DATA Group is a leading provider of document management and marketing solutions
This week, our neighbors to the north play host to a business communications services company that has issued a convertible, Canadian dollar denominated debenture that is currently yielding a scorching 18% and matures in a relatively short 26 months. Data Group Ltd (TGX: DGI) has its roots in the design, printing and distribution of pre-printed products for its customers. As its industry has continued to evolve due to technology, the company has resolutely implemented strategies to redesign the company, launching integrated, technology-based document solutions to its established customer base. It has also aggressively reduced costs, accelerated debt repayments and stabilized revenues to position the company for growth. By the end of 2015, it will have reduced annual costs by CAD $27.3 million, representing almost 9% of its 2014 annual revenues. It has also paid down CAD $11.0 million in outstanding debt over the past two years, illustrating the company’s determination to improve its business and strengthen its competitive position. These cost and debt reductions will most likely translate to an increased interest coverage of 4x in 2015. A 4x interest coverage ratio with an 18% yield is nothing short of extraordinary, as this kind of interest coverage is more commonly associated with a much lower yielding instrument. Cost and debt reductions have translated to significantly increased net income for 2014, with revenues poised for growth in 2015. With these bonds currently trading at a significant discount, we feel this profitable company represents a rare high-yield opportunity for investors looking for currency diversification, good cash flow, as well as an excellent possibility for sizeable long term capital gains from its maturity at par. Therefore, we have marked these bonds for addition to our FX2 and FX3 global income portfolios.
Canadian Dollar Bonds for Diversification
Diversification is a tested method used to reduce investor risk. We encourage diversification in a portfolio not only through the addition of other countries, but also through the addition of other currencies. The Canadian dollar (CAD) is among the top ten most used currencies in the world, including the US Dollar (USD), the Euro and the Japanese Yen. Recent news has highlighted the strength of the USD against the CAD. While some investors may view this as an inopportune time to add CAD bonds to a portfolio, the current level of CAD to USD may have some benefits.
First, a weaker CAD should make Canadian exports cheaper. For current Canadian Data Group customers with US operations, this makes DGI’s products and services cheaper for their US counterparts. This cost savings is significant at the current exchange rate and may result in additional business for DGI from US based operations of its existing customer list.
Also noteworthy is that the Canadian Dollar is currently at a ten-year low against the USD:
The dollar has strengthened recently due to the notion that the US economy is recovering while other developed economies are struggling. The speculation that the Federal Reserve is poised to raise rates as early as June this year has also added to the dollar’s rise. One has to question if all of the economic news affecting the exchange between the US dollar and Canadian dollar has already been factored into the current 10 year low point. While the USD is currently thriving, any appreciation of the CAD against the USD will reflect favorably for US-based investors holding Canadian dollar investments.
About the Issuer
DATA Group Ltd. is a managed business communications services company specializing in customized document management and marketing solutions. DATA Group develops, manufactures, markets and supports integrated web and print-based communications, information management and direct marketing products and services that help its customers reduce costs, increase revenues, maintain brand consistency and simplify their business processes. Based in Brampton, Ontario, Canada, the company has approximately 1,640 employees working from 34 locations across Canada and the United States. The company has an impressive customer portfolio including Canada Post (Canadian postal service), TD Bank, Manulife Financial, PetroCanada and Bank of Montreal. Many of their clients have signed multi-year, multi-product contract agreements.
Data Group’s legacy business was built around supplying pre-printed products for its customers. As technology advanced, the demand for those types of products declined. The industry has transformed to more digital forms of communication and new client demands for blended print and digital solutions. In response to this, Data Group committed to a Transformation Plan in 2013. The goal of this plan is to reposition the company for sustained profit growth by adding new revenue streams, while at the same time significantly reducing costs and positioning the company for accelerated debt reduction. The company has made slow, but constant progress on each of these initiatives.
Actively Engaged in Cost Reductions
From a cost reduction standpoint, the company has made significant progress since beginning its restructuring process. Initially, DGI targeted to reduce manufacturing floor space by 35% and reduce headcount at all levels by 20%. By mid-2015, the company will have reduced floor space by 26% and reached their target of reducing headcount by 20%. The company anticipates an additional CAD $9.0 to $11.0 million annual savings from these actions. Factoring in the CAD $5.3 million in cost savings achieved in 2012, and the CAD $13.0 million in cost savings from 2013, DGI will realize a minimum of 27.3 million in annual cost savings moving forward.
Accelerated Debt Reduction
One of the vital pieces of the 2013 Transformation plan is accelerated debt reduction. Since adopting this plan, Data Group has made excellent progress in paying down its outstanding debt. In 2013, the company repaid CAD $4.5 million in debt, and in 2014, that amount increased, with DGI eliminating an additional $6.5 million in debt. These steps have also contributed to its bottom line, saving the company CAD $600,000 in annual interest expense. For 2015, the company has set a goal to reduce debt by an additional minimum of CAD $10.0 million. Since these bonds currently trade at a significant discount, the company has been able to repurchase a portion of these bonds at a favorable price.
As the print and document management industry continues to evolve, Data Group continues to respond to pricing competition while introducing new product blends for their customers. As a result, the company’s revenues appear to be stabilizing and have made the turnaround to greater profitability. For Q3 2014, EBITDA was CAD $6.2 M, as compared to CAD $4.4 M in Q3 2013, an increase of 41%.
This bond has a convertibility feature which allows the bondholder to convert to shares of common stock at a strike price of CAD $12.20. Although the stock is currently trading significantly lower as compared to this strike price (around CAD $0.71 / share), it has traded near CAD $10/ share mark within the last five years. If the company continues to execute well, and the stock appreciates, this feature has the potential to increase investor return.
For 2014, Data Group had operating income of CAD $12.9 million and interest expense of CAD $6.1 million, reflecting a healthy interest coverage ratio of 2.1x. Factoring in the additional scheduled CAD $9.0 – $11.0 million cost reductions mentioned earlier, interest coverage for 2015 will very likely be a remarkable 4x.
The company’s net income also increased in 2014 as compared to 2013. Net income for the period January 1 to December 31, 2014 was CAD $4.5 million as compared to a net loss for the same period in 2013 of CAD ($45,842). DGI did register a CAD $44 million impairment charge in 2013, but even after factoring in this charge as strictly a balance sheet item (not cash flow), the company still registered a loss in 2013 of CAD ($1.8 million).
The default risk is Data Group’s ability to perform. Since adopting its Transformation Plan in 2013, the company has made solid progress towards its goals of cost reduction, accelerated debt reduction and revenue stabilization. It has reduced debt by CAD $11.0 million in the past two years (with the associated $600,000 in annual interest savings), is on track to realize annual cost savings of over CAD $27.0 million, and its revenues are increasing. Giving further consideration to the company’s option to convert the debt to equity (at a 5% discount to the market) at its maturity, we feel the default risk for this bond is minimal relative to its rather astonishing return potential.
This bond issue is denominated in Canadian dollars; consequently, there is currency risk present. While we covered some of the factors to consider when diversifying to other currencies earlier in this review, we acknowledge that a stronger US dollar will decrease returns for US based investors. Conversely, any appreciation of the CAD against the USD will impact US based investors favorably.
This 27 month convertible debenture from Data Group, denominated in Canadian dollars, has similar duration and risks to other convertible foreign debt instruments that we have previously reviewed, such as 9% 5N Plus Bonds, 9% Lake Shore Gold, 7.5% Canwel Building Materials, and 10% Transglobe Energy Convertible Bonds.
Summary and Conclusion
Data Group has successfully navigated the transition from solely, paper-based printing services to technology-based, real-time document solutions for its customer companies. The company is profitable and should see increased revenues and profits in 2015. Its current interest coverage ratio of 2.1x will most likely increase to 4x with cost reductions slated to be completed in Q1 2015. A 4x interest coverage ratio is nothing short of phenomenal considering the over 18% yield indicated with these bonds. The company continues to effectively execute its Transformation Plan, begun in 2013. With significant cost reduction, debt reduction and increasing revenues and net income, the company is well-positioned to continue its growth in profitability. These Canadian-dollar, convertible bonds, currently trading at a significant discount and yielding about 18% are a must have addition, not only currency diversification, but for the possibilities of an increased portfolio yield. For these reasons, we are adding these short term Loonie convertible debentures from Data Group to our Fixed-Income2.com and Fixed-Income3.com global portfolios.
Issuer: Data Group Inc.
Ticker: DGI (TSX Exchange)
Stock Price: 0.76 (CAD)
Bond Coupon: 6.00%
Conversion Option Price: $12.20 CAD
Price: 78.85 (4/6/15)
Yield to Maturity: ~18%
Disclosure: Durig Capital and certain clients may have positions in Data Group 2017 Convertible Debentures.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this Data Group bond, call our fixed income specialist at 971-327-8847
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