Sunday, January 21, 2018

January 19, 2018, Update: Peanut Convertible Debentures Power Rankings

Hi, again.  This is the 25th update of the Peanut Convertible Debentures Power Rankings, which is current to January 19, 2018.  Thank you for continuing to read and support the Canadian Convertible Debentures Project!
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.

Public Service Message: the Financial Post Convertible Debentures List
We've received quite a few emails asking about the Financial Post's convertible debentures list, which has apparently vanished from the newspaper's website.  Unfortunately, we don't know of another complete list of Canadian convertible debentures that is available free to the public that has the same depth of information that was contained in the Financial Post list.  The stats and figures we use for the Peanut Power Rankings we collect from various public sources and calculate ourselves (it's a lot of work!); we don't have a complete list of convertible debentures either.

For those of you out there that are clients of a full-service brokerage firm with a research team that covers convertible debentures, you may be able to obtain a complete list if you ask your broker.  Also, as we announced on December 20, thanks to one our valued readers, we were informed that the TSX publishes a basic list on its website approximately monthly.  It's not the same as the old Financial Post list, but hopefully it can still be of use to some of you out there. 

Market Commentary - Quick Points (January 20, 2018)
  • As we (and just about everyone else) expected, the Bank of Canada raised its overnight rate target, its primary policy interest rate, to 1.25%.  This is the third rate hike in the last year, and market watchers are a bit divided on just how many times Poloz will seek to tighten in 2018. 
  • We had previously guessed that the Bank of Canada would raise rates only one to two times this year, and we'll stick with that view for now.  Trying to interpret central bank speak is always a bit of an art, but our opinion on the Bank's Wednesday press release is that there's a dovish tone present, and definitely concern about the state of the NAFTA negotiations. 
  • It's questionable whether the current deadline of end-of-March to re-work NAFTA to the satisfaction of all three partners in NAFTA will be met.  Any residual uncertainty with the trade deal may be disruptive to the Canadian economy, and the Bank of Canada will likely want to have multiple options to deal with the potential fallout. 
  • In the event of NAFTA uncertainty, the Bank of Canada would likely want the Canadian dollar to fall somewhat, and increasing rates aggressively in such circumstances would not help to guide the Canadian dollar lower. 
  • Currently, the Canadian dollar is at a lofty 80.26 US cents, and in the very near-term, we think it actually has the potential to go a bit higher.  By year end though, we see the Canadian dollar closer to 76 US cents, as we think that the uncertainty around NAFTA and the assumption we will see fewer-than-expected interest rate increases by the Bank of Canada will help rein in the loonie.  
  • As hybrid fixed income instruments, all Canadian convertible debentures are affected by interest rates.  For those issuers that also have US operations and/or have issues denominated in US dollars, the state of the Canadian dollar also has obvious implications for the Canadian-based investor.  For those (like us) with a somewhat bearish outlook on the loonie, it may be an opportunity to get into debentures such as American Hotel Income Properties REIT's 5.00%, 30-June-2022 convertible debentures (HOT.DB.U) and Tricon Capital's 5.75%, 31-March-2022 convertible debentures (TCN.DB.U) while the Canadian dollar is over 80 US cents. 
  • In other news, the US federal government's inability to pass a funding bill Friday night means US federal government services will grind to a halt and effectively be shut down.  I find this remarkable since one party, the Republicans, control the Presidency, House, and Senate yet couldn't find a way to get some kind of deal done.  How abysmally dysfunctional.  We will see how US markets respond on Monday morning. 
  • Let's get to the Top-5.  

Peanut Power Rankings Top-5 Convertible Debentures and Additional Bonus Coverage (January 19, 2018)
1. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #3).  Yeah, we're kind of sticking our necks out there and taking a chance by moving DHX.DB back to the top of our list this close to the release of DHX's fiscal Q2 earnings, which are expected by mid-February.  If you've been reading us for awhile, you're fully aware of this rollercoaster story: the initial excitement of DHX's coup of an acquisition of Peanuts (i.e., Charlie Brown and Snoopy) last spring was followed up by a terrible miss on earnings for its fiscal 2017 fourth quarter (June 2017 quarter).  DHX stock got crushed in the aftermath, the company announced a strategic review (this is code for trying to find a buyer for the company), and then recovered somewhat after posting a better financial results in its fiscal 2018 first quarter (September 2017).

Although the company has been radio silent about its strategic review, newsflow out of the company as of late has been mostly positive.  DHX seems to be busy in trying to execute deals to distribute their library of content, and in December, the much-hyped Disney acquisition of the film, television, cable assets of Twenty-First Century Fox indirectly highlighted the value and importance of the kind of quality content that DHX has in today's digital world.  Bay Street and market wants to see results, and we'll get a look at the company's fiscal 2018 second quarter (December 2017 quarter) results soon enough.  Can the propel the company higher or is another disappointment in the books?  We shall see.

The bottom line:  DHX has attractive media content assets. Its Peanuts intellectual property has cash cow characteristics, and the company is currently undergoing a strategic review and could be sold at a premium (see our previous update on our theory as to why it could sell for $9.32 a share).  Nevertheless, there are considerable risks here.  The company is highly levered (there is outstanding net debt of about $1 billion), and the company has lost the confidence of Bay Street.  That said, we think the unique nature of the assets are potentially worth the risk if you can stomach the volatility, and the underlying common shares and the convertible debenture seem to have stabilized.  The convertible debenture (DHX.DB) closed Friday at $97.00.  At this price, DHX.DB has a yield-to-maturity of 6.43% (note: there is no hard call provision for DHX.B, which is good for investors), and the common shares closed the week 76.6% away from DHX.DB's conversion price of $8.00.  Recovery may take awhile, but if it happens, investors in the convertible debenture could do very well indeed.  Management needs to execute, though, and there is limited room for error.  We are long DHX.DB at an average price of $99.22.  We also have a position in DHX's Series B common shares (ticker: DHX.B). For more information on DHX, please have a look at the company's most recent investor presentation.

2. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last update's ranking: #1).  All Cargojet has done since our last update is continue to perform, so you might be wondering why we curiously dropped it to #2 in our rankings this update.  Well, for successful convertible debenture issues like CJT.DB.C that start to trade well in-the-money, the risk-return characteristics start to change, and its price action starts to closer resemble the issuer's underlying common stock.  If not already invested in such an issue, a potential investor would be wise evaluate whether stock-like volatility is appropriate for the fixed income portion of his or her portfolio - mileage will vary depending on personal circumstances.

At current prices, an investment in CJT.DB.C is effectively an alternative to buying shares of CJT outright.  One should essentially participate in-step with with any upside associated with the common shares, less the dividend.  In return for giving up the dividend, debenture holders effectively get a worst-case scenario floor on downside (important: this of course assumes there aren't any kind of solvency issues with Cargojet, but we don't currently expect any) represented by the current annualized yield-to-hard-call-date of -2.13%.

The bottom line: Cargojet is a winner.  The company has approximately 90% market share of the overnight air cargo market in Canada, and remains a terrific growth story.   The company is effectively a play on the growth of online retail and continues to have a dominant market position in an area of long-term, secular growth.  At current lofty prices (CJT.DB.C closed Friday at $120.75), an investor has to determine for him or herself whether the risk-return profile of debenture works in the context of his or her investment portfolio.  We continue to really like it, and consider it a cornerstone of our convertible debenture portfolio.   We've been long CJT.DB.C since it debuted at $100.00.

3. American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' US Dollar Convertible Debentures. (Ticker: HOT.DB.U), (Last update's ranking: #2).  Not much has happened with this REIT since our last update.  As a US dollar-denominated issue and a REIT with exclusively US operations, the direction of the Canadian dollar has a big impact on Canadian-based investors of the REIT's securities.  Thus, if you have a view one way or another on the loonie, HOT.DB.U is potentially a vehicle in which to express that view.  Furthermore, there's another notable positive going for the REIT: the insider buying.

The bottom line: HOT.DB.U has traded below par in the months since it hit the market, and will be negatively affected if the Canadian dollar continues to be strong. That said, with a yield-to-hard-call-date of 5.33% and about 3.5 years to the hard call date, we think it's great value, especially if you share our view that the Canadian dollar will depreciate somewhat by year's end.  The company just needs to continue executing.  It closed Friday at US$98.97 and we're long HOT.DB.U at US$98.00. For more information on American Hotel Income Properties REIT, please have a look at the trust's most recent investor presentation.

4. Diversified Royalty Corp, 5.25% 31-December-2022, Convertible Debentures.  (Ticker: DIV.DB), (Last update's ranking: #4).  Not much has happened with this company either, but the story remains intact: with $88 million of cash ready to be deployed, the market is eagerly awaiting the company's next move.  Management has a history of adding value, but are patient in executing deals.  Investors in DIV.DB need to be patient, too.

The bottom line: this is an interesting royalty company, which currently owns the Sutton Realty, Mr. Lube, and AIR MILES® trademarks in Canada.  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 reasonable credit risk, in our view.  At Friday's close of $100.99, we have a yield-to-hard-call-date of 4.97%, and the common shares need to rise 27.1% to hit the conversion price.  We continue to think that the stock has the potential to pop at the announcement of the next royalty acquisition. We're long DIV.DB at an average price of $100.08, and quietly await with everyone else.  We also have a position in DIV common shares.

5. Surge Energy, 5.75% 31-December-2022, Convertible Debentures. (Ticker: SGY.DB), (Previous ranking: #6).  Oil is at two-year highs, and we all seem to be paying more at the gas pump, but for the most part, Canadian energy companies haven't really participated in oil comeback thus far.  Maybe this isn't surprising - a lot of investors were burned in the last oil downturn, and I imagine many are quite reticent about getting back into the space.  Furthermore, the widening discrepancy between WTI and WCS is hurting Canadian producers, not to mention the higher loonie and the groundswell of support to move towards a fossil fuel-free future.  So yes - there is still a lot of negativity surrounding the oil patch.

That said, I think there's a case to be made that oil prices will remain higher in the next year or so.  We aren't all driving electric vehicles just yet, plus as we've mentioned several times, the Saudis have billions of incentives to keep OPEC production in line as they seek to fetch the best possible price in their planned IPO of their giant state oil company, Saudi Aramco.

So for the adventurous, you could do worse than to take a chance on a junior like Surge Energy, which has taken measures to improve its balance sheet and can be considered to be quite sustainable at today's oil prices.  Production is at around 16,000 boe/d so this is by no means a huge producer, but its conventional wells in Alberta and Saskatchewan mostly produce light and medium oil, so it should be somewhat less affected by the deep discounts facing its peers who produce a heavier variety of crude.

The bottom line: if you have a positive (or even neutral) outlook on energy prices, SGY.DB is the top oil-related convertible debenture on our list.  At Friday's close of $102.25, the yield-to-hard-call of SGY.DB is 5.11%, and the common shares need to rise about 31.6% to hit the conversion price.  Surge has an ok balance sheet and provides an an opportunity for participation in the optionality of oil prices heading higher, but at lower relative risk to holding Surge common shares directly.  We have no position in SGY.DB but are thinking about it.  For more information on Surge Energy, please have a look at the company's most recent investor presentation.   

6. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #5). This blog's inaugural #1 atop the Peanut Power Rankings, Tricon made a transformative acquisition in 2017 and is really well-positioned for 2018.  However, like American Hotel Income Properties REIT, a lot of Tricon's interests are south of the border and, as such, for the Canadian-based investor, a strong Canadian dollar is a negative.

The bottom line: TCN.DB.U continues to be a very good quality convertible debenture issue, and has a nice combination of potential upside, yield, and USD-denominated exposure (for those of us who believe the Canadian dollar will depreciate somewhat).  At Friday's close of US$107.52, the yield-to-hard-call date is 3.25% and there are 3+ years left until the hard call date. The common shares need to rise about 17.5% to hit the conversion price.  We've been long TCN.DB.U since it debuted at US$100.00. For more information on Tricon Capital, please have a look at the company's most recent investor presentation.

7. Liquor Stores, 4.70% 31-January-2022, Series 'B' Convertible Debentures.  (Ticker: LIQ.DB.B), (Last week's ranking: #7).  On pure numbers, our quantitative model has always liked LIQ.DB.B, in part because the underlying shares of LIQ are volatile.  Like, really volatile - and moreso than you would expect from kind of a sleepy purveyor of the tipsy stuff.  Unfortunately, as long-term investors in the company can attest to, much of this volatility has been of the downside variety.  After a contentious proxy battle and a dissident win, will the company finally put it's disappointing past few years behind it in 2018?

The new board and management have been busy, closing down the company's stores south of the border and refocusing efforts in its core Alberta, British Columbia, and Alaska markets.  The company is also potentially a sneaky cannabis play; although provincial government frameworks for marketing the green are not yet finalized, a company with established infrastructure like Liquor Stores could have an advantage in retailing product once it becomes officially legal.

The bottom line:  If you believe in the Alberta recovery, want a stealth cannabis play, and generally like the our outputs of our quantitative model, then LIQ is worth a long look here.  At Friday's close of $104.00, LIQ.DB.B has yield-to-hard call date of 3.30% and the underlying common shares need to rise 26.5% to hit the conversion price.  We no longer have a position in LIQ.DB.B. For more information on Liquor Stores, please have a look at the company's most recent investor presentation.

8. Hydro One, 4.00%/0.00% 30-September-2027, Instalment Receipts. (Ticker: H.IR), (Last week's ranking: #13).  It's been a long time since we've mentioned the Hydro One instalment receipts.  Those who were lucky enough (we weren't) to get a share of the heavily oversubscribed offering have largely been sitting on a nice little capital gain since the issue hit the market.  However, for those having to buy on the secondary market, the price of H.IR has always been kind of high and our quantitative model has consistent rated H.IR as overvalued.  That is, until now.

I don't follow Hydro One particularly closely, and shares of the company have traded down since about Christmas.  I suspect that the rising rate environment has at least something to do with it. In any event, the instalment receipt is at it's most affordable since the offering.

We did a special update post when the instalment receipts were first announced back in the summer.  Here's a quick review summary of the details  First, the large $1.4 billion instalment receipts offering is part of Hydro One's foray into the US through its proposed acquisition of Spokane-based Avista.  Avista shareholders approved the deal back in November, but we are still awaiting various regulatory approvals before the deal is finalized.   Second, the Avista acquisition will be accretive for Hydro One shareholders.  Third, the offering has a complex structure, and is essentially a deferred equity raise by Hydro One that's been disguised as a convertible debenture that will be represented by instalment receipts until deal finalizes this summer - got all that? Fourth, 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 time period before deal close.  Fifth, that coupon drops to zero after deal close, which means investors would, if they're rational, convert the debentures into common shares well before the debenture's 10-year maturity term as long as it stays in-the-money.  Sixth, even though this instalment receipt offering is quite unconventional, it effectively constitutes a rare convertible debenture issue from a large, investment grade issuer.

The bottom line: If you weren't lucky enough to get in on the offering, a second chance might have presented itself.  However, before making any investment decisions, as always, consult a highly qualified investment professional - H.IR is a more complex issue than most and you want to know exactly what you're getting into.  Based on Friday's close price of $35.50, our quantitative model says H.IR is currently undervalued by 2.20%.  We have no position in H.IR.  For more information on Hydro One, please have a look at the company's most recent investor presentation

9. Algoma Central, 5.25% 30-June-2024, Series 'A' Convertible Debentures. (Ticker: ALC.DB.A), (Previous ranking: #9).  A couple of fun facts: Today, Algoma Central is the largest owner and operator of dry and liquid bulk carriers on the Great Lakes - St. Lawrence Waterway, and the company has been a Great Lakes shipper since all the way back to 1900.  This company doesn't get much coverage on Bay Street as insiders own 78% of the company doesn't offer much in the way of investment banking business as it somewhat famously has never done an offering of shares after its initial offering back in the 1960's.

Shipping is an economically sensitive and cyclical industry, and in the last couple of years, management has been busy with a number of initiatives to position the company for the next upswing in the cycle.  First, the company has divested over $100 million in real estate.  Second, the company has been reinvesting heavily to modernize its fleet to make it more efficient and profitable.  Third, the company has been building out its global short sea shipping (i.e., think of this as international shipping along coastlines without having to cross an ocean) capabilities, which has the potential to be a promising growth opportunity over the medium- to long-term.  Shares of Algoma Central have responded positively, and are up some 27% in the last three months.

The bottom line: although Algoma Central doesn't ever issue new equity, its ALC.DB.A convertible debenture just hit the market last year, and demand for it has remained high in the secondary market.  ALC.DB.A is a good credit and offers exposure to a company with unique shipping infrastructure assets, a market-leading position, and a management that thinks sustainably for the long-term.  ALC.DB.A closed Friday at $106.51, which gives it a yield-to-hard-call of 3.65%.  The common shares need to rise about 34.7% to hit conversion price.  We have no position in ALC.DB.A but have a position in ALC common shares. For more information on Algoma Central, please have a look at the company's most recent investor presentation.

Picture of the Day
Pacific sunset. Kohala Coast, Hawai'i. Copyright © 2015 Felix Choo / dingobear photography.  Picture is available for sale as prints or wall art at Fine Art America. Picture is also available for licensing at Alamy Images.  Photo may not be reproduced without permission. 

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