Alaris Royalty: Take The Money And Run (OTCMKTS:ALARF)

Summary

We were bullish on the stock when we last wrote about it.
Since then, it has announced its Q1 results and had a dividend cut.
We analyse the numbers and present our current outlook on the company.
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The dividend cut was priced in! That may come as a shock to those who ascribe to the school of thought that a dividend cut can never be priced in, but in this case it was. We are talking about Alaris Royalty Corp. (OTC:ALARF). When we last touched on this company, we suggested that investors look past the likely dividend cut and still hold their nose and buy.

Alaris is a good buy (not good bye) at the current price, and the yield and tangible book give investors good reason to get involved. We are expecting 50% upside along with a big dividend yield. This yield can be cut down the line, so we would not get too attached to it. Regardless of what happens here, Alaris Royalty is mispriced as a commoner and should provide good returns in all but the worst-case scenarios.

Source: "Alaris Royalty: Currently Priced As A Commoner," Seeking Alpha, March 26, 2020

Alaris went a bit lower as investors started pricing not one, but two, asteroid strikes on planet Earth. However, it soon bottomed and rocketed higher.

With Q1-2020 results and a dividend cut coming into play since we wrote that article, we decided to do an update and let you know why we are ready to stick a fork in this.

Q1-2020

Alaris determined that its revenue streams were definitely going to be hit down the line, even if they were not in Q1-2020.

Based on the Corporation's assessment of COVID-19 and its current and possible future impact on Partner businesses, fair values of certain investments were reduced (recorded as an unrealized loss of investments at fair value) by a total of $84.9 million in the period ($2.33 per share). This reduction results in a fair value of investments of $739.7 million at March 31, 2020.

Source: Alaris Q1-2020 press release

The company pointed out that it has so far been hit with deferred revenues from Body Contour Centers, LLC and Planet Fitness Group. It has also stopped receiving distributions from M-Rhino Holdings ("Providence") and won't receive them for April, May and June 2020. The updated presentation showed the coverage ratios, but they failed to provide any useful information, as the worst of it happened post March 31, 2020.

Source: Alaris Presentation

We would note, though, that the three sub-1.0X coverage companies are likely to be restructured. Alaris said this about Providence in its report:

Providence has effectively cut costs to help manage through this downturn, but with uncertainty surrounding future revenue and impact to the overall apparel industry, the Corporation anticipates Providence may have difficulty servicing their debt as well as Alaris’ distributions in the near term. As a result of the impacts of COVID-19 and issues discussed in previous quarters, liquidity management is now a key priority beginning in the second half of 2020. As a result of no future distributions expected to be paid by Providence and possible liquidity issues expected in the near term, the Corporation has reduced the fair value of the Providence units to nil during the three months ended March 31, 2020. This has resulted in a write-down of US$22.9 million.

Source: Alaris Q1-2020 financial report

Kimco and ccComm have fared better as per Alaris management, but those two have been struggling for so long that we don't have any great expectations from them. Even outside of these three, there are some key issues facing Alaris' investments as detailed in the financial report.

Buyback

Alaris recognized the same thing we did when we recommended it - it was trading at a huge discount to tangible book. Hence, the company initiated a buyback and actually went ahead with it. The company had purchased just a shade over 1 million shares till May 5 (date of the results), and as can be seen below, it has continued to buy back shares after that date.

Source: Canadian Insider

Dividend Cut

Alaris cut the dividend, but it was a bit less than we expected.

Due to the current and expected future impact of the COVID-19 pandemic on our Partners (as defined below), the Corporation is announcing a reduction in its dividend of approximately 30% to $1.16 annually and $0.29 per quarter (from $1.65 annually and $0.4125 per quarter). This reduction will come into effect with the Q2 dividend to be declared in June 2020.

Source: Alaris Q1-2020 press release

At this point, Alaris is still flying blind like a bat out of hell and has no idea what the ultimate impact will be on its partner companies. We would remind investors that Alaris has been blindsided by companies even during the epic decade-long boom, so in this climate, we think its visibility is extremely limited. Based on that logic, it would have made more sense to have a more drastic cut. The company did move its dividend schedule to quarterly from monthly, and that likely will lose some of its fan club that lacked the ability to plan one quarter of spending at a time. 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.

Valuation

When we made the case for Alaris, it traded at less than half of tangible book. One quarter later, with writedowns and a big rally, we are rapidly approaching the 1.0X mark.

In all likelihood, the price today is above the nadir of tangible book value once writedowns have gone through the balance sheet. Alaris has now achieved close to fair value on this metric.

The second metric we look at for Alaris is the yield spread versus BAA bonds. We would love to show this to you graphically, but unfortunately, YCharts has still not gotten over the shock of the dividend cut and is pricing in the yield based on the old dividends. But we can share the numbers, and the current yield of 8.75% provides a 500-basis point yield spread to BAA bonds. This metric is in neutral territory, and our buy point for this royalty company is when it yields at least 600 basis points above BAA bonds.

Conclusion

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 writedowns 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.

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This article was written by

Trapping Value

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