Value Library

The following is an excerpt from the ABC Perspective - January 2011 - 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 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 have rebounded 30% in 2010 and 20% in 2011 to $15 billion, after falling approximately 40% in 2009.

On November 4th, Flint reported its third quarter financial results.  As expected, the results were down slightly on a year over year basis, due to the completion of two major oil sands projects before the start of the third quarter of 2010.  Revenue for the three month period ended September 30, 2010 was $406.5 million compared to $459.7 million a year ago. EBITDA for the third quarter of 2010 was $30.7 million, with a margin of 7.6%, compared to $35.5 million, with a margin of 7.7%, for the third quarter of 2009.  Net earnings were $6.2 million or $0.14 per diluted common share compared to $9.7 million or $0.21 per diluted common share. We expect that revenue and earnings will continue to contract in the Facility Infrastructure segment in the final quarter of the year before reaccelerating in 2011.

Despite the dip in Flint’s major project work, we are quite optimistic for 2011 and 2012.  In fact, subsequent to the end of the third quarter, Flint announced four decent contract awards that will positively impact future reporting periods. Flint Transfield Services Limited, the 50% owned maintenance division, was awarded a three-year, $95 million contract by Nexen for work at its Long Lake SAGD project. Flint also announced a contract extension of $78 million for the construction and commissioning of Suncor’s Firebag SAGD project.  In addition, the Company won a six-year construction contract from Imperial Oil, with the option for an additional four-year extension, for facilities across Western Canada.  Finally, the Company announced that it received an $18.9 million module fabrication contract from Suncor for work on its Firebag SAGD project.

In the earnings release, the Company disclosed that it had actively bid on several major construction projects and expects the decisions to be made within the next three to six months. Importantly, several notable companies in the oil and gas sector are ramping up capital spending and are specifically targeting projects that increase oil production.

Subsequent to the earnings release, shares of FES fell from a high of $17.10 to a low of $14.44 (a decline of 16%) and then rebounded to close the year at $18.17.  Obviously, the Ireland banking bailout and tensions between North and South Korea were concerning events for investors during this period.  However, we believe that the magnitude of the volatility is overly dramatic given the stable nature of Flint’s contracts and backlog.

Management has, quite correctly, ignored temporary swings in the Company’s share price and has gone about continuing to strengthen their business. In addition to the contract wins that we discussed previously, they have recently announced a small but significant acquisition in the United States.

On November 22, Flint completed a US$36 million tuck-in to expand the Company’s oilfield hauling services in the United States. Importantly, the purchase included property and equipment in five locations, including three in East Texas, one in Louisiana and one in Oklahoma in close proximity to several major shale gas fields. In fact, Flint has already expanded into the Marcellus shale gas basin, moving under-utilized assets from western Canada to Pennsylvania.  With the 170 new employees and 450 pieces of equipment, management now has the wherewithal to staff and equip an additional location in Williston, North Dakota (currently under construction) to provide oilfield hauling services to the Bakken shale oil play. Once the deal closes, the US Oilfield Services division will have eight locations and will be one of the market leaders in the segment.

Next to the oil sands, unconventional resource plays such as shale gas or oil have garnered the most attention and capital in recent years. We believe that management has made an important strategic decision to increase their exposure to the busiest fields in North America. Using the strong Canadian dollar to purchase assets in the United States is also a particularly astute move. In short, we expect that investors will be well rewarded in the coming twelve to eighteen months.

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.

Last April, Genworth MI Canada clarified its plan to return a significant amount of capital to shareholders. Management announced a substantial issuer bid, offering to purchase and cancel up to $325 million of the Company’s common shares between $24.00 per share and $28.00 per share. We were very pleased with this development and wholeheartedly agreed with management’s rationale. As Brian Hurley, Chairman and CEO, said, “Our board of directors believes that the recent market price of the Company’s common shares does not fully reflect the value of our business and future prospects.  This offer represents an equitable and efficient means of returning capital to our shareholders and allows the Company to continue to pursue our growth agenda”.

With the tender closing during a week of horrible housing data, including a 27% decline of US existing home sales, perhaps it was no surprise that the bid was oversubscribed.  More than 19 million common shares were tendered and the Company expected to take up approximately 12.3 million shares at a purchase price of $26.40 per share, slightly above the mid-point of the range of $24.00 to $28.00 per share. These results were consistent with our estimates, as we were assuming a price of $26.00 per share and 12.5 million shares repurchased to calculate earnings accretion of almost 9%.

Since the bid was oversubscribed, shareholders who tendered had the actual number of shares repurchased prorated. Genworth Financial, the parent entity, participated in the bid by making a proportionate tender and is expected to continue to hold approximately 57.5% of the outstanding common shares of the Company. Post cancellation, approximately 104.8 million common shares remain outstanding.

With the subsequent release of the Company’s third quarter results, Genworth MI Canada Incorporated surprised investors and hiked its dividend. Even after Genworth’s substantial issuer bid, the regulatory capital ratio or Minimum Capital Test (MCT) ratio was 153%, well above the Company’s internal MCT target of 145%. In response, the Board of Directors approved an 18% increase in the dividend from $0.22 to $0.26 per share on a quarterly basis. At current price levels, the $1.04 annualized dividend yields approximately 3.8%. Needless to say, we were quite pleased with this decision.

Genworth’s third quarter financial statements corroborate management’s confidence in their business. In the quarter, net premiums written increased 6% sequentially and 60% year over year to reach $166 million as a result of a strong spring housing market, improved market penetration and higher average premiums. Also on a positive note, losses on claims of $47 million declined $2 million sequentially and $17 million on a year over year basis. The loss ratio improved to 30% from 32% in the second quarter and 42% a year ago. Investment income of $45 million was $3 million higher sequentially and $2 million higher year over year. Net operating income totaled $92 million or $0.81 per fully diluted common share compared to $86 million or $0.73 per share a year ago.

During the conference call, management discussed their outlook for the Canadian housing market. They suggested that tighter mortgage insurance criteria and the Harmonized Sales Tax in Ontario and British Columbia, that took effect July 1, pulled forward some housing demand from the second half of 2010. However, management suggested that the housing market is normalizing, with supply and demand becoming balanced, which is positive for the health of the overall market. Further, improving consumer confidence, low mortgage rates for the foreseeable future and stabilizing unemployment all bode well for home sales across Canada.

Genworth MI Canada now has $5.3 billion in total assets, an investment portfolio of $4.9 billion, $1.9 billion in unearned premiums in reserve and $2.6 billion in shareholders’ equity or $24.30 per fully diluted share. With an operating return on equity of 14%, we believe that various regression models indicate that the 10% premium to book value is too cheap. With $2.27 per fully diluted operating earnings per share year to date and the potential to earn over $3.00 per share for the full year, we believe that a price to earnings multiple less than ten is too low. With a dividend yield of approximately 3.8% compared to one year GIC rates at 1.15% and Canadian one year government bonds at approximately 1.4%, we believe that the stock remains relatively undervalued and should move higher over the next twelve months.

Irwin A. Michael, CFA