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Topic: Wealth Management

Takeover strategy adds risk for high-yielding Canadian stock

Investment Counsellor

Every Monday we feature “A Stock to Sell” as our daily post. With every stock or investment we recommend as a sell, we give you a full explanation of why we advise against investing in it at this time.

Exchange Income Corp. (symbol EIF on Toronto; www.exchangeincomecorp.ca) operates in two main areas: aviation and manufacturing.

The aviation business (63% of revenue) includes regional airlines Perimeter Aviation, Keewatin Air, Calm Air International, Bearskin Lake Air Service, Custom Helicopters and Regional One. These airlines serve communities in Manitoba, Ontario and Nunavut.

The manufacturing business (37% of revenue) includes WesTower Communications Canada (a maker and installer of wireless communication towers), Jasper Tank, Overlanders Manufacturing, Water Blast Manufacturing and Stainless Fabrication.

Exchange Income prefers to expand by acquisition. On November 12, 2014, it announced its biggest purchase to date: $246.0 million for St. John’s, Newfoundland-based Provincial Aerospace Ltd.

Provincial operates three distinct businesses:

  • Provincial Airlines operates about 210 regularly scheduled flights weekly in Newfoundland and Labrador, Quebec, New Brunswick and Nova Scotia. It also provides charter services across the region. The company’s fleet mainly consists of Dash 8s and Twin Otters.
  • In addition, Provincial Airlines operates Innu Mikun Airlines, a partnership with the Innu First Nations of Labrador that serves Labrador’s coastal communities.

  • Provincial Aerospace designs, modifies, maintains and operates sensor-equipped aircraft. It also operates maritime surveillance planes in Canada, the Caribbean and the Middle East.
  • PAL Aviation Services provides aircraft refuelling, ground handling and aircraft maintenance services at the Halifax and St. John’s airports.

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Stock investing tips: Subsidiary sold to help relieve high debt

In the three months ended September 30, 2014, Exchange Income’s revenue rose 6.7%, to $143.5 million from $134.5 million a year earlier. Before one-time items, earnings fell 2.7%, to $5.2 million from $5.3 million. Per-share earnings declined 8.0%, to $0.23 from $0.25, on more shares outstanding. The lower earnings are mainly because of higher interest costs and an increased tax rate.

Exchange Income has just raised its monthly dividend by 3.6%, to $0.145 from $0.14. The stock now yields 7.7%.

The company’s free cash flow (cash flow less capital expenditures) rose 2.7% in the latest quarter, to $11.4 million from $11.1 million. Exchange Income paid out dividends of $9.3 million (or 81.7% of free cash flow), so it will only be able to maintain its dividend—or raise it further—if its cash flow remains steady or rises.

Exchange Income recently sold its WesTower subsidiary’s U.S. operations for $200 million U.S. It will use the cash to pay down its long-term debt, which totalled $471.9 million on September 30, 2014. That’s a very high 93% of Exchange Income’s market cap.

The company’s growth-by-acquisition strategy adds a lot of risk, particularly because the firms it targets operate in cyclical businesses. Newly purchased companies may also come with hidden problems or face unforeseen setbacks. Meanwhile, the acquiring company’s managers have to divide their attention among unfamiliar firms and industries.

We don’t recommend Exchange Income Corp. If you own the shares, we think you should sell.

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