Monday’s breakouts: Nearing strong technical support, this trust yields 7% with a forecast price return of 31%
On today’s Breakouts report, there are eight stocks on the positive breakouts list (stocks with positive price momentum), and 137 securities are on the negative breakouts list (stocks with negative price momentum). The negative breakouts list will likely expand with equity markets continuing to slide lower today.
Discussed today is a high-yielding trust that is nearing strong technical support – Alaris Equity Partners Income Trust. Over the past nine trading sessions, the unit price has held steady, trading around the mid-$18 level. The stock has strong initial technical support between $17.50 and $18.
Alaris has five buy recommendations and two “sector perform” recommendations. The average one-year target price implies a potential price return of 31 per cent over the next year, not including the attractive 7 -per-cent yield (potential total return of over 38 per cent including the 7 per cent yield).
A brief outline on Alaris is provided below that may serve as a springboard for further fundamental analysis when conducting your own due diligence.
The trust
Calgary-based Alaris provides capital to private companies, referred to as “partners,” in exchange for income including royalties, dividends and interest. Distributions received are based on measures such as a partner’s percentage change in revenue, percentage change in same-store sales, and percentage change in gross profit. Distributions are adjusted annually based on a partner’s top line performance in its underlying operations (i.e. organic or internal growth) with specified limitations in many cases (like distribution collars of between plus or minus five to eight per cent per year with 17 of its partners). Alaris currently has 18 partners that operate across four sectors (consumer products and services, consumer financial services, business services and industrial).
In terms of total annualized partner revenue, only one partner accounts for more than 10 per cent of Alaris’ total revenue - Body Contour Centers, BCC, at 17 per cent of total annualized partner revenue. Overall, Alaris’ revenue is well diversified with 11 of its 18 partners each accounting for less than 5 per cent of total revenue.
Alaris has roughly 88 per cent of its fair value of investments in U.S. companies. As a result, investors should be aware of currency risk. A weaker U.S. dollar negatively impacts Alaris’ revenue.
Alaris operates a lean business with just 16 employees.
To fund its investments, Alaris has frequently announced financings. Most recently, in January, Alaris completed a $65-million bought deal offering of senior unsecured debentures.
Investment thesis
- Attractive yield: Currently yielding over 7 per cent with a conservative payout ratio.
- Revenue growth: Opportunities to enter into deals with new partners with $137-million of available capacity. However, on the first-quarter earnings call, CEO Steve King said there is a noticeable decrease in the number of companies seeking private equity capital and the average deal size may be smaller, “The number of deals being shown to us has gone down, which is not surprising. If you’re a really successful, profitable company that isn’t desperate, now would not be the time that you would choose to go to the market.”
- Organic growth: Tevenue from its partners has historically increased between 1 per cent and 8 per cent annually.
- Diversified investments.
- Supportive Earnings Coverage Ratios (ECR): The higher the ratio, the greater ability that a partner can cover its distributions to Alaris. Every single partner has an ECR exceeding 1 times and 14 of Alaris’ 18 partners have ratios of 1.5 times or higher. The portfolio’s weighted average ECR is over 1.75 times.
- Potential key risks to consider: 1) Higher interest rates and cost of capital; 2) Potential redemptions by partners that may reduce Alaris’ revenue. When asked about this on the earnings call, CEO stated, “Nothing imminent at all but there are a couple of companies in our portfolio that we’re having discussions with about that.”; 3) Fewer and smaller new partnership deals completed; 4) continued selling pressure in stock markets; 5) inflation, recession or stagflation negatively impacting Alaris’ partners; and 6) currency risk.
Quarterly earnings
After the market closed on May 5, the company reported first-quarter financial results that were above expectations. Revenue came in at $39.6-million, up 23 per cent year-over-year, topping management’s guidance of $38.6-million. Cash from operating, prior to changes in working capital totaled $35.4-million, a metric reported instead of normalized earnings before interest, taxes, depreciation, and amortization.
On the first-quarter earnings call, Mr. King commented on the challenging environment, “Looking forward, it’s difficult to predict how the various market forces are going to play out between the lasting impact of the pandemic to the impacts of the Russian invasion on Ukraine, general supply chain issues and the growing threat of inflation and interest rate increases. We’re in the midst of a very volatile world, obviously. Given the nature of our partners’ businesses being largely required service businesses, our exposure to these forces are actually quite limited. The earnings coverage ratio of our partners remain at historical highs, and they also are quite under-levered, so the risk of interest rate increases for our partners is quite minimal. We also feel very comfortable that given our dividend payout ratio is in the low 60′s, we’re generating a meaningful amount of free cash load to help fund our ongoing growth. And we will not be beholden to a very volatile capital market.”
He added, “The one place that we’re seeing an impact is on the number of quality companies that are going out to the market to access private equity capital. We’ve noticed a noticeable decrease in the number of opportunities being presented to us by the advisory network over the last two months, but with that being said, as a niche player in the broader private equity industry, we’ve always found unique opportunities to deploy our capital in any scenario. We’re uniquely suited to withstand an inflationary environment as well, given that our cash distributions we receive from our partners go up with the revenue that they achieve on an annual basis. And in an inflationary environment, those resets should elevate, giving our company a higher growth rate. Higher interest rates actually help us quite a bit in our capital deployment program as well, because it’s less attractive to use traditional private equity options that have high levels of debt involved.
“We have not seen a meaningful decrease in the valuations in the private markets as of yet, despite the decline in the public markets. This is largely due, in my opinion, to the massive amount of undeployed capital that still remains in the private markets. We’ll continue to be cautious in our growth and stay vigilant to our investment criteria as we work our way through this volatile time.”
Management guided to revenue of $56.1-million in the second quarter, in-line with the consensus estimate.
Distribution policy
Alaris pays its unitholders a quarterly distribution of 33 cents per unit or $1.32 per unit yearly, equating to a current annualized yield of 7.1 per cent.
The actual payout ratio in the first quarter stood at 54 per cent.
The distribution used to be much higher. In May 2020, management announced a 30 per cent distribution cut, slashing its annualized distribution to $1.16 per unit from $1.65 per unit due to impacts from COVID-19. Alaris has been slowly restoring its distribution. It’s most recent distribution increase was announced in July 2021.
In 2021, the blended tax rate was 37.5 per cent. In Alaris’ investor presentation released this month, management provided the following tax considerations, “Unitholders will pay tax on such distributions based on the character of the distributions…77.5 per cent of the distributions are taxed as Regular Income in the hands of the unitholders, 0.76 per cent of distributions are taxed as Dividends, and 21.7 per cent of distributions are Return of Capital (not taxable). The overall blended tax rate for a unitholder is 37.5 per cent. This can be compared to the overall applicable tax rate on a dividend from a corporation in Canada which is 34.3 per cent.”
Analysts’ recommendations
There are seven analysts who cover Alaris, of which five analysts have buy-equivalent recommendations and two analysts (Scotiabank’s Phil Hardie and RBC’s Geoffrey Kwan) have neutral recommendations.
The firms providing research coverage on the trust are as follows in alphabetical order: Acumen Capital, CIBC World Markets, Cormark Securities, Desjardins Securities, National Bank Financial, RBC Dominion Securities and Scotiabank.
Revised recommendations
In April, three analysts revised their expectations.
- Acumen’s Trevor Reynolds lifted his target price to $24.50 from $24.25.
- Desjardins’ Gary Ho raised his target price by 50 cents to $24.50.
- RBC’s Geoffrey Kwan downgraded his recommendation to a “sector perform” from an “outperform” but maintained his target price at $24.
Financial forecasts
According to Bloomberg, the consensus EBITDA estimates are $147.5-million in 2022, increasing 7 per cent to $157.5-million in 2023.
Financial forecasts have been rising. For instance, three months ago, the Street was forecasting EBITDA of $139.3-million in 2022 and $147.8-million in 2023.
Valuation
According to Bloomberg, Alaris is trading at an enterprise value-to-EBITDA multiple of 7.8 times the consensus 2023 estimate, below its five-year historical average of 8.2 times.
The average one-year target price is $24.29, suggesting the unit price has 31 per cent upside potential. Individual target prices arer: $21 (from Scotiabank’s Phil Hardie), $23.50, $24, two at $24.50, $25.50 and $27 (from National Bank’s Zachary Evershed).
Insider transaction activity
Over the past year, there has not been any trading activity in the public market reported by insiders.
Chart watch
With stocks coming under pressure, Alaris has also seen its unit price fall, but less so than its sector peers. For instance, over the past month, the S&P/TSX Small Cap Financials Sector Index has declined 8.6 per cent, while Alaris’ unit price has decreased 4.7 per cent, making it the top performing security in the sector. Year-to-date, the unit price is relatively unchanged, down 1 per cent, outperforming the S&P/TSX Small Cap Financials Sector which is down 12.4 per cent, making it the third best performing security in the sector.
Looking at major support and resistance levels, the unit price has initial technical support between $17.50 and $18. There is a ceiling of resistance between $20 and $20.50, and after that, around $23.50.
Despite the drop in the unit price over the past month, the security is not yet in oversold territory. The relative strength index is at 42. Generally, an RSI reading at or below 30 reflects an oversold condition.