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AGF spending yields gains, but does firm have traction?

Profit has soared after investment, but costs are rising and margins falling, KEITH DAMSELL writes

The jury is out on AGF Management Ltd.

The Toronto fund company is giving the investment community some mixed signals. The firm reported a whopping 47-per-cent profit increase last week for the March-May quarter, a period in which Canada's benchmark stock index hit a record high and AGF benefited from a large non-recurring gain.

Canada's ninth-largest mutual fund operator earned $33-million or 37 cents a share in its second quarter ended May 31. That was up from $22.4-million or 25 cents in the year-ago period. Analysts surveyed by Thomson Financial were on average expecting 22 cents a share.

The bottom line was boosted by a $13.3-million gain from repayment of debt, partly offset by a $2.1-million loss arising from last year's sale of unit Unisen, a transaction-processing business, to Citigroup. Gross sales of mutual funds jumped 77 per cent year over year, while redemptions were 11 per cent lower. Total assets under management rose 18 per cent to $37.7-billion.

The company's class B shares rallied on last week's news, climbing 5.7 per cent over five days to end the week at $20.15.

But a look at the fine print suggests the market's enthusiasm may be premature. Costs are rising and margins are in decline.

Under the leadership of Randy Ambrosie, president of AGF Funds Inc., the company has courted key advisers, overhauled its sales team and launched a series of new products, including AGF Elements, a portfolio product that's attracted more than $555-million in assets.

All that hard work has cost money. Selling, general and administrative expenses climbed to $41.4-million in the most recent quarter, up 32.3 per cent from the comparable period a year ago.

Meanwhile, margins are falling. The firm's earnings before interest, taxes, depreciation and amortization (EBITDA) in investment management operations fell to $56.8-million in the second quarter, down about 7 per cent from $60.9-million a year ago.

There's some concern among Bay Street analysts as to what will happen when AGF turns off the tap and tries to rein in costs.

"Over time, can they continue that sales momentum, while trying to improve profitability by bleeding off expense levels?" asked John Aiken of National Bank Financial Inc.

The analyst has a "market perform" rating on shares, a self-described "straddling the fence" position. He is not alone -- of the eight analysts covering the company, according to Bloomberg, two have "buy" ratings, four have "hold" ratings and the last two, "sell."

May's poor showing is adding little comfort. The sales team stumbled and the company reported net redemptions of $11-million, ending a three-month winning streak. AGF management insists the weak performance reflects an industry-wide sales slowdown and is just a blip on the long road to recovery.

"We made a very conscious decision to invest in the business," Mr. Ambrosie said. Heavy spending to rebuild the company is done, he said. "You can't predict if you have to make another investment here or there but the lion's share in infrastructure has been made."

The turnaround of the company is on track and management is pleased with the progress to date, he said.

"We have made huge strides in growing our gross sales, we've reduced our redemptions, we feel that if we stick to the knitting and stay focused on our strategy that the numbers are just going to keep getting better," Mr. Ambrosie said.

The problem is the deck may simply be stacked against AGF. The Big Five banks, along with CI Financial Inc. and IGM Financial Inc., continue to dominate the sector and benefit from massive economies of scale, leaving little room for mid-tier players to make headway. Despite management making all the right moves, the long-term fate of AGF remains a question mark.

Retrocom auditor exits

The auditor of troubled Retrocom Growth Fund Inc. has quit.

Smith Nixon & Co. LLP has resigned because it has no financial data to review. The Toronto labour-sponsored fund has been unable to provide the auditor with statements for the year ended Aug. 31, 2005, "because it has been unable to determine its net asset value and contingent liabilities as at that date and remains unable to do so," the fund manager said in a June 21 statement.

In December last year, Retrocom took the drastic step of suspending redemptions in the $48.9-million fund, attributing the freeze to a flood of investors wishing to exit. The real estate development fund has warned its estimated 21,000 investors that "a significant reduction" in the value of the fund will be required.

RSM Richter Inc. is reviewing the fund's financial position. The consulting firm is expected to submit its findings to the fund's board of directors by the end of July.

"The plan is to figure out exactly where we are at," said Robert Blakely, the director of Canadian affairs of the Building and Construction Trades Department, a construction trades lobby group and Retrocom investor. Mr. Blakely was appointed chairman of the fund in February.

"We just need to know if this thing is viable," Mr. Blakely said, adding that "the door is open" to potential solutions, including the sale of assets or the fund itself. "Unfortunately for me, this thing with Retrocom is sweeping up after the elephants. But somebody's got to stick around and do it."

Keith Damsell is editor of GlobeinvestorGOLD

© 2007 The Globe and Mail. All rights reserved.

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