We’ve got a jam-packed e-mail today, going over Stocktrades Premium companies reporting earnings, some tricky terminology in the Equitable Bank acquisition that we will clear the air on, along with some comments on the state of the markets due to both rate fears and geopolitical concerns, and historically what has been the best thing to do.
Let’s start with our Foundational Lists which only saw the one company report earnings – TC Energy (TRP)
One of Canada’s leading midstream companies delivered solid results in which earnings of $1.06 beat by $0.02 and revenue of $3.58B beat by $18M. The company commented on the Coastal GasLink project which has been mired in setbacks.
While it is 59% complete, costs are expected to increase materially given the significant delays. Former Bull List stock Aecon (ARE) has also been caught up in this issue and we’ll be awaiting their upcoming quarterly results for additional commentary.
TC energy also expects to move forward with $24B worth of projects, of which $6.5B are expected to enter service in 2022. It also announced a 3.4% increase to the dividend.
While this is smaller than historical averages, it has already warned of slowing dividend growth in favor of capital project growth last fall. The company obviously sees opportunities to grow internally, and we’re excited to see what they can do.
Shifting to our Bull List, Restaurant Brands International (QSR) delivered a strong quarter
Earnings of $0.94 beat by $0.06 and revenue of $1.968B beat by $56M. This marks the first beat on the top and bottom lines in a few quarters and was in large part due to the performance of Tim Horton’s and Burger King.
These two restaurants topped estimates and delivered 10.3% and 11.3% comparable sales growth. A solid performance from the Tim Hortons segment is a strong sign, as the restaurant has been a drag on results for quite some time. If the company can turn that segment around, we could see strong growth moving forward.
Restaurant Brands also welcomed a new brand to the fold as it closed on its acquisition of Firehouse Subs which delivered comparable sales growth of 14.7% Q4 of Fiscal 2021. The company also announced a small 1.9% raise to the dividend. The smaller than average raise is likely tied to the Firehouse acquisition which caused debt ratios to rise and higher inflation costs which are impacting margins.
You can read our full report of Restaurant Brands Intl here
Newest Bull List stock Waste Connections delivered on earnings
For its part Waste Connections (WCN) delivered as expected. Earnings of $0.83 beat by a penny and revenue of $1.62B beat by $30M. The company delivered double-digit growth all around and released Fiscal 2022 outlook.
Waste Connections expects revenue (11.8%) and adjusted free cash flow (13.9%) to once again reach double-digit growth. Given the company’s strong cash generation, it is also targeting further acquisitions and increasing return of capital to shareholders.
Overall, Waste Connections is just doing its thing, and in the midst of a pretty volatile market correction, this quarter reiterated our reasonings for adding it to the Bull List.
You can read the full Waste Connections report here
A&W Royalty Fund posts strong results
Another defensive option added to the Bull List in light of the market correction and rising inflation was A&W Royalty.
A&W Royalties Income Fund (AW.UN) is finally starting to put the pandemic behind them as for the first time they announced all their stores were open and operating. This led to strong royalty income (+12.0%) and royalty pool same-store sales growth (+13.8%).
The company added 23 more stores to the royalty pool in the quarter and reported strong growth in gross sales. With the strong 2021, this marks the 20th year out of the past 21 that A&W has driven royalty sale growth and net restaurant growth. If it weren’t for the pandemic, there is a good chance it would have been 21 consecutive.
You can read our report on A&W here
Next, let’s turn our attention to Killam Apartment REIT (KMP.UN)
Valuations have come down a little as the entire REIT sector is undergoing a pullback. Killam proved yet again not to worry, which is why we think it is an excellent income play.
The company officially entered Dividend Aristocrat status this past year as it exited Fiscal 2021 with five consecutive years of dividend growth. In Fiscal Q4 revenue of $77M was in line with expectations and the company ended the year with FFO and AFFO payout ratios of 90% and 76% respectively. This is down from 98.8% and 82% previously.
The company also announced that it intends to close on $150M in acquisitions this year, up from its annual long-term target of $100M annually. Once again, it was a solid quarter by Killam and we view it to be one of the most attractive residential REITs in the country.
You can view our full report on Killam here
Up and coming this week
This coming week we are expecting results from Quebecor (QBR.B), Royal Bank of Canada (RY), Loblaw (L), and Home Depot (HD). While Toronto-Dominion doesn’t report until the following week, the bank earnings season is always one of the most closely watched and we’ll be paying close attention to Royal Bank on Thursday.
Worth noting, Canadian Imperial Bank (CM) and National Bank (NA) are expected to report this coming Friday.
There will also be the conclusion of our Model Portfolio updates with the late-stage portfolios. With all of the information this week, including earnings, the Equitable acquisition and the geopolitical tensions, we decided to push the portfolios out a week to avoid information overload.
Equitable Bank’s acquisition
Although this acquisition took place on February 7th, there’s been a lot of confusion on some terminology in the acquisition itself. Equitable is a popular stock here at Stocktrades Premium, so we figured this would be a good moment to clear up some things.
Of note, I (Dan) have added to my Equitable Bank position. As the company continues to execute, my conviction continues to grow. The company now sits alongside Telus, Toronto Dominion Bank, Constellation Software, and The Royal Bank of Canada as one of my Top 5 holdings.
First, the subscription receipts. If you had been reading the news on the acquisition, it’s possible that the offering of these tripped you up.
Mergers and acquisitions are far from guaranteed. Deals can fall through for a number of reasons and if a company were to simply issue shares to fund an acquisition, if that acquisition were to not go through, they’d be sitting on a stockpile of cash they really don’t need.
So in this instance, it is smarter for a company to issue a subscription receipt. The concept of the receipts is simple. Institutions who are involved in the offering will hold the receipts until the deal is closed. Upon closing, for every receipt they hold, they will be given a common share of Equitable Group. If the deal doesn’t close, they will get their money back.
Overall, the acquisition makes Equitable Bank the 7th largest bank in the country by assets. The acquisition of Concentra will add new products to the company’s pipeline, including the 7th largest trust in Canada.
The company expects the deal to be accretive to earnings per share in the first year of operation after it closes. And, this leads to our next topic, as many members have been asking what exactly this means.
If you’re unsure what “accretive” means, it has to do with how earnings per share are expected to be impacted coming out of a merger or acquisition.
As shareholders, we have a claim to a portion of the company’s earnings. This is primarily represented by the company’s earnings per share. A company’s earnings per share are calculated by dividing its net income after preferred share dividends have been paid by its shares outstanding.
For simplicity’s sake, we won’t involve preferred dividends in the example below.
If a company has $1M in net income and 1 million shares outstanding, earnings per share would be $1. To understand accretion and its counterpart, “dilution”, we can look to see how different situations can impact the earnings per share.
If that same company were to issue 200,000 shares to raise funding for an acquisition and that acquisition was not expected to increase net income by at least 20%, the acquisition would be considered dilutive.
Why? We have a situation now where there is a higher amount of shares outstanding relative to the company’s net income. If the acquisition wasn’t expected to drive any earnings growth over the short term, we’d have shares outstanding of 1.2 million and net income of $1M, for earnings per share of $0.83 instead of $1. Overall, your share of the company’s earnings has decreased.
However, when an acquisition is accretive, the impact of the acquisition when it comes to earnings is expected to exceed the issuance of the shares. Equitable Bank expects mid to high single-digit accretion in the first year. So in the situation above, this would be like the company issuing 200,000 shares, but net income growing to $1.3M as a result of the acquisition. We now have more shares outstanding at 1.2 million, but with net income of $1.3M, we have earnings per share of $1.08, higher than it was prior to the acquisition.
Although the company has issued more shares, as a shareholder you’ve ultimately benefitted. This is exactly why despite the subscription receipts being priced at $70.50 per share, Equitable is currently trading at $76.50. You’ll typically (but not always) see this type of reaction from an accretive acquisition.
Keep in mind, however, synergies with acquisitions and accretion always have a degree of speculation with them. Successful integration is far from guaranteed and there can certainly be bumps in the road. It is not out of the question for an acquiring company to expect an acquisition to be accretive and change its tune down the road. This is something to be aware of.
On a final note, it is not always a bad thing for an acquisition to be dilutive. As long-term shareholders, something that is immediately dilutive but is expected to bring strong value further down the line can be beneficial.
Geopolitical tensions and their history on the stock market
As I write this, the MOEX Russia Index fell 10.5% today, which not only brings it to its lowest level since November of 2020, but is its sharpest daily decline in nearly 8 years.
There is a significant amount of fear being priced into the markets right now, and it is virtually impossible to predict future movements of the market based on geopolitical issues. The only thing we can do is look at historical events and how the market has reacted. And surprisingly, it has a very short memory when it comes to things like this.
The average drawdown of the US stock market after a large geopolitical event is 5%. The most significant event? The 1941 attack on Hawaii’s Pearl Harbor, which caused a 1-day loss of nearly 4% and a near 20% bear market over the next 6 months. The collective strikes on US soil on September 11th 2001 was another large event, causing a near 5% daily drop and a 12% drawdown overall.
The key thing to note is historically it has taken on average just 3 weeks for the market to hit bottom prices, and only around 45 days to recover.
In fact, there have only been two major events since the second world war that have resulted in the US market taking more than 3 months to fully recover. That being again Pearl Harbor (300 days to recover) and Iraq’s invasion of Kuwait (189 days to recover).
We’re writing this because we’ve had a significant amount of members reaching out to us and asking how they should modify their portfolios based on the fears of war. And as we’ve mentioned, we cannot predict the future. But historically, doing nothing has been the best strategy.
In light of these issues and rising inflation overall, however, as we mentioned back in September of 2021 (you can read the e-mail here) holding exposure to oil over the short to mid-term is likely a strong hedge. I (Dan) currently hold a position in XEG, an ETF that holds some of the largest oil and natural gas producers in the country.
If you insist on looking for a defense-style company in light of global tensions, look no further than Foundational Stock Lockheed Martin. Of note, we viewed Lockheed as a strong company long before this situation arose. In fact, both Mat and I own it. If you’re going to buy, the purchase should be made with a long-term outlook, not based on events over the last month.
We hope this week’s e-mail answered a lot of questions members had. The markets have certainly not been fun over the last 6 months. But as we’ve reiterated time and time again, a strong portfolio begins with a good core.
This is exactly why we release the Foundational Stocks, of which both lists are outperforming their benchmarks to start 2022.
