Top Dividend Stock for 2017

[Pages:6]Dividend Investor Canada's

Top Dividend Stock for 2017

Candidate #3

Dividend Investor Canada's

Top Dividend Stock for 2017

A special message from Bryan White, Lead Adviser,

Motley Fool Dividend Investor Canada

Dear Fellow Investor,

The next time someone tells you that dividend-paying stocks are "boring" or have no real growth potential, here's something you might want to point out...

According to data from renowned Yale economist and market researcher Robert Schiller, over the past century the S&P 500 index in the U.S. is only up about 900% when adjusted for inflation.

Surprised? Most investors are! But here's the truly shocking thing...

If, over that same time period you had simply reinvested your dividends, that return would jump to an incredible 58,623%.

That's a 65X difference! And if it's not proof positive of just how important it is to own stocks that pay dividends, I don't know what is! But let's face it... not all dividend-payers are created equal.

Some truly are nothing more than stodgy old "cigar butt" businesses that have no real potential to grow your underlying investment dollars over time.

Meanwhile, some super-high-yielders may simply not have the financial means to continue to pay out such a whopping dividend -- especially if they come from a more cyclical "boom and bust" industry like energy or mining.

And trying to separate the wheat from the chaff can be a very daunting -- and time consuming -- task. Honestly, it's enough to make many folks just forego investing in dividend stocks altogether.

17 January 2017

Which is why I wasn't the least bit surprised when a recent survey showed that a whopping 98.9% of our Motley Fool Canada readers and premium members would like more guidance on which dividend stocks to buy and when.

It's also why I am both so proud -- and so excited -- to have been selected to serve as the Lead Adviser for our newest premium investment solution, Dividend Investor Canada, which will have its grand opening on Thursday, January 19.

And because we want you to have everything you need to make a well-informed decision about whether membership in a service like this might be right for you...

In the days leading up to this this historic event, my team and I will be sharing our top three candidates for our Top Dividend Stock of 2017 -- which will also be our first official recommendation within Dividend Investor Canada.

Plus, we'll be posting a wide variety of other dividendfocused bonus content that we believe you'll find both very informative and very valuable.

Everyone here is extremely excited about the launch of Dividend Investor Canada and all of the pre-launch festivities that will precede it.

We hope you'll enjoy everything we'll be putting together for you -- and that you'll consider joining us in Dividend Investor Canada when we officially open our doors here in a few short days!

To helping making 2017 your most profitable year yet,

Bryan White Lead Adviser Dividend Investor Canada

P.S. -- As with all of our premium investment services here at Motley Fool Canada, Dividend Investor Canada is fully backed by a 30 day, 100% membership-fee-back guarantee.

So you're always welcome to "test drive" the service for a full month before really having to decide whether it's right for you. And if it's not, no problem! We'll happily return your membership fee in full. Full details will be made available the morning of Thursday, January 19. So please keep an eye on your inbox!

2 The Motley Fool

Top Dividend Stock for 2017

fool.ca

Pason Systems (TSX: PSI)

By Bryan White

The company provides critical technology and equipment that can be found on the vast majority of drilling rigs in Canada and a growing number in the U.S.

Why we're considering buying:

? A low-risk way to gain exposure to a recovery in oil markets.

? Profits should take off as demand returns thanks to a capital-light business model.

? A high-quality operator with an attractive yield and plenty of upside potential.

Headquarters:

Calgary, Canada

Website: Industry: Volatility: Market Cap: Dividend Yield: Cash/Debt: Free cash flow (TTM): Dividends (TTM): Payout ratio: Total Insider Ownership*: Recent Price: TTM: Trailing 12 Months

Oilfield Services

High CAD$1,652

3.5% $24/$442

$14 $57 407% 13.3% $19.56

Dollar amounts in millions except recent price. *Percentage of shares outstanding owned by insiders

Data as of 01/05/17

While the impacts of the deep cyclical decline in oil markets are still being felt in places like Alberta, there have been some early signs of a recovery. The graph below reminds us just how sharp the downturn was and how long it's lasted. Active drilling rigs (on the left) in North America were clearly hit the hardest.

* Source: Baker Hughes, EIA, Bernstein Since the election in the U.S., oil prices have steadily risen back above $50 per barrel, bringing with it optimism in the industry and some signs that the worst may be behind us. While nobody can accurately forecast the future price of oil, we can look for investments positioned to benefit if the cycle has indeed turned upward. In doing so, we'll want to find high-quality companies that are operating from a position of strength. Companies that are asset-light and that don't need to spend heavily on equipment and staffing in order to meet rising demand. We're looking for companies that benefit right away, without incurring heavy costs to get back up and running.

That's why I couldn't resist taking a long look at Stock Advisor Canada recommendation Pason Systems (TSX:PSI).

The Business

Pason Systems outfits drilling rigs with equipment and software systems used to manage and remotely monitor well drilling operations. The company's equipment provides oil and gas companies with critical data driving improvements in drilling efficiency, performance, and safety.

The company's core product offering is its Electronic Drilling Recorder (EDR). It allows rig operators to collect and manage drilling data and information in real-time from the wellsite or remotely. Pason has developed a suite of additional solutions to improve safety and drilling performance. The more complex or remote the drilling area, the more valuable Pason's solutions are for its customers. The company charges a daily rental rate for its equipment, which means its fortunes are directly tied to drilling activity and rig counts.

Pason's devices can be found on more than 90% of the drilling rigs in Canada. Pason's dominant market share in its local market and the technology-intensive nature of its offerings allow for incredibly high profit margins. We're talking about some of the best returns on invested capital you'll find in the oilfield services industry. Pason has delivered average returns on equity of 23% since its IPO in 2007, and average returns on invested capital of 30% since 2005.

The Opportunity

Pason Systems, along with the rest of the oilfield services industry, is finally feeling some relief from one of the worst

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Top Dividend Stock for 2017

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cyclical downturns in a long time. At this stage of the cycle, the company's costs are largely fixed. As incremental revenue comes in, it comes at a very low cost to the company. We saw the impact this had in the most recent quarter--a modest rise in demand in the U.S. led to a material uptick in the company's profit margins. We think there's plenty left where that came from. As rigs return to work, supported by a notable rise in oil prices since the U.S. election, Pason Systems should drive truly impressive operating leverage (when profits are growing faster than revenue).

In addition, Pason is coming off an investment cycle that began in 2014, which means it has a whole new slate of products to introduce to the market as drilling activity resumes. This is an incredibly important product rollout since the enhancements were primarily software-focused in an effort to improve drilling performance. This software focus will help create stickier relationships with its customers and offer higher-margin cash flows.

Some of the company's research and development efforts are already bearing fruit. Pason recently signed an agreement with Helmerich & Payne, the largest driller in the U.S., to outfit its rigs with an enhanced well control system. This agreement grows its presence in the Permian Basin and moves its U.S. market share to around 60%. I think we'll see further strength in the U.S., particularly in the near term, as activity picks up. With market share in Canada steady in the 90%-plus range, the U.S. and other international markets represent compelling growth opportunities.

I think Pason Systems is a great way to gain exposure to a recovery in oil markets. While the company doesn't look cheap on the surface--it sports a trailing price-to-earnings (P/E) ratio of 112--this is actually typical for a cyclical company. The abnormally high P/E ratio is caused by depressed earnings during the downturn. For most cyclical companies, this is a temporary phenomenon. As earnings "normalize," the P/E ratio will follow suit. Given the company's ability to turn incremental revenue into profits quickly, I think there's plenty of upside in the stock over the next three to five years.

Dividend Sustainability

With the business so closely tied to drilling activity, the cyclical downturn has taken its toll on the company's cash flow. In fact, by the latter half of 2015, operating cash flow had declined to a point where it no longer covered the dividend, and it's persisted ever since. That said, management continues to support the dividend, and with the stock trading at $19.56, it currently yields 3.5%.

Thanks to the pragmatic way management runs the company, it was sitting on $198 million in cash with no debt when operating cash flow really began to dry up. The company has supported the dividend with its cash ever since, but still holds $155 million in net cash as of Sept. 30, 2016. That's an enviable position to be in two years into the downturn.

Historically, the company has spent very little on acquisitions, and I expect capital spending to slow down after the thorough reinvestment period the company just underwent to produce its new product lineup. Over the long term, I'd expect the capital intensity of the business to decline further as new product rollouts become more software-oriented. This means more cash flow available to return to shareholders.

With the recent rise in oil prices, and notable increase in demand in the U.S., I expect Pason to stick with its dividend in 2017. That said, if the recent rise in prices is just temporary, and the downturn persists, management would likely cut the dividend in order to preserve cash on the balance sheet. Since we're more interested in the long-term value of this business and the cash flows it generates, a temporary reduction in the dividend would be disappointing, but far from a deal breaker. In fact, it'd probably open up another excellent buying opportunity.

What We're Watching

In the near term, the price of oil will have the biggest impact on Pason and its cash flows. Frankly, we'd love to see the recent rise in oil prices continue to provide a lift to rig counts, which is the key industry figure to watch here. We'll also need to keep an eye on the company's cash flows and its competitive position.

A new competitor named PHX Energy Services (TSX: PHX) recently entered Pason's market in Canada. The stock initially took a hit on the news that PHX had agreements in place to outfit 15 rigs in Canada. Given the sticky nature of Pason's services and the quality of its new product rollout, taking meaningful market share won't come easy for PHX. Further penetration into the U.S. and international markets should also help offset any market share losses in Canada.

Long term, we'll watch to see how well adoption goes for Pason's new products. If it's able to deliver enough value to customers, the company's new product suite could fetch higher day rates.

The Foolish Bottom Line

When investing in cyclical industries, it's always a good idea to seek out capital-light businesses that offer "sticky" products or services that generate attractive profit margins. They're not easy to find, but thankfully Stock Advisor Canada did the heavy lifting for us.

In Pason Systems, we have a business poised to deliver impressive results if spending rebounds. If the recovery is delayed or postponed, the company has a strong balance sheet with $155 million in net cash. This provides patient investors a low-risk way to gain energy exposure and earn an attractive dividend yield as we await a more robust recovery.

4 The Motley Fool

Top Dividend Stock for 2017

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How to take the next step with Dividend Investor Canada...

We hope you enjoyed getting the full story on Pason Systems, and that it has given you a better idea of why the team is considering naming it their Top Dividend Stock for 2017 -- as well as the first official pick for their Dividend Investor Canada service.

If you haven't already had a chance to do so, we'd encourage you to also have a look at the "executive summary" video that Dividend Investor Canada analyst Taylor Muckerman and Lead Adviser Bryan White recently recorded, which will give you even more insights into why they have their eye on this unique dividend payer.

We'd also ask that you please be on the lookout for your invitation to join us for a very special live and interactive pre-launch Q&A session that the team will be hosting tomorrow at 1PM EST.

In the meantime, should you have any questions about Pason Systems, any of the other free content we're making available, our Dividend Investor Canada service, or even just dividend investing in general, please feel free to send them to dividends@fool.ca and a member of our team will get back to you as soon as possible -- or possibly even answer them in the Q&A session tomorrow.

We're thrilled that you've decided to follow along with all of the festivities leading up to the grand opening of Dividend Investor Canada on Thursday, January 19 -- and we sincerely hope you'll consider joining us as a Charter Member.

Thank you again for your time and interest, and as always, Fool on!

Disclosure: All figures as of January 5, 2017. All dollar amounts are represented in Canadian Dollars, unless otherwise noted.

This report is: (a) for general information purposes only and not intended as investing advice; and (b) not to be used or construed as an offer to sell, a solicitation of an offer to buy, or an endorsement, recommendation, or sponsorship of any entity or security by The Motley Fool Canada, ULC, its employees and affiliates (collectively, "TMF"). This report represents the opinion of the individual author and does not attempt to give you professional financial advice or advice that relates to your personal circumstances.

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