Sunday, July 16, 2017

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. 

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