Anodyne

Tuesday, April 24, 2007

Anodyne Inc. Quarterly Report to Shareholders

TSE 300 index, 25 October 2006 - 24 April 2007: 10.12% gain

Anodyne Inc. 25 October 2006 - 24 April 2007: 12.51% gain

Relative result: 2.39%

Anodyne Inc. and the TSE 300 index have both been on a tear since my first attempt at public portfolio management toddled out into the world in late October 2006. For this first six month period, Anodyne Inc.'s gain has exceeded the TSE's gain by a small but significant margin.

The TSE figure is important because it shows what you could earn by passively investing your money in an index fund, thereby missing out on annual report reading, financial statement deciphering, and ceaselessly worrying when the CFO of one of your largest positions is dismissed just a week or two before the annual report's release. The index also serves as an objective benchmark of my investment choices. For example, if Anodyne Inc. reports a 5% gain, while the index gains 15%, Anodyne's gain sounds OK on its own, but actually represents poor relative performance. Similarly, if Anodyne loses 12% while the index loses 18%, the relative result indicates better-than-average performance, despite the objective loss.

I judge my performance, as should you, over the mid- to long- term. I hope to consistantly beat the TSE 300 index over a rolling three year period, a benchmark that many professional Canadian fund managers find hard to meet. Over shorter time periods the portfolio may fluctuate in value, sometimes impressively. These fluctuations don't bother me, and they shouldn't bother you, either.

That said, I have certain advantages that most real fund managers don't. I'm running money for myself, as a purely didactic enterprise. Real managers have clients, and need to maintain a cash position to satisfy the needs of clients who, for whatever reason, need to cash out in a hurry. I am not constrained by investment "themes" or "styles" -- I don't have to buy "mid-cap growth," or "large cap value," or maintain a certain percentage of the portfolio in a number of different sectors of the economy in the name of "diversification." I don't have to buy the stock of companies I don't personally like or understand. And I don't have to trade like mad, with all the frictional costs that implies, in order to hit a quarterly performance target that benefits the marketing department more than the fund's investors.

A few thoughts about some of Anodyne Inc.'s holdings:

Parkland Income Fund (PKI.UN) is by far the fund's largest position. Parkland is a diversified fuel retailer; they operate gas stations and convenience stores all over Western Canada, run a fuel transportation service, and own a refinery in Red Deer, Alberta, which was mothballed for many years, but has recently begun to process fluids for the oil drilling industry on a toll basis. I've owned Parkland in real life since my teens; it's the first company I ever attempted critical analysis on back in the 1980s, hunting up its annual reports in the old Vancouver Public Library at Burrard and Robson, and then writing away for more detailed information. It's steadily, consistantly profitable, and, to my mind, fully priced at $41+. I wouldn't add to my position at this price, but am more than comfortable to hold the units long-term. The 2006 annual report, which was just released a week or two ago, and is currently available on the SEDAR website, is a model of fiscal clarity.

Dominion Citrus Income Fund (DOM.UN) is a produce wholesaler with operations in Toronto and Quebec City. Most produce wholesalers are private companies, and the whole produce industry is undergoing massive consolidation as monolithic customers like Loblaw, Sobeys, and Wal-Mart attempt to trim their own costs by relentlessly squeezing their suppliers. On paper, Dominion lost money in fiscal 2006. But a little closer examination of the financial statements shows that much of that one-time loss was the result of a goodwill writedown (Goodwill is an accounting term, used to account for the excess an acquirer pays above and beyond the tangible value of an acquiree's assets). An adjustment to accounting goodwill doesn't neccessarily imply the impairment of a business' operating results. Dominion's margins are being squeezed ruthlessly by its customers, and its gross sales have definitely declined in the last few years, but it is still generating enough cash to cover its mouth-watering 15.5% yield.

A similar situation exists over at Hart Stores (HIS), an operator of mid-size bargain department stores in tertiary markets in Ontario, Quebec, and the Maritimes (ie., towns not large enough to attract Wal-Mart). Hart's recent financial results look ugly, until you consider that most of the charges are related to a single situation: the termination of a head office lease and the move to a new distribution complex. How many times is head office going to move in the forseeable future? Just once. So, the one-time charges should logically be backed out of the operating results. The consequence? Modified results that show consistant, steady growth. Hart even pays an annual dividend, which has slowly been increased each year. I own Hart in real life as part of my RRSP portfolio, and took advantage of the market's recent inability to figure out the significance of the termination-of-lease charges to load up on some more shares at bargain prices. (It should also be said that I sold some of Anodyne's position in Hart on the same day that I was adding to my real-life position, underlying my frequent warnings to not treat any of my purchases or sales as a recommendation to do likewise).

I don't get correspondence about Anodyne Inc. nearly as often as I do about magnolias, ghosts, art-crit & etc. That said, I will be happy to entertain questions about the portfolio's holdings, or what passes for my "investment philosophy." I've learned a lot by reading the writing of investors like Marty Whitman, Warren Buffett, and Toronto's Irwin Michael, who have generously shared their analysis of specific situations with readers not personally known to them. Working out philosophical problems in public -- aesthetic; financial; W.H.Y. -- seems to me to be a good way to go about things, and I'm proud to be able to make a small and idiosyncratic contribution here.

- posted by cjb @ 6:09 PM

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