KeyStone’s Stock Talk Show Episode 254.
Great to be back. We will start the show with our Poll Question from last week on the proposed new capital gains tax in Canada and I will give you and simple example detailing how the tax may affect your pocket book. In our YSOT segment Aaron begins with a viewer question on A&W Revenue Royalties Income Fund (AW.UN:TSX), a California-based company that operates a quick service restaurant business in Canada. The stock which pays a healthy 6.71% dividend, is down over 20% in the past year and Aaron let’s you know if today’s price a good entry point. Brennan will take a quick look at TD’s Q2 2024 results, their recent Anti-Money Laundering investigation by the Department of Justice and how it could impede their growth in the U.S. He will also highlight their mortgages by remaining amortization which will then, in his words, “flow” into looking at some recent news in the Canadian Mortgage space. Finally, Brett answers a viewer question on TerraVest Industries Inc. (TVK:TSX), a diversified industrial manufacturing company for multiple industries, including, energy, agriculture, mining, transportation, and more. The company has four operating segments: HVAC, Compressed Gas Equipment, Processing Equipment, and Services. The stock is up a whopping 180% over the past year and Brett ;et’s you know if the good times can continue.
Let’s get to the show – we welcome my cohost, Mr. Aaron Dunn and the killer B’s, Brett, and Brennan.
Aaron on Money Talks with Mike Campbell – how did it go?
As you may have already heard, in Budget 2024, the Canadian government has proposed to increase the Capital Gains Tax rates for capital gains realized on or after 25 June 2024 from 50% to 67%.
This is not the tax you will pay, but rather how much of your gain will be taxed.
The actual tax will depend on the size of the gain and your personal tax brackets – I can go through an example below.
Additionally, on the personal side (vs. the corporate side), there is a first hurdle of $250,000 per person of gain that will still fall under the 50% inclusion rate.
At this point we do not have any documentation showing what will officially become law and when – in fact the government has pulled last second reversals on several initiatives. (including amendments to firearms law. It would be great to see some written clarity but we are in a holding pattern for now.
In fact, the proposed capital gains tax changes were notably absent from the motion the Liberal government tabled to introduce Budget 2024 in the House of Commons. It appears the government intends to ask Parliament to approve them in separate legislation.
To do or not to do, that is the question:
- Some individuals are wondering whether to sell assets with gains now vs after.
- Tax should never drive your investment decisions. You want to consider the investment itself.
(this is somewhat of a unique situation)
If you were planning to sell anyways then it may make sense depending on pricing to do it now.
Based on high-level net present value calculations (using a 5% after-tax rate of return and currently proposed tax rates), it may be more beneficial for a taxpayer to pay the income tax today at the lower inclusion rate if the taxpayer was otherwise intending to realize the capital gain within the next five years.
Simple Example:
If you are in the highest tax bracket, your rough change in tax after the first $250,000 of gain will be calculated as follows (this is a basic example):
Gain: $1,000 (amount over $250,000 – total gain is $251,000)
Inclusion rate 67%: $667 vs Inclusion rate at 50%: $500
So a difference of $167 additional gain to be taxable.
Highest BC tax bracket for 2023: 53.5%
So additional tax on the increased inclusion would be $89.35
Comments on the Arguments around the Tax.
Many business groups and private-sector economists argue that raising taxes on capital gains disincentivizes investment and entrepreneurship – an unwise move at a time when the Bank of Canada has declared weak productivity growth and lacklustre business investment a national emergency.
Disingenuous to say and this tax will only affect the ultra rich. This not just a quip – they have it in print that the government data indicates only 0.13 per cent of Canadians — people with an average income of about $1.4 million a year — are expected to pay more in personal income tax on their capital gains as a result of the change.
I would love to see the actual inputs behind that data – it is bs.
Anecdotally. My nieghbour that has a summer house that has been in the family for 50 years. It was bought for around $20,000 (with after tax dollars I will add) and it now worth $1.4 million. They do not make $1.4 million a year (he wished he made a tenth of that), but they will be affected by this tax.
- $1.38 million Gain. (Minus the $250K)
- $1.13 million taxable.
- 67% inclusion rate: $757,100 taxable.
- Vs. 50% inclusion rate: $565,000 taxable.
- After Proposed tax increase: 53.5%: $405,048.50.
- Prior to Proposed tax increase: 53.5%: $302,275.
- $102,773.5 more.
TD Earnings and Mortgages
Slide 1
I have been doing a recurring segment on the podcast since May of 2023, which was spurred when I discovered that Canadian Banks were beginning to extend mortgage amortization periods on outstanding mortgages to help ease the pain of some Canadian’s facing higher interest rates and ongoing inflationary pressures. But over the second half of 2023 banks were beginning to get this under control.
So for my segment I am going to quickly look at TD’s Q2 2024 results, their recent Anti-Money Laundering investigation by the Department of Justice and how it could impede their growth in the U.S., And then I will highlight their MORTGAGES BY REMAINING AMORTIZATION which will then flow into looking at some recent news in the Canadian Mortgage space.
Slide 2 TD
TD (Q2 2024)
- CLICK Financials (Q2 2024):
- Revenue grew 10% y/y, driven by momentum in its markets-driven businesses and higher volumes and margins in Canadian personal and commercial banking.
- Adj. EPS was up 6.8% to $2.04 for Q2 2024 and declined 2.4% YTD to $4.04.
- Provision for Credit losses were $1.07B, an increase of 58% (in line with TD’s guidance). If you remember last time, I did this segment in late 2023 Provisions for credit losses were much higher than expected by analysts which was a common theme among all the banks.
- CLICK For fiscal 2024, management believes it will be challenging for the Bank to meet its medium-term adjusted EPS growth target range of 7-10% and return on equity target of 16+%. The Bank also has a 2027 target of 150 additional branches in the U.S. by 2027… HOWEVER….
- CLICK Given the U.S. Department of Justice (DOJ) investigation on how Chinese drug traffickers allegedly used the bank to launder $653M U.S. and bribed TD employees to do so… this growth in U.S. branches could potentially be hampered. TD noted that it set aside $450M U.S. to be paid to one of the regulators and is bracing for other fines with some analysts indicating that fines could be upward of $1 Billion. TD’s management said in their conference call that while growing their branches is important for longer term growth, in the short term, they are focused on their digital and mobile strategies. And on May 3rd the bank announced that the overhaul of its Anti-Money Laundering program is underway with the bank investing over $500M in program remediation and platform enhancements.
- CLICK As well, I brought this up at the end of 2023, TD initiated a restructuring program which is expected to generate approximately CAD$400 million pre-tax in savings in fiscal 2024 and an annual run rate savings of approximately CAD$725 million pre-tax. Management noted they are on track to achieve these savings.
Slide 3 TD
Looking at the Mortgages by remaining Amortization, we are seeing the number of mortgages with an amortization period of greater >30 years come down to about 17.9% of all Canadian mortgages. This is down from 21% from October 2023, but again, just a reminder, there were 0 mortgages which had an amortization of >30 years in Oct 2021. So while it is improving, if we compare it to two and a half years ago when rates were significantly lower, it continues to be at elevated levels.
Slide 4
Now, while outstanding mortgages with an amortization of greater than 30 years are declining on the banks books – the Liberal Federal government announced that it would now allow first time home buyers to take out an insured mortgage amortized over 30 years, up from the traditional 25 years.
The move will take place on August 1st, 2024, and will allow Canadian’s to essentially lower their overall monthly mortgage costs on the loan…. However, over the long run, it means that borrowers will have to pay more in interest.
Slide 5
Here is a quick example to show how much more interest one would be paying on a $400,000 mortgage if they extended their amortization period to 30 years rather than the conventional 25 year mortgage.
For my example I am using the assumption of a 5% interest rate, and for the 25 year mortgage a borrower’s monthly payment would be about $191 more than the 30 year mortgage. But over the life of the mortgage a borrower would be paying about $71,000 more in interest….
So while the liberals may be making it easier for Canadians to purchase a home, it is in fact costing Canadian’s about 24% more in interest (on my specific example).
Slide 6
We have talked about this before given elevated interest rates, but to finish my segment and open it up to the guys, the Canadian Watchdog OSFI released last week that 76% of outstanding residential mortgages as of February will be coming up for renewal by the end of 2026 with about 15% of those mortgages having variable rates. So the longer rates stay elevated, the longer those households will be dealing with the looming financial strain.
YSOT Terravest TVK:TSX
1)
TerraVest Industries symbol TVK on the TSX is a diversified industrial manufacturing company
for multiple industries, including, energy, agriculture, mining, transportation, and more. The
company has four operating segments: HVAC, Compressed Gas Equipment, Processing Equipment, and Services.
2)
Terravest currently trades at $77.50 up a whopping 180% over the past year and a market cap of $1.5 billion. So quite a good year for the stock to say the least.
3) Even then zooming out to a 5-year chart, the stock has risen 488%. When you see a price rise this dramatic you always need to have the question of do the fundamentals still support the price.
4)
Looking at the last quarter, fiscal Q2 2024 ending March 31st.
The company had strong sales growth of 22% to $215 million from $177 million. However, the sales growth is due to the acquisition LV energy services and Highland Tank Holdings last year. So removing the impact of that acquisition there was actually a decline in sales by 4%. So, no organic growth just acquisition-driven growth.
Notably gross profit margin increased substantially to ~30% from 25% in the prior year. The shift is in part due to the acquisitions as well as product mix and cost controls.
Gross margin increase is the driving force behind the bottom line growth past the sales growth.
The other significant line item change that materially influenced the bottom line is other gains which primarily relate to foreign exchange gain and gain on disposal of equipment. Both of which are non-recurring.
Net income attributable to common shareholders, increased 152% to $22.4 million and diluted EPS grew to $1.19 per share from $0.49.
And for non-GAAP, Terravest adjusted EBITDA increased 36% to $44 million and cash available for distribution increased 29% to $22.6 million. The company does pay a quarterly dividend of 0.15 or a yield of 0.8%, which has of course dropped due to the share price increase. The dividend has increased from $0.10 a couple years ago but with that share price appreciation the stocks yield is just too low to consider for its income at this time.
5)
Moving to the balance sheet the company does have significant net debt and leases. Debt of $281.1 and leases of $100.7 million offset partially by cash of $18.1 million resulting in a net debt and lease position 363.7 million.
However, after quarter’s end the company placed $96.5 million in shares at $74.25 a piece. The placement was initially lower at an expected $65 million and then raised to $84 million plus then further the undewrwriters exercised their over allotment option. This is when the underwriting investment bank has the option to purchase additional shares at the same price. This option is generally standard but when it is fully executed on it generally means that the demand for the issuance was high. And given the share price remained above the issuance price the market was accepting of this raise.
The additional cash will be used for debt repayment acquisitions and general usage. The prior acquisitions were $95 million, so this really just offsets the increased debt from the acquisitions.
Incorporating this the pro forma net debt EBITDA is roughly 1.8 times based on trailing figures. And assuming all else holds will likely drop as the company laps previous results to include the acquisitions.
6)
Moving to valuations, the company has a trailing P/E of 24 times, and an adjusted EV/EBITDA of 12 times. Neither of these are cheap valuations given the organic growth.
7)
A couple other factors I’d just like to highligh to do with the company’s underlying operations. The financials are seasonal with fiscal Q3 being significantly weaker as it is all of the 4 segments weakest quarter.
Although not purely dependent on Canadian energy it is significantly influenced by the sector, meaning the company will have the energy market cyclicalility built into its earnings as well. So if we were to see another 2014-like strain on the Canadian oil market would Terravest implode, probably not, but that is also why the debt level needs to be watched as well, so management raising capital at all-time highs instead of a cyclical low like many energy exposed companies do does show risk management.
Additionally, like many sectors, the company is facing labour shortages.
8)
Concluding,
At this time Terravest is expensive due to lack of organic growth.
The company has now improved is balance sheet due to the capital raise at effectively all-time high prices. While leverage still is a touch high at 1.8 times, its more reasonable than what would be over 2 times if no raise were to have occurred.
I would either like to see a valuation or lower price to enter the company, assuming funadementals stay similar, or see better organic growth given the risks of the company.
