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Tuesday, October 25, 2016

What I like about turnaround investments is that they offer the kind of returns you expect from speculative high-growth ideas, but at half the risk. The exciting growth stories can work out, but they have an almost equal tendency to cause head trauma. Turnarounds, by contrast, offer a steady increase in capital that rarely surprises to the negative once the recovery gains traction.

I've shared a few over the years in this space - New Flyer Industries Inc., EasyHome, Intertape Polymer Group Inc., American International Group Inc. and, more recently, IBI Group and Polaris Infrastructure - and pretty much all of them have done very well.

All of these ideas shared many characteristics with today's idea: Colabor Group Inc. I think this stock will do as well as the other broken stocks on the mend I've recommended over the years, and I've been a buyer recently.

The company is a Quebecbased food distributor. There's the first thing it shares with its turnaround kin: It operates in a boring but stable industry for which demand will never go away.

Colabor has been operating since 1962, the second communal issue. Old companies have lots of historical data to lean on when one analyses the prospects of a recovery.

The firm went public in 2005 as an income fund and its stock once traded for $13, whereas it can be had for a buck today.

Successful turnarounds have usually had much higher stock prices, and while the shares rarely retouch old highs, they nonetheless multiply from the bombed-out price if all goes well.

What almost killed Colabor, not surprisingly, was a debtfuelled expansion plan that increased revenues by 50 per cent in seven years to $1.5-billion but that nonetheless destroyed profitability. Sound familiar?

It always helps if the company's market cap is a fraction of its sales. Colabor has a market value of $110-million while sales are almost 15 times as high.

Colabor also sports a hefty, turnaround-typical debt load, which I like because what debt does in damage when things get tough, it does in rehabilitation when things improve, as I believe they are now.

Then there are the two circumstances in Colabor that aren't always shared or even necessary in picking broken stocks on the mend but that are very helpful. The first is insider buying, which needs no explanation, and the second is a stock price at around $1.

These shares tend to perform the best. They're high enough to be respectable but they're not penny stocks that can do well for a brief period and then crumple for months or years (or forever).

That brings me to the last shared point: Things must be getting better before a turnaround can be pronounced. And they appear to be at Colabor.

Let's start with debt, which, thanks to a recent equity-rights issue, has been cut by almost $50-million, or about a quarter.

There is still a lot of debt, but I believe it's manageable, and the market agrees given that the stock is starting to move. The company also has about $80million of net working capital, which adds a nice buffer.

Next, profitability: Food distribution is a low-margin affair, but this company's profitability fell off a cliff as it raced to acquire competitors.

EBITDA margins averaged 3.6 per cent from 2008 to 2011.

After years of neglect they'd been cut in half by 2015. But profitability is up 33 per cent so far this year and there is room for tremendous improvement.

The company has also brought in some new talent as part of its restructuring, notably food distribution veteran Rob Briscoe, who has already written a $5.4million cheque for stock and accepted the role of executive vice-chairman.

He's got 25 years experience in the business, and I don't think he's doing this to make chump change. Mr. Briscoe was in the business until 2014, when he sold a private concern to a partner. But he clearly sees an opportunity here, and I don't mind riding his coattails.

In short, Colabor has all of the hallmarks of an exciting turnaround, with a very recent restructuring and recapitalization.

It doesn't hurt that the float - the amount of stock not in the hands of big institutions in it for the long term - is very small, less than a fifth of stock outstanding.

All in all the risk-reward equation looks heavily tilted in the investor's favour.

Fabrice Taylor, CFA, publishes the President's Club investment letter, for which The Globe and Mail provides marketing services and receives compensation.

Colabor Group (GCL)

Close: $1.16, up 1¢

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