Toronto, Ontario -- January 23, 2018 -- In this week's Tuesday Ticker, the BofC hikes rates, Uni-Select earnings estimates, Fenix Parts charts new course, and much, much more!
The Bank of Canada (BOC) announced its latest interest rate hike this past week. The Canadian central bank raised rates a quarter point, the third time it has done so in recent months. The bank’s key lending rate is now 1.25 percent, which is low by historical standards. But the rate increase comes at a time when Canadians are more indebted than ever, which has led to speculation that consumers may pull in their spending in 2018.
The BOC has been under pressure from certain sectors to raise rates. Banks and insurance companies would like to see higher rates so bond portfolios offer better returns. But at the same time, Canadian consumers are sitting on record levels of debt. As rates rise Canadians will pay more per month for variable-rate mortgages and personal lines of credit. And that is going to test the resilience of the average consumer. According to the Conference Board of Canada, growth in consumer spending can be expected to slow through 2018 as a result of the hike.
The disturbing level of indebtedness among Canadian consumers has become a common refrain for many analysts and economists. According to Statistics Canada, in 1980 the ratio of household debt to personal disposable income was 66 percent. That ratio recently passed 171 percent, which means that households owe $1.71 for every dollar of after-tax, disposable income.
With interest rates rising, many assume Canadians will be forced to begin paying down that debt, leaving less money left over for spending. A credit advisory firm recently conducted a study that found that 33 percent of respondents said they are not able to cover their monthly bills and debt payments.
The Canadian subsidiary of the Australian investment bank Macquarie recently released a report warning the BOC might be too hasty in terms of raising rates, and risks a flaring out of the consumer economy as a result.
“The Canadian economy has experienced an unprecedented period of hyper-leveraging,” according to the report. At the same time the economy has become more exposed to interest rate hikes. Over the last three years a remarkable thirty percent of GDP growth has come from residential investment and auto sales.
Typically the economy is not so dependent on housing and autos. The current share is about fifty percent higher than in the past, according to Macquarie. Both the housing and the auto sector are dependent on interest rates on loans and mortgages. As a result the current rise rate hikes may not be beneficial. “When taken together, these observations mean the BOC is proceeding with hikes despite uncertainty surrounding the severity of tightening performed so far… This elevates the risk of policy error,” claimed the report.
The Conference Board of Canada assumes the rate hikes will crimp demand for new vehicles. This is occurring as the baby boomers begin to retire. That demographic shift will also hurt sales. As urban millennials continue to purchase fewer vehicles as a result of the emergence of ride-sharing companies, it can be assumed auto sales will decline from current record highs.
A survey of analyst expectations finds that Uni-Select is predicted to report earnings per share of $0.34 when the company next releases financial results on February 14. Quebec-based bank Desjardins has a $37.00 price objective on the stock, up from their previous price objective of $34.00. Royal Bank of Canada has a $33.00 price target on shares. The stock price of the company is currently just about $29 per share. Of the six analysts covering Uni-Select, five rate the stock a ‘buy.’
The global paint maker PPG just reported its latest quarterly results. According to the company, net sales were up nearly eight percent, partly as a result of currency fluctuations. Overall sales advanced by three percent. According to PPG executives the recent growth is the highest quarterly rate since the forth quarter of 2014.
“Our strong volume growth in the forth quarter was balanced, with at least two percent sales volume growth contribution from each region and each operating segment,” according to executives speaking on a conference call held to discuss the results.
“Automotive OEM coatings grew sales volumes by low single-digits percentage, in line with the global industry automotive builds. In Performance Coatings, automotive refinish grew organic sales by mid-single-digit percentage, supported by above-market performance in the U.S. and Europe. Our independent dealer network and national retail accounts were relatively flat compared to last year, which is an improvement from recent quarters' unfavourable trend in these channels,” said PPG executives.
Supplementing the company's growth were gains from the acquisition of Crown Group, which services heavy-duty equipment customers. “We are pleased to own the business as the heavy-duty equipment market is in the early stages of recovery,” said management. Some raw materials for paint continue to be in short supply, and so costs in that area are expected to rise in 2018.
“We experienced continued and elevated raw material inflation in the forth quarter at about a mid-single-digit percentage increase from the prior year. Raw material costs tend to moderate seasonally—in the seasonally low forth quarter. However, this year, they continued to increase. The main inflation driver is the continued enforcement in environmental regulations in China, which is resulting in ongoing supplier production curtailments. We do not expect this to abate in the first quarter of 2018, ” According to executives on the call.
As a result, “Selling prices were modestly up versus the prior year third quarter, with additional pricing secured for the first quarter of 2018. We're continuing to work with our customers on further selling price initiatives. We now expect the current level of raw material inflation to last well into the first half of 2018.”
The company has also expanded research into raw material efficiency. “These efforts are beginning to yield modest raw material efficiency benefits, with more expected as we progress through the first half of 2018,” according to those on the call. Management also said it is, “Mitigating raw material inflation through aggressive cost management. We are able to achieve savings from our business restructuring actions of $50 million in 2017.”
PPG executives also announced the business has been helped out by the acquisition of an automotive refinish company based in Southern China, Futian. The company sold off its last remaining ‘noncore’ (non-paint related) business when it sold its U.S.-based fibreglass business this past quarter. According to management, “We are now a 100 percent core paints, coatings, coating services and specialty materials focused company.”
Management was happy to announce that it will continue to pay a strong dividend to shareholders. According to the executives, “We are proud that 2017 marked the 118th consecutive year of dividend payouts and the 46th consecutive year of annual payout increases. We anticipate economic growth rates to improve in the U.S. and Canada, including modest acceleration in industrial production and GDP rates versus 2017… We believe the recently enacted U.S. tax reform legislation may bring further growth in the U.S. However, there are many still many uncertainties, including how our end markets will be impacted. Specific to our business, we believe that regional automotive industry builds will be relatively flat year-over-year.”
Overall the company is financially secure. It ended the year with over $1.5 billion in cash and short-term investments. PPG will spend $2.4 billion in 2018 on acquisitions and share repurchases in the year ahead. “We continue to believe the coatings space remains a consolidating industry, and our acquisition pipeline remains active across geographies and end use markets,” said the executives.
In response to a question from analysts PPG executives did warn that recent increases in the price of oil will drive up the cost of oil-based solvents. “I think crude was about $55. Now it's $69 for Brent and it's $64 for WTI. So I think that's going to flow through into solvents. So you have to watch that, according to management.
The executives also discussed the high cost of titanium dioxide, which is the basic ingredient in white paint. According to management, “... we took out about one percent of our TiO2 in 2017. We expect to take out one to two percent in 2018. We're trying to make our formulas more efficient and still provide as good or better quality on the final corrosion protection for our customers, as well as other properties. So TiO2 pricing itself, I would say, is starting to moderate. I think you know that one of the, well, in fact, the largest supplier is trying to take a different approach to the pricing... We'll have to wait and see how the other folks react. But we certainly have been watching this closely, and I would think there is some small increases expected in the first half of 2018.”
There is some good news from auto recycler Fenix Parts. Just a couple years ago a group of auto recyclers in the U.S. and Canada got together to create a new publicly-traded auto recycler and parts distributor. The company had some early issues, however. As the deal to merge almost a dozen different recyclers came together the price of scrap steel dropped, hurting earnings. A fire at the company’s Toronto facility didn’t help either. The volatility forced the company to miss some earnings statements. Shares suffered as a result. Nevertheless, the company is working through the issues and seems to have sorted out some key concerns.
Recently the company announced it received a letter from the staff of the United States Securities and Exchange Commission (SEC), advising Fenix that the SEC has completed its inquiry into the missed earnings statements and that no enforcement action has been recommended. According to Kent Robertson, CEO of Fenix Parts, “The conclusion of this matter will allow Fenix to stop incurring significant legal costs and committing management resources associated with the inquiry.” The company’s stock will now trade on the so-called over-the-counter “pink sheets” desk. This is a market for relatively low volume stocks (Fenix has about 300 different shareholders). OTC Markets Group operates the pink sheets market, which requires fewer financial reports. Fenix found that the costs attached to reporting extensive monthly financial statements were too great a cost to bear (a common complaint from companies in the wake of the Sarbanes Oxley legislation brought in to deal with the outcome from the Great Recession).
According to Robertson, the decision to move to the over-the-counter market “Was made after careful consideration of the advantages and disadvantages of being a public company under current circumstances. It took into account several factors, including the significant costs associated with preparing and filing periodic reports with the SEC and high outside accounting, audit, legal and other costs and expenses associated with being a public company, including Sarbanes Oxley compliance, as well as the small number of company stockholders and the relatively low level of trading in the company’s common stock. This decision should result in a benefit to the company’s stockholders by reducing expenses and permitting management and staff to focus more energy on operating matters.”
In lieu of SEC filings, the company intends to provide periodic updates to its shareholders about the company’s financial condition. According to the company net revenues for the second quarter of 2017 were approximately $32 million. For the nine months ended September 30, 2017, revenues were $96.6 million compared to approximately $99 million for the first nine months of 2016. According to a press release, “The year-over-year revenue decline is primarily the result of the suspension of operations at the Company’s facility in Scarborough, Ontario, which had been generating approximately $2 million per quarter in revenues.”
That said, Robertson was quoted as saying “We continue to see strong demand for our recycled OEM parts, supported by positive industry dynamics… We reduced the amount spent on vehicle inventory for the full-service operations by approximately eight percent for the first nine months of 2017 as compared to the prior year, and we expect this trend to continue as we identify additional opportunities to further reduce costs. The conclusion of the SEC investigation and suspension of SEC reporting requirements will help support these cost-saving efforts going forward.”
As well, Fenix Parts has removed all the fire-related debris and received the environmental approvals to restart the Toronto facility. Permit requests have been filed to reconstruct the facility, a major step toward a re-start of the facility.
Another bit of good news is that the company has reached an agreement with its lenders (one of the main ones being BMO) to refrain from exercising their rights under a credit facility signed with the company. Fenix Parts had been in contravention of some of the debt covenants. But the banks have signed a forbearance agreement, which means they will overlook the contraventions and let Fenix Parts continue to operate as is. According to a press release, “The Forbearance Agreement also permits the company, among other things, to add certain quarterly interest payments otherwise due each quarter of 2017 to the principal amount of debt outstanding and defer the principal payments that were otherwise due at the end of each quarter in 2017 to the end of the forbearance period.”
Could the recent troubles at Fenix be fading into history? Arguably so.