The Facts (as of October 22, 2010)

Unit price: $12.01. Book value per unit: $6.08. Market cap: $1073 million (large). Distribution: $0.0629 per month or $0.7548 per year AFTER conversion in January. Post-conversion yield: 6.37%. P/E: 21.3x. Debt/equity ratio: 0.59. Current payout ratio: 104%.

The Story

As the largest provider of medical imaging services in Canada, a leading provider of laboratory testing services
in Ontario, and a leading provider of medical imaging services in the U.S., our centres play a critical role in health
management. CML’s operations are focused on providing the following services:
• Laboratory Services: conducting a wide range of medical tests used by physicians to diagnose medical
conditions, plan or evaluate treatment, and monitor diseases, through CML’s Ontario–wide network comprising
121 specimen collection centres (“SCCs”) and a central laboratory located in Mississauga, Ontario.
• Imaging Services: providing medical imaging services, such as magnetic resonance imaging (“MRI”), computed
tomography (“CT”), Positron Emission Tomography (“PET”), x-ray, ultrasound, mammography, nuclear medicine,
fluoroscopy, and bone densitometry (“DEXA”), through a network of 108 centres in Canada located in Ontario (77),
British Columbia (19), Alberta (nine), Manitoba (two) and Québec (one); and 23 U.S. based centres located
in Maryland (17), Delaware (one) and Rhode Island (five).

The unit price peaked over $17.00 at the end of 2007, while the distribution increased from $0.08 per month to $0.09 during that year. They were maintained during the recent recession, but the unit price  fell to just under $13.00 during the worst of the crash. The unit price recovered to $14 over the course of 2009, before crashing in 2010 with the prospect of conversion and a reduced dividend. This year, the price has gone from $14 to $10 and back to $12. We know that the yield with the new dividend, after conversion to a corporation, will be a little under 7%, based on the current unit price.

Pros

This stock provides a good yield, and there is some certainty about what the income will be in future. Once the income trust converts to a dividend-paying corporation, those dividends are expected to be eligible for preferential tax treatment. Medical services are profitable and are experiencing increasing demand as the population ages.

Cons

The current price seems high relative to earnings. With a P/E over 20 and a market value that is twice the book value, there is some inherent speculation that earnings will recover to pre-recession levels. That may be a reasonable expectation, given that 2009 earnings were around 50% of 2008 and 2007 levels. However, with changes to health care provisions by governments in Canada and the US, there is some uncertainty.

Impression

The yield is reasonably good, and I like the fact that management has already announced their intention for their dividend post-conversion. This company seems to be relatively stable and, at these prices, offer a reasonable investment. Even if the integration of their radiology acquisition is not successful, the share price appears to be relatively low, offering some downside protection. This could work as a part of an income portfolio.

CML Healthcare CLC.UN

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