Value Library

The following is an excerpt from the ABC Perspective - July 2010 - Pg. 4-5

ABC Fund Value Favourites

Flint Energy Services Limited

Flint Energy Services Limited provides a range of integrated products and services for the energy industry.  With a history dating back over 100 years, the Company’s 10,000 employees cover the full cycle of oil and gas exploration and production from 60 locations in North America.

Flint Energy Services is relatively unusual when compared to traditional energy services companies.  Although Flint has significant conventional operations, a much greater proportion of its business is related to oil sands facility construction and ongoing maintenance than its peers.  Importantly, oil sands capital spending is expected to rebound 30% in 2010 and 20% in 2011 to $15 billion, after falling approximately 40% in 2009.

Flint’s oilfield services segment includes drill and service rig moving, off road transportation, pressure & vacuum services and fluid hauling.  In 2009, this segment generated $212.4 million of revenue and $16.3 million of EBITDA. In terms of percentages, oilfield services represented 11.3% of total revenue and 10.9% of total EBITDA at a 7.7% margin.  Unfortunately, we believe that the Company’s entry into the rig moving business several years ago has never been well received by investors.

The next segment, production services, focuses on conventional oil and gas production in addition to shale gas, heavy oil and oil sands.  Capabilities include well tie-ins, pipeline, field & mechanical construction, safety services, equipment manufacturing and tubular management. In the most recent fiscal year, the segment generated $792.0 million of revenue and $45.7 million of EBITDA or 42.2% and 30.6% of the respective totals implying a 5.8% margin. This is the weakest segment from a margin perspective but, hopefully, margins will rebound along with drilling activity.

Moving to the facility infrastructure segment, we finally get to the heart of our investment thesis. In 2009, the segment generated $592.5 of revenue and $70.8 million of EBITDA. Although facility infrastructure accounted for only 31.6% of revenue, with a company-leading 11.9% margin, the segment produced 47.4% of the Flint’s total EBITDA.  Looking forward, Flint has a backlog of approximately $200 million related to various oil sands projects in Fort McMurray including Suncor’s Firebag 3, Shell’s Albian Sands and Statoil’s Leismer projects.

The last segment, maintenance services, could almost be considered “the gravy” on the story. Flint’s operates this segment as a 50/50 joint venture with Transfield Services, an Australian-based, infrastructure services provider. As opposed to the other three segments that are cyclical, the maintenance division is a source of relatively stable cash flow.  For the year, the segment generated $279.6 million of revenue and $16.5 million of EBITDA or 14.9% and 11.1% of the respective totals. Although the margin was lower than the Company average, at 5.9%, the stable nature of the cash flow should be highly prized by investors.  Major contracts include a five-year rolling contract with Suncor Energy covering oil sands projects and the Sarnia refinery, a three year contract with Canadian Natural Resources related to the Horizon Oil Sands Project and a two year contract with Royal Dutch Shell on the Scotford Complex. Thankfully, this stable cash flow stream protected the Company’s balance sheet through the downturn.

We were able to purchase our position in Flint Energy Services just slightly above the Company’s book value of $11.32 and at approximately 4x trailing EBITDA. The shares had underperformed both engineering & construction and oil & gas services stocks for a non-fundamental reason.  It had become known that Flint’s largest shareholder, SCF Partners, had filed to sell its block of stock.  Once the shares were placed with fundamental investors, the stock was able to lift quite nicely.

We believe that additional upside could come from three main drivers. First, the ramp up in oil sands capital expenditures could translate into growing cash flow and multiple-expansion. Second, the clean balance sheet with $160.9 million of cash and cash equivalents (or approximately $3.60 per share) and the stable cash flow from the maintenance division could be used to initiate an annual dividend in the range of $0.20 to $0.24 per share. This would yield 1.4% to 1.7% at current price levels and would open the stock to a new class of investors.  Finally, there is the slim possibility that Transfield Services could make a bid for either the maintenance services division or even the entire Company. This outcome may not be as far-fetched as it sounds, since Transfield is publicly listed in Australia and trades at almost twice Flint’s valuation.

We believe that we have purchased a misunderstood growth stock at value multiples. Further, if any of the three potential catalysts fails to play out, we believe that the Company could reactivate its normal course issuer bid, which would support the shares. For the year ended December 31, 2009 the Company purchased 688,300 common shares at an average cost of $7.94 per share.  Although the share price is significantly higher today, the normal course issuer bid was renewed on March 2, 2010 for up to a maximum of 2,379,689 common shares, representing 5.0% of the total issued and outstanding common shares. In any event, we believe that patient shareholders will be rewarded through the balance of 2010 and into 2011.

Genworth MI Canada Incorporated

Genworth MI Canada Incorporated (TSX: MIC) is the leading publicly-traded, residential mortgage insurer in Canada.  The Company provides insurance against mortgage default to Canadian residential mortgage lenders that enables low down payment borrowers to own a home.  Genworth operates in an industry that is effectively a duopoly, holding a market share of approximately 30% with the Canadian Mortgage and Housing Corporation (CMHC), a crown corporation, controlling the balance.
 
Genworth MI Canada Incorporated became a public company upon the closing of its IPO on July 7, 2009.  Genworth’s US parent, Genworth Financial, was forced to float a portion of its Canadian subsidiary to investors in order to repair its own balance sheet. Essentially, the parent sold 39,640,000 shares and the Company issued 5,100,000 shares from Treasury. After completion of the offering at $19.00, there were 117.1 million common shares outstanding, which created a $2.2 billion company.

Investors were able to gain some insight into the Canadian housing market by examining the Company’s fiscal 2009 operating and financial results. Net premiums written increased from $461 million in 2005, peaked in 2007 at $984 million and declined to $360 million in 2009.  However, because 50% of the upfront premium is booked as revenue in years two to four, net premiums earned grew from $277 million in 2005 and peaked in 2009 at $610 million.

In terms of profitability, net operating income was $307 million, operating earnings per diluted share were $2.67 and the operating return on equity was 13%. Underwriting results were generally in line with expectations, with a loss ratio of 42% and a combined ratio of 57% for the year ended December 31, 2009. Because of higher unemployment and a soft real estate market in 2009, these numbers were slightly weaker than the results reported in 2008.  However, we believe that the performance demonstrated the relative stability of the Canadian housing market during the global economic turmoil in 2009.

The solid profitability and clean balance sheet implies that Genworth is extremely well capitalized. The Company is regulated under OSFI and is required to hold capital to meet a minimum capital test ratio of 120%. Genworth’s management has a conservative capital test ratio target of 132% to 135% and the actual capital test ratio was 149% at December 31, 2009. Excess capital above the Company’s internal target could be used to grow organically, buy back shares or pay dividends. In fact, the Company currently pays a quarterly dividend of $0.22 per share, implying an attractive 4.6% yield at the IPO price.

Subsequent to the IPO and the release of the fiscal 2009 results, management disclosed their intention to optimize the Company’s capital structure.  In June of this year, they issued $275 million of senior unsecured debentures and plan to return up to $350 million of excess capital to shareholders. The nature, size and timing of any event were not precisely set but will depend on market conditions and final approval from the Company’s board of directors. We believe that this reflects management’s confidence in the overall health of the Canadian housing market and Genworth’s solid prospects going forward.

Despite the improving results and the dramatic plan to return a significant amount of capital to shareholders, Genworth’s stock has declined approximately 20% since the beginning of May. We acknowledge that several potentially negative events including changes in mortgage rules, the introduction of a harmonized sales tax and rising interest rates have occurred.  However, we believe that fears of a wide-spread housing downturn in Canada are overblown.  We would highlight the fact that even if mortgage originations slow, Genworth has over $2 billion of unearned premiums in reserve. This represents premiums that have already been written and will flow through the income statement as revenue and earnings in coming periods.

Importantly, we believe that index players may have exacerbated the recent decline since Genworth was removed from the MSCI Canada Index during the month of May.  After touching $28.50 in April, the stock is currently trading at approximately $23.00.  We believe that the non-fundamental sell-off represents an excellent buying opportunity.

Irwin A. Michael, CFA