Published on June 14th, 2019 by Aristofanis Papadatos
Alaris Royalty (ALARF) has dramatically underperformed the market in the last five years, as the stock has lost 50% of its value whereas the S&P 500 Index has rallied 48% during this period.
However, Alaris operates a strong business model, it distributes dividends every month, and it currently offers a 10% dividend yield.
Alaris is a rare stock, as it combines a double-digit yield with monthly dividend payouts. There are nearly 40 companies with monthly dividend payments. You can see the full list of monthly dividend stocks below:
We will thus analyze the prospects of this stock, which should be of interest to some income-oriented investors.
Alaris provides capital to well-managed profitable private companies in exchange for a monthly cash distribution. It thus fills a niche in the private capital markets, as it offers funds to companies that have solid business but cannot borrow funds economically from the usual channels.
As there are minimum overhead requirements for this business, Alaris enjoys EBITDA margins above 80%.
Source: Investor Presentation
The cash distributions paid by the companies to Alaris are determined 12 months in advance based on the terms of the partnership and they are adjusted based on the top line performance of the companies.
Alaris creates long-term partnerships with companies that have a proven performance record under various economic conditions. Those companies offer required products or services, they have non-declining asset bases (no exploration companies) and have low risk of obsolescence.
In addition, they have healthy free cash flows, low capital expenses to maintain and grow their business and low debt levels.
Source: Investor Presentation
Alaris uses a metric called “earnings coverage ratio” in order to determine which companies are suitable to partner with. The higher this ratio is, the stronger the company is from a financial point of view. Alaris currently has 12 partners with an earnings coverage ratio above 1.0 and 4 partners with a ratio below 1.0.
Alaris used to partner primarily with healthcare companies. However, its portfolio has changed in recent years and thus 58% of its invested dollars are exposed to business service companies, 35% to industrial companies and 7% to consumer products and services.
Source: Investor Presentation
Alaris currently has 91% of its fair value of investment dollars in U.S. based companies.
Alaris aims to create long-term partnerships with fundamentally strong private companies and thus generate recurring and growing revenue streams. Within its current revenue streams, the company aims to generate organic growth of 3%-5% per year.
Some companies incur temporary setbacks and have reduced their distributions to Alaris in some years. However, the management team of Alaris expects the strong performance of the other companies to more than offset the effect of the temporary setbacks of a few partners.
The business model of Alaris is certainly attractive, at least on the surface. However, it is much harder in reality to generate growing revenue streams by providing funds to private companies. To be sure, Alaris has a remarkably volatile performance record. In addition, it has failed to grow its earnings per share in the last decade, as its earnings per share of $1.65 in 2018 were 10% lower than the $1.83 posted in 2009.
The reason behind the poor performance record is the fact that some companies opt to terminate their partnership with Alaris as soon as they do not need its funding anymore or they find a more attractive source of funds. When they terminate their partnership with Alaris, the latter makes a decent profit but it incurs a shock in its cash flows in the years after the termination of its partnership. Overall, given the volatile results of Alaris, it is prudent to keep growth expectations low in order to avoid negative surprises.
Alaris needs to spend minimal amounts on overhead costs and capital expenses. As a result, almost all its incoming revenue streams are available for shareholder distributions. This fact has helped the company offer attractive dividends to its shareholders every single year.
Alaris has paid $0.69 in dividends in the first six months of this year. As management has stated that it expects the performance in the first quarter to repeat in the other quarters of the year, it is reasonable to expect the company to pay a total of $1.38 in dividends this year.
Given the current stock price of ~$13.50, the stock is offering a 10.2% dividend yield. This is certainly an exceptional yield and should be attractive to some income-oriented investors. The lean business model of the company results in high free cash flows and ample funds available for distributions.
On the other hand, investors should not assume that the dividend is safe. As the company distributes almost all its earnings in dividends, its dividend will be vulnerable if the company incurs a shock in its cash flows. Such a risk may materialize in the event of a recession.
During rough economic periods, most companies become conservative and try to reduce their leverage and preserve their cash. It is likely that some partners of Alaris will terminate their partnership with the company whenever the next recession shows up. Consequently, Alaris would likely incur a shock in its cash flows and may be forced to slash its dividend in a recession.
On the bright side, the Fed has become more flexible in its interest rate policy this year and hence the risk of an upcoming recession has materially decreased. But investors should always keep this risk factor in mind.
Valuation & Expected Returns
Alaris is currently trading at approximately 9.6 times this year’s expected earnings per share. While this valuation may seem cheap, particularly compared to the broad market, investors should note the volatile performance record of the company and its vulnerability to a potential economic downturn. We thus consider the stock to be fairly valued right now.
Overall, it is prudent for investors not to expect strong earnings growth, nor should investors expect a meaningful expansion of the price-to-earnings ratio for the stock. As a result, most of the returns of Alaris will come from its generous dividend. It is reasonable to expect an approximate 10% average annual return from Alaris in the upcoming years, in the absence of a recession, comprised entirely of the dividend.
Alaris has an attractive business model, as it fills a niche in private capital markets. Thanks to its lean business model, the company offers an attractive 10% dividend yield and pays dividends on a monthly basis.
However, investors should note the volatile performance record of the company and its sensitivity to the underlying economic conditions.
As a result, even though the stock is trading near its 5-year lows, we recommend waiting for an even lower entry point.