weathering the 2008-09 market crash/credit crunch/economic recession, as well as when they converted from income trusts to corporations. Colabor actually began paying trust taxes some years before its 2010 conversion, which occurred in 2010.

The company has covered dividends comfortably with cash flow this year, despite challenging conditions in its industry. Colabor’s first-quarter payout ratio zoomed to 207 percent due to a series of margin pressures. The last two quarters, however, have seen a sharp rebound in both sales and profit margins, as a spate of strategic acquisitions has paid off.

The third-quarter payout ratio fell to just 79 percent. The 12-month payout ratio is 81 percent, down from 86 percent at the end of the second quarter. And the company was also able to buy back 328,000 more of its own shares.

Colabor’s food distribution industry is challenged by fierce competition arising from a combination of food-price inflation and a weak economy that’s hurt sales. The Canadian Restaurant and Food Service Association reported a 2.7 percent rise in commercial food service sales for the first half of 2011. This gain was entirely based on price, however, as volumes declined.

Colabor, however, reported a 3.2 percent increase in its third-quarter comparable sales growth, which excludes acquisitions. That reversed several quarters of declines and testifies to the company’s market skills and focus on geographic and product niches where it enjoys scale advantages. That’s a strategy the company has followed throughout its history, and the bigger it gets, the more able it is to grow.

Colabor’s balance sheet is also quite strong. The company has CAD113.5 million drawn on its authorized credit facility of CAD150 million, which matures Apr. 28, 2016. It also has CAD14.3 million left on a convertible bond that matures at the end of December. The convertible would be “in the money” in terms of exchange value on a boost in Colabor’s share price to just CAD10.25, so it may not involve any cash outlay.

The company was able to put cash flow to work to reduce obligations of CAD12.5 million during the quarter--a high priority--and still meets all its debt covenants comfortably. These are a maximum total debt-to-cash flow ratio of 3.25-to-1 (it’s currently 2.82-to-1) and minimum interest coverage by cash flow of 3.5-to-1 (it’s currently 5.29-to-1).

Management’s goal is still to make the company a national player in the food distribution business. That eventually will require considerable expansion beyond the company’s current Quebec-Atlantic Canada-Ontario focus. And it will probably include a major merger or acquisition, as CEO Gilles C. Lachance all but ruled out “going greenfield” during the company’s third-quarter conference call.

This policy, however, is the best guarantee such expansion will be immediately accretive or nearly so, which is also a major positive for long-run dividend safety.

The key concern investors seem to have about Colabor is whether or not the past two quarters’ positive earnings trend can last, given the uncertain macro environment. For its part, management has been pretty up front that, in the words of Mr. Lachance, “it’s very difficult for us as managers to predict exactly what’s going to happen in terms of sales and things like that.”

Those aren’t exactly the words fearful investors want to hear, and it likely explains why the stock, though off its lows, continues to trade with such a high dividend yield. But this is a company that’s used to fighting for those inches that are so critical for weathering tough environments.

We’ll find out a lot more when the company announces its fourth-quarter and full-year earnings, most likely in February. But based on what we know now, the stock appears to be pricing in too much dividend risk and looks set for a solid rise this year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.