One income trust looks to the future

“We’ve unloaded companies showing signs of underlying weakness and never looked back,” says the author, continuing his Darwinian theme on investment. “We’ve avoided real blowups in a market more rife with them than any in memory.”

But we’re making an exception for Yellow Pages, he states clearly. Even though it appears to have gone back on its word.

“Since the Canadian government announced on October 31, 2006 that it would begin taxing income trusts as of January 2011, Yellow’s management has stated repeatedly its intention to maintain its current distribution by outgrowing its prospective burden.”

And so it did, Mr. Conrad says, consistently maintaining double-digit growth in its distributable income per share quarter after quarter.

“Unfortunately, that winning streak came to an abrupt end in the first quarter of 2009.”

Switching strategies

The company’s core directory business — the good old Yellow Pages — kept on growing. But that wasn’t the case for its so-called “vertical media” — that’s the going jargon for concentrating on specific areas of the market, like automobiles and real estate.

Its “vertical” advertising publications, online and print, tumbled rather badly. Cash flow was down 30 per cent from the year before.

Overall, the distributable cash flow held steady, says Mr. Conrad, but for the first time since 2002, it did not grow.

So management did the only sensible thing. It switched strategies. It cut the distribution by 31.6 per cent. What’s more, it set a new payout ratio of 60 to 70 per cent when it converts to a corporation in 2011.

This bad news was well reflected in the unit price, the author adds. But the units subsequently rallied, “mainly because expectations for the business have been so low due to the crackup of U.S. directory companies.”

The question now is where Yellow Pages can go from here. “Fortunately,” says Mr. Conrad, “the answer is ‘much higher’.”

Fingers walking briskly

The vertical media division isn’t liable to stand up straight as long as the recession lasts, the author admits. But there are signs that it is beginning to rebound.

And anyway, it represents just 12 per cent of the company’s cash flow. “The rest is the core directory business, which continues to enjoy steady revenue on the print side thanks to its de facto monopoly in Canada.”

But the company’s future, you might say, is online. Well, fingers are walking very briskly through the online Yellow Pages, as revenues went up 29 per cent for this segment in the first quarter. It now represents 17 per cent of overall sales.

Distributable cash flow in the first quarter covered the previous distribution at a ratio of 82 per cent. “At the lower rate, however, the payout is only 57 per cent, leaving plenty of room for management to pursue its stated debt reduction goals.”

In short, Yellow Pages isn’t showing weakness, it’s building strength.

“I’m no fan of dividend cuts,” concludes Mr. Conrad. “In this case, however, Yellow appears to be taking a conservative line that will ensure its longevity and draws a clear distinction with its so-called comparables, i.e., the U.S. directory companies.”

Hold on to Yellow Pages, he tells his U.S. readers. “We’re underwater, but the recovery is still on.”

Even in a flood of bad times, good companies look ahead for ways to keep their shareholders high and dry.