Post by
SunsetGrill on Nov 06, 2019 7:34pm
Scotia Analysis
Rating Sector Perform
1-Yr. Target C$20.00
AD-T C$20.06
1-Yr. Return 7.9%
Div. (NTM) $1.65 Div. (Curr.) $1.65
Yield (Curr.) 8.2%
A Number of Positive Developments Should Help Ease Some Investor Concerns OUR TAKE: Modestly Positive. AD reported a largely in-line quarter with a number of positive developments. Key takeaways include: (1) BCC seeing a positive jump in its ECR ratio, easing some investor concerns around its challenges; (2) AD increased the limit of its credit facility, allowing for additional capacity for capital deployment; and (3) a number of smaller deals are expected to materialize prior to the end of the year. Management remains bullish on its capital deployment outlook as it noted the pipeline remains active, with the company expected to remain busy on the deal front in the near term. The team expects the redemption of Sandbox to materialize in the coming weeks, although management has limited visibility into the potential return it may receive given a few moving parts. Maintaining $20.00 target price and SP rating. While AD's shares have rebounded from recent lows, the stock continues to experience volatility, likely underpinned by fragile investor confidence amid a number of lingering uncertainties, which are likely to recede given the progress made on a number of fronts. With limited expected nearterm upside, we believe the company's shares are fairly valued, and are maintaining our Sector Perform rating. KEY POINTS Normalized EBITDA/sh of $0.71 was right in line with our forecast, but a touch below the Street's estimate of $0.72. This quarter's print showed a 29% y/y increase mainly from a strong top line, reflecting the increased distributions from new partners, 2019 positive resets, and follow-on contributions into a number of partners. NCOA/sh of $0.55 came in a bit ahead of our forecast. The Q3/19 payout ratio was 75.2%, and the combined rate for the first nine months of 2019 was 79.2%, in line with management's previously stated goal of bringing it below 80%. On net, the health of AD's investment portfolio appeared to improve, and remains in good shape. The quarter saw 14 partners experience no change in their earnings coverage ratio (ECR), while Fleet and BCC, which previously experienced some challenges, showed some improvements. That said, these improvements were met with a slight deterioration in Sandbox’s ECR to 1.0x-1.2x. As at the end of the quarter, three partners have ECRs less than 1.0x, one in the 1.0x-1.2x range, five in the 1.2x to 1.5x range, three in the 1.5x to 2x range, and five above 2.0x.
While capital deployment garners much of the headlines, we encourage investors to focus on “net capital deployment,” which incorporates redemptions of investments over time. While much of the attention is paid to the outlook for gross new investment activity, we think the more telling metric is net new investment, which reflects early redemptions and sale of legacy investments. We believe this better reflects the growth outlook, along with true underlying funding needs given the ability to recycle capital. While management continues to expect elevated levels of capital deployment, as mentioned, it is also in the process of redemption of its investment in Sandbox (Q3/19 fair value of $53.2M). Net of redemptions, we are projecting net capital invested of just under $140M for 2019, before moderating to roughly $30M in 2020, and just under $50M for 2021. That said, we believe further net capital deployment could be a source of upside to our outlook and target. Near-term liquidity not likely an issue, with a higher limit on the credit facility, and proceeds from expected Sandbox sale over next few weeks expected to return leverage ratio to more normal levels. Following its most recent investment, Alaris has just under $270M drawn on its credit facility. This would leave it with total additional debt capacity of ~$110M, consisting of roughly $60M of capacity from the credit facility, that saw its limit increased from $300M to $330M, along with an additional $50M from the accordion feature (see Exhibit 4). The proceeds from the expected Sandbox sale over the next few weeks are expected to return leverage ratio to more normal levels. Management did not provide any indication on any potential premium it may receive on the sale of Sandbox given that there are a “whole bunch of different factors in play” in terms of the waterfall of proceeds that need to be sorted. Until the company receives clarity on those, it has no visibility if it will receive a premium on the preferred shares or not. Target Intact; Modest Revisions to Our Forecast As We Fine-Tuned Our Capital Deployment Forecast Minor forecast revisions as we refined our capital deployment outlook. We have refined our forecast, which resulted in modest revisions to our estimates. Our revisions largely reflected (1) the timing and amount of the capital deployment on the back of the increase in the company’s credit facility limit; (2) fine-tuning some collar resets effective Q1/20 on the back of improved visibility into the performance trends of the underlying investments; and (3) f/x assumptions. As a result of these changes, our 2020E forecast declines very modestly largely due to timing, with 2021E largely intact (see Exhibit 5). Maintaining $20.00 target price and Sector Perform rating. Given modest revisions to our forecast, we are maintaining our $20.00 target price. Our target price is derived from an equal weighting of a 7.0% NCOA/EV Yield (2021E) and 9.5x EV/EBITDA (2021E). The stock is currently trading at 6.6% NCOA/EV (NTM) Yield and 10.4x EV/EBITDA (NTM; see Exhibits 6-7). We believe the significant stock volatility over the past 12 to 24 months demonstrates the combination of fragile investor sentiment and a series of upside and downside surprises. The stock appears to be fairly valued; with limited upside implied by our target price, we remain on the sidelines on the name.
Overall Portfolio Remains Relatively Stable and in Decent Shape with a Couple of Investments Trending Positively in the Quarter Overall portfolio remains in good shape with BCC and Fleet showing improvement, while Sandbox saw its ECR deteriorate. The health of Alaris’ investment portfolio remains in decent shape (see Exhibits 1 and 2). Compared to last quarter, 14 partners experienced no change to their earnings coverage ratio (ECR), while Fleet and Body Contour Centers (BCC), which previously experienced some challenges, showed improvements. These improvements were offset by a deterioration in Sandbox’s ECR. Fleet (~1.8% of total distributions) saw a sequential improvement as its ECR moved from 1.2x-1.5x to greater than 2.0x. Body Contour Centres (~7.4% of total distributions), which saw its ECR dip below 1.0x in Q4/18, saw a notable jump in its ECR from less than 1.0x to 1.2x-1.5x. In contrast, Sandbox saw its ECR decline from 1.2x-1.5x to 1.0x-1.2x, largely due to a loss of a couple of sizeable customers, who are in the midst of being replaced. In addition, higher capex as a result of the company moving into a new floor in their office building also served as a drag on the ECR. As at the end of the quarter, three partners have ECRs less than 1.0x, one in the 1.0x-1.2x range, five in the 1.2x to 1.5x range, three in the 1.5x to 2x range, and five above 2.0x.
We are encouraged by the improvement demonstrated at Body Contour, but Kimco’s recovery appears more protracted than we had hoped: Body Contour Centers’ (BCC) ECR improved as the company appears to be putting its challenges in the rear-view mirror. In Q4/18, BCC’s coverage ratio slipped to just under 1.0x from 1.5x-2.0x, where it remained until Q2/19. At the time, management noted the slide in the coverage ratio occurred as BCC grew and opened more clinics. Its management team outsourced the recruiting of the sales team, and as a result, execution of the sales team in certain locations was below BCC’s internal standards and resulted in missed sales opportunities. Management of Alaris then met with BCC’s team, who identified and addressed the issue, and Alaris remains comfortable with the company’s long-term prospects. Management had noted last quarter that it was forecasting EBITDA growth and improvement in BCC’s coverage ratio, as continued improvement in sales conversion that negatively impacted BCC’s profitability in late Q4/18 were expected to materialize in Q3/19 and Q4/19. With the notable improvement recorded on the back of significantly increased revenue and EBITDA (compared to prior year), we believe investors will be monitoring to the company’s ability to sustain its current ECR level moving forward.
No miss on Providence’s distributions in Q3/19 following reduction earlier in the year given challenges with the loss of a major customer. Developments surrounding Alaris's investment in Providence were a focus heading into Q1/19, following actions taken by Providence's senior lender to block distributions to Alaris in the wake of financial deterioration driven by the loss of a major customer. This drove a fairly dramatic sell-off in the stock in April, with investors likely fearing a full suspension of the distribution through 2020 and significant write-down of that investment. That said, the near-term outcome was not as bad as feared, with the senior lender providing a two-year forbearance and permitting a modified distribution to Alaris, representing ~60% of the contracted distribution over the same period. As a result, starting April 2019, Providence has been paying Alaris US$195K/month for the next two years. With Providence making its revised contractual distributions to Alaris for the second consecutive quarter without any issues, we believe the immediate concern with the investment appears to have subsided for now. Timing for Kimco turnaround appears to be more protracted than management had hoped. Alaris noted that this quarter’s disappointing results were driven by a revenue issue as Kimco has been able to successfully downsize its expense. Kimco made some significant changes to the sales force, and the management team is optimistic that the company will get back on track. While Alaris had anticipated distributions to resume in late 2019, it has now pushed the timeline out further into 2020. Management Remains Bullish on Deal Pipeline with Additional Deals Expected to Materialize Prior to Year-End Deal flow picked up through mid-2019, although Sandbox redemption expected in the coming weeks. After deploying a record level of capital in 2018 at $185M, which saw investments in four new partners along with a couple of follow-on contributions in current partners, deal flow picked up through the mid part of the year following a slow start to 2019 (see Exhibit 3). Alaris’s most recent investments include deploying just under C$150M via a US$60M follow-on contribution in Planet Fitness and a C$70M investment in Amur Financial Group. PF has been one of AD's top-performing partners for more than five years. Alaris initially made its investment in PF in 2014, when the company had 27 clubs opened, serving ~95K members. Today, the company operates 63 clubs in various U.S. states, serving over 530K members, with aspirations of opening 15 new clubs by 2020 and having a club count in excess of 95 by end of 2024. Meanwhile, Amur was founded 30+ years ago and is one of Canada's leading fully integrated independent originator, manager, and servicer of home equity loans. Its business model is based on home equity loans being issued for debt consolidation, home renovation, or other uses. Amur has two revenue streams: mortgage origination (through Alpine Credits) and investment management. In addition, Alaris is also in the redemption process of investment in Sandbox (Q3/19 fair value of $53.2M), which should materialize in the coming weeks. Alaris is on pace for a record year on the capital deployment front, with management expecting a few smaller deals to materialize in the U.S. prior to the end of 2019. In terms of capital deployment, Alaris has historically had a solid track record. We estimate that from 2011 to 2018, Alaris has invested, on average, ~$135 million per year, with the record high being set this past year. Year-to-date, Alaris has deployed ~$170M. Management noted that its deal pipeline remains active, with a number of smaller transactions likely to materialize in the coming weeks. More specifically, the company is looking at a mix of follow-on and new investments in the US$6M-$12M range, all sourced south of the border. Management also noted that it is currently seeing a diverse group of companies in its pipeline, into which it has a roughly 90-day visibility. The team is seeing more cyclical-type deals show up than in the past year or two.
While capital deployment garners much of the headlines, we encourage investors to focus on “net capital deployment,” which incorporates redemptions of investments over time. While much of the attention is paid to the outlook for gross new investment activity, we think the more telling metric is net new investment, which reflects early redemptions and sale of legacy investments. We believe this better reflects the growth outlook, along with true underlying funding needs given the ability to recycle capital. While management continues to expect elevated levels of capital deployment, as mentioned, it is also in the process of redemption of its investment in Sandbox (Q3/19 fair value of $53.2M). Net of redemptions, we are projecting net capital invested of just under $140M for 2019, before moderating to roughly $30M in 2020, and just under $50M for 2021. That said, we believe further net capital deployment could be a source of upside to our outlook and target. Near-term liquidity not likely an issue, with a higher limit on the credit facility, and proceeds from expected Sandbox sale over next few weeks expected to return leverage ratio to more normal levels. Following its most recent investment, Alaris has just under $270M drawn on its credit facility. This would leave it with total additional debt capacity of ~$110M, consisting of roughly $60M of capacity from the credit facility, that saw its limit increased from $300M to $330M, along with an additional $50M from the accordion feature (see Exhibit 4). The proceeds from the expected Sandbox sale over the next few weeks are expected to return leverage ratio to more normal levels. Management did not provide any indication on any potential premium it may receive on the sale of Sandbox given that there are a “whole bunch of different factors in play” in terms of the waterfall of proceeds that need to be sorted. Until the company receives clarity on those, it has no visibility if it will receive a premium on the preferred shares or not. Target Intact; Modest Revisions to Our Forecast As We Fine-Tuned Our Capital Deployment Forecast Minor forecast revisions as we refined our capital deployment outlook. We have refined our forecast, which resulted in modest revisions to our estimates. Our revisions largely reflected (1) the timing and amount of the capital deployment on the back of the increase in the company’s credit facility limit; (2) fine-tuning some collar resets effective Q1/20 on the back of improved visibility into the performance trends of the underlying investments; and (3) f/x assumptions. As a result of these changes, our 2020E forecast declines very modestly largely due to timing, with 2021E largely intact (see Exhibit 5). Maintaining $20.00 target price and Sector Perform rating. Given modest revisions to our forecast, we are maintaining our $20.00 target price. Our target price is derived from an equal weighting of a 7.0% NCOA/EV Yield (2021E) and 9.5x EV/EBITDA (2021E). The stock is currently trading at 6.6% NCOA/EV (NTM) Yield and 10.4x EV/EBITDA (NTM; see Exhibits 6-7). We believe the significant stock volatility over the past 12 to 24 months demonstrates the combination of fragile investor sentiment and a series of upside and downside surprises. The stock appears to be fairly valued; with limited upside implied by our target price, we remain on the sidelines on the name.
Q3/19 normalized EBITDA/sh was in line with our forecast. Alaris reported normalized EBITDA/sh of $0.71, which was right in line with our call, but came in a touch short of the Street’s estimate of $0.72 (see Exhibit 8). This was up a healthy ~7% q/q, and a robust ~29% y/y. The y/y growth was largely from a strong top line reflecting the increased distributions from new partners, 2019 positive resets, and follow-on contributions into a number of partners. Net cash from operating activities per share came in a bit ahead of our forecast. Net cash from operating activities per share (NCOA/sh) in Q3/19 of $0.55 came in ahead of our forecast of $0.48, and was up ~20% y/y. The y/y gain was also driven by higher distributions, partially offset by higher finance costs. Sequential decline in payout ratio. Alaris posted a Q3/19 payout ratio of 75.2%, down from 94.3% last quarter. Management estimates the run-rate payout ratio at roughly 84%, in line with last quarter, when including run-rate distributions, overhead, and existing capital structure.