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Trust's Yield Heats up After Cold Shower

09/21/2010 12:09 pm EST


Benj Gallander

President, Contra the Heard

An out-of-favor Canadian supplier of rented water heaters is yielding well north of 10%, write Benj Gallander and Ben Stadelmann in Contra the Heard.

Consumers Water Heater Income Fund (Toronto: CWI.UN) followed the pattern of many trusts. The public gulped it down at $10 in 2002, and the distribution was a fat C$0.0875 per month. Then, every year through 2007, the distribution increased, peaking at $0.1075 in 2007, where it stayed through most of 2009.

The unit price jumped up handsomely, touching $18.25. But in 2009, the distribution was cut in half, to $0.054 per unit. Predictably, the trading price swooned, touching a low of $3.22. Pity investors who were in for the long haul—they were in for a cold shower indeed.

That debacle enticed Benj to buy at $4.31 last October. Ben continues to kick the tires. Consumers currently trades around $4.75.

This income trust is now more intriguing. The distribution cut dropped the payout ratio from 117% one year ago to 52% in the most recent quarter, making it much easier to maintain. Revenues are trending upwards, hitting $51 million, from $48 million this time last year. The big negative, though, is that earnings dropped from $7.5 million to $2.3 million.

Management is looking at growth opportunities, perhaps to extend the corporation’s reach beyond its base in Ontario. Units and convertible debentures were sold, bulking up cash to $76 million from $25 million. The vast majority of the debt load has been transitioned from short to long term, but it is fairly fat at close to $600 million, given annual revenues of around $200 million. This entity would be well advised to take a firmer hand on the debt and taper expansion plans until the balance sheet is firmed up.

One key metric for this enterprise is the customer attrition rate. There are alternatives to renting a water heater—including buying one outright or installing a tankless system—and the rate at which consumers are pursuing them is increasing dramatically. Recently, the organization has been focusing on slowing this trend, and its efforts appear to be paying off. In the most recent quarter, the attrition rate was 1.6%, down from 2.4% last year.

Plans are in the works to turn Consumers [from a trust] into a corporation in the fourth quarter of this year. While the conversion itself is of minor consequence, the future dividend is significant. While a cut is a real possibility, odds are that if it happens, it will be nominal. A drop in the trading price would be expected, at least in the near term.

 At this point, many investors are grabbing the distribution, knowing that in the longer term there is a realistic possibility of capital appreciation. A double wouldn’t be out of the question, a result that would keep shareholders warm and toasty.

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