Three "medium risk" ideas

My employer rates equities with a risk rating, in order to judge whether investments are appropriate for clients. Most clients will admit some high risk investments in their account, but some will not. Things get interesting when someone will accept nothing rated “high risk”, but requires a certain, high level of income. Here are a couple ideas.

I put “medium risk” and “high risk” in parentheses because, as I understand it, the risk ratings are based on characteristics of the stock, such as liquidity and volatility, and not on characteristics of the company. If those attributes equate to risk for you, let me know. More commonly, the investors I work with usually equate risk with the possibility of a permanent loss of capital.

Parkland Income Fund (PKI.UN)

Parkland owns the Bowden refinery and distributes fuel to mostly rural gas stations including Esso and their own FasGas stations. They have locations throughout Ontario and the West, and have recently acquired a heating oil company in the maritimes. Management is very capable and, while they did experience a hiccup integrating a supply management program, they are growing the company to cover more geographic area and diversify the income stream. They have stated that, with the purchase of BlueWave Energy, they will be able to maintain distributions at 75% – 125% of the current level. Not very specific, but not pie-in-the-sky either.

Facts: Parkland is a $630 million company that currently yields 11.25% in distributions. The P/E is 17.8x earnings that have been depressed over the last year. They seem to be recovering as trucking traffic picks back up. The share price is lower than six months ago, implying a good buy, if the economy continues to recover or if this winter presents particularly cold weather. Debt doesn’t seem particularly onerous and the bank has recently expanded their credit facility. This seems like a great current yield for what I agree is a medium risk investment. As a bonus, shares are fairly liquid (over $1 million trades each day), even though they tend to trade in small lots.

WesternOne Income Fund (WEQ.UN)

I personally know much of the management team and I have visited their Calgary location. They have grown through acquisitions over the past four years. They have diversified their locations and their businesses, although they are all related around construction equipment and heating. It has been a tough environment over the last couple years, but they have maintained their market share and built up relationships.  They have been able to maintain their distribution through good times and bad, which is impressive, and they hope to be able to maintain it through the conversion to a taxable entity in 2011. However, management is very carefully, always keeping a margin of safety, and they will reduce the payout if it is not sustainable.

Facts: WesternOne is a $57 million company that currently yields 14.5% in distributions. The P/E is undefined, given that earnings for the last year were negative. Distributable cash was still positive, and distributions represented a payout of approximately 85%. Management would like to see that lower, and a cold winter would improve the profitability of their propane distribution and construction heating activities. The company’s debt level is reasonable. This seems like a great current yield for what I feel is a riskier investment, given the company size.

Davis+Henderson Income Fund (DHF.UN)

Davis+Henderson has a virtual monopoly on printing cheques in Canada. Because cheques are less common to use personally, they tend to focus on business customers. They also provide other services to banks, especially software for determine mortgage eligibility. Management is reputed to be very competent and the company is relatively stable. During a past conference call, management refused to answer questions (from owners!) about their plans for the distribution, which did not impress me. On the other hand, most professional money managers and investment analysts seem impressed by the quality of management.

Facts: Earnings and share price have been fairly consistent, even over the last two years. The P/E is a low 9.8x and debt is low at 0.36 debt to equity. The share price has been rising over the last three months, and it’s currently as high as it’s been since 2007. The yield of 10% is as high as one could expect from a fairly stable investment. I would agree that this is a medium risk investment, if there were more clarity from management about the company’s future.

Combining these three companies as part of a portfolio will likely increase income with taking undue risk. As a bonus, it works for my clients who won’t allow any “high risk” rated stocks in their account. That could be a moving target, however, as risk ratings may be adjusted at any time.