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General Commentary (March 24, 2017)
Eventful week. The S&P 500 Index ended down 1.4% and the tech-laden NASDAQ fell 1.2%, leaving some market commentators to wonder if the (feckless?) rally in US equity prices since the November elections is starting to run out of steam. It's possible. By my count, the S&P has run up almost 13% since November 8 largely on hopes that the surprise new administration in Washington will cut taxes, slash regulations, and embark on large fiscal stimulus. Well ok, but from an investment standpoint, on what basis can the new administration be reliably depended on to deliver such promises given the preponderance of lies, mistruths, fake news, ineptitude, racism, misogyny, homophobia, degradation of environmental protections, deference to deep-pocketed special interests, and possible treason(?!) that have pervaded thus far? Color me a cynic, but I'm not that confident.
On Friday, the divisions among Republicans were on full display as the GOP, even with full control of the White House, Senate, and House of Representatives, failed in their widely publicized effort to repeal the Affordable Care Act (a.k.a. Obamacare). The effort failed because of, interestingly, the divergent positions of both moderate and conservative factions of the GOP ... moderates balked at the prospect of 24 million Americans (according to the non-partisan Congressional Budget Office) losing their health care coverage under Trumpcare (i.e., it was too cruel), while conservatives didn't like Trumpcare because it still required insurance companies to provide coverage for such basic services as hospital stays, maternity care, and mental health and addiction treatment (i.e., Trumpcare wasn't cruel enough). Yes, this one-line synopsis of the events is a gross oversimplification of course, but who knew health care could be so complicated, right?
Well, the tax code, fiscal stimulus, and deregulation are complicated topics too, and it's possible that the same divisions within the Republican Party which sunk one of President Trump's main campaign promises on Friday could resurface as the administration pivots its focus to these other priorities. And if one puts two-and-two together, and one assumes that US markets have rallied since the election on the basis of Trump's promises ... well, let's just say, protect your capital, folks.
In Canada, the federal budget announced Wednesday was mostly notable in its projections of deficits for the foreseeable future. For investors, the rumor of a hike in the capital gains tax never materialized, and the equity markets breathed a sigh of relief and the S&P / TSX Composite recovered to end the week down only about 0.3%. Gold is up above US$1250 as at the time of writing; WTI Oil is still well below US$50.
Given the surfacing of worries in the equity markets, the Canadian bond market had a good week. Yields fell in the neighbourhood of 5 basis points across the entire interest rate yield curve for Canadas. This is good for bond prices; we will see if this is the start of a near- to medium-term trend.
We had one change in the Peanut Power Rankings Top-5 this week. More details below.
Peanut Power Rankings Top-5 Convertible Debentures (March 24, 2017)
- Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible Convertible Debentures. (Ticker: TCN.DB.U), (Last week's ranking: #1). TCN.DB.U has been the #1 since we started these rankings. As we've indicated previously indicated, TCN.DB.U is part of an offering intended to help finance Tricon's proposed transaction for Silver Bay Realty Trust. The Silver Bay deal is transformative and should be accretive to the common shares, which would in turn drive the price of debentures. In a declining Canadian dollar environment, the US-denominated issue and coupon is nice, too. As at March 24, my quantitative model is pricing the fair value of the debentures at $114.55 vs. the market close price of $102.60. Bottom line: good potential for the equity + generous US-dollar denominated coupon = lots of room for upside here. I'm long TCN.DB.U at $100.00.
- Gibson Energy, 5.25% 31-July-2021, Convertible Debentures. (Ticker: GEI.DB), (Last week's ranking: #2). Both Gibson's common shares and its convertible debentures were down for a second consecutive week, as WTI oil prices continued to plumb below US$50 levels. Quite frankly, US shale production remains high, and there's a glut of oil out there. President Trump's approval of Keystone XL on Friday didn't give Gibson much of a bump, even though the company is involved in energy services. Our quantitative model indicates GEI.DB is 8.27% undervalued. Gibson has some leverage on its balance sheet, and I think you have to like the outlook for energy prices to be in this one as the current yield-to-hard-call-date is only 2.75% at it's Friday closing price. Bottom line: you're here for the capital gains potential and because you like oil going forward. I have no long position in GEI.DB.
- Innergex Renewable Energy, 4.25% 15-August-2020, Series 'A' Convertible Debentures. (Ticker: INE.DB.A), (Last week's ranking: #3). This renewable energy producer is mostly focused on hydro and is known to have somewhat boring price action on its underlying shares. I don't find this as a problem as I think renewable energy is an important secular theme for the future. Also, INE.DB.A's conversion price is now only 5.0% above where the common shares closed on Friday. My quantitative model indicates the debentures, based on their closing price of $107.80, are 4.18% undervalued. Bottom line: slow and steady wins the race. With about 2.5 years until the earliest possible date of the issue being hard called, the probability of the convertible debentures trading in-the-money is very good. The yield-to-hard-call-date is still positive at 1.00%. I like this issue; you'll participate in the upside of the shares and you still have a floor on your principal if it doesn't work out. I'm long INE.DB.A at $102.75.
- Cargojet, 4.65% 31-December-2022, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last week's ranking: #4). The dominant air cargo carrier in Canada, an investment in CJT.DB.C is effectively a play on the continued growth of online retail and shopping. Free cash flow generation remains strong and the outlook looks bright. The conversion price of the underlying debentures is 27.2% above the closing price of the shares; yield-to-hard-call-date is 2.55% based on a debenture price of $107.50. Bottom line: Cargojet operates in a sector which has good secular tailwinds, the company is well-operated, and at these prices, CJT.DB.C looks like a decent opportunity. I've been long CJT.DB.C since it debuted at $100.00.
- Chemtrade Logistics, 5.00% 31-August-2023, Series 'C' Convertible Debentures. (Ticker: CHE.DB.C), (Last week's ranking: #9). Chemtrade Logistics, which trades as an income trust on the TSX under the ticker CHE.UN, is one of North America's larger producers of industrial chemicals such as sulfuric acid, sodium chlorate, sodium nitrite, sodium hydrosulfite, phosphorus pentasulfide, and inorganic coagulants water treatment. This is a somewhat economically sensitive cash flow business, but it isn't a huge grower. Earlier in March, Chemtrade closed a takeover transaction for its former competitor Canexus, which is a potential positive for its growth rate. Bottom line: with an investment in CHE.DB.C, you essentially get a long call option (the hard call date is more than four years away and the issue doesn't mature until 2023) on the Canexus deal adding value to Chemtrade's equity, while enjoying a 4.50% yield-to-maturity based on Friday's closing prices. Worth a shot within a diversified convertible debentures portfolio. I currently have no long position in CHE.DB.C.
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