Ryan Modesto is managing partner with 5i Research. 5i Research offers conflict-free investment research for DIY investors. You can purchase individual reports in the Globe Data Store. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation.
Halloween is fast approaching, and as all of the ghouls and goblins take to the streets, investors have some goblins that they need to be concerned about in their portfolios. With a U.S. election approaching in about a week's time and an interest rate increase looking likely in December, volatility will become a familiar word over the next month or so. Investors can take advantage of this volatility by adding to names that see declines over this scary period. We are highlighting three spooky stocks that may have a place in your portfolio:
Park Lawn Corp.
Graveyards are spooky, right? Well, Park Lawn Corp (PLC) owns and operates 34 cemetery properties and 16 crematoriums in Canada and the US along with 22 funeral homes. The company is a leading provider of "death care" and is essentially consolidating this industry while paying shareholders around a 2.6 per cent yield. The CEO and CFO appear to have interests aligned, owning nearly 5 per cent of outstanding shares between the two of them, and analysts are expecting just over 20 per cent growth in 2017. For those who believe the only certainties in life are death and taxes, PLC could offer an interesting complement to a portfolio.
Nothing scary about lending and payment solutions providers, that is unless the stock drops nearly 40 per cent after an earnings release, then it becomes terrifying. To put that number into perspective, DH lost $1.15-billion in market value after a poor quarterly earnings result indicating slowing (and in some areas, declining) growth and large international banking customers pushing back spending due to uncertainty in the economy.
So why did this warrant nearly half of the market-cap being severed from the company? Likely two things: DH Corp has a lot of debt, and if 2016 guidance comes in at the lower end of the guided range, the company could be flirting with a debt covenant breach once the debt-to-EBITDA covenant steps down in the new year. The other issue is that investors are also looking at the dividend and wondering if management is considering cutting this distribution. There has been no indication that this will occur, but since dividends are discretionary and once a stock begins being priced for a cut, management will often decide to just pull the band-aid off quickly and get it over with. On the debt concern, flirting with a covenant is never a good thing, but we think lenders will be more than willing to relax these restrictions. Rarely do lenders actually want to call a company on their debt and force a technical bankruptcy.
On the dividend, DH still posted $192-million in operating cash flows against dividends of $90 million, so while still sustainable, there is the psychological question of what will the board decide to do.
Where does this leave an investor? Probably in a wait-and-see position. DH will provide 2017 guidance by the time year-end results are released and management has a better idea of what fourth-quarter sales look like (typically the strongest quarter). If DH has trouble doing deals before year-end, the drop in shares could be more than justified, but if guidance ends up not being a disaster, this could be viewed as an exciting entry point. Unfortunately, speculating on any single quarter is just that, which likely makes it appropriate to wait for a bit more information before taking any action.
This is more of a scary space than a single fear-inducing stock. The blistering returns over the last year may be a sign of caution for some or a sign of more good things to come for others, but what may spook investors is the recent increase in short positions on these names from the end of September to mid-October.
It's a bit too early to hide under the bed here, as the overall short position is still on the smaller side and the growth in the short position is coming from a small base, but it is certainly a trend to watch in what is already a small-cap and highly volatile space with a great deal of uncertainty surrounding the industry. Some investors have already reaped scary profits in this area and there could be more to come, but investors would be prudent to be aware of the dangers lurking in this space.
The writer owns no positions in any companies mentioned. Please perform your own due diligence before making any investment decisions.