July 30, 2017, Update: Peanut Convertible Debentures Power Rankings

This is the 11th update of the Peanut Convertible Debentures Power Rankings.  This update is current to July 28, 2017. 

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The Top-5 picks in the Power Rankings are also described with more detail in the corresponding section below.

For background information on the Peanut Power Rankings, please see our FAQs by clicking here. 

Important: the Peanut Power Rankings are provided as information and opinions only and are not intended to be a provision of investment advice or a recommendation of any investment action in any form.  As with all information concerning investments, it is highly recommended that an individual consult with a qualified investment professional before making any investment decisions.


General Market Commentary (July 28, 2017)

Friday night, Tesla delivered the first 30 of its much-hyped, mass-market Model 3 to 30 happy new owners.  All 30 individuals were employees of Tesla, who were given first crack at the sleek electric sedans as appreciation for their hard work and dedication.  

Seems fair, because they're going to be busy.  A backlog of some 500,000 orders for the Model 3 awaits in the pipeline - and Tesla's manufacturing facility in Fremont, California, is currently capable of producing only 25,000 cars a quarter.  Apparently, Toyota, can produce that many vehicles in a single day.

Clearly, Tesla still has challenges to overcome.  But it's hard not to be peppered with excitement over the future for this company and, maybe more importantly, the possibilities it represents - that is, technology that advances the world in positive and sustainable ways.

“The whole point of this company was to make a really great, affordable electric car,” said Tesla CEO Elon Musk, “And we finally have it.”

Potentially groundbreaking stuff.  Too bad Elon Musk isn't plying his genius trade in Canada.  Fun fact: Elon Musk has held Canadian citizenship since 1989, and his mom is from Regina, Saskatchewan.

Maybe the next time our federal government decides to send another billion to Bombardier, they could also send an incentive or two Mr. Musk's way to convince him to build a few Teslas in, say, Saskatoon.  Or some solar panels in Sarnia.  And while we're at it, how about a hyperloop between Edmonton and Calgary, and Montreal and Toronto?  Yes, please.

Well, one can dream. 
 
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Elsewhere in Silicon Valley, four of the five powerful FAANG companies reported quarterly earnings this past week.  Facebook (there are now 1 billion users a day on WhatsApp!) and Netflix (5.2 million new subscribers!) basically crushed it, while Google and Amazon didn't exactly because they apparently weren't dominating the world as much as investors thought they had dominating the world.  For the latter two, maybe the slight pause in their respective stocks provide those on the outside-looking-in an opportunity to get onboard.  Since our last update, the tech-happy NASDAQ is up 0.99%, and the broad-based S&P 500 is up 0.52%.

Meanwhile, back home in the Great White North, the S&P/TSX Composite fell another 0.30%.  Oil prices recovered at the end of week to park itself just shy of US$50 a barrel and Canadian energy stocks responded in kind, but it remains to be seen if this mini-rally is sustainable.

Over in the bond market, interest rates keep going up.  The yield for a Canada 5-year bond breached 1.60%.  In the whole scheme of things, this is still very low, but it is a remarkable move when one considers that the same bond was yielding below 1.00% as recently as June.  Here's a graph:

One-year graph of a Government of Canada 5-Year Bond (July 27, 2016 to July 27, 2017).
Source: Bank of Canada.

  
Higher rates have provided continued lift to the soaring Canadian dollar, which finished the week above 80 US cents, at 80.34.  This, of course, has been punishing for the returns of US dollar-denominated investments when converted back into Canadian dollars, including some of our favourite convertible debenture issues such as Tricon Capital's 5.75%, 31-March-2022 (ticker: TCN.DB.U, this week's ranking: #3). As always, true investing is a long game, and currency risk is just one of a whole spectrum of risks to diversify within a portfolio.

Let's get to the Top-5 for this update.  Lo and behold, we have a new issue atop our leaderboard.

Peanut Power Rankings Top-5 Convertible Debentures (July 28, 2017)

1. Hydro One, 4.00%/ 0.00% 30-September-2027, Instalment Receipts. (Presumed ticker: H.R), (Last week's ranking: unranked).  We went into the details of this offering in our last post, so we won't go into too many details here except for a few quick highlights.  First, this large $1.4 billion offering is part of Hydro One's foray into the US through its proposed acquisition of Spokane-based Avista.  Second, this deal will be accretive.  Third, this offering has a complex structure, and is essentially a deferred equity raise by Hydro One that's been disguised as a convertible debenture offering that will be represented by instalment receipts until deal close sometime next summer - got all that? Fourth, complex terms be damned, there was great demand for this offering and it sold out very quickly.  Fifth, owning the instalment receipts is essentially like owning an in-the-money call option, but instead of having to pay a premium for the privilege, Hydro One pays the investor a 4% coupon on the full value of the (eventual) convertible debenture in the year before deal close.  Sixth, that coupon drops to zero after deal close, which means investors will in all likelihood convert the debentures into common shares well before the debenture's 10-year maturity term as long as it stays in-the-money.  Seventh, even though this is an unconventional offering, this is a rare convertible debenture issue from a large, investment grade issuer.  The bottom line: if one can obtain the instalment receipts when they hit the market (approximately, August 9) anywhere near the offering price, the value is there to make this a very promising investment.  We tried to subscribe to this issue, but were too late as the entire offering reputedly sold out in less than six hours.  If the price is right, we would be interested in acquiring a position once it becomes available for trading on the TSX.     
2. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Presumed ticker: DHX.DB), (Last week's ranking: #1). First things first: this issue is not yet trading.  Still.  If you've been reading this blog and previous updates, you know that this issue was a part of DHX's acquisition of 80% of Peanuts (i.e. Charlie Brown, Snoopy, and friends), and 100% of Strawberry Shortcake.  Based on my interpretation of the SEDAR filings, this convertible debenture issue should be available for trading as soon as DHX files a prospectus to allow for wider distribution of the debentures.  Even though the acquisition is now closed, as at the time of writing, no prospectus has been filed and, as such, we're still waiting to see if we can actually get our hands on this issue by buying it on the exchange.  As this issue was technically completed via private placement, liquidity of the debentures may be very limited even if a prospectus is eventually filed.  So this is a big caveat.  If liquidity weren't an open question, this issue would be an easy #1.  As we've repeated several times before, the terms (5.875% coupon, $8.00 conversion price, favourable call provisions) are very positive for investors.  In addition, the shares of DHX are starting to move, and it closed Friday at $6.38.  The bottom line: DHX is a unique media content company, Peanuts is a once-in-generation type of asset, and the terms of the convertible debenture are excellent.  We have no position in DHX.DB, but would be interested in acquiring one once (if?) it becomes available for trading on the TSX.  We do, however, have a position in DHX's Series B common shares (ticker: DHX.B).   


3. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Last week's ranking: #2).   A long-time #1 in our rankings, this issue is holding up in US dollar terms (Friday's close: US$107.42), but the surging Canadian dollar means that investors who participated in the offering are now underwater in Canadian dollar terms.   Higher interest rates are a risk, but the the story for Tricon is still intact - good management, scale with its single-family rental portfolio in the US, and organic growth.  The bottom line: good long-term potential for the equity, a decent US-dollar denominated coupon, and the recent action in Canadian dollar means this issue is now on sale.  We've been long TCN.DB.U since it debuted at US$100.00.  


4. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last week's ranking: #3).  As we've mentioned the last couple of updates, the recent increase in the Canadian dollar may help spur increased online sales from US retailers, and in turn be a positive for Cargojet, Canada's dominant air cargo carrier.  Cargojet shares increased above $51 during the week, before retreating to close Friday at $48.32.   No real new news here: Cargojet is a strong company in the right space, and growth in online retail and shopping is only going to continue to increase.  The bottom line: Cargojet has a superb market position in an area of long-term, secular growth. At Friday's close, the yield-to-hard-call-date is 1.92%, so it's still a decent entry point from our point-of-view.  We've been long CJT.DB.C since it debuted at $100.00.   


5. Rogers Sugar, 5.00% 31-December-2024, Series 'E' Extendible Convertible Debentures. (Presumed ticker: RSI.DB.E), (Last week's ranking: #5). This new issue, which was announced in conjunction with Rogers Sugar's $160.3 million acquisition for L.B. Maple Treat Corporation, first hit the market on Friday.  It was a successful debut, with RSI.DB.E closing up at $101.60.  The market seems to like this deal.  It's significant for Rogers Sugar because it represents a leap from its traditional, low-growth sugar business into the maple syrup business - an industry segment that has pricing power, grows at 8% per annum (according to Rogers Sugar) and, unlike sugar, has better export prospects.  Further, L.B. Maple Treat is not a small player in the maple industry - its global market share is above 20%.  Even better, the deal is expected to be accretive to Rogers Sugar from day one. The bottom line: there are trade and growth risks in Rogers' traditional sugar business, but maple syrup provides a synergistic growth platform, which is something that Rogers has needed for a long time.  RSI.DB.E provides an intriguing way to play the possibilities.  We have no current position in RSI.DB.E.

Picture of the Day


Temple sunset. Wat Chomkao Manilat Buddhist Temple in remote Huay Xai, Laos. Copyright © 2011 Felix Choo / dingobear photography.  Photo is available for licensing at Alamy Images. All rights reserved. Photo may not be reproduced without permission. 

Drop Us a Line

Thank you for reading this blog.  As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com.  

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Special Update: Hydro One's $1.4 Billion Convertible Debenture Offering

Quick update on this bit of news that crossed the newswires after market close yesterday (July 19).  Hydro One, Ontario's largest electricity transmission and distribution provider, announced that it is buying Spokane, Washington-based Avista for US$5.3 billion in cash, which will effectively create a top-20 North American utility focused on regulated transmission as well as electricity and natural gas local distribution.


Associated with the deal, Hydro One also announced a $1.4 billion bought deal offering of convertible debentures, which will be initially represented by instalment receipts until the acquisition closes, which isn't expected until the middle of 2018.  I haven't had a lot of time to research and analyze the issue, but here are some quick thoughts:

• $1.4 billion, in sheer dollar terms, is massive for a convertible debenture offering in the Canadian market.
• This is a bit of a complex structure and unconventional for a convertible debenture, so interested investors will want to read the press release carefully and speak with their investment advisors before subscribing.
• The convertible debentures are being sold on an instalment basis at a price of $1,000 per debenture, of which $333 is payable on the closing of the offering (which is expected August 9) and the remaining $667 is payable on a date (sometime in mid-2018) following the satisfaction of all conditions precedent to the closing of Hydro One's acquisition of Avista.
• The instalment receipts bear an annual interest rate (paid quarterly) of 4.00% per $1,000 principal amount until the closing date of the acquisition (again, which is expected in mid-2018).  However, because only $333 of a $1,000 investment in the instalment receipts is payable upfront (on August 9), an investor is in effect getting $40 worth of interest on an initial $333 outlay, which translates to approximately a 12% effective annual yield.  
• After the acquisition closes (in mid-2018), the interest rate on the convertible debentures drops to 0%, sweet nothing.
• The convertible debentures are convertible into common shares of Hydro One at any time after the acquisition closes in mid-2018 until the maturity date.   The conversion price is $21.40 per common share.  Note that Hydro One closed yesterday (July 19) at $22.53, so this issue is technically already in-the-money.
• The debentures mature on September 30, 2027, so nominally, this is a 10-year convertible debenture.  A 10-year convertible debenture is rare in the Canadian convertible debenture market.
• However, I say the convertible debentures are nominally 10-years because as long as Hydro One shares don't completely tank and stay above (or near) the conversion price of $21.40, most (or substantially all) of the convertible debentures will be converted far before the issue is scheduled to mature.  With a 0% interest rate after the acquisition closes, there would be little incentive to hold on to the convertible debentures long-term in the (probable) scenario of Hydro One share price not completely crashing.
• For an investor, I view this offering of convertible debentures essentially more like owning an in-the-money call option on Hydro One shares over the next 10 years.  But instead of "paying" for the option, Hydro One effectively pays the investor 12% on the invested portion upfront (recall, 4% interest on a $1,000 debenture, but only $333 is payable upfront on August 9) for the option.  I know it's not a perfect analogy, but this is just my simplified way of viewing things.
• For Hydro One, this is effectively a deferred equity issuance, disguised as a convertible debenture.

Quick pros that I see of the Avista acquisition and the Hydro One offering of convertible debentures:

• Hydro One gets a foothold growth platform into the US. 
• According to Hydro One, the deal looks to be accretive to earnings in the mid-single digits (percentage-wise) from year one. 
• The terms of the offering, though complex, seem attractive as long as you are comfortable with the business and prospects of Hydro One. 

Quick risks and cons that I see:

• As a utility, Hydro One will be negatively affected by rising interest rates. 
• The Ontario government will still own over 40% of Hydro One after the Avista deal closes; some investors consider the Ontario government's ownership block a negative, as political interference may be a perceived or real risk. 
• Hydro One isn't cheap, and by my count, is trading at a trailing P/E ratio of about 19.7x.

Bottom line: I've taken a flyer on this issue and subscribed.  We'll see if I get any allotment of the instalment receipts (convertible debentures).

As always, remember this blog is for information only.  Please remember to consult a professional investment advisor before making any investment decisions.

Picture of the Day


Chasing waterfalls. Skógafoss, Iceland. Copyright © 2006 Felix Choo / dingobear photography. 

July 16, 2017, Update: Peanut Convertible Debentures Power Rankings

This is the 10th update of the Peanut Convertible Debentures Power Rankings.  This update is current to July 14, 2017.

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The Top-5 picks in the Power Rankings are also described with more detail in the corresponding section below.

For background information on the Peanut Power Rankings, please see our FAQs by clicking here. 

Important: the Peanut Power Rankings are provided as information and opinions only and are not intended to be a provision of investment advice or a recommendation of any investment action in any form.  As with all information concerning investments, it is highly recommended that an individual consult with a qualified investment professional before making any investment decisions.


General Market Commentary (July 14, 2017)
 
"Today, we raised our key policy rate by 25 basis points, in the context of an economy that is approaching full capacity and with inflation expected to reach the 2 per cent target within the next year," said Stephen Poloz on July 12, making good on the Bank of Canada's recent telegraphing efforts.

This is the first time in seven years the Bank of Canada has raised its policy target overnight rate, which now sits at 0.75%.  Expect at least one more 25 basis point bump up before the end of the year. 

The bond market has been pricing in the reality of a rate tightening environment for the better part of a month now.  For example, take a look at this graph of a Canada 5-year bond:

One-year graph of a Government of Canada 5-Year Bond (July 13, 2016 to July 13, 2017).
Source: Bank of Canada.

Besides being a drag on existing bond (and convertible debenture) issues, the Canadian dollar has been on a roll, ending the week at it highest point (78.91 US cents) since the start of 2017. 

Since our last update two weeks ago, the divergence in the major North American equity markets has only been further exacerbated.  While the US S&P 500 Index (+1.48%) and tech-happy Nasdaq Composite (+2.80%) have reached new heights on softer-than-expected inflation figures, the S&P/TSX Composite remains stuck in neutral (-0.05%).  While higher interest rates should help the margins of Canadian banks and insurance companies, it's just another negative for Western Canada's debt-burdened energy companies.  In addition, the higher Canadian dollar is also generally a negative for other Canadian commodity producers, as commodities products are priced in US dollars.

Besides having to adjust to a higher interest rate environment, the last two weeks in the Canadian convertible debentures market have been relatively uneventful. We have one re-entrant (Liquor Stores, ticker: LIQ.DB.B, ranking: #4) into our Top-5.  Furthermore, we have a new, interesting convertible debenture issue from Rogers Sugar (presumed ticker: RSI.DB.E, ranking #5) that has also cracked our elite list.  More details on this issue and Rogers Sugar in the section below.  (Sidebar: is it just me, or does anybody else always think back to this classic Simpsons episode whenever an investment in Rogers Sugar is contemplated?)



Ok, enough joking around, let's get to our Top-5 for this update.

Peanut Power Rankings Top-5 Convertible Debentures (July 14, 2017)

1. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Presumed ticker: DHX.DB), (Last week's ranking: #1). First things first: this issue is not yet trading.  If you've been reading this blog and previous updates, you know that this issue was a part of DHX's game-changing US$345 million acquisition of 80% of Peanuts (i.e. Charlie Brown, Snoopy, and friends), and 100% of Strawberry Shortcake.  Based on my interpretation of the SEDAR filings, this convertible debenture issue should be available for trading as soon as DHX files a prospectus to allow for wider distribution of the debentures.  Even though the acquisition is now closed (Charlie Brown and Snoopy are now Canadians!), as at the time of writing, no prospectus has yet been filed and, as such, we're still waiting to see if we can actually get our hands on this issue by buying it on the exchange.  As this issue was technically completed via private placement, liquidity of the debentures is a big question and might, in fact, be very limited even if a prospectus is eventually filed.  If liquidity proves to be a big issue, then this issue isn't a #1 ... but because we don't yet have clarity on this matter, we're keeping the issue in its lofty position because the actual terms of the debenture are so favourable for investors.   The highlights: a nice 5.875% coupon, an $8.00 conversion price that's a reasonable 33.3% over the Friday close price of $6.00 for the Series B shares, and a soft call provision that can't happen until September 30, 2020, and unless the common shares are trading at 35% over the conversion price, which is better than the standard 25% provision that's typical of most Canadian convertible debenture issues.  Bottom line: DHX is a unique media content company with growth and prized trophy assets like Peanuts + excellent coupon and terms in the convertible debentures = an exciting issue, notwithstanding any liquidity problems that may arise when the issue finally becomes available for trading.  We have no position in DHX.DB, but would be interested in acquiring one once it becomes available for trading on the TSX.  We do, however, have a position in DHX's Series B common shares (ticker: DHX.B).    


2. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible Convertible Debentures. (Ticker: TCN.DB.U), (Last week's ranking: #2).   A long-time #1 in our rankings, this issue continues to be steady-Eddie in spite of higher interest rates and a higher Canadian dollar.  At this point, as long as Tricon continues to execute on its business plans and demonstrate its ability to operate its growing single-family rental portfolio in the US Sun Belt markets, its share price and this convertible debenture issue should continue to reward investors.  As of Friday, the yield-to-hard-call remains at 3.02%, and the potential upside from the conversion option is well intact.  Bottom line: good potential for the equity + decent US-dollar denominated coupon + yield-to-hard-call still above 3% = still an excellent choice if you have idle cash sitting around waiting to be deployed into the convertible debentures market.  We're long TCN.DB.U since it debuted at $100.00.  


3. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last week's ranking: #3).  As we mentioned last week, the recent increase in the Canadian dollar may help spur increased online sales from US retailers, and in turn be a positive for Cargojet, Canada's dominant air cargo carrier.  I know this is sounding like a broken record, but Cargojet is a strong company in the right space, and growth in online retail and shopping is only going to continue to increase.  CJT.DB.C closed Friday at $109.00; the yield-to-hard-call is at 1.95%. Bottom line: Cargojet has a superb market position in an area of long-term, secular growth.  Get on board!  We've been long CJT.DB.C since it debuted at $100.00.   


4. Liquor Stores, 4.70% 31-January-2022, Series 'B' Convertible Debentures.  (Ticker: LIQ.DB.B), (Last week's ranking: #9).  Shares in Liquor Stores have been volatile since dissident shareholders successfully toppled the existing board of directors about a month ago.  LIQ.DB.B returns to our Top-5 as, based on Friday's close price of $104.00, the convertible debenture price hasn't kept pace with the recent increase in the common shares.  The catalyst for this recent price increase? The old CEO got canned by the new directors.  I guess long-suffering Liquor Stores shareholders are eager for a new direction, and want to see action.  We will see if the new team steering the ship will have more success than the old in this regard.  What would help: a recovery in oil prices and the Alberta economy, both of which have been sluggish.  Also, a long Stanley Cup playoff run by both the Oilers and the Flames would be nice for Liquor Stores sales, but we're still nine months away from that possibility or fantasy, depending on who you like to cheer for.  Bottom line: this is a decent credit risk in a turnaround story waiting to happen.  You could do worse than to enjoy the 3.94% yield-to-hard-call while you wait. We're long this issue at $99.96.


5. Rogers Sugar, 5.00% 31-December-2024, Series 'E' Extendible Convertible Debentures. (Presumed ticker: RSI.DB.E), (Last week's ranking: unranked). Rogers Sugar, which has been in business for 127(!) years, announced this new $50 million convertible debenture issue on July 10 in conjunction with its $160.3 million acquisition of L.B. Maple Treat Corporation.  Note that RSI.DB.E is not yet trading; the debenture issue should hit the market when the acquisition closes sometime in August.  This deal is significant for Rogers Sugar because it represents a leap from its traditional, low-growth sugar business into the maple syrup business - an industry segment that has pricing power, grows at 8% per annum (according to Rogers Sugar) and, unlike sugar, has better export prospects.  Furthermore, L.B. Maple Treat is not a small player in the maple industry - its global market share is above 20%.  Even better, the deal is expected to be accretive to Rogers Sugar from day one.  However, as tasty as this acquisition sounds, the issue with Rogers Sugar has always been on the sugar side, and any investor in the company has to be aware of the risks and reality of this particular market.  Rogers Sugar (and its wholly owned operating subsidiary, Lantic Sugar) has a virtual monopoly in the sugar industry in Western Canada (~90% market share), and is part of a duopoly with Redpath Sugar in Eastern Canada (~50% market share for Rogers, which as been growing in recent years).  On the surface, this sounds terrific but its market dominance is essentially due to high tariff protection from lower-cost foreign producers (most notably, those in the US and Mexico).  As I understand it, the current tariff protection for Rogers Sugar is due for renegotiation in 2020, and there is no guarantee that this protection will be extended.  Given the unpredictability of the Trump administration and its protectionist stance on trade, one can't discount the risks here.  Furthermore, given the so-called obesity epidemic in Canada, sugar is a bit of boogeyman in the public eye, which limits growth to changes in the population. However, all this said, Rogers Sugar has been in business for years, faithfully producing free cash flow, paying out dividends to shareholders, and making interest payments to creditors.  The terms of the convertible debenture are decent enough.  The conversion price of RSI.DB.E is set at $8.26, which is a reasonable 36.1% above the Friday close price of $6.07 for Rogers Sugar's common shares.  Given that the entry into the maple syrup business should provide growth, synergies, and accretion, it isn't inconceivable that Rogers Sugar's common shares can reach in-the-money status during the term of the convertible debentures.  Bottom line: there are trade and growth risks in the traditional sugar business, but maple syrup provides a synergistic growth platform for this century-old company which has been in need of exactly such a platform.  RSI.DB.E provides an intriguing way to play the possibilities.  The convertible debenture issue sold out quickly; we did not subscribe to the issue.  As such, we have no position in RSI.DB.E but would consider acquiring one when it becomes available for trading on the TSX.

Picture of the Day


Darling Harbour and the spectacular Sydney skyline at night.  Darling Harbour, Sydney, New South Wales, Australia.   Copyright © 2010 Felix Choo / dingobear photography.  Photo is available for licensing at Alamy Images. All rights reserved. Photo may not be reproduced without permission. 


Drop Us a Line

As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com.  

*** 

July 2, 2017, Update: Peanut Convertible Debentures Power Rankings

Happy Canada Day long weekend and Happy Canada 150!

This is the ninth update of the Peanut Convertible Debentures Power Rankings.  This update is current to June 30, 2017.

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The top-5 picks in the Power Rankings are also described with more detail in the corresponding section below.

For background information on the Peanut Power Rankings, please see our FAQs by clicking here. 

Important: the Peanut Power Rankings are provided as information and opinions only and are not intended to be a provision of investment advice or a recommendation of any investment action in any form.  As with all information concerning investments, it is highly recommended that an individual consult with a qualified investment professional before making any investment decisions.


General Market Commentary (June 30, 2017)

"Rates are, of course, extraordinarily low," said Stephen Poloz, Governor of the Bank of Canada, in Portugal on June 28.    

"It does look as though those cuts have done their job," he added, in reference to 2015, when the central bank surprised the market and cut rates twice, 25 basis points each time, in response to plummeting oil prices.

Well, Poloz's comments pretty much confirmed the smoke signals put up by his chief deputy (and this blog's favourite central banker), Carolyn Wilkins, two weeks earlier.  Seems as if the Bank of Canada has fully transformed its feathers from dove to hawk. 

Bond markets agreed.  For example, look at the right side of this graph of a Canada 2-year bond:

Not surprisingly, the previously listless loonie has also taken flight due as a result.  Over the last two weeks, the Canadian dollar has moved up from 75.57 US cents to 77.06 US cents.

As we wrote last time, the Bank of Canada's change in tone has implications for the convertible debentures market in at least two ways.  First, as you know, an increasing rate environment means lower prices for existing bond issues, everything else being equal.  Second, a higher Canadian dollar has a negative impact on the value of US dollar-denominated convertible debenture issues.

The major North American stock markets were flat-to-down in the month of June.  Losses on the broad-based S&P 500 were modest (-0.27%), while the tech-laden NASDAQ gave back materially more (-1.70%).  The latter's decline in the last couple of weeks seemed to coincide with the European Union slapping Alphabet (a.k.a. Google) with a record-setting US$2.7 billion anti-trust fine.  Ouch.

Here in Canada, the S&P/TSX Composite continued with its uninspiring performance thus far in 2017, falling a further 1.69% during the month.  Oil inventories remain high, which is keeping a lid on prices (WTI oil is currently at about US$46), and savaging Canadian energy stocks.  At least financials seem to have stabilized a bit for the time being.  They've no doubt been helped by the hefty investment by Warren Buffet's Berkshire Hathaway in Home Capital, which has effectively stopped the bank run in the alternative lender.

In the Canadian convertible debentures market, there are a couple of developments of note since our last update.

First, Cargojet's 5.50% 30-June-2019, Series 'B' Convertible Debentures (ticker: CJT.DB.B, this week's ranking: #17) have been soft-called for July 4, so this will be the last update in which the issue will appear in our Peanut Power Rankings.  The issue last closed at a lofty $168.00; if you were lucky enough to be a holder, by now you've either sold the debentures on the open market or have exercised your conversion option.

Second, for the first time since we started these rankings, we have a new #1! Also, we have one brand new entrant in our Top-5.  For more details, see the corresponding section below.   

Peanut Power Rankings Top-5 Convertible Debentures (June 30, 2017)

1. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Presumed ticker: DHX.DB), (Last week's ranking: #3). Well, here it is, the new #1.  I suppose this is something of a controversial pick considering that the issue has yet to trade, but since the terms of this debenture are so enticing provided you can get it at or near par value, we can't really ignore it any longer.  After the market shut down for the weekend, DHX Media announced the closing of its game-changing US$345 million acquisition of 80% of Peanuts (i.e., Charlie Brown, Snoopy, and the rest of the crew), and 100% of Strawberry Shortcake.  With that out of the way, based on my reading of the SEDAR filings, this convertible debentures issue should be available for trading as soon as DHX Media files for a prospectus to allow for wider distribution of the debentures.  As the issue was technically first completed via private placement, the liquidity of the debentures remains an open question and might be very limited.  (If so, this would certainly have an impact on the issue's current #1 placement in our rankings).  For now, we consider it to be #1 because the terms of the issue are generous for investors - presumably, they were designed this way to ensure that the financing would get done in order for the company to close on the important Peanuts deal.  Let's go over the main features.  The 5.875% coupon is sizable, and the $8.00 conversion price is a reasonable 39.4% over the Friday close price of $5.74 for the Series B shares.  In addition, the convertible debenture cannot be soft called until September 30, 2020, and unless the common shares are trading at 35% over the conversion price, which is better than the standard 25% provision that is typical of most Canadian convertible debenture issues.  Bottom line: a unique media content company with growth and prized trophy assets like Peanuts + excellent coupon and terms in the convertible debentures = our new #1, notwithstanding any liquidity problems that may arise when the issue finally becomes available for trading.  We have no position in DHX.DB, but would be interested in acquiring one once it becomes available for trading on the TSX.  We do, however, have a position in DHX's Series B common shares (ticker: DHX.B).    


2. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible Convertible Debentures. (Ticker: TCN.DB.U), (Last week's ranking: #1).   This issue was our #1 ranked convertible debenture in our first eight updates, and slips to #2 in this iteration.  Fundamentally, not a whole lot has changed except for the fact that the price of the convertible debenture has started to move up towards fair value (as we suspected it would), and it isn't quite the relative bargain it had been in the last few months.  That said, the nice story here is still very much intact and as long as Tricon keeps executing going forward, TCN.DB.U should respond accordingly.  As we now have said many times, the Silver Bay Realty Trust deal was transformative, and Tricon is now effectively the fourth-largest single-family rental landlord in the US, with most of its SFR assets in the attractive, higher-growth Sun Belt markets.  At this point, the yield-to-hard-call is still 3.02%, and the potential upside from the conversion option remains.  Bottom line: good potential for the equity + decent US-dollar denominated coupon + yield-to-hard-call still above 3% = still an excellent choice if you have idle cash sitting around waiting to be deployed into the convertible debentures market.  We're long TCN.DB.U since it debuted at $100.00.  


3. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last week's ranking: #4). The recent uptick in the Canadian dollar may help spur increased online sales from US retailers, and in turn be a positive for Cargojet, Canada's dominant air cargo carrier.  This is a strong company in the right space; growth of online retail and shopping is only going to continue to increase.  CJT.DB.C closed Friday at $109.00; the yield-to-hard-call is at 1.98%. Bottom line: Cargojet has a super market position in an area of long-term, secular growth; get on board and fly the friendly skies.  We've been long CJT.DB.C since it debuted at $100.00.   


4. Algoma Central, 5.25% 30-June-2024, Series 'A' Convertible Debentures. (Ticker: ALC.DB.A), (Last week's ranking: unranked).  Oops, we missed this one in the last version of our rankings.  This brand new $82.5 million (including over-allotment option) offering closed on June 21, and represents an interesting opportunity to invest in the convertible debentures of a historic, if overlooked, Canadian company that is today majority-owned by the Jackman family.  For those unfamiliar with Algoma Central, it is a leading Canadian shipping company, which owns and operates the largest Canadian flag fleet of dry-bulk carriers and product tankers operating on the Great Lakes - St. Lawrence Waterway. Algoma Central's history as a company dates back to 1900, and it's been listed on the TSX since 1958. Fun fact: the company has the same number of shares outstanding today as it did in 1958.  As such, perhaps it's no coincidence that not a single Bay Street analyst follows the company, as there hasn't been much investment banking business to be had over the years.  In fact, probably the only way new shares in Algoma Central will be issued is if this convertible debenture manages to work its way into in-the-money territory sometime over its seven year term-to-maturity.  This brings us to maybe the only real bad news with this issue: with a conversion price of $21.15 and a Friday closing price of the common shares at $12.96, a 63.2% increase in the common shares is required for ALC.DB.A to trade in-the-money.  That's pretty steep.  Fortunately, there's lots of good news here too.  First, Algoma Central has a very good balance sheet, and is considered to be superb credit despite operating in a somewhat cyclical industry.  Second, Algoma Central stock is a true value sleeper, trading at a price-to-book value of only about 0.8x and a price-to-earnings ratio of about 15.0x.  Third, over the last couple of years, the company has been selling some of its non-core real estate assets in the St. Catharines and Sault Ste. Marie areas, and is expected to monetize up to $125 million in these sales - compare this figure to Algoma Central's current market capitalization of approximately $504 million.  Fourth, the company is widely regarded to be excellent operators in their line of business, and its current fleet renewal program is expected to garner 11 Equinox-class carriers by 2018, which is expected to contribute materially to Algoma Central's operating efficiencies going forward.  (For some bonus reading on Algoma Central: in August 2016, travel writer Porter Fox published a captivating story in the New York Times about his journey through the Great Lakes on the Algoma Equinox ship - I think the piece provides a rare glimpse into the business and the fascinating geographies it traverses, so give it a look).  Bottom line: a good credit + unique company with a historic pedigree + underrated underlying equity = a strong new entrant in our Top-5.  We have no current position in ALC.DB.A, but we do have a position in ALC, the common shares of Algoma Central. 


5. Innergex Renewable Energy, 4.25% 15-August-2020, Series 'A' Convertible Debentures. (Ticker: INE.DB.A), (Last week's ranking: #2). Quick recap: this company is a renewable energy stalwart (and especially so on the hydro side).  That said, as a utility, the equity of Innergex is sensitive to the overall interest rate environment, and the Bank of Canada's new hawkish stance works against the company from this perspective.  That said, we still consider renewable energy to be a highly important secular theme and this company is a good operator in this space.  INE.DB.A itself continues to be an attractive investment because it remains close to trading in-the-money; the common shares closed only 5.2% below conversion price on Friday.  However, the yield-to-hard-call date for INE.DB.A is now effectively down to 0.00% based on Friday's debenture close price of $109.20.  Bottom line: we want renewable energy in our portfolio and INE.DB.A, at current prices, allows for participation in any potential upside of the common stock with a safety net floor provided by the par value of the debentures.  We're long INE.DB.A at $102.75.

Picture of the Day


Happy Canada 150.  Churchill Square, Edmonton, Alberta, Canada. Copyright © 2017 Felix Choo / dingobear photography.  Photo is available for licensing at Alamy Images. All rights reserved. Photo may not be reproduced without permission. 

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