It Pays To Listen To Wealthy People Parkland's High P/E Ratio Means It's Only For Aggressive Investors

During a recent game of pool in the billiard room of his palatial home, my wealthy friend Jim said he was delighted that he’d invested in Parkland Fuel Corp. (PKI/TSX).

Parkland, based in Red Deer, Alta. sells gasoline and other petroleum products to businesses, households and wholesale customers in Canada and the United States. The company also owns gas stations under banners such as Pioneer in Ontario, FasGas Plus in western Canada and Race Trac in rural communities. The company was called Parkland Industries until it became Parkland Income Fund in 2002, then converted to a corporation at the end of 2010.

The day before Jim and I played pool, Parkland announced it had made the biggest acquisition in its history. The company reached a $1.46-billion deal with Chevron Corp. to buy Chevron Canada R&M, including its retail and commercial assets in western Canada.

The news sent Parkland’s shares up 10% the next morning, prompting Jim’s enthusiasm.

“Did you see Parkland this morning? I’ve owned it for years. It’s been very good to me,” he said.

Jim, 82, has been a buy-and-hold investor since the bear market of 1973-74.

“My biggest investment mistake? Those damned tulip bulbs,” he quipped, testing my knowledge of market history. (Tulipmania, popularized in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, occurred in 1637.)

Seriously, Jim said he had accumulated his position in what was then known as Parkland Industries in the 1990s, held it through the eight years it was an income trust, and still owns it. Though he would not tell me how much he’d invested, figures from longrundata.com show an investor who put $1,000 into Parkland 20 years ago in 1997 and reinvested the dividends would have about $250,000 today.

When I told Jim I might write something about Parkland, he turned cautious.

“I’m just happy with my investment,” he said. “I don’t follow it that closely and I’m not trying to recommend it to anybody. For all I know it’s overvalued.”

That said, when a wealthy investor tells you he has done very well over the years with one of his long-term holdings, you should at least pay attention, if only as a starting point for further research.

Since converting back to a corporation at the end of 2010, Parkland’s share price has grown to $29.70 from $11.50, a gain of 160%, while the S&P/TSX index is just 17.5% higher. Over the same period, shares of Canadian Tire Corp. (CTC/TSX), itself a solid investment in the gasoline and retail space, is up 150%, while Suncor Energy Inc.’s shares are up just 16%. The gains have not been smooth and steady. The plunge in the oil price kept western Canadian customers away from Parkland’s stations, crushing revenue and profits, and the stock slid in 2015.

Parkland is in a competitive industry, but its locations are often in rural communities where consumers have fewer choices, which allows for higher profit margins.

Parkland has a long history of making shrewd acquisitions that have benefited its shareholders.

“As the fuel distribution market remains significantly fragmented in North America, we believe that we are well-placed to be a leader in its consolidation,” the company says in its management discussion and analysis (MD&A), released March 2.

In addition to owning a refinery and three port terminals, the Chevron deal means Parkland will have 1,834 corporate and dealer gas stations, making it the largest Canadian retail fuel marketer and the second largest convenience store operator.

As a result of its most recent deal, Parkland now owns Chevron’s refinery in Burnaby, B.C., which should benefit once the capacity of the Trans Mountain pipeline is increased. Ottawa approved the $7.4-billion twinning of the pipeline last year despite opposition by environmental groups, and once it’s finished, the pipeline will pump nearly three times as much oil and related products.

Along with the refinery and three fuel terminals, the deal will net Parkland 129 Chevron gas stations in the Vancouver area, 37 cardlock stations (unmanned stations for fleet vehicles) in B.C. and Alberta, three marine fuelling stations and a jet fuel business at Vancouver International Airport. The deal will add economies of scale and improve efficiency, linking the refinery and terminals to Parkland’s retail, commercial and wholesale businesses.

Parkland will finance the deal with $660-million in new shares, a $268-million draw on its credit facility, a $500-million bridge facility (later replaced with a debt issuance) and $40 million in cash flow from operations.

The deal will add more than 2.5 billion litres of annual volume and $230-million in earnings before interest, taxes, depreciation and amortization, or EBITDA, and increase its distributable cash flow by more than 30%, Parkland said in a news release.

The Chevron deal follows Parkland’s acquisition of most of the assets of CST Brands from gasoline and convenience store giant Alimentation Couche-Tard Inc. (ATD.B/TSX) last summer for $965-million. The move added Ultramar to Parkland’s brands and expanded Parkland into Quebec and Atlantic Canada, with 490 service stations, 72 commercial cardlock sites and 27 commercial and home heating sites.

Parkland’s dividend, which has been raised every February for the past four years, now pays $1.15 a year to yield about 3.9%. The company’s dividend reinvestment plan (DRIP) allows Canadian shareholders to use their dividend to buy more shares at a 5% discount to the stock’s volume-weighted average price. DRIP subscribers who bought Parkland when it converted to a corporation at the end of 2010 would have enjoyed an annualized return of about 23%, and a $1,000 investment made then would now be worth $3,687, figures from longrundata.com show.

The dividend payout ratio sits at 91%.

At $29.70, Parkland’s shares are certainly expensive, trading at about 60 times trailing earnings of 49 cents per share and 3.56 times book value per share but just 0.45 times sales per share, which many argue is a better indicator of value. The company has a market capitalization of $2.92-billion.

The company’s long-term debt has increased over the past few years and now sits at $538-million, still a modest 18% of its market capitalization. Parkland’s long-term debt to equity is 70%, while its debt to total equity is 1.04 and total debt/total capital sits at 51%. Though the debt seems high, Parkland operates in a capital-intensive industry that requires refineries, pipelines, trucks and gas stations and its debt levels are actually lower than other pipeline companies. Even so, Parkland’s current ratio (current assets/current liabilities) of about 1.1 is reasonable.

Perhaps the most worrisome debt indicator is the fact that its corporate notes are tagged with speculative ratings from both Standard & Poors (BB-) and DBRS (BB).

Parkland had $25.6-million in net cash at the end of 2016.

In 2016, Parkland earned $47.2-million or 49 cents a share on revenue of $6.27-billion, up from profit of $39.5-million (45 cents) on revenue of $6.3-billion.

In the fourth quarter of 2016, the company’s adjusted EBITDA grew to a record $77.1-million, up 19% over the $64.8-million reported in the same quarter of 2015. The growth came in all its operating units, including 21% in supply and wholesale, 15% in retail fuels and 5% in commercial fuels, the company’s management, discussion and analysis (MD&A) says.

In the fourth quarter, Parkland delivered about 2.8 billion litres of fuel and petroleum products, up 6% from the 2.6 billion litres recorded in the same quarter of 2015. Sales and operating revenue rose to $1.74-billion from $1.66-billion, mainly thanks to increased fuel volumes.

Not all the news was good, however. Net earnings plunged to just $3-million from $15.6-million, largely because of a $14.2-million finance cost charge involving the fair value of some redemption options on its senior unsecured notes due to changing credit market conditions.

Despite its high P/E ratio, Parkland looks like a great growth stock but it has a number of risks that make it ill-suited to conservative investors. Since it’s based primarily in western Canada, fluctuations in the oil price affect the regional economy, which in turn changes the level of demand for its products. This risk is reflected in the “speculative” rating that both S&P and DBRS give to its corporate notes.

There is another reason investors might want to have a small stake in Parkland, though. When Jim mentioned Parkland, I immediately thought of Alimentation Couche-Tard, which I described in the March issue of Canadian MoneySaver. The acquisition-hungry gasoline and retail giant, with a market capitalization of $36.2-billion, is 12 times the size of Parkland and, providing the federal Competition Bureau allowed it, could easily make a takeover bid for the smaller company and award Parkland shareholders a premium in the process.

“I own Couche-Tard, too,” Jim said.

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca