A small note and investing in the lottery!

Almost everything I’ve put bids on (very near the market) have creeped away from the bid. It is also not like I put a ten million dollar limit order in the market either – I break things away into very small sized chunks and scale in as market volatility takes pricing lower (or vice-versa in the event of a sale).

My lead hunch at this point is to simply buy into long-dated US treasury bonds (e.g. NYSE: TLT) and just sit and wait and be patient for other opportunities as they may arise. If long-term 30-year yields go to about 3.2-3.3%, I just may pull the trigger. But if anything is like how things have been throughout the year, it is going to be a very boring year. Maybe I am slightly resentful that had I did the TLT route in early 2014, I’d be sitting on a rough 20% gain at present.

I will also point out that the Lotto MAX is at $50 million plus $33 million bonus draws which means that you have a better than 1-in-a-million probability with a $5 fee to win a million. Although the expected value of the lottery of course is negative, it almost seems like the only real chance of getting a big payout is through this medium compared to what I am seeing out in the markets at present.

Sad times indeed!

Maybe I should have invested in the CPP instead

The Canada Pension Plan reported a 2015 fiscal year-end (their fiscal year goes from April 1 to March 31) performance of 18.7% gross, or 18.3% net after fees.

Over the past 10 years, the CPP has realized a 6.2% real rate of return, while in order to remain sustainable they require a 4% real rate of return. When dealing with a $250 billion dollar fund, two percent compounded over 10 years makes quite a big difference.

I have had my doubts that the CPP would be able to realize increased returns as it grew simply because they are competing with a lot of other big players for the same pool of income. In a smaller scale, individual investors have to scour the beds of the financial oceans in order to find reasonable risk/reward opportunities.

There is likely going to be increased political pressure to either reduce CPP premiums or raise CPP benefits due to the outperformance of the CPP. It is likely such a decision would be a mistake because in the macroeconomic sense, central bank quantitative easing has inflated asset pricing to extremely high levels. It is very improbable the CPP can maintain its current performance and quite probable that they will pull in more “real-world” rates of returns (i.e. single digits).

However, all Canadians should be happy that the CPP is doing what it did – there is this pervasive myth that the CPP will not be able to pay out for existing and future generations and with the existing payment and benefit regime it is quite likely they will be able to pay for the indefinite future. Assuming you have made maximum contributions to the CPP, you would be entitled to a $12,780/year retirement benefit when you turn 65 years of age. While this is not a huge amount of income, when coupled with Old Age Security ($6,765/year) leaves approximately $19,500/year of pre-tax income which, if properly budgeted, will pay for a basic lifestyle in retirement.

Not finding a lot to invest in

Barring any investment discoveries in the next month, the cash balance I will be reporting in June is going to be a considerably high fraction of the portfolio.

While cash is great, it also earns zero yield.

Compounding this problem is the majority of it is in US currency.

Unfortunately I have done some exhaustive scans of the marketplace and there is little in the way of Canadian fixed income opportunities (specifically in the debenture space) that I have seen that warrants anything than a small single-digit allocation. I would consider these to be medium reward to low-medium risk type opportunities. Things that won’t be home runs, but reasonable base hit opportunities.

Rate-reset preferred shares have also piqued my interest strictly on the basis of discounts to par value and some embedded features of interest rate hike protection, but my radar on future interest rates is quite fuzzy at the moment (my suspicion is that Canadian yields will trade as a function of US treasuries and the US Fed is going to take a bit longer than most people expect to raise rates since they do not want to crash their stock market while Obama is still in the President’s seat).

I have yet to fully delve into the US bond space, but right now the most “yield-y” securities in the fixed income sector are revolving around oil and gas companies.

There are plenty of oil and gas companies in Canada that have insolvent entities with outstanding debt issues, so I am not too interested in the US oil and gas sector since the dynamics are mostly the same, just different geographies.

I’m expecting Albertan producers to feel the pain when the royalty regimes are altered once again by their new NDP government. There will be a point of maximum pessimism and chances are that will present a better opportunity than present.

Even a driller like Transocean (NYSE: RIG) that is basically tearing down its own rigs in storage have debt that matures in 2022 yielding about 7.9%. If I was an institutional fund manager I’d consider the debt as being a reasonable opportunity, but I think it would be an even bigger opportunity once the corporation has lost its investment grade credit rating.

Canadian REIT equity give off good yields relative to almost everything else, but my deep suspicion is that these generally present low reward and low-medium risk type opportunities. Residential REITs (e.g. TSX: CAR.UN) I believe have the most fundamental momentum, but the market is pricing them like it is a done deal which is not appealing to myself from a market opportunity.

The conclusion of this post is that a focus on zero-yield securities is likely to bear more fruit. While I am not going to be sticking 100% of the portfolio in Twitter and LinkedIn, the only space where there will probably be outsized risk-reward opportunities left is in stocks that do not give out dividends. It will also be likely that a lot of these cases will involve some sort of special or distressed situations that cannot easily be picked up on a robotic (computerized) screening.

I would not be saddened to see the stock markets crash this summer, albeit I do not think this will be occurring.

The continuing saga of Pinetree Capital

Pinetree Capital (TSX: PNP) announced it will be redeeming another $10 million in its debentures on June 5, 2015. This is on top of the $10 million that was already redeemed on April 30, 2015.

For those of you following the Pinetree Capital saga (history of posts here), I continue to hold Pinetree debentures (TSX: PNP.DB) as I believe it is more probable than not they will be made whole at maturity.

On December 31, 2014 Pinetree Capital had approximately $107 million of investment assets on its balance sheet (at fair value, $75 million level 1, $8 million level 2 and $23 million level 3) and $54.8 million in debentures that are now senior and secured by all assets of the company. They have no other debt. When the debtholders got three of their directors on the board when Pinetree defaulted on their debt covenants in late January, presumably on February they start on their liquidation spree. On March 29, 2015 they had $14.3 million cash in the bank which they used to redeem the first $10 million of debt. After June 5, 2015, they will have $34.8 million in debentures outstanding.

Debentureholders will also receive their semi-annual interest payment (10% annual coupon) on May 31, 2015.

As part of their forbearance agreement (to stave off their debt being declared fully payable with likely CCAA implications), Pinetree Capital was required to redeem a minimum of $20 million face value in debentures by July 31, 2015. They had the option of redeeming the debentures with 1/3rd equity, which they have not done so to date. They are also required to maintain a debt-to-assets ratio of 50% until October 31, 2015 and then 33% afterwards.

When doing a quick and dirty pro-forma with no change in assumed asset value other than the payment of interest and principal on debentures, after the June 5 redemption they will have a debt-to-assets ratio of 40.5%. If Pinetree were to redeem another $11 million in principal by the end of August, this would bring the ratio to 33%. Presumably they would want a little bit of a margin of error to work with, so it is likely before October 31, 2015 that they will redeem around $15-20 million in further principal which would bring them safely below the 33% mark.

Not surprisingly, the market has picked up on this and has bidded up the debentures to 88 cents on the dollar. What has previously been a 75 cent dollar is now considerably more expensive and will likely converge to par throughout 2015 with diminishing market liquidity as the debenture supply dries up.

Disclosure: Still long on PNP.DB, but as the redemptions occur, my portfolio weighting decreases.

WYNN not winning

One of the best commentators on conference calls is Steve Wynn (Nasdaq: WYNN) and suffice to say, he has a few zingers in his last conference call. His company’s stock has gotten hammered some 16% today and over half since early 2014.

wynn

Some notable quotes from his conference call:

It is impossible for us to predict how long [the downtrend in business conditions] that will last. We’re not in a position to answer those kinds of questions intelligently. We’re only in a position to react intelligently to what we see.

He goes on a speech about how the company will always be able to manage its debts and affairs, and also about how dividends will only be given from cash that has historically been earned:

So as we look backwards for the fourth quarter and especially during the last four months, and understand what’s happening, both in Las Vegas because of the Asian impact on Baccarat, and we look back and then we extrapolate and try predict the future, or at least understand what most likely will be the future, it is foolhardily and immature and unsophisticated to issue dividends on borrowed money. We only distribute money that’s free cash flow based upon our earnings that trail.

Dividends are nothing and – we don’t say that because we have a business, that we now have a $0.50 dividends forever. That’s baloney and any company that does that is irresponsible. We distribute the money that we make after we make provisions for capital expenditures and all of our other obligations, to creditors and to our employees. And then we distribute aggressively whatever is free and easy to distribute after that.

The note about issuing dividends from borrowed money should resonate with most oil and gas producers in Canada these days – the only reason why most of them are issuing dividends is simply because they’d get their shares jettisoned from the huge pool of income funds. It would also be an admission of defeat and a negative signal to the market.

On a dialog on the conference call with his own president of the Las Vegas casino (which in my humblest opinion had a dinner buffet that was remarkably worth the US$45-ish that I paid for it):

If you were to ask me, since we’re making forward-looking statements, what will the second quarter look like in Las Vegas? Weak. Do you hear me? Weak. So I’m trying to lower expectations here. This notion of a big recovery is a complete dream. I don’t think Las Vegas is experiencing a great recovery. I think it’s still very patchy and I think that that’s probably our non-casino revenue in the first quarter was flat. I’d be thrilled if it was flat in the second quarter.

It is very rare when you get a CEO making such refreshingly honest statements. There’s a bunch of other commentary here, but I will leave that as an exercise to the reader.

Business notwithstanding, there is a whole bunch of drama going on over at WYNN at the present time, including the divorce of the CEO spilling over onto the business side of things.

Genworth MI Q1-2015 review and analysis

Genworth MI (TSX: MIC) reported their 1st quarter earnings results yesterday. The report can be summed up as a relatively boring, “steady as she goes” type quarter, which is somewhat surprising considering the general predictions that the degradation in the Alberta real estate market would cause considerable stress in the sector.

The bottom line earnings took the book value to $36/share.

While the market is signalling there is going to be further losses later this year, the first quarter result had a loss ratio of 22%, which is generally on-level with prior quarters – the company projects 20% to 30% for the year.

Despite the winter quarter being the slowest quarter of the year, year-over-year statistics show a marked increase in unit volume (23,951 in 2014 vs. 32,760 in 2015) and also the net premiums written ($84 million to $130 million). The Q1-2015 net premiums written was also goosed up by the recent CMHC mortgage insurance premium increases. On June 1, 2015, there is another CMHC premium increase on higher ratio mortgages which will also result in a $25-30 million increase in net written premiums.

The company’s insurance in force exposure is 18% in Alberta for “transactional” type mortgages, which are mostly those with 20% or less down-payment. Delinquency rates continue to be very low (0.11% nationally) without any pronounced increases other than a mild rise in Quebec. Ontario has a 0.05% delinquency rate.

On the balance sheet, the company’s investment portfolio yielded 3.4%, but they had some interesting commentary, stating “At this time, the Company believes that the capital adjusted return profile of common shares is less favorable than in the prior year”. As a result of this and also minimum capital test guidelines, they have increased their allocation to preferred shares. Similar to last quarter, they also went out of their way to specify that 75% their energy company investments (in bonds and debentures) were in pipelines and distribution, and the other 25% were in “integrated oil and gas companies with large capitalizations”. The bond portfolio has a mean duration of 3.8 years.

The company has capital that is 233% of the minimum capital test (currently $1.52 billion required) and the internal target with buffer is 220%. This leaves $200 million available for the company to either repurchase shares or distribute in a special dividend. They announced their regular quarterly dividend of CAD$0.39/share with the quarterly release but did not give any indications as to what else they will do with the excess capital.

At a current market price of (roughly) CAD$35/share, I generally believe the company’s valuation is slightly on the low side of my fair value range estimate. I would not start to think of divesting until CAD$40, but an actual sale decision would likely be at higher prices.

I still hold shares from MIC, purchased back in the middle of 2012. Seeing the recent price drop to CAD$28/share would have been a decent opportunity to add more shares and I doubt we will see that again unless if there is a profound economic malaise that hits Canada. If we can survive US$50 oil, our economy is more robust than most think (noting that the rest of the commodity markets have also plummeted). MIC also continues to be a stealthy way to purchase Canadian real estate and also a proxy for a bond fund at a very low management expense ratio. The yield in today’s income starved market is a bonus.

Centrus Energy (formerly USEC)

Centrus Energy (Amex: LEU) was formed out of the pre-packaged Chapter 11 bankruptcy proceedings of the entity formerly named USEC Inc.

LEU since recapitalization (September 30, 2014)
LEU since recapitalization (September 30, 2014)
LEU - 5 year chart (adjusted for reverse stock split)
LEU – 5 year chart (adjusted for reverse stock split)

The corporation primarily derived its revenues from reprocessing Uranium from nuclear warheads from Russia and the USA. The reprocessed nuclear fuel was then sold to nuclear power facilities. It was a reasonably profitable activity – for example, in 2006 and 2007, the company earned roughly $100 million in after-tax income.

In addition, the company is working on a centrifuge project that would allow for the cost-effective (compared to gas diffusion) enrichment of low-grade enriched uranium. These enrichment projects, as Iran is discovering (and they are attempting to produce weapons-grade uranium), are not trivial tasks to overcome. Imagine being given a million ping-pong balls, and half of them weigh 1% lighter than the others – how do you separate them?

Things changed with the business. The contract with Russia expired (and diplomatic relations between the countries had soured anyhow). Nuclear energy after the Fukushima reactors blew up took a massive hit. The market for Uranium had essentially peaked in the early 2000’s and pretty much now most producers are on life support if your name is not Cameco or subsidiaries of Uranium One. We fast forward in 2014 and the company cannot pay back its $530 million in convertible notes and is forced to recapitalize.

The recapitalization left the company with $240 million in notes to existing note holders and preferred share holders and 95% of the equity. This also left USEC equity holders with 5% of the company. These shares continued to trade down some 50% post-recapitalization until the remaining entity has a market cap of about $50 million and $240 million in notes.

In terms of the balance sheet, things are very ugly. At the end of 2014, while they do have $220 million in cash, they have significant pension liabilities and also considerable negative tangible equity. On the income side, they have negative gross margins and without a real market for nuclear fuel, which is stocked up for the remainder of this decade.

So what could possibly be an investment case for this company?

It deals with the centrifuge project. One would suspect that this is an item of USA national security and that there would be geopolitical considerations to keeping it alive for future purposes. Accounting-wise, this project does not really appear on the balance sheet except as intangibles. One could argue that the “true” value of the project is worth much more than what appears on the balance sheet.

A very condensed consideration of nuclear energy at this point in time:

One also has to weigh in the factor that world uranium supplies have not been mined as intensively given the relatively low prices seen in the last decade. Nuclear power plant construction has also slowed down due to the 2011 Japan earthquake, but China is building more than 20 reactors, and this is higher than Germany’s 9 (which will be shut down). It is likely China will continue building more nuclear reactors to replace their coal power plants (pollution being one reason).

Japan is a wildcard – they currently have 43 reactors operating and the current government’s intention is to continue producing nuclear power. India is also expanding their nuclear generation portfolio (noting that their nuclear production is going to increase 70% in the next two years – reference Cameco).

Oil and gas does not explicitly compete with nuclear power because of how the power is generated – nuclear power provides base loads, while gas powered plants can be turned on and off relatively quickly and are peak load providers. Nuclear plants are direct competitors to coal powered plants.

Management

Centrus’ first real act was to hire the former deputy secretary of the US Department of Energy in the US federal government. His rolodex must be quite large and considering that the Republican-held congress has made some inquiries is probably a better sign than not that the new CEO carries a bit of clout as Centrus is fairly dependent on US government funding at present.

The investment thesis

The short part of the story is that the stock is trading extremely low simply because there is a culmination of nearly every single bad circumstance for the production and sale nuclear fuel. If these variables were to change, it would appear that a $50 million market cap for this sort of company would be extremely low. While it is not likely that they will ever get back to the days where they will earn $100 million in net income, there is a considerable chance they could generate positive income of some quantity.

Other than pension liabilities, the other primary liability the company has are its US$240 million in notes, which are structured for maturity on 2019 but can be extended to 2024 if the centrifuge project goes ahead. In 2015, the notes accrue 5% cash interest and 3% payment-in-kind (in the form of more notes), while in 2016 and beyond, the notes accrue 2.5% interest and 5.5% payment-in-kind (in the form of more notes). They will not be a huge financial burden until maturity.

Past history would suggest that the company would recapitalize these notes if solvency became an issue again.

The last reported trades on TRACE of any real size (i.e. par value of $100,000 or greater) was at 45 cents on the dollar, which is hardly a ringing endorsement by the bond market. Assuming a 2019 payout, that would be roughly a 25% yield to maturity.

TRACE prices of LEU 8% notes (maturing September 30, 2019 or 2014)
TRACE prices of LEU 8% notes (maturing September 30, 2019 or 2014)

The risk-reward here on both the equity and debt are high risk and extremely high reward if things work out for the nuclear fuel industry. There are a ton of what-ifs to consider, but one would think the worst-case outcome for Centrus at this point is bleeding cash until another recapitalization in 2019 (I’d guess you’d see a maximum of 50% downside but it should be reasonably obvious that they are going nowhere). In terms of upside, if all the stars lined up correctly, you could see a 10-bagger over a few years. I have no idea what the probability of this would be, but I’d ballpark it at 10-30%.

This is also a rare company that would likely be bidded significantly higher in the event of a nuclear detonation occurring somewhere in the world, although they would likely be sold if there was a civilian nuclear power plant incident (in line with Chernobyl or Fukushima).

The financial statements otherwise are nearly useless in terms of properly trying to value the company.

Final note

There is a lot of analysis work that I have performed here that is not in this post, but the previous 1,000 words roughly summarizes the investment. A whole bunch of commodity risk, political risk, technology risk and financial risk.

Brookfield swallows North American Palladium

North American Palladium (TSX: PDL) operates a mine which has been somewhat profitable, but financing expenses have killed any chances of the overall operation returning money to shareholders.

Balance sheet-wise, they invested $450 million in mining operations, while having a $220 million debt to deal with and a requirement for some cash, which they do not have. A classic case of solvent, but not liquid.

The primary cause of this was doing a deal with the Brookfield devil, where management borrowed US$130 million at a rate of 15% interest in June 2013. The debt was secured by PDL’s assets. Not surprisingly, it has gone financially downhill since then. The debt has since morphed into US$173.2 million as interest has been subsequently capitalized into the loan (and other drama that has happened since that point which I will not get into).

What’s amazing is the corporation somehow managed to find enough suckers to invest in some toxic convertibles in 2014 that significantly diluted the company’s equity but kept enough cash to keep the zombie alive for another year.

Finally, they succumbed to having a quarter of your revenues go out the door in the form of interest expenses and are coming to grips in the form of a recapitalization proposal.

The term sheet (attached) that management came up with to ensure its own survival is quite onerous to all involved.

The salient details are that existing shareholders will keep 2% of the company, unsecured debenture holders will receive 6% of the new company, and Brookfield and partners will keep the 92% after generously injecting US$25 million and releasing their accumulated debt to the firm. Afterwards, Brookfield will float a rights offering where they will raise another CAD$50 million and this will presumably dilute the interests of the then-common shareholders even further if they do not wish to participate.

A holder of 52% of the convertible debentures has been spoken to and agrees to this proposal. They need 2/3rds approval, which is likely considering that the convertible debentures are unsecured and they would receive nothing if the company went through the CCAA route.

Not surprisingly, existing shareholders/debentureholders of PDL took down the price:

PDL.TO share price
PDL.TO share price
PDL.DB.TO price
PDL.DB.TO price

The recapitalization document was released on the morning of April 15, 2015 half an hour before trading opened, so astute traders that could skim through the news release and the actual term sheet would have been able to get out at 19 cents if they hit the opening market trade. If you waited until the end of April 15, you would be sitting at 12 cents.

At 7 cents per share of PDL stock and roughly 400 million shares outstanding, the market is valuing the recapitalized version of PDL at CAD$1.4 billion.

It does not take a genius to figure out that, with $220 million in revenues in 2014, the existing stock price is still significantly over-valued. If I was owning any shares of this train wreck, I’d still be dumping at market. Fortunately I’ve never owned any shares (or debt!) of PDL. Purchasing a mining operation at 7 times revenues is not exactly a value play.

However, the albatross of having to deal with a crushing 15% senior secured loan will be off their backs and the resulting entity may have a fighting chance when it doesn’t have to shell out $50 million a year in interest expenses. You just have to figure out at this point what Brookfield’s incentives are to ensuring they get the most of their 92%+ equity stake in a post-recapitalized PDL.

Q1-2015 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the first quarter of 2015, the three months ended March 31, 2015 is approximately +0.7%.

Portfolio Percentages

At March 31, 2015:

40% equities
3% equity options
2% equity warrants
31% corporate debt
24% cash

USD exposure: 57%

Portfolio is valued in CAD;
Equities are valued at closing price;
Equity options valued at closing bid;
Corporate debt valued at last trade price;
Portfolio does not include accrued interest.

Notification

I am still considering an e-mail subscription service for these updates. When I am in a position to do so, I may give an abbreviated summary of the report on the website, but send something more detailed through email.

Portfolio Commentary

This was an odd quarter. There was some accumulation of five new names in the portfolio, which to my knowledge is a record for me in accumulating names – I’m usually a little bit more calm. The new acquisitions amounted to approximately 18% of the portfolio. One of them I bought both the equity and debt of the issuer, and I obtained about 80% of the equity position I wanted to in this before it began to skyrocket upwards. Oddly enough the debt remains roughly at the same level where I had bought it – one of the debt or equity markets has to be correct (unfortunately in most cases it is usually the credit markets provide the better insight on pricing simply due to the fact that irrational retail investors rarely trade in debt – they usually deal in the equity).

The portfolio continues to remain concentrated in the name of mainly three issuers. The lead one, which I have still not disclosed, did a successful debt rollover during the quarter and also closed a divestment that resulted in an after-tax gain that will bring its reported tangible book value about 10% higher than what the current market value of the stock is. Although ambient market conditions have not been tremendously good for the underlying business, it is a matter of time before this will turn around and a simple matter of being patient and waiting for the market to take the stock up to a proper fair value. Management is also on-the-ball by repurchasing shares under book value, which results in appreciation of the book value figure. It has been about 18 months since I took my initial stake, and have been twiddling my thumbs and waiting for meaningful appreciation.

The portfolio also holds some equity in Genworth MI (TSX: MIC) that I have written about many, many times before. This company is trading as a proxy for expectations on Canadian real estate in general, and is trading below book value (as of the date of this post, a market value of CAD$31/share, book value of CAD$35/share). Management has been relatively cautious because of the economic frailty of the Alberta and Saskatchewan markets, but I believe it would be well contained. Frankly, they should be repurchasing shares at current prices rather than giving out dividends. Not only would they get a “5% yield” on their investment, but they’d also be purchasing a dollar for 85 cents.

Speaking of 85 cent dollars, I’ve also written about Pinetree Capital (TSX: PNP) and their ongoing saga. I own some of the debt. The debtholders (specifically some Toronto financial institutions that combined have more than 2/3rds of the debentures) have forced an arrangement where they amended the debt agreement to secure the assets of the underlying company and now the new directors face a liquidation challenge to ensure that they are paid off. Management will be required to redeem $20 million (36% of their debt outstanding) by the end of July and up to one-third of this can be in the form of issued (and highly dilutive) equity. There is a very tight leash (covenant) that will be tested on July 31st (50% debt-to-assets ratio) and October 31 (33% debt-to-assets ratio). If management cannot reduce its debt to assets ratio to 33% or under, they will continue to be in breach and debtholders will extract another pound of flesh. The redemption structure will also likely result in the debtholders retaining some sort of equity influence over the company if the company cannot redeem in cash. It is a very interesting incentive structure.

There is a redemption that will occur on April 30, 2015 that will remove 18% of my position in the debt; presumably future redemptions will reduce this fixed income level in my portfolio to a smaller amount. a I am not intending on repurchasing the debt at current market values – I am relatively grateful to be getting my money out at pr plus 10% accrued interest. I will also note that the debt-to-assets ratio at the end of December 31, 2014 was 52%.

There’s a lot of fixed income in my portfolio, and most of it could be considered to be highly speculative debt. In all of these cases, there is a high underlying incentive structure to ensure the debt either gets paid off, or rolled over. Only time can tell whether I have been able to pick needles out of a junky haystack.

Future Outlook and musings

The big news is going to be what will happen to the oil market. It is early in the game. We will likely need to see more consolidation in the oil and gas space before we will see some real appreciation in the commodity price. Strategically speaking, however, companies like Canadian Oil Sands, Cenovus, Suncor, etc., are all very relevant to Canada’s energy security framework and are trading a lot on asset value rather than current underlying cash flows. There has been a lot of equity raises in the oil and gas market and as a result, this will likely have the effect of seeing capacity continue being built and warrants further waiting before jumping in. When hedges start to expire in 2015, it will continue the financial pressure on firms with higher cost structures. Eventually there must be consolidation and a slowdown of production as drilled wells exhibit decaying output.

Companies involved in oil infrastructure (e.g. drillers such as Transocean, Seadrill, etc.) and other related companies (e.g. the servicing industry) have equivalently been hammered due to capacity management issues. There have been some firms that have other businesses not related to oil and gas and they seem to have been a classic case of “throwing the baby out with the bathwater”.

A commodity that has been beaten to death since the last decade is Uranium, especially after the Japanese earthquake. I have been giving this sector a bit of attention as of late. One of the unnamed companies in the portfolio mentioned above is an indirect proxy play on a potential resurgence of nuclear power or nuclear re-armament. It has been absolutely miserable times to be a Uranium producer, but I believe enough capacity has been stripped out of the system that we might start seeing some life in the sector again. This (similar to oil) will not be a quick process, but most of the damage to the sector has already been done. Indeed, when I initially looked around for an ETF, I could only find one.

When Bombardier did its announcement that it was seeking equity funding and suspending its dividend, I thought their preferred shares (specifically BBD.PR.C) was a steal at around $15/share, which would have provided an over 10% tax-preferred yield. The Bombardier family has a huge incentive to ensuring that it does not lose control of its company, and while they have every right to suspend preferred share dividends, I very much doubt they will take that measure unless if everything else has been exhausted first. Unfortunately I missed the boat on this trade.

If you believe interest rates are going higher (I do not), then buying preferred share instruments that have floating-rate characteristics (or at least a rate reset every five years) would appear to be a huge investment opportunity. Most issues are trading at insanely depressed prices from par value and patient investors would likely see yield and capital appreciation in the event of an uptick in interest rates. However, the Fairfax theory of global deflation appears to be the winning theory at present, and indeed, Fairfax itself is trading at such a huge premium over book value that a large part of the market believes them.

I also believe the huge amounts of sovereign debt trading at negative yields (Switzerland, Denmark, Germany, etc.) is a fairly good sign that there are fundamental issues going on within the whole global monetary system. How this ends up breaking will be a good question as there will be plenty of money to be made for the resolution.

I note that China is slowly slipping into the currency exchange markets with the internationalization of the Renminbi. What will be even funnier is them selling a boatload of Chinese paper and then devaluing their currency. Do people ever learn? Also, the Shanghai stock index appears to be a reasonable creation of the 1928 Dow Jones Industrial Average. History may not repeat itself, but it indeed rhymes.

Genworth MI and Canadian real estate speculation

It is fairly obvious by looking at the graph of Genworth MI (TSX: MIC) that institutions are dumping stock in fears that mortgage default rates are going to spike up as a result of economic calamity in Alberta. The CEO of Genworth talking about “heightened vigilance” isn’t helping matters any.

While this might be true, it appears that other real estate metrics are relatively in tune. My cursory scans of the REIT market (e.g. Riocan, H&R, Calloway, all apartment trusts, etc.) doesn’t show any erosion in that marketplace. Banks (e.g. BMO, BNS, etc.) are showing some equity erosion since the middle of 2014, but I’d suspect this is more due to yield curve compression and partially due to the solvency risk posed by syndicate loans to various oil and gas companies.

Other direct lenders, mainly Equitable and Home Capital, have both seen erosion but it is not significant to the point where one would think there is going to be a complete and utter collapse in the fundamentals.

Genworth MI appears to be the whipping boy in the real estate industry. If such fears are warranted, then one would think that REITs and other related stocks would also get proportionately taken down.

So the question now is whether the market is wrong about REITs or wrong about Genworth. Assuming the negative momentum for Genworth MI continues, one would guess that looking at the financial metrics and historical charts (and then-fundamentals of the company at that time) that it is conceivable the stock can get down to about $22-23/share as a floor. This is based on the discount assigned to the stock during the mid 2012-2013 period and the fundamentals of the company at the time.

Today is a little different in that the company has less shares outstanding and has more equity on the balance sheet.

Assuming the Canadian real estate market does not completely nose dive, an investor would still be looking at around 20% downside on existing technical momentum, but fundamentally there is still significant value as the firm is trading deeply below book value at present (right now at a 20% discount). It is like purchasing a leveraged bond fund at a significant discount.

The combined ratio (this is the loss ratio plus the expense ratio) during the depths of the 2008-2009 economic meltdown, did not go above 62%. Delinquency rates never got above 0.30%. Today, it is 39% and 0.10%, respectively. Yes, these numbers will increase as people start defaulting on their Alberta homes, but I simply do not see at present those numbers getting worse than it was in the 2008-2009 era.

I am watching this carefully and may choose to add to my position.