Post by
SunsetGrill on Mar 07, 2018 12:30pm
Scotia - $23 - Outperform
PERTINENT DATA
Rating Sector Outperform
1-Yr. Target C$23.00
AD-T C$18.12
1-Yr. Return 35.9%
Div. (NTM) $1.62 Div. (Curr.) $1.62
Yield (Curr.) 8.9%
Valuation: 13x 2019E N
COA PERTINENT REVISIONS New Old CFPS from Ops18E $1.68 $1.63 CFPS from Ops19E $1.80 $1.77
timeline to clean up an unusually high number of challenged investments. We are encouraged by the progress made over the last few quarters along with the most recent developments, which include the closing of Agility's sale, along with improvements across two other challenged files that are likely to result in the resumption of royalty payments from one, and increased payments from the other. We believe the remainder of the portfolio is in good shape with an estimated 82% of partner revenue coming from companies that are increasing royalty payments through 2019. We continue to look for stronger-than-expected capital deployment activity as a catalyst to lift the stock over the coming twelve months with an eye on management's progress on cleaning up challenged files. The private equity environment remains highly competitive, but management sees opportunities to grow its capital deployment given rising rates, restrictions on the use of high debt levels along with its own new initiatives. Maintaining $23.00 target and SO rating. The stock remains out of favour, but we believe valuation remains attractive with an 8.9% dividend yield providing support. KEY POINTS Q4/17 normalized EBTIDA/sh (ex-items) of $0.51 was in line with expectations. Included in the non-core charges was a reserve related to the uncertainty of collecting a portion of promissory notes largely from Group SM, however, management expects the full recovery of the principal. The disappointment and challenges with SM were disclosed in Q3/17, but the additional reserve will not help boost investor confidence on the ultimate outcome. A new initiative announced in the quarter was Alaris' intention to not just invest in preferred shares of its partners, but also some small level of common stock, providing a source of additional upside and likely widening the scope of potential transactions that it can participate in. Alaris currently trades at 10.1x our 2019E net cash from operating activities (NCOA), well below its 5-year historical average of 14.9x, and at a 22% discount to its 3-year average of 12.9x.
Despite a number of positive developments, Alaris remains out of favour with investors. An elongated timeline required to address an unusually high number of challenged investments, combined with an intensely competitive environment for private equity, has put Alaris out of favour with investors. That said, the company has made significant progress across its challenged files over the past few months and deployed near-record amounts of capital into new investments in 2017, and expanded its bank lines and financial flexibility. We think demonstrating further momentum in capital deployment, continued growth and maintaining the health of the existing portfolio, along with avoiding further disappointment will be key for Alaris’ stock performance over the coming twelve months. Management expecting another record year for capital deployment in 2018. The private equity environment remains highly competitive but management sees opportunities to grow its capital deployment given rising rates, restrictions on using high debt levels along with its own new initiatives. Alaris has historically had a solid track record for capital deployment, having invested approximately $1B in 26 partners since 2011 (see Exhibit 1). During that period, it has collected in excess of $500 million in distributions and $448 million in redemptions by nine partners. We estimate that in the past seven years, Alaris has invested on average, $130 million per year, reaching a record high of $178 million in 2015. 2017 was a near record year with $175 million in capital deployed, reflecting a very strong second half of the year. Alaris has deployed C$19M so far in 2018, with management expecting another record year. That said, given the current environment and risk of potential redemptions, we are forecasting gross new investment of roughly $130M, more in line with the historical average for 2018 and $100M for 2019. We expect Alaris to build on its growth through new investments and followon investments to existing partners, coupled with organic growth in distribution streams. Management announced a number of updates and developments post-Q4/17, along with additional colour on its investments and some key events that transpired during the quarter. These developments include: a contribution to a new partner, redemption of units in a challenged file, and an improved outlook on some investments.
Agility Health Holdings Inc. On February 28, 2018, Alaris announced the closing of its previously announced redemption of Agility Health Holdings Inc. (AHI). Alaris redeemed all of its units in Agility for CAD$34M (US$26.5M), resulting in a total return of CAD$23.5M (US$17.5M) or 116% in CAD (87% in USD). The IRR on the investment was 25% CAD (18% USD). Recall, the Agility investment was one of Alaris’ challenged files. The total proceeds were used to pay down the company’s outstanding debt.
Heritage Restoration Inc. On January 23, 2018, Alaris entered into a subscription and operating agreement with Heritage Restoration Inc. (Heritage) for US$15M in exchange for preferred units. Heritage is a leading specialty contractor, providing masonry and masonry-related services to the commercial building industry in the New England area. Some of its services include: masonry procurement, installation and restoration, concrete structure restoration, waterproofing, and coating repair. As per the agreement, Alaris is entitled to an annual distribution of US$2.25M (or 2.9% of annualized revenue) for the first year (equates to an initial yield of 15%), with US$3M of the Heritage units redeemable at par at any time. The contribution is subject to a 6% collar which will reset for the first time on Jan. 1/19. The coverage ratio for Heritage at the time of the investment is between 1.5x – 2.0x.
Kimco. Management announced that it expects to receive $100K a month in partial distributions from Kimco, effective April 1/18. The announcement comes on the back of Kimco’s improving financial results and the approval of a new ABL credit facility with a new bank, which will replace its senior lender as of March 31/17. As part of the refinancing, Alaris will replace the US$6M subordinated debt in Kimco, paying cash interest of 12% annually (5 year payback). Its coverage ratio remains below 1.0x when considering all distributions owed to Alaris, although management noted that the ratio has improved since last quarter.
SCR Mine Services. Recall, SCR restarted its distributions payments of $100K per month to Alaris in July/17. SCR maintained the distribution payments through the end of the year. Management noted SCR’s financial results improved significantly versus the comparable prior twelve month period. With significant cash on its balance sheet to invest in capex and working capital, Alaris intends to amend its agreement with SCR to include a fixed portion of the $100K monthly distribution payment to add a variable format based on available FCF, with the ability to catch up previously unpaid distributions. While SCR’s coverage ratio improved sequentially, it remains below 1.0x when considering the full distributions for Alaris. At the current distribution rate of $1.2M annually, the coverage ratio is healthy at 1.5x to 2.0x.
KMH. Recall in June, Alaris redeemed all of its outstanding preferred units in KMH for a total consideration of $30.5M ($9.8M of cash and $20.7M of secured promissory notes). The $20.7M of promissory notes was issued by Phoenix Holding Ltd., with Alaris expecting the payment in three different tranches. The first tranche repayment of $12.4M is expected within the next twelve months, with the remaining $8.3M to be collected over a longer-term period as Phoenix continues with its strategic process and recapitalization of their U.S. operations. That said, post year-end, Alaris now has the significant rights as the secured lender. As the secured lender, it has the ability to force a sale of the business, which Phoenix has acknowledged, and a strategic process to realize the debt is underway.
Progress made on a number of challenged investments; the remaining portfolio appears to be in good shape. As discussed above, Alaris made progress on a number of its challenged files. We estimate 82% of the partner revenue comes from companies that are increasing royalty payments in 2018 (Exhibit 2). The overall portfolio remains in good shape as an estimated 96.8% of revenue contributed from investments remains greater than 1x (vs. 93.8% last quarter). Although down from 50% last quarter, a solid 33.8% of revenue was contributed from investments with a coverage ratio above 1.5x (see Exhibit 3).
Attractive 8.9% dividend, with payout ratio expected to drop to the mid 80% range through 2018. Management provided its 2018 outlook for revenue and G&A based on existing partners, putting its current run-rate payout ratio at just over 92.5%. Management also highlighted a number of considerations with a potential to boost cash flow through 2018 (see Exhibit 4).Given our expectations of capital deployment, combined with additional distributions from Kimco, we are projecting the payout to improve towards the mid-80% range for 2018.
Larger losses are an anomaly with historical IRR on exit likely averaging around 17%. Near-term investor focus and sentiment is likely on the write-down of Group SM in Q3/17 and its related bad debt reserving in Q4/17, however we believe this overshadows a more constructive historical track record (see Exhibit 5). Alaris has generated total returns of $307M (83%) in excess of its initial investment on partners that have either repurchased Alaris’ units or ceased operations.
Modest forecast revisions. With the quarterly results and outlook coming largely in line with expectations, we have made only minor adjustments to our forecast largely reflecting updates to our FX assumptions. Exhibit 6 summarizes the changes to our estimates.
Yield spread differential continues to signal a fair degree of risk has been priced into the stock. An alternative way to look at Alaris from a yield investor perspective is to track its dividend yield spread over a high yield Index. The spread relative to the US Corp. BB Index remains wide compared to its estimated historical average of ~55bp (see Exhibit 7). This suggests that a fair degree of risk has been priced into the stock.
Maintaining $23.00 target and Sector Outperform rating. Our target is derived using a 13x multiple of our 2019E NCOA. Alaris currently trades at 10.8x our NTM Net Cash from Operating Activities (NCOA), and a cash flow yield of ~8% (see Exhibit 8). This represents a roughly 16% discount to its historical 3-year average of 12.9x NCOA. We are looking to capital deployment as a catalyst to lift the stock over the coming twelve months with an eye on continuing progress in cleaning up the remaining challenged files. Maintaining Sector Outperform rating.