Sunday, July 30, 2017

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. 
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. 

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