When a stock offers a big dividend, you should ask yourself, “What are the risks?”
Looking at Alaris Royalty Corp.’s (TSX:AD) five-year stock price chart, it doesn’t take a rocket scientist to realize that its business is higher risk than average.
Over the period, the shares have been like a roller-coaster ride with some occasional big dips. As a result, Alaris Royalty offers an above-average yield of 7.1% to compensate shareholders for taking on the additional risk.
As of November, insiders owned about 10% of the company. With such a large ownership, could there really be value in the shares?
Here’s what you need to know before deciding if Alaris Royalty is the right investment for you.
What does it do?
Alaris Royalty offers capital to private businesses that wish to maintain the ownership in their companies. These partners have a history of generating strong cash flows, and Alaris Royalty receives monthly cash distributions from them.
Alaris Royalty has 70% of its investments in the United States and 30% in Canada. By industry, roughly 34% of its invested dollars are exposed to business and professional services, 34% are exposed to industrials, 24% are exposed to health care and 8% are exposed to consumer discretionary.
Recent results
Alaris Royalty earns revenue streams from 16 partners. In the third quarter, 11 of its partners, which represented 81% of the quarterly revenues, were performing at or above expectations. Four of these partners, which represented 38% of the quarterly revenues, were expected to increase their distributions this year.
Risks
Not all is rosy, though. Alaris Royalty has no control of the businesses it partners with. Its role is to look for potential new partners and to monitor the financial health of its existing partners with an aim to generate diversified cash flows that support a sustainable dividend.
Alaris Royalty has been experiencing problems from five of its streams. As a result, about 19% of its distributions is deferred; there’s no telling when Alaris Royalty will receive those distributions, if at all.
Is its dividend safe?
The million-dollar question is if the company’s 7.1% yield is safe. Historically, its growing cash flow per share allowed it to grow its dividend per share at an average annualized rate of 14% over five years.
Due to deferred distributions from selective revenue streams, Alaris Royalty’s payout ratio is expected to be about 103% this year. However, the occurrence of six events could reduce its payout ratio to as low as 76%.
Half of these events involve receiving regular distributions from its problem streams again when the related partners have fixed their issues.
Additionally, Alaris Royalty has $10 million of cash to support the near-term shortfall. This cash can cover more than five years of dividends based on the current payout.
Of course, not all of it is going to be used as a buffer for dividend payments. For example, some of it could be used to invest in new revenue streams. In either case, the cash will help sustain Alaris Royalty’s dividend.
