Transiting in opposite directions

Mullen Group’s investment quality is growing. Transat A.T.’s investment quality is declining. These two transportation stocks are going in opposite directions.

Our quality rating system uses a two-stage process to assess investment quality and risk, always from a long-term viewpoint. We base our stage one, or initial, quality rating on asset size, adjusted to exclude goodwill.

One positive aspect of using asset size is that management are more interested in adjusting their earnings than their assets.

In addition, large companies have many workers, customers, suppliers and shareholders. Naturally, governments will want the company to do well. A major company is often seen as ‘too big to fail’. Governments will often let them feast from the public purse. When a small company fails, captains of industry hypocritically say: “Well, that’s capitalism!” Big companies can offer the best employees lucrative careers. When one executive retires or is shown the door, another can replace them. Large companies typically have broader product offerings. Large companies can usually weather a longer, deeper business setback than small ones.

Keep in mind, too, that asset size is more stable than market capitalization. When investors drive share prices up or down, market capitalization can soar or plunge in a single day.

Asset size and fundamentals matter most

In our system, stocks with assets of over $3 billion start out with our top rating, ‘Very Conservative’. With assets of $1.5 billion to $3 billion, ‘Conservative’. Assets of $300 million to $1.5 billion, ‘Average’. Assets of $150 million to $300 million, ‘Higher Risk’. And assets of under $150 million, ‘Speculative’.

On September 30, 2021, Calgary-based Mullen Group (TSX—MTL) had assets of $1.931 billion. Subtract goodwill of $354 million and its adjusted assets of $1.577 billion give it a stage-one quality rating of ‘Conservative’.

On October 31, 2021, Transat A.T. (TSX—TRZ) had assets of $1.98 billion. While it did have intangible assets, Transat had no goodwill. Its assets gave it a stage-one quality rating of ‘Conservative’.

In the second stage, we analyze a company’s fundamental factors, such as its economic sector, capital structure, long-term prospects and so on. In this second stage, we may raise or lower our initial rating by a notch. In rare cases we may raise or lower the rating by even more than one notch, if that seems appropriate.

We examine a company sector

We often stick with our initial quality rating of a company in the consumer sector. We usually raise the first-stage rating of a company in the stable utilities or financial sectors. We often lower by a notch the initial quality rating of a company in the volatile resources or manufacturing sectors. That’s because they’re more vulnerable to unforeseeable sharp shifts in demand.

Mullen Group operates in many sectors, including some that are volatile. It writes that it operates in the “energy, forestry and construction industries in Western Canada, including water management, fluid hauling and environmental reclamation”. This has led us to cut the company’s stage-one rating by a notch, to ‘Average’. Even so, ‘Average’ is better than last time’s quality rating of ‘Higher Risk’.

We expect Mullen’s quality rating to continue to improve. For one thing it’s investing more in the consumer sector. For another thing, we expect its assets to keep on growing over time.

Transat’s dreadful finances

Transat operates in the consumer sector. Even so, we’ve reduced its quality rating by two notches, to ‘Higher Risk’. It lost $11.83 a share in the year to Halloween 2020. It’s thought to have lost $5.49 a share last year. And it’s expected to lose another $2.15 a share this year.

Transat’s finances are dreadful. It generates negative cash flow. In fiscal 2021, its cash flow came to minus $229 million. This means that you cannot use the net debt-to-cash-flow ratio to assess the company’s debt. Transat also has a shareholders deficit of negative $8.34 a share. As a result, we cannot calculate its net debt-to equity ratio either. We calculate Transat’s net debt at nearly $970 million. That’s why we continue to rate it a ‘sell’.

This is an edited version of an article that was originally published for subscribers in the January 21, 2022, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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