Sunday, April 15, 2018

April 13, 2018, Update: Peanut Convertible Debentures Power Rankings

Hello. Welcome back as we resume our regularly scheduled programming.  This is the 29th update of the Peanut Convertible Debentures Power Rankings, which is current to April 13, 2018.  Thank you for continuing to read and support the Canadian Convertible Debentures Project.
      
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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 (April 13, 2018)
  • 2017 was a remarkably calm year in US equity markets.  2018? Not so much.  Volatility continues to reign, and we're up several hundred points in the Dow one day, and down the next.  Rinse and repeat.  It's as if markets have finally woken up to the all of the nightmare geopolitical worries out there, not the least of which is the toxic environment in Washington.
  • Meanwhile, here in Canada, is it just me or is the consensus bearishness on the TSX getting a little out of hand? There's been plenty of whinging about Canada's competitiveness, which I gather is due in part to the relatively different tax, fiscal, and corporate welfare (let's call it was it is) philosophies between here and south of the 49th.  Everything being equal, tax-and-spend is a recipe for deficits, this is true.  But cutting tax-and-spend means monsterously large deficits, which is what our neighbours to the south are staring at in the near- to medium-term.  And no, trickle-down economics don't work.
  • So where am I going with this? With its moribund start to the year, the TSX is better value now than the S&P 500.  Our view remains that interest rates will rise somewhat less than consensus expectations (like it or not, a lower dollar will be the balancing mechanism to keep exports competitive).  If so, this will help interest sensitives like utilities, telecoms, and pipes.  The banks would benefit from a steeper yield curve, but forecasts aren't signaling this.  That said, valuations are getting cheaper, and over the medium- to long-term, when have we ever known a Canadian bank to not be good at making money?  Our take: buy, hold, and DRIP away.  Finally, oil prices are now on the rise, which may provide a bid under the Canadian energy companies which have all but been for market once again. 
  • Speaking of oil, we've mentioned on this blog as far back as January that we thought oil prices might be higher over the next year purely on the fact that the Saudi royal family has incentive to manage prices higher as we head into the upcoming IPO of the massive Saudi state oil company, Aramco.  This article in Bloomberg, which ran this past week, more or less confirmed what we suspected.  The target to look out for: $80 oil.  
  • As we've been saying pretty much since we've started this blog: it's risky out there.  As such, like a broken record, we still think it's probably best to emphasize broad diversification across portfolios and focus on quality names.  As always, protect your hard-earned capital. 
  • Let's get to the Top-5 convertible debentures.  If you have any comments, you can drop us a line as per usual.     


Peanut Power Rankings Top-5 Convertible Debentures and Additional Bonus Coverage (April 13, 2018
    1. Hydro One, 4.00%/0.00% 30-September-2027, Instalment Receipts. (Ticker: H.IR), (Previous ranking: #1).  For the second straight update, the Hydro One instalment receipts sit atop our list.

    Of course, Hydro One, as a utilities stock, is interest rate sensitive, not to mention being exposed to the strange dynamic of being a former Crown corporation in which the Government of Ontario still owns a sizable minority stake.  As Ontario slips into election mode, Hydro One risks being dragged into all sorts of political mudslinging, and it made news this past week when the new Progressive Conservative leader (facepalm) suggested he would fire Hydro One's CEO is elected.  These types of things aren't going to help shareholders and instalment receipt holders.

    Ok, so you may be wondering, why do we have it at #1 then? Well, mostly, our quantitative model says it's undervalued.  Based on Friday's close of $30.80, the model says H.IR is now about 15.0% undervalued.

    By now, you probably already know that these Hydro One instalment receipts have a complex structure.  We won't go into details again in this post but for more information, check out our write-up from a previous update.  

    The bottom line: The interest rate environment has hit the price of the Hydro One instalment receipts quite hard.  If you didn't get in on the offering and have been a keeping an eye on this story, a second chance has presented itself as long as you're comfortable getting into a utilities play at this point in the interest rate cycle.  Further, the upcoming Ontario election may throw Hydro One investors some additional curveballs.  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.  It is currently trading slightly out-of-the-money; if the share price of H does not improve, you run the possibility of getting stuck in a zero-coupon convertible debenture after the Avista deal closes.  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.

    2. Surge Energy, 5.75% 31-December-2022, Convertible Debentures. (Ticker: SGY.DB), (Previous ranking: #2).  Oil is up (WTI is at US$67.39 as of Friday).  Gas prices are up (I fueled up this morning, trust me).  Surge Energy is up.  Is there light at the end of the tunnel for Canadian E&P companies?

    Same comments as last time: Surge continues to quietly execute within the context of a tough environment for oil juniors - year-end results released March 14 were decent enough.  If you believe management's estimates based on its proven and probable reserves, the company has a net asset value per share of over $6, which is three times higher than its current share price.  The question is, however, with so many investors badly burned in the last oil downturn, are there any investors left who care?

    The bottom line: If you have a positive outlook on energy prices or even just a neutral one, SGY.DB might be worth a look here.  Please note, however, investing in an junior Canadian resource company requires a relatively higher risk appetite.  At Friday's close of $101.00, the yield-to-hard-call of SGY.DB is 5.45%, and the common shares need to rise about 31.0% to hit the conversion price.  We have no position in SGY.DB.  For more information on Surge Energy, please have a look at the company's most recent investor presentation.

    3. Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #4).  Tricon has been busy refinancing some debt and completing securitizations, which should save the company in interest expense going forward.  In addition, the company entered an agreement to sell its manufactured homes division, but financial terms were not disclosed.  These bits of news helped stabilize Tricon's stock price, which had sold off in recent weeks in sympathy with the rest of the real estate sector. 

    As we've been saying for awhile now, Tricon is executing very well and fundamentals are intact, so we haven't been too worried about the price volatility in the share price and convertible debentures.  TCN.DB.U was this blog's inaugural #1 atop the Peanut Power Rankings.  Tricon made a transformative acquisition in 2017 and continues to be well-positioned for the future.

    The bottom line: TCN.DB.U is a very good quality convertible debenture issue, and has a nice combination of potential upside, yield, and USD-denominated exposure (for those who believe the Canadian dollar will depreciate somewhat, as we do).  At Friday's close of US$105.00, the yield-to-hard-call date is 3.95% and there is about 3 years left until the earliest potential hard call date. The common shares need to rise about 25.8% to hit the conversion price.  We've been long TCN.DB.U since it debuted at US$100.00 and will continue to hold it unless there's a change in fundamentals.  For more information on Tricon Capital, please have a look at the company's most recent investor presentation.

    4. American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' US Dollar Convertible Debentures. (Ticker: HOT.DB.U), (Previous ranking: #6).  As we mentioned last time, this hotel REIT reported its year-end financial results on March 7 and the results missed, and the HOT.UN was punished.  The HOT.DB.U convertible debenture is holding up relatively better, but Bay Street seems to want the company to execute better in 2018.  

    The bottom line: HOT.DB.U has traded below par in the months since it hit the market. This is a play for those who have confidence in the REIT's highly regarded management, believe in the strength of the US economy, and have a negative forward view on the Canadian dollar.  Arguably, the trust units of the REIT are trading cheaply, but the company does need to start hitting earnings estimates.  With a yield-to-hard-call-date of 6.72% and over 3 years left to the hard call date, we continue to think the convertible debenture is very good value.  It closed Friday at US$95.10 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.

    5. DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #3).  Disappointingly, DHX continues to plumb levels near its 52-week lows.  Two priorities for this embattled little company going forward: (1) de-lever the balance sheet by paying off debt and (2) completing the ongoing board strategic review, which the company has indicated will occur before June 30.

    On the latter, it remains to be seen if the company will be sold.  DHX has desirable sought-after assets, but retains a heavy debt-load.  This said, the DHX.DB convertible debentures are trading at sizable discount to par, and in the event of a change of control, they may be redeemed at par. However, I wouldn't be surprised to see the company sell off just some of its assets (for example, perhaps, its TV channels), and use the proceeds to pay off debt, but this would not constitute a change in control.

    The bottom line: DHX has attractive media content assets, but clearly there are risks. DHX's Peanuts intellectual property has cash cow characteristics, and the company is currently undergoing a strategic review, which are both positives.  However, although the company is making progress in paying off debt, it remains highly levered, which is potentially risky in a rising interest rate environment.  Further, the exit of the CEO and CFO does not help the company's relationship with Bay Street.   Results have been disappointing but we still think the unique nature of DHX's assets are potentially worth the risk if you can handle the volatility.  However, at this point, any new investment in the shares or convertible debenture has to be considered borderline speculative.

    The convertible debenture (DHX.DB) closed Friday at $91.25.  At this price, DHX.DB has a yield-to-maturity of 7.61% (note: there is no hard call provision for DHX.B, which is good for investors), and the common shares closed the week 113.9% away from DHX.DB's conversion price of $8.00.  Recovery may well be a long road, but if we get there, investors in the convertible debenture could do well in the end.  Management needs to execute, though, and as we've seen in the last few weeks, there is limited room for error.  We are long DHX.DB at an average price of $99.22 and continue to hold.  We also have a position in DHX's Series B common shares (DHX.B). For more information on DHX, please have a look at the company's most recent investor presentation.



    6. Morneau Shepell, 5.00% 30-June-2021, Series 'A' Convertible Debentures. (Ticker: MSI.DB.A), (Previous ranking: #10).  Morneau Shepell, the human resources, retirement benefits, and technology company, just keeps going up, doesn't it?  Defying gravity, Morneau Shepell has done remarkably well in the market volatility of the last couple of months.  Year-end results were released on March 7, and the company increased earnings 33% year-over-year. 

    The bottom line: This is quietly a pretty solid company that executes very nicely in its niche, and the convertible debenture is now trading in the money thanks to the continued strength of the MSI common shares.  At Friday's close price of $112.05, the yield-to-hard call is a -0.64%, but there are still over 2 years until the earliest possible date of hard call.  MSI stock isn't cheap, but should it continue its positive price momentum, the MSI.DB.A convertible debentures will come along for the ride.  We have no position in MSI.DB.A.

    7. Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Previous ranking: #5).  Cargojet is a dynamo in its space, but it's now trading well in-the-money. Those lucky enough to be in the CJT.DB.C convertible debenture must feel like they are flying in first class.

    The bottom line: Cargojet is a terrific little company and remains a very good story operating in an area of long-term, secular growth - online retail is only going to grow.  No, the stock isn't cheap and the yield-to-hard call on the convertible debentures now sit at -3.68% based on Friday's close.  At this point, an investment in CJT.DB.C is an alternative to buying CJT outright.  We no longer have a position in CJT.DB.C.  Apparently we sold too soon!

    8. Diversified Royalty Corp, 5.25% 31-December-2022, Convertible Debentures.  (Ticker: DIV.DB), (Last update's ranking: #7).  2017 year-end financial results were released on March 29.  The company's royalty interest could be summed up very quickly like this: Mr. Lube was strong, Sutton Realty was steady, and AIR MILES® was mildly disappointing.  Based on the fourth quarter, the payout ratio of DIV is slightly above 100%, but taking into account the company's DRIP which has sizable participation, the payout ratio is closer to 94%.

    This suggests to me that the dividend is more or less sustainable, but it would be nice if the company could close another accretive royalty deal here in the near future.  We patiently await and clip coupons in the meantime.  
      
    The bottom line: DIV is an interesting royalty company that focuses on well-known trademarks, and 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.  DIV.DB is holding steady in the current volatile market environment.  At Friday's close of $101.00, we have a yield-to-hard-call-date of 4.95%, and the common shares need to rise 39.6% 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 - but it's unclear when that will be. We're long DIV.DB at an average price of $100.08, and quietly await along with everyone else.  We also have a position in DIV common shares.

    9. Premium Brands, 4.65% 30-April-2025, Series 'G' Convertible Debentures. (Presumed Ticker: PBH.DB.G), (Previous ranking: #9).  A noted consolidator in the pre-packaged sandwich and lunch meats industry, the stock price of Premium Brands has done very well in recent years.   The stock continued to do even better this week when the company announced on Thursday that it would use its new convertible debenture proceeds and purchase the 100-year old beef jerky and sausage company, Oberto.

    The bottom line: We don't closely follow this company, but there's no question that the company's stock and convertible debentures have done very well for investors in recent years.  Last time, we said that we didn't think the terms of the financing were exactly super generous for investors as the 4.65% coupon seemed a little skimpy in a rising rate environment and the conversion price was set some 60% away from the price where the common shares were trading.  Well, with the announcement of the Oberto deal, the common shares are now only 51.0% away from the conversion price, and the yield-to-hard call is 4.44% with some 5+ years until the earliest possible date of hard call.  So, if you believe that can continue to be effective in executing continued consolidation and operating in its business niche of pre-packaged foods, then you could do worse than consider PBH.DB.G.  We did not subscribe to the PBH.DB.G offering.  For more information on Premium Brands, please have a look at the company's most recent investor presentation

    Picture of the Day

    https://fineartamerica.com/profiles/felix-choo.html
    Sleeping wolves.  Saskatoon, Saskatchewan. Copyright © 2018 Felix Choo / dingobear photography.  Picture is available for licensing at Alamy Images.  Photo may not be reproduced without permission. 

    Drop Us a Line

    Thank you for reading this blog.  As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com. 

    In addition, for media, sponsoring and/or financial institution inquiries, please email us at convertibledebs@gmail.com.  Thank you for your interest!

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