Stock Market Smarts: Exchange Income – A Risk/Return Trade-off
The 7.3 per cent yield looks great but there’s no free lunch in investing.
One of the axioms of investing is that there’s no free lunch. There’s always a price to be paid.
If your main priority is to preserve capital, that price is a low return. The greater the degree of safety, the less your profit will be.
Conversely, if you goal is to generate above-average returns, the price is enhanced risk. No one is offering something for nothing; if you want to earn more from your investments you have to be prepared to take on enhanced risk.
Recently, I revisited Exchange Income Corp., a company I had recommended years ago, sold for a profit, and then allowed to slip below my radar. I was impressed with what I found so I’m once again suggesting readers take a look. But fair warning: this stock falls into the high risk/high return category. The yield is excellent, the potential for capital gains is good, but there’s risk as well and the market is pricing it accordingly.
Here are the details.
Why I like it: The company is experiencing the strongest growth phase in its history and is passing on the benefits to shareholders. The dividend has been increased twice in the past 12 months, from $0.14 per month in November 2014 to $0.16 per month currently. As a result, investors are enjoying a very attractive yield, plus there is the prospect of future growth through acquisitions.
Financial highlights: Third-quarter results were very good across the board. Revenue was up 48 per cent from the same period a year ago, to just under $213 million. Adjusted net earnings came in at $18.8 million ($0.76 per share) compared to $6.1 million ($0.27 per share) in 2014. Free cash flow less maintenance capital expenditures was $1.01 per share, a 71 per cent improvement year-over-year. The payout ratio based on this metric was 46 per cent, down from 71 per cent in the same period last year.
For the first nine months of the fiscal year, revenue was up 44 per cent to almost $583 million. Adjusted net earnings were $39 million ($1.65 per share) compared to $8.9 million ($0.40 per share) in 2014. The payout ratio was 59 per cent, a far more sustainable figure than the 119 per cent of the previous year.
Risks: The aviation segment of the business operates mainly in the Canadian north, so operations slow down in the winter months. Therefore, expect fourth-quarter results to be less impressive although the company believes that this will still turn out to be the most profitable year in its history.
Any company that is acquisition driven, as this is, runs the risk of a deal going sour. There are also short-term costs involved in absorbing new companies into the existing system although long-term synergies should more than offset this.
There’s also economic risk as a lot of the company’s business is in the West, where oil prices have had a serious impact on economic growth and activity.
Distribution policy: As mentioned, the stock pays a monthly dividend of $0.16 per share. At a recent price of $26.39, the yield is 7.3 per cent.
Tax implications: Canadians who hold the shares in a non-registered account will qualify for the dividend tax credit, which greatly reduces the applicable tax rate on dividends. U.S. residents will have to pay a 15 per cent withholding tax on dividends, unless the shares are in a retirement plan.
Who it’s for: This stock is best suited to investors who can handle a higher level of risk in exchange for an excellent yield and future growth potential.