Student Transportation Inc. just keeps rolling along.
The Barrie, Ont.-based school bus company has traded between $6 and the low-$7 range for four years, all the while maintaining a dividend yield in the high single digits. (It's currently 7.8 per cent.) Despite an earnings miss in its most recent quarter, the company is trading at a dividend-adjusted record high.
At first glance, it looks like a neat addition to the portfolios of income-hungry investors. A peek under the hood, however, suggests otherwise.
The Student Transportation story certainly seems compelling. The company bills itself as North America's third-largest – and fastest-growing – provider of school-bus services. It has 11,500 vehicles operating in Ontario and a number of U.S. states. A combination of acquisitions and new business has allowed it to post annual revenue growth in the mid-teens during most of the last decade, with sales coming in just under $500-million (U.S.) in the year ended June 30. It's led by chief executive officer Dennis Gallagher, one of the pioneers of the for-profit school-bus industry.
The company also fits into a larger narrative: School districts, facing the burdens of increasing health and pension costs for their workers, will look to outsource services such as busing.
Analyst John Larkin of Stifel Nicolaus, in initiating coverage of Student Transportation in May, 2012, said the North American pupil transportation industry is a $24-billion business where two-thirds of the fleets are operated by governments. This is what is known as a large "addressable market."
So, it's a growth story! And it's an income story! What's not to like?
It's too easy to pick on Student Transportation for its price-to-earnings ratio, which on a trailing basis is something on the order of 369, per Standard & Poor's Capital IQ. It's not really a one-year aberration; the company's best earnings-per-share number was 5 cents, in each of 2010 and 2013.
No, you see, Student Transportation is a cash story. The company's EBITDA, or earnings before interest, taxes, depreciation and amortization, is consistently higher than net income. It was about $66-million in the just-closed fiscal year, as a matter of fact.
Writing about investing, I've stopped being a net-income absolutist. I use EBITDA quite a bit. It's a good tool for evaluating a company's earnings power. In the case of Student Transportation, however, I do feel the need to note something when looking at the long-term performance of the company: School buses are a really important part of the company's business model. Student Transportation owns about 75 per cent to 80 per cent of its fleet. And when you leave depreciation out of the equation, you're leaving out most of the costs of the single most important productive asset the company has.
This is borne out by a look at the company's cash-flow statement (also courtesy of Capital IQ.) Take the company's cash from operations and subtract its annual capital expenditures (which accounts for most of the buses) for a basic form of "free cash flow." The last time the free cash flow was enough to cover the company's annual cash dividend payments was 2005.
In the 12 months ended in June, 2014, the company had free cash flow of $8.6-million and paid cash dividends of $34.1-million. Over the past 10 years, the company generated $29.4-million in free cash flow and paid $208.5-million in dividends. And that doesn't even include $565-million spent on acquisitions.
Now, to be clear, I'm not suggesting a dividend cut is imminent or that the company is about to collapse. Not at all. In fact, this sort of thing can continue indefinitely, as long as bankers and other financiers are willing to lend the company money to finance the dividends and acquisitions that the company can't afford through its own operating performance.
The company has multiple issues of debt, convertible into common shares, that pay interest from 6.25 per cent to 7.5 per cent. These rates strike me as high, particularly for a company that's never posted a return on capital higher than 3.4 per cent. (That's based on that pesky net income that includes depreciation on buses.)
To be fair, Student Transportation has an eye on improvement: It has a stated goal of growing earnings so it's paying out a smaller portion as dividends. And some of its new technologies, including allowing parents to track the buses, sound neat.
But while the wheels on this bus go round and round, I think there's just a little bit too high of a chance they'll fall off completely.
David Milstead