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  A time to reap?

BENJ GALLANDER and BEN STADELMANN

Friday, August 14, 2009

Assuming the role of clinician to your stock portfolio means having to constantly confront issues that will impact your results. Some concerns are naturally more pressing than others. But even if the signs are there, human frailties can prevent investors from acting on them. Then the shoe drops.

We haven't escaped this outcome in the past, and a conscious effort is being made to avoid repeats. As such, the level of comfort with our holding in Viterra has diminished relative to the company's acquisition trend.

Viterra can be considered as the house that Mayo Schmidt built. This ambitious CEO has always been forthright about his vision of expanding the company into a global player, even when it was formerly known as Saskatchewan Wheat Pool. With his focus firmly on the next 10 years, Mr. Schmidt is banking on the demand for commodities to increase by 20 percent.

Having barely evaded bankruptcy less than five years ago, it seems almost cavalier in its ignorance of its own history. The current blockbuster acquisition of ABB Grain, the former Australian Barley Board, will add a lot of new debt to an already large figure.

The silo was previously crammed with the takeover of Agricore United. Associated Proteins was bought this summer for roughly $64 million and was part of the reason why Viterra raised another $300 million from an offering of five-year notes at an 8.5 percent coupon rate — relatively rich, considering we're in a low-interest environment.

Shareholders had already been diluted to the tune of $450 million in a new stock offering at $8 per share. One hopes that we can make it past the first frost without another of Mayo's corporate actions.

Certainly, these transactions have the potential to be advantageous, if the company doesn't drown in the debt first. The Associated Proteins deal strengthened Viterra's position as the Canadian leader in canola exporting.

Adding ABB will improve access to a highly desirable Asian market hungering for grain. Yet the claim of new synergies created will likely just cover the additional interest payments from the financing.

Another question is the upcoming harvest. Prairie wheat production is estimated to drop 20 percent, with total crop production down by 50 percent. A reduction in shipments could crush Viterra's revenues. The firm's second-quarter results were only so-so, and the company lost $6.6 million in the first six months of the year.

Thus far we are profitable with our shares, which were purchased at $5.67. We sold 55 percent of our position in March of 2008 at $13.65, a nice stretch above our initial sell target of $12.74. At that point we were much more concerned about selling too early and missing upside, rather than the downside risk.

As do many others, we find Viterra's long-term prospects to be compelling. It is no surprise that this company is a favourite among many large cap Canadian equity fund managers. In the longer term, as they profess, demand for food from developing countries should continue its rapid growth. We also think it is realistic that Mayo can eventually pull off his bold scheme to lead a global company. But in the here and now, our concerns aren't being alleviated.

So the question remains: in keeping with our commitment to preventing the shoe from dropping, how should we act with Viterra? The shares are trading near $9, which is reasonable for an immediate exit point. But historically, this stock does well towards year-end. Yet, if the crop numbers are indeed poor, the sell target likely won't be retouched this annum and the stock could fall a distance. At this point in time, fate will be tempted.


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