Annual report season!

Two up for discussion this evening. Parkland Industries sells gasoline in non-urban Western Canadian markets through its Fas Gas branded stations, familiar to any book scout driving the Trans Canada east from Kamloops, and also owns a refinery, now mothballed, in Red Deer, Alberta. I've followed this one on and off since high school. A little pricey now, since its conversion to an income trust a year or two ago, but margins are rock-solid on the core business, and the income payout is more than covered by earnings. Note the annual report paragraphs concerning the company's ongoing negotiations with the Blood Tribe of Red Deer vis-a-vis selling the refinery to the tribe; a successful sale will apparently boost cash flow 20% or so from current levels. The sale's timing is uncertain, hence impossible to accurately value via a discounted cash flow analysis, but, if completed, should provide a nice earnings boost some time in the next few years. I have tried to construct a portfolio packed with potential "positive earnings surprises" like this one; none of my investments are made strictly on the basis of their presence -- no sense in paying present dollars for hypothetical future earnings -- but they do lighten my trademark dour mood when they go off without a hitch, like fireworks that rise just slightly above their neighbors.

Dominion Citrus is an Ontario-based produce wholesaler busily remodelling itself as a "diversified food service company." Margins are tight on the core business (selling carrots, apples, onions & etc. from a terminal in downtown Toronto to customers like the Real Candian Superstore), so the ambitious management is diversifying by purchasing thematically related businesses like a line of fine Italian pastas, oils and sauces; a maple syrup processor; a Quebec-based produce distributor, & etc. No problems with the core business or the acquisitions, which are producing solid financial results. Check out the margins, which are expanding every year, and the terrific ROE. But the discipline management shows in running its various businesses doesn't carry over into its investing and financing activities, as disclosed in the management information circular sent in advance of the AGM.

Some things that give me pause:

• Management's dilution of existing shareholders' equity by continually issuing new shares for acquisitions and "investing activities," like the share issue made in 2002 to fund an ill-starred takeover bid of Humpty Dumpty, Inc., a Waterloo-based snack food maker whose balance sheet is a mix of lame management excuses for piss-poor financial performance and a textbook example of the persistant overuse/abuse of bank debt. The Humpty Dumpty investment is still carried on Dominion's books as a loss, and Humpty Dumpty's inept management doesn't give me any hope that the situation is going to change any time soon.

• A provision to dilute current shareholders by up to 25% (!!!) in order to fund "working capital requirements" for acquisitions; why these can't be addressed using the company's existing banking and credit facilities is left unexplained.

• Options and more options for senior management! Which, unsurprisingly, will help managerial shareholders assuage the pain non-managerial stockholders will experience as their equity trickles away like sand through their fingers.

None of these complaints take away from the undeniable skill Dominion's managers bring to running their core businesses. But they have the depressing and all-too common effect of converting present profitability into future hypotheticals, spreading a small pool of profits thinner and thinner across an ever-expanding bed of shares. Count my proxies as a big fat gaff to the head of the managerial genius who thinks that issuing new shares, or options for that matter, is a cost-free activity.


- posted by cjb @ 10:51 PM