Even though the markets slow down in the summertime, there’s no slowing down here at Stocktrades, and we have a jam-packed newsletter for you this week.
A lot went on this week, including a few US Foundational Stocks reporting exceptional earnings, the Microsoft/Activision deal finally having a resolution, and Telus, along with Telus International, reducing guidance in a big way.
In addition, we have our July Value Calls, which will feature two stocks we feel provide some strong value at this point. Let’s dive into the value calls first and get to the additional content afterward.
Note: We will focus on Telus and Telus International in next week’s newsletter. The reduction in guidance from both companies came out of left field and at the end of the week. So, we’re still digging to figure out what has been happening.
July Value Calls
A&W Royalty Income Fund (TSE:AW.UN)
A&W Royalty Income Fund has quietly remained on the Dividend Bull List for almost two years. The overall returns haven’t been world-beating by any stretch. However, with flat returns since November of 2021, including distributions, it’s only trailing the TSX Index by a few percentage points.
Why flat returns, especially from a company growing at an exceptional pace? It’s mostly due to the rising rate environment. A&W is an income fund that pays most of its earnings to shareholders.
Its business model is about as simple as it gets. Suppose you go to one of the restaurants in the royalty pool and order a $10 meal. In that case, A&W Royalty takes $0.30, pays its expenses and costs, and distributes the rest to you as a distribution. This is why you’ll often see payout ratios near or over 100% for this fund. It is designed to be that way.
The difficulty for a business structured this way is that fixed-income investments like GICs or bonds pay just as much in yield; investors don’t feel the need to take on the added equity risk by owning A&W.
The thought process is, “Why own a stock that can go up and down in value based on the market and human emotions when I can get the same yield with my initial investment guaranteed.”
However, for those with a long-term time horizon, we feel investors can take advantage of this short-sighted mentality and add one of the fastest-growing burger chains in the country at discounted valuations.
Despite growing royalty revenue and its restaurant pool in 21 of 22 years, with the COVID-19 pandemic being the lone outlier, the company trades at a 15% discount to historical valuations. If we exclude the short-term blip during the COVID market crash in March 2020, the company is yielding the highest levels witnessed since 2015.
The cooling of interest rates and inflation should be a tailwind for A&W’s share price. In our opinion, we feel it’s only a matter of time before it returns to historical valuations and grows in line with its overall growth.
This is a company that both Mat and I own and plan to accumulate over the long term.
Click here to read our full report on A&W Royalty Fund
Allied Properties (TSE:AP.UN)
While there is plenty of negative sentiment towards Real Estate Investment Trusts (REITs), the industry has been surprisingly resilient this year. The S&P TSX REIT Index is pretty much flat YTD (-0.26%) as most of the sector has begun to stabilize after a rough second half of 2022.
Conversely, Allied Properties (AP.UN) is still struggling to gain traction and is down by 14.77% year to date. That is the bad news. The good news is that the company has been consolidating in the $22 range since April, and the market is undervaluing what we consider the best office REIT in the country.
True, Office REITs are still struggling with the shift to work at home, and many big office buildings and industry competitors are seeing big vacancy rates.
The thing is, Allied is not one of them and is sporting vacancy rates in the 90% range – which is only a ~5% dip from where it was pre-pandemic.
Furthermore, the company recently announced the sale of its Data Center portfolio for $1.35B. Not only did they manage to get above IFRS value for the assets, but the company will be in a much stronger financial position once closed.
Estimates are that the sale will be 10% accretive to its net asset value, and management expects that debt/EBITDA will fall to ~8x by the end of Fiscal 2023. That would make it the best capitalized office REIT in the country.
It also expects debt to gross book value (GBV) to drop from 36.5% to 32.7%. These are material drops from the leverage ratios the company has today and significantly improves the company’s liquidity and ability to fund growth initiatives.
Speaking of which, the company also transitioned from a closed-end to an open-end trust. This means that the company is no longer restricted in terms of assets and, as per the company, will allow it to “remain competitive in the marketplace by ensuring the ability to take advantage of appropriate acquisition opportunities and to conduct its activities without unnecessary restrictions.”
In our opinion, both developments are positive, and despite Allied’s unique business model, the markets continue to undervalue the company. They are effectively treating Allied the same as the other office REITs when it is one of the best positioned to grow thanks to urban growth trends and will soon have a best-in-class balance sheet.
Today, Allied trades at a 57% discount to NAV, providing an attractive entry point for investors.
Of note, Mat recently initiated a position in AP.UN since he was light on his real estate allocation.
You can read our full report on Allied Properties here
US Foundational Stock Earnings
Blackrock (BLK)
After a mixed Q1, US Foundational Stock BlackRock delivered a solid second quarter. Earnings of $9.28 (+26%) beat by $0.86, and revenue of $4.46B (-1%) beat by $10M. The negative impact on revenue was primarily due to market movements which impacted Assets Under Management (AUM) mix. As we know, Fiscal 2023 has been a volatile year in the markets. Therefore, it is not surprising that these headwinds are impacting Blackrock.
That said, it was a pretty decent quarter. AUM increased to $9.425T from $9.09T at the end of last quarter (Q1), and since the end of December, it has seen an $831B increase in AUM. In Q2 of ’23, BlackRock delivered $80 billion of quarterly long-term net inflows (+4% annualized organic asset growth & 2% organic fee base growth). It saw $48B in ETF net inflows, up from $22B in the previous quarter. Of the $48B, 73% was associated with fixed-income ETFs as investors flock to safety thanks to market uncertainty, inflation, and higher rates.
Finally, it is worth pointing out that the company spent $375M on share repurchases in the quarter. On its quarterly call, it announced its intentions to repurchase “at least $375 million of shares per quarter for the balance of the year”.
Pepsi (PEP)
It was the second consecutive quarter in which PepsiCo delivered strong results. Earnings of $2.09 per share (+13% Y/Y) beat by $0.13, and revenue of $22.32B (+10.3% Y/Y) beat by $590M.
Organic sales grew 13% YoY, driven by better pricing as year-over-year (YoY) volume dropped by approximately 3% in the Convenience Food segment, while beverage volume dipped by 1% YoY. Frito-Lay (North America) again led the way with 14% organic sales growth, and Europe (+19%), Africa, Middle East & South Asia (+18%) and Latin America (+13%) all saw double-digit organic sales growth. In the end, organic growth was positive across all its product and geographical segments. As mentioned, volumes dipped mainly due to lower activity in North America which saw Quaker foods (-5%) and beverages (-4.5%) volumes dip YoY.
For the second straight quarter, the company also announced it was revising Fiscal 2023 guidance upwards. It now expects the following:
- A 10% (up from 8% and 6% before that) increase in organic revenue;
- A 12% (up from 9% and 8% before that) increase in constant currency earnings per share;
- A core annual effective tax rate of 20%
- Total cash returns to shareholders of approximately $7.7 billion, comprised of dividends of $6.7 billion and share repurchases of $1.0 billion.
The company’s long-term top-line growth target is 4-6%, so PepsiCo is delivering strong results and guidance. This is especially true when revenue guidance has almost doubled, and Core EPS guidance is up by 50% since Fiscal 2023 guidance was first introduced.
Activision/Microsoft Deal Closing
Back in January of 2022, we signalled to members that a large arbitrage opportunity was available on Activision (ATVI) with the announcement that Microsoft had offered to purchase the company at $95 a share.
At the time, the market did not believe the deal would go through, and Activision hovered around the high $70 mark. A patient investor, and one willing to take on a bit of risk in terms of the acquisition falling through, could have bought Activision back then and earned 21%~ when the deal closed. Both Mat and I ended up taking advantage of this opportunity and buying.
Fast forward 18 long months later, and the deal finally looks like it will close. Regulators who opposed the deal have lost, and appeals have also been exhausted.
The company should open on Monday at $95 a share, and investors who bought back in January 2022 will enjoy a 21% gain. Of note, the S&P 500 over this timeframe has lost 0.6%. This works out to be an outperformance of 20.4% relative to the S&P 500.
It’s a big win for investors, and I (Dan) plan to sell my shares on Monday if the price hits the $95 mark.
As to what I will buy with the proceeds, I will fill members in with that information later. I did have a healthy position (around 2.5-3% of my portfolio) in Activision, so I will have a decent amount of capital to deploy. I’m just going to take a few weeks to think about it and will be making a newsletter release based on the purchases.
