Pape Looks North of the Border

02/10/2006 12:00 am EST


Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

"Having just returned from The World Money Show, I can report that there appears to be growing awareness of the Canadian success story among American investors" says Gordon Pape, editor of Internet Wealth Builder. Here, he reviews the prospects "north of the border."

"More American investors are waking up to the fact that something rather intriguing is happening up there where all those cold fronts originate. The interest was heightened by a growing concern about the future of the US dollar. There were worries about the greenback last year, but at this year’s show the subject was top of mind, with speaker after speaker stressing the need to diversify globally.

"Traditionally, Americans have tended to be stay-at-home investors but this year I found them to be much more receptive to the idea of putting some of their money into foreign securities. Energy is top-of-mind in that regard. For example, I was bombarded with questions about the Alberta Oil Sands and how to invest in them. Some seemed surprised to find that they were rather late in coming to the party and that every Oil Sands stock has already experienced a big price run-up. They were looking for bargains and, of course, there are not many to be had right now.

"I also found a great deal of interest in the in-coming Conservative government of Stephen Harper, but also some misunderstanding as to what it all means. Many people I spoke to were under the impression that Mr. Harper’s administration would be a virtual clone of the Bush government in Washington. I found myself patiently explaining that while Mr. Harper may be closer to the US President on some key issues like Kyoto, public opinion will require him to maintain a strong Canada-first policy in his dealings with the United States.

"Meanwhile, here is a summary of the main points I made in my presentations:

  • A rising Canadian dollar. During the show, our loonie flirted with US88c before pulling back a little. Some were surprised to learn that our currency has appreciated more than 35% against the US dollar in the past three years. I pointed out that many economists believe we will hit US90c this year and par no longer seems like an improbability if oil prices stay high.

  • Moderate Canadian inflation. The US inflation rate of 3.4% is causing some concern, especially in the context of weak fourth-quarter growth and the lowest productivity gains in many years. There is hope the new Fed chairman, Ben Bernanke, will end the current round of interest rate tightening in March but core inflation must stay low for that to happen. I pointed out that Canada’s CPI rate of 2.2% and core CPI of 1.6% are both well below the US level, making any dramatic rate increases here unlikely.

  • Toronto to outperform New York. The Toronto exchange gained about 22% last year, while the S&P 500 was up 3%. I explained that I did not to expect another 22% gain in Toronto this year but that I believe 10% is a realistic target. In any event, I expect to see Toronto outperform New York again this year, with any currency gains a bonus for US investors.

  • Stable income trust prices. More US investors are discovering income trusts. Unfortunately, they appear to have overblown expectations regarding them. I had to explain that the yields have come down as the prices have risen so the big capital gains we have seen in recent years are not likely to continue. While trusts are still attractive for cash flow, I advised against investing in them in the hope of making a quick buck. If the yield looks good and the business is solid, fine, but be realistic in your targets.

"Overall, I came away from The World Money Show with the feeling that US investors are in a generally positive mood right now but are somewhat worried about domestic developments and more willing to consider diversifying internationally than in the past. It would not surprise me to see increased cash flowing into Canadian securities from the US this year as a result."

Meanwhile, contributing editor to Internet Wealth Builder, founder and manager of the ABC Funds, Irwin Michael, notes, "Outside of the cyclical commodity sectors, we have been able to discover a few hidden gems. Companies with hidden real estate, REITs that trade below net asset value (NAV), and broken income trusts have always intrigued us. We believe that Atlas Cold Storage (CA:FZR.UN Toronto) combines these three themes into one story and it is our pick of the month.

"Atlas is one of the most controversial names in the income trust sector. An investigation of its 2002 financial statements revealed that certain members of senior management team improperly assigned certain expenses to capital expenditures in an attempt to inflate net income. After the smoke cleared, distributions were suspended, management was ousted, and bankruptcy looked like a foregone conclusion.

"Since these turbulent times, Atlas’ new management team has instituted several initiatives to restore its business and balance sheet. One of the most significant developments has been the refinancing of all outstanding debt. Now, with only $100 million in long-term debt, the trust’s debt/equity stands at a conservative 30% (below the average for its peer group and for real estate investment trusts). This new package should help Atlas resume distributions in the middle of 2006.

Atlas is the second-largest cold storage operation in North America, providing warehousing and distribution services to the refrigerated food industry. We suspect that 2006 will be the year that Atlas zeroes in on its core operations. The trust has already started to show improvement in 2005 with revenue, gross margins, and earnings higher than 2004 levels. More importantly, net cash flow has increased by about 40% over 2004.

"As the bottom line starts to improve, we believe that current unit prices do not fully reflect Atlas’s underlying net asset value. Its US peers have been valued between $100 and $125 per square foot. However, Atlas’s most recent balance sheet reveals that the implied value of its buildings and real estate is currently between $45 and $55 per square foot. In other words, Atlas’s balance sheet does not accurately illustrate the true replacement cost of its assets.

"Based on a conservative valuation, we believe Atlas’ cold storage facilities alone to be worth, at minimum, $7 per unit. In addition to these physical assets, Atlas’ logistics and transportation division could be worth $1.50 per unit. Clearly, Atlas’ troubled past still casts a dark shadow in the minds of many investors. The pending class action lawsuit is currently asking for damages that exceed the market capitalization of the trust. In our view, a sizeable award is unlikely. With a focused management team, flexible balance sheet, and opportunities to grow the bottom line, Atlas is on the road to recovery.

"To communicate his belief in the future of the trust, Mr. Williamson, on his own accord, has purchased 285,000 units between $5 and $6. With an estimated NAV of $8.50 per unit, and an expected yield of 6%–8%, we believe the units represent good value at current levels. The units are also traded through the over-the-counter Pink Sheets in the US but volume is very light. Atlas is a buy for aggressive investors."

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