Saturday, October 14, 2017

October 13, 2017, Quick Update: Peanut Convertible Debentures Power Rankings

This is the 17th update of the Peanut Convertible Debentures Power Rankings.  This update is current to October 13, 2017.  This is one of our quick updates, with abbreviated commentary.      

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 a little 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.

Market Commentary - Quick Points (October 13, 2017)
  • The next Bank of Canada rate announcement is scheduled for October 25.  Our guess is that the Bank will hold off on raising rates for now, given the uncertainty around the NAFTA trade negotiations, strength of the Canadian dollar (now back above 80 US cents), and worries about what rising rates might do heavily indebted Canadian homeowners.  
  • Since our last update a week ago, interest rates on the short end of the curve have increased a few basis points, while rates on the long end have decreased about a corresponding amount.  All-in-all, not a whole lot of change.
  • For the week, the S&P/TSX was up 0.49%, the S&P 500 up 0.17%, and the NASDAQ up 0.24%. As the US markets start to slow, will Canadian markets take the baton and lead us into winter?
  • We have one new re-entry into our Top-5 convertible debentures in this week's update.  More on the Top-5 below.     
Peanut Power Rankings Top-5 Convertible Debentures (October 13, 2017)
  1. American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' Convertible Debentures. (Ticker: HOT.DB.U), (Last update's ranking: #1). On trend, this issue has continued to slowly inch higher in recent weeks.  Acquisitive in the last couple of years, the hotel REIT's revenue mix is now approximately two-thirds from ownership of branded midmarket hotels (e.g., think brands like Hilton Garden Inn, Courtyard by Marriott, Holiday Inn, Windgate by Wyndham) in secondary US markets, and one-third from so-called rail hotels, where revenue is generated via long-term contracts with rail companies.  The accommodations sector is among the most volatile of the investable real estate sectors, sensitive to economic and interest rate risks.  That said, we think the REIT and this convertible debenture are good value at current trading values and management is experienced and well-regarded.  Insiders are aligned with shareholders and recently bought over 225,000 units of the REIT - see press release here. The bottom line: HOT.DB.U has traded below par in the months since it hit the market.  With a yield-to-hard-call-date of 5.60% and almost four years to the hard call date, we think it's great value here and has good potential for future gains.  It closed Friday at US$98.00 and we're long HOT.DB.U at US$98.00. 

  2. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last update's ranking: #2).  Cargojet just keeps going about its business, doing its job.  The air cargo carrier is estimated to have a +90% share in the overnight air cargo market, and with the secular movement towards e-commerce and online retail, the future looks outstanding for the company.  Cargojet has long-term contracts with Canada Post (Purolator Courier) and UPS, and also has a developing relationship with Amazon in Canada. The bottom line: Cargojet continues to have a dominant market position in an area of long-term, secular growth, and even at current prices, it's not a bad entry point for CJT.DB.C.  There are still 3+ years to the hard call date and based on Friday's close of $110.10, the yield-to-hard-call-date is a positive 1.42%.  We continue to really like this one.  We've been long CJT.DB.C since it debuted at $100.00.      

  3. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #3). Higher interest rates, the stronger Canadian dollar and the fact that REITs and real estate operating companies have been somewhat out of favour on the TSX haven't helped Tricon in the last few months.  This said, there is organic growth in the company, scale in its US single family rental portfolio, good management, a decent US-dollar denominated coupon, and a reasonable company valuation.  The bottom line: there's still lots to like here, and quite frankly, we think this current sale makes for a nice opportunity to get in if you're looking for USD-denominated convertible debenture exposure with possibility of future upside.  At Friday's close of US$106.10, the yield-to-hard-call date is 3.85% and there are about 3.5 years left until the hard call date. We've been long TCN.DB.U since it debuted at US$100.00.   

  4. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #5). The news flow just keeps coming with this one; whether you're hot or cold on the name, I think we all agree this has been the most exciting convertible debenture on our board as of late.  On Thursday, DHX announced through a press release that the company had signed a large-volume content deal for 13 DHX Media kids’ shows (including Bob the Builder, Fireman Sam, Caillou, Johnny Test, Yo Gabba Gabba!, classic Inspector Gadget and In the Night Garden) with Amazon Prime Video for its global subscription-video-on-demand (SVOD) service. Financial terms were not disclosed, but it was noted that the agreement was the the largest between the two companies to date, covering more than 200 countries and territories and 15 languages.  The market reacted moderately positively on the news, while also balancing out the disappointment of a terrible fiscal Q4 and the ongoing strategic review of the company, which could result in an outright sale.  On the latter, we had mentioned in an October 5 special update that we thought that a sale could fetch between $8 and $10 per share, and we've gotten questions as to how we came to that conclusion.  In short, management guided fiscal 2018 EBITDA to a range of $125 to $155 million (see DHX's quarterly earnings presentation slides for this information).  Notwithstanding whether you believe in management after its last quarterly miss, if you assign a 10x EBITDA multiple on $125 million (the low end of the guided range), you get a valuation of $9.32 per share.  Yes, it's true that the DHX had levered up to buy Peanuts and Strawberry Shortcake (outstanding net debt is just over $1 billion), but we don't expect debt service to be a problem.  Peanuts has cash cow attributes, and management guided fiscal 2018 free cash flow to a range of $50 million to $70 million, which should provide opportunities to de-lever (though granted, maybe not as quickly as the market would prefer).  The bottom line: certainly there are a lot of moving parts, and there's risk.  That said, DHX's media content assets have value, as Thursday's Amazon deal demonstrates.   The company just needs to execute, and it's our feeling that the market isn't yet taking into account the prospects of Peanuts and Strawberry Shortcake.  At Friday's close of $98.63, DHX.DB has a yield-to-maturity of 6.12% (note: there is no hard call provision for DHX.B, which is a bonus for investors) and the underlying common shares closed Friday 63.6% away from DHX.DB's conversion price of $8.00.  Recovery will probably take patience and a strong stomach, but if it happens, investors could be very handsomely rewarded.  We're long DHX.DB at $101.00 and are looking to add more at these levels.  We also have a position in DHX's Series B common shares (ticker: DHX.B).  

  5. Liquor Stores, 4.70% 31-January-2022, Series 'B' Convertible Debentures.  (Ticker: LIQ.DB.B), (Last week's ranking: #6).  And this issue is back in our Top-5.  After dissidents won a proxy fight with the previous board of directors back in June, the new board and management  have been pretty quiet.  That is, up until Friday, when it was announced that the embattled Alberta-based liquor retailer was considering the sale of its Kentucky-based liquor stores.  If the sale goes through, it's probably a good move.  The Kentucky stores never really performed to expectations, and I always thought it was a bit of a curious strategic fit.  The shares of LIQ spiked briefly on Friday on the news, before settling back down.  The bottom line: under previous management, the company had been kind of wandering the desert for a long time, not really creating shareholder value.  The jury is still out on the new board and management, but there is potential for a rebound, and LIQ.DB.B is a way to play this.  At Friday's close of $100.50, the yield-to-hard call is 4.53% and there's still 3+ years out to the hard call date.  The underlying common shares closed Friday 49.4% away from LIQ.DB.B's conversion price of $14.60.  In time, it may get back to those lofty levels if the company regains its focus and the Alberta economy recovers.  We had sold our previous position in LIQ.DB.B and do not currently have a position at this time.
Picture of the Day
This is what an American red squirrel (Tamiasciurus hudsonicus) looks like when he sneezes! Whitemud Nature Reserve, Edmonton, Alberta.  Copyright © 2014 Felix Choo / dingobear photography.  Photo may not be reproduced without permission. 

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