Saturday, October 21, 2017

October 20, 2017, Quick Update: Peanut Convertible Debentures Power Rankings

This is the 18th update of the Peanut Convertible Debentures Power Rankings.  This update is current to October 20, 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 20, 2017)
  • Alert! The next Bank of Canada rate announcement is scheduled for Wednesday.  As we've mentioned the last couple of updates, 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 (which is oscillating back and forth around 80 US cents), and worries about what rising rates might do heavily indebted Canadian homeowners.
  • Looks like the bond markets seem to be of the same mind as we are? For the week, interest rates are down across the yield curve.   
  • For the week, the S&P/TSX was up 0.32%, the S&P 500 up 0.86%, and the NASDAQ up 0.34%.  Damn the torpedoes, the equity markets keep steaming ahead in the is long-running bull market. 
  • In the convertible debentures market, two new issues of interest - a whopping $260 million offering (including both private and public portions of the offering) from Osisko Gold Royalties, and a $50 million offering from Diversified Royalty Corporation, were announced during the week.  Both made our Top-5 ... let's get to the details on these below.     

Peanut Power Rankings Top-5 Convertible Debentures (October 20, 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). Not much new to report here that we haven't already covered in the last couple of weeks.  After selling off somewhat earlier in the summer, the underlying REIT units have stabilized and seem to be on the comeback trail.  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 5.54% and almost four years to the hard call date, we think it's great value here and the potential is there for future gains.  It closed Friday at US$98.20 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).  As above, not much new to report here either.  Cargojet just keeps going about its business, doing its job (well).  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.  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 decent entry point for CJT.DB.C.  There are still 3+ years to the hard call date and based on Friday's close of $109.02, the yield-to-hard-call-date is a positive 1.73%.  We continue to really like it.  We've been long CJT.DB.C since it debuted at $100.00. 

  3. Osisko Gold Royalties, 4.00% 31-December-2022, Convertible Debentures. (Presumed ticker: OR.DB), (Last update's ranking: unranked).  Note: this issue is not yet trading.  This whopper of a $260 million deal ($160 million offered to the public, $100 million privately placed with PSP Investments) was announced on Monday, and adds a relatively high credit quality, growth precious metals royalty company to the Canadian convertible debentures universe.  This, of course, is very welcome and word on the street is that demand for the issue was at pound-the-table levels.  This isn't surprising as there's lots to be positive on here.  For those unfamiliar, Osisko Gold Royalties is essentially an intermediate-sized precious metals royalties and streaming company.   Its impressive portfolio is anchored by a 5% net smelter return (NSR) royalty on the Canadian Malartic mine (this is the largest gold mine in Canada, and is operated by Agnico-Eagle Gold and Yamana Gold), as well as a 2.0% to 3.5% NSR royalty on the Éléonore mine (a rich Quebec mine operated by Goldcorp).  In fact, the company holds, in total, over 130 royalties, streams, and precious metal offtakes, most of which are in stable North American jurisdictions.  In our view, when investing in resource companies, one of our risk management prerequisites is to minimize country risk by focusing on companies (like Osisko Gold Royalties) which focus on stable jurisdictions.  Finally, it's worth mentioning that the company has a superior cash flow growth profile to like precious metals royalty and streaming companies, and also holds material equity interests in other publicly traded junior resource companies under its "incubator" program.  As for the convertible debenture itself, it sports a relatively low coupon rate of 4.00% (which, in our view, speaks to the credit quality of the company), a conversion price of $22.89 per share, cannot be soft called unless the underlying shares of OR are trading at 130% above the conversion price and, unlike most Canadian convertible debentures that we follow, has no hard call provision at all.  The latter is of course, an advantage for investors.  The bottom line: this high-quality, gold-focused convertible debentures issue is a blue-chipper convertible in our eyes, and we subscribed to the issue at $100.00.  We only received a partial fill, and we will be looking to expand our position once the issue hits the market on or around November 3.  We also have a position in OR common shares.

  4. Diversified Royalty Corp, 5.25% 31-December-2022, Convertible Debentures.  (Presumed ticker: DIV.DB), (Last update's ranking: unranked).  Note: this issue is not yet trading.  This is a fascinating little company whose stock has been on fire (i.e., up almost 50%) for the past two months. The company bills itself as "a multi-royalty corporation, engaged in the business of acquiring top-line royalties (author's note: this is the best kind, a royalty that's simply a percentage of sales) from well-managed businesses and franchisors in North America."  Currently, DIV owns the Sutton Realty, Mr. Lube, and AIR MILES® trademarks in Canada.  Previously, the company also owned the trademarks for the Franworks group of restaurants (which included fast casual dining chains such as Original Joe's, State & Main, and Elephant & Castle), but this was previously sold to reduce exposure to the struggling Alberta economy.  The current momentum in the underlying stock price was attributable to an August 25 announcement of DIV's acquisition of the AIR MILES® royalty stream, which appears to be accretive.  Furthermore, in the associated press release, it was hinted that another royalty acquisition by the end of 2017 was the company's objective.  The announcement of this $50 million convertible debentures offering on Tuesday only reinforced this market view, and the stock actually rallied after the announcement.  So, on the convertible debenture: it offers an attractive coupon rate of 5.25%, and the conversion price of $4.55 is about 33% above where DIV closed on Friday.  The bottom line: this is an interesting royalty company which, after a long lull following its Mr. Lube acquisition and Franworks divestment, is starting to gain momentum once more.  It is also noteworthy that management is highly regarded, and are aligned with shareholders through their own shareholdings.  Finally, the terms of the convertible debenture seem positive and this is a decent credit risk, in our view.  We did not successfully subscribe to the issue, but we are interested in acquiring one once the issue hits the market on or around November 7.  We also have a position in DIV common shares.

  5. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #3). Not a whole lot to report on this mainstay of our Top-5. 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 plenty 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$105.98, the yield-to-hard-call date is 3.88% 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.   

  6. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #4). Bonus coverage!  Well, disappointingly, DHX has been a roller-coaster ride in the worst way, and this week was the kind of week that, um, builds character.  DHX stock plumbed new lows and the bottom fell out Friday morning, prompting the market regulator to seek a statement from DHX, which in turn commented that it was not aware of any material undisclosed information relating to the company.  The market seemed to be comforted by that news, and DHX's Series 'B' shares actually closed Friday at $4.52, after hitting a harrowing low of $3.81 just that morning.  Hard to believe that just a month ago, this company was trading with a 7-handle at 52-week highs.  Yikes.  Well, as those of us who follow and invest in DHX are all too aware, this has not been a name for the meek.  As the market action on DHX securities continues to gyrate, as long-term investors we choose to stick to the fundamental story: DHX has attractive media content assets, its Peanuts IP assets (Charlie Brown and Snoopy!) have cash cow characteristics, and the company is currently undergoing a strategic review and could be sold at a premium (see our update last week on our theory as to why it could sell for $9.32 a share).  Yes, we will reiterate that the company is highly levered (outstanding net debt of just over $1 billion) and there are risks.  However, we think its assets and potentially are worth the risk.  The convertible debenture (DHX.DB) closed Friday at $96.00.  At this price, DHX.DB has a yield-to-maturity of 6.60% (note: there is no hard call provision for DHX.B, which is good for investors), but the struggling underlying common shares closed Friday 77.0% 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 added to our position this week, and sit with an average acquisition cost of $99.22.  We also have a position in DHX's Series B common shares (ticker: DHX.B).  
Picture of the Day
Like a DHX Media investor, this Madagascar Day Gecko (Phelsuma madagascariensis madagascariensis) is holding on for dear life.  Botaniska Trädgården, Lund, Sweden.  Copyright © 2009 Felix Choo / dingobear photography.  Picture is available for licensing at Alamy Images. Photo may not be reproduced without permission. 

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