5i Research Blog
Jan 30, 2017 Why this high yield dividend name has caught our eye
Just a few days ago we sent out a notification to our membership about a high yield stock that was being added to our model income portfolio. The stock replaced a name that did well for us (Andrew Peller) but whose yield had fallen to a level that no longer made it a good fit in the portfolio. This new addition helped to add to our target portfolio yield of 4% to 5% while itself offers a dividend yield in excess of 8%.
Crius Energy Trust (KWH.UN) is involved in the sale of electricity and natural gas to residential and commercial customers in states across the US. With a business similar to Just Energy, which many Canadians may be familiar with, the company takes a bit of a different approach. Crius uses a white-label strategy where instead of knocking on your door as a stranger, the company partners with groups that are already ‘in the door’ as exemplified by a recent partnership through Comcast Energy Rewards. This type of strategy removes one of the harder parts in the sales process for Crius, that is getting the actual qualified leads. Crius has also recently purchased a solar business that was in bankruptcy. While this business still needs to be proven out, the ability to cross sell to individuals and an already existing base of customers that may be interested in solar power does offer some interesting potential for synergies. So while KWH may not be the most exciting stock in someone’s portfolio, here are a few things that have grabbed our attention:
An 8.7% yield that is growing
There are a few reasons this interests us. First, the dividend has been increased five times since January 2016. Additionally, the payout ratio looks sustainable at 59% as referenced in recent investor presentations. The other nice thing about the distribution is that at these levels, event if the stock did nothing for a year, investors would still be left with a very competitive return. With the general rule of thumb being for investors to expect 5% to 7% annual returns, an 8.7% yield does not sound too bad. But is it too good to be true? If the payout is sustainable, why does the yield remain so high?
With debt of $14 million against equity of $125 million and operating income of $5.6 million over a nine-month period, debt does not really seem to be an issue at the company either. It is not a perfect balance sheet that Crius holds, given a high level of intangible assets and goodwill but it still is not a company that looks to have a high yield due to an unsavoury amount of debt or a high payout ratio.
Capital gain potential
While already offering a good annual return through the dividend, KWH does seem to have some potential for capital gains through the stock. The company has recently launched a partnership with Comcast that could offer some potential growth in the customer base. KWH is also just starting out with its solar business, which has potential, but is likely the highest risk portion of the shares given the volatility surrounding solar. Regardless, if the company can gain some traction in this business, it could bring some life into the shares. The other area is that of the company getting acquired. While we would not invest on speculation of mergers and acquisitions, it is difficult to not view KWH as a target for a company such as Just Energy. Just Energy is nearly four times the size of KWH and the businesses are quite similar. Between a high dividend and low debt at KWH, it would be hard to envision a scenario where a purchase of the business would not be accretive to cash flows. Regardless, even if the solar business, Comcast partnership and any potential takeover all floundered at Crius, investors are still left with an ~8% yield and decent balance sheet. So what are the risks?
Whenever talking about investing, the risks need to be weighed and considered. The first one is simply that of customer churn. The business that Crius is in tends to have fairly high turnover, so the company always needs to be adding customers, and then some, to make up for customer attrition. There are also fairly low barriers to entry in the business. Finally, while the dividend does seem to have quite a cushion available, lower cash flows that lead to a dividend cut would be a big problem for the shares. What is interesting though is that we do not see the red flags one would typically see with a high yielding stock, namely a very high payout ratio, very high debt or a business in decline.
Overall, we like the outsized distribution of KWH that is supported by a strong balance sheet along with upside potential from recent initiatives. Investors looking for a higher risk, but outsized source of distributions may be interested in Crius Energy Trust.
We have also recently initiated coverage on Altus Group (AIF). Members can access the report here.
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