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  With Consumers, the water's not necessarily fine

BENJ GALLANDER and BEN STADELMANN

Friday, August 27, 2010

Whenever an economic sector turns hot, institutions and stockbrokers love to foist it on the public.

Often enough, the outlook is not very good for investors — past returns are not necessarily indicative of future returns — but exciting segments are where the floggers of slog can make mucho dinero quickly, so out the door the shares fly.

One of the areas that sizzled a decade or so ago was the realm of income trusts, and purveyors took a relatively brief time to stuff the public with questionable wares. Many entrepreneurs were happy to oblige, seeing the opportunity for a quick payday as they unloaded the shackles of their corporations at inflated prices.

The original idea behind trusts was that the underlying businesses generate reasonably stable earnings. In this way, a healthy, reliable distribution could be pretty much guaranteed to the purchaser.

Alas, when investors gobbled up offerings, the salespeople went to work to find more product to sell. They became less discriminating about the predictability of earnings and marketed to an unsuspecting public outfits with fat distributions that would likely prove unsustainable.

And alack, in a huge number of cases, distributions were not only sliced and diced, but unit prices dropped, leaving people bereft of the anticipated revenue stream as well as part of the capital they invested.

Effectively, it was a double whammy and, for the many buyers in or entering their twilight years, it wasn't the boon they'd envisioned for their retirement.

While we often come down hard on the Harper government for boneheaded moves, the elimination of the vast majority of income trusts deserves kudos.

There is ample evidence that these investments don't just suck tax revenue from government, but a large proportion are simply not self-sustaining. There is a good reason why Australia, Great Britain and, to a large degree, the United States deemed these investment vehicles as folly and shuttled them to the sidelines.

Consumers' Waterheater Income Fund followed the pattern of many trusts. The public gulped it down at $10 in 2002, and the distribution was a fat 8.75 cents per month.

Then, every year through 2007, the distribution increased, peaking at 10.75 cents 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 5.4 cents 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 $4.65.

This income trust is now more intriguing. The distribution cut dropped the payout ratio from 117 percent one year ago to 52 percent 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, possibly extending the corporation's reach beyond its base in Ontario. It has sold units and convertible debentures to bulk up its 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 percent, down from 2.4 percent last year.

Plans are in the works to turn Consumers 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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