Considering Domlec, Dominica Utilities as an Equity Investment

Thank you for joining Caribbean Virgin: The Podcast on Unique Investment Deals in the Caribbean. I am your host, Neal Nixon. This is episode number 1.

For this inaugural piece, we are going to take a snoop at Domlec, a utility company in the tiny island of Dominica. The company is the only utility concern on the island with a durability of advantage, a wide sustainable moat and a perennial rewarder of dividends. We are going dissect the company's 2015 annual report and go beyond the mathematical elegance of betas and alphas and highlight the figures that matter to investors.

But first a little background:

The company was started in 1949 by the Colonial Development Corporation. In 1976 the government of Dominica purchased 49% of the shares of the company and in 1983 acquired the remaining shares.

Subsequently, In 1987, Government sold 60% of the shares to the general public.

Further, in 1997, the Commonwealth Development Corporation (CDC) purchased 73% of the shares from the government.

In May 2004 WRB Enterprises, a Florida utility concern, and Dominica Social Security in a joint effort purchased CDC's shares in DOMLEC, with WRB owning 53% and Dominica Social Security 20%.

In April 2013 the Barbadoes Light and Power Holdings (a subsidiary of Emera Corporation) bought WRB Enterprises’ shares and became the majority shareholder of the company. Intuitively, apart from Domlec, Emera owns 100% of Barbadoes Light and Power, 19% of St Lucia Utilities, 80% of Grand Bahama Power Company.

The company is listed on the Eastern Caribbean Stock Exchange (ecseonline.com) with a current price of $4.10 a share.

At present, Domlec is a rear bird, certifiably one of the best-managed utility company in the Caribbean Regions.

In 2015, total revenue was 93.5m down sequentially from 101.9m in 2014. Conversely, fuel cost is a much better determinant of profitability than gross revenue. More on the impact of fuel later.

Net income was 12.3m, including the benefit of a 1.5m insurance reimbursement for damages sustained from Tropical Storm Erica. Net income per share was $1.18

For year end 2015, the board of directors approved a dividend payment of .40 cents, which is a yield of 9.75% on its market price of $4.10. Compare that return to the average 2-3% interest that depositors receive from Caribbean banks this is a fabulous investment opportunity.

Shareholders equity increased from 86.6m to 94.7m, a 10.5 percent increase over 2014. The corollary is a 13.5% return on average equity.

Astutely, famous investor, Warren Buffet avers that if you "Double the return on equity of a company and, you get much more than a doubling of the company's intrinsic value." Unfortunately, while Domlec shareholders equity increases beyond 10% on an annual basis and intrinsic value increases in tandem, the price per share remains unmoved.

The Number of authorized shares is 15m with 11.4m shares outstanding - or owned by all shareholders. Anecdotally, Domlec can raise capital by issuing 3.6m more shares to the public without amending its bylaws.

The company's average assets were 169.5m which resulted in a 7.3% return on assets. Which means for every $1 of assets employed by the company, it was able to make 0.073 cents in profits

Assets and Liability

The company has a current ratio, current assets / current liability of 2.40, a sound indicator that there is sufficient working capital to sustain the business in the short run.

Long-term debt of 31m is payable to the National Bank of Dominica with a 5.75% rate. Don't be alarm at that amount. The company can pay for all its long-term debt from its free cash flow in less than three years if management so choices. In fact, Domlec's interest coverage, the number of times a company can pay interest payments with net income is 8.6; so attending to its debt obligations is a non-issue.

Key Factors

In 2015 the company endured 35m fuel cost, a dramatic improvement of 22.2% from 45m in 2014. That is a 10m dollar reduction with total fuel consumption of 4.8m gallons and an average cost of $7.45 a gallon verse $11.21 in 2014

Presumably, a 10% decrease in the price of diesel leads to a corresponding decrease of $4.5m in fuel cost - and fuel cost accounts to about 60% to 80% of operational expenses.

Recommendations

1. Domlec has 31,300 customers on an island of 72,000 people. When a market is small and the market is limited three things need to occur to propel growth and employ the intelligent commitment of invested capital: Rationalize, optimize and consolidate. The company has rationalized (its assets) and optimized (processes) its operation in recent times, what is needed for growth in the Caribbean is consolidation - which should lead to efficiency and economies of scale.

Domlec has an 83.5m credit facility with National Bank of Dominica. It is time Domlec goes on an expansion spree. Buy the Nevis Utilities of St. Vincent Utilities, for example.

2. The stock is demonstrably undervalued. Its net tangible book value per share is $9.12, while its price per share is only $4.10. An investor can purchase its assets for less than 50 cents on the dollar. In fact, that is the kind of incredible deal that Emera of Canada got when it purchase 53 percent of Domlec shares in 2013. To remedy this gross misalignment between price and value, the company should buy back its shares on the open market or through a TENDER OFFER, something it has never done. Instead of paying over $4m in dividends payment the company could allocate half the amount to share buy-backs which would increase the market price and shareholders return.

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