Alaris Royalty Corp ALARF

AD Scotias Top Contrarian Pick in Financials

[SunsetGrill]

ECN Is Our Top Pick in the Specialty Finance Space, While AD Is Our Contrarian Play OUR TAKE: Our top pick within the Specialty Financials space continues to be ECN Capital, while Alaris is our contrarian play. We rate both stocks Sector Outperform. In our note, we provide our outlook and detail our expectations for upcoming Q3/17 results. CAD appreciation during the quarter is likely to cause some noise and headwinds related to earnings and book value, for those with significant U.S. operations. Our names, in declining order of exposure, are EFN, ECN, AD and to a lesser extent MSI. That said, the weakening of the CAD since Q3 is likely to provide an offset in Q4/17

We view Alaris as an attractive business model for investors seeking solid yield. The stock has been out of favour, largely reflecting the pace that has been required to clean up a number of challenged investment. We believe the focus for investors heading into the print is on commentary related to capital deployment and any additional insight related to SM Group and Alaris’s other challenged files.

Alaris Royalty Corp. Sector Outperform; $24.00 Target Price An attractive business model for investors seeking yield. Alaris is a specialty investment management firm that uses innovative financing structures primarily to invest in well-managed private companies through preferred shares. The business model was born out of a desire to create the optimal business model for investors seeking solid yield. Solid yield is generated from strong cash flow, relatively stable and predictable revenue streams, and growth. Focus will be on any commentary related to capital deployment and additional insight related to SM Group and Alaris’s challenge files. The stock has been out of favour, largely reflecting the pace that has been required to clean up a number of challenged investments. Heading into the print, investors are likely to focus on commentary related to capital deployment, given tat the company has already deployed $150M in capital, along with updates on SM Group and Alaris’s other challenged files. In September 2017, Alaris announced that the net amount it will receive from SM Group will not be sufficient to repay its receivables and that it will take a non-cash impairment charge on the book value. We expect management to provide further commentary on this matter. An active third quarter with a number of developments. A number of interesting developments in the third quarter caused Alaris’s share price to fluctuate from a low of $20 to a high of just over $23 in Q3 (see Exhibit 3): Announced Sequel redemption: During the third quarter Alaris announced that Sequel would redeem its units for US$91.7M, an 18% premium above Alaris’s book value and a CAD IRR of 29%. Shares of Alaris dipped after the announcement as Sequel at the time was Alaris’s largest partner in terms of annualized revenue streams at ~17%. Short report: Shares of Alaris plummeted by 8% following the release of a short report questioning the company’s business model. SBI investment: At the end of August, Alaris announced that it had invested US$85M (C$107.1M) in a new partner, Sales Benchmark Index, LLC (SBI), in exchange for US$11.1M (C$13.9M) of distributions. The deal is the largest investment in the company's history and we estimate the distribution from SBI will represent just under 20% of AD's current distribution. While SBI yields 13%, slightly below the average ~15%, Alaris is trading yield for larger participation in SBI's growth by expanding its distribution reset collar to 8% per year from the typical 5% or 6%. Update on SM Group: In September, Alaris announced that SM had received the final arbitration award from the international tribunal. The cash award for damages to SM was substantially less than Alaris had been expecting and SM Group did not make Q3 distribution payments to Alaris due to continued cash flow shortfalls in the business. In 2017-to-date, SM Group has only made $200K of payments to AD. Additional add-on investment: At the end of September, Alaris announced that it had made two followon contributions to its existing partners Sandbox and ccComm. Alaris invested an additional US$6M in Sandbox and US$2M in ccComm for annual distributions of US$0.9M and US$0.3M, respectively.

2017 capital deployment likely to be the second-highest on record for the company. Alaris has historically had a track record for capital deployment, having invested over $1B in 25 partners since 2011 (see Exhibit 4). During that period it has collected in excess of $350 million in distributions and $392 million in redemptions by seven partners. We estimate that in the past five years, Alaris has invested on average $130 million per year, reaching a record high of $178 million in 2015. 2017 YTD has been a solid year on the capital deployment front, with the company having already deployed $150M. That said, we are not expecting significant investments in the fourth quarter and are forecasting capital deployment to be around $150M in 2017 but to fall to $125M and $100M in 2018 and 2019, respectively. We expect Alaris to build on its growth through new investments and follow-on investments to existing partners, coupled with organic growth in distribution streams. Trimming estimates and introducing 2019 forecast. Heading into the quarter we have slightly trimmed our Q3 and full-year estimates, largely reflecting revised FX assumption as we fine-tune our forecast. We have also introduced our 2019 forecast. We are estimating Q3/17 NCOA/sh to decline by 3% QOQ to $0.40/sh. Our Q3 normalized EBITDA per share estimate of $0.55 is slightly lower than estimated consensus of $0.58. Exhibit 5 summarizes our full-year estimates. Maintaining $24.00 target price and Sector Outperform rating. As we roll forward our valuation year, we have maintained our target price. Our $24.00 target price is derived using a 14x multiple of our 2019E NCOA. On a NCOA (NTM) basis we estimate that Alaris currently trades roughly in line with its three-year average. We estimate that Alaris currently trades at just 14x its NTM NCOA, representing a cash flow yield of 7% (see Exhibit 6). We are looking to capital deployment as the next leg up for the stock, with an eye on continued progress in cleaning up challenged files. Yield spread differential likely signals a fair degree of risk has been priced into the stock. Since the start of the year, Alaris’s dividend yield has increased from 6.6% to 7.8% and the spread relative to the US Corp. BB Index is up 108 bp from 176 bp to 284 bp; this is a modest premium to the historical average spread (see Exhibit 7). This suggests that a fair degree of risk has been priced into the stock.

[gvixid]

Complete freefall today. Trading like garbage yet again. It's great that Scotia reiterates a $24 target. However, all the brokerages have been setting mid 20 - low 30 targets for two years, and we have yet to meet a single one of them.