Author: Sacha Peter

Bombardier, Bombardier – yield on debt – recapitalization upcoming?

Why people would be long-term investors in this company’s common shares is beyond me. It is, however, a good speculation vehicle on government bailouts, of which I cashed in on about four years ago when the Liberals took control of government.

Bombardier common shares (TSX: BBD.B) are trading down 32% today on the news their quarterly results are not going to be as good as expected. In fact, this is somewhat of an understatement as they just threw everything bad into the release. Transportation is performing very badly, and a couple key quotations:

Consolidated free cash flow for the fourth quarter is estimated at approximately $1.0 billion, approximately $650 million lower than anticipated.

Oops.

While the A220 program continues to win in the marketplace and demonstrate its value to airlines, the latest indications of the financial plan from ACLP calls for additional cash investments to support production ramp-up, pushes out the break-even timeline, and generates a lower return over the life of the program. This may significantly impact the joint venture value. Bombardier will disclose the amount of any write-down when we complete our analysis and report our final fourth quarter and 2019 financial results.

The “call option” embedded in Bombardier’s disposal of its participation in the C-Series aircraft is increasingly looking like to come to a (metaphorical, not literal) zero. The agreement with Airbus required cash injections up to a ceiling and it looks like this threshold will be reached. While the minority stake Bombardier has will still have some value (especially as Airbus eventually gets around to selling the aircraft, which by all accounts, are superior) it isn’t anything like what they anticipated a decade ago when getting into the market, which is a real shame.

And on the issue of their capital structure (which is getting quite debt-heavy in relation to their cash flows):

The final step in our turnaround is to de-lever and solve our capital structure. We are actively pursuing alternatives that would allow us to accelerate our debt paydown.

Easier said than done. With their market cap under CAD$3 billion, any de-leveraging through common share issuances are going to be highly dilutive and not make too much of a dent on their US$9.3 billion debt (as of September 30, 2019). They are pursing asset sales to inject a billion into the balance sheet, but Bombardier is clearly running out of options. They’ve gotten rid of their commercial aircraft division, and 30% of their transportation division, so there isn’t much left. “solve our capital structure” is a code-word for a “light recapitalization”, which would explain the common stock tanking today.

It has been awhile since I reviewed Bombardier’s debt maturity curve and I’ll show a snapshot of my trading console and also a yield-to-maturity graph that I have been keeping of the company. The thick line is the present yield to maturity of their debt and despite today’s news, doesn’t appear to be too catastrophic (yet):

Bombardier can still likely raise debt financing, albeit more expensive today than it was yesterday (when most of their bond issues were trading at above par).

The preferred shares (TSX: BBD.PR.B, BBD.PR.D) also took a dive, and are now trading at around an 11% yield for those that like to gamble. Just be warned that “alternatives to allow accelerating our debt paydown” might include the suspension of preferred share dividends (suffice to say, this would likely result in lower prices for the preferred shares). An interesting gamble for yield chasers!

Circumstances behind forced selling

Something to always keep in mind is that whenever you see a transaction, it represents a price that a buyer and seller agree to. When the price is lower than the previous trade, media and people alike state that “the stock has been sold off”, when more precisely it means that “the price that people are willing to sell it at is lower than those willing to purchase”. The number of shares outstanding after a trade is the same with the exception of a primary offering (a company offering shares directly to the public, which can also come in the form of option exercises or restricted share vesting) or a share buyback.

When can an investor get the lowest price? There are a couple circumstances that come to mind, both which are somewhat intertwined. One is that the sentiment for the underlying company is at a low – sometimes the reasons for this is legitimate (e.g. the business model went bust, such as what we are seeing in the marijuana sector at present), but sometimes the lowering of sentiment is transient – for instance when a poor two or three quarterly earnings results comes but the underlying business is still solid (yet stock traders cannot see the underlying strength). This happens all the time in investing, and one advantage of investors with smaller portfolios is that they can jump in and out of these circumstances.

The second circumstance where an investor will be able to capitalize on a low price is if there is forced selling, but these opportunities are transient. There are several situations where selling can be forced and I will outline them.

a) Index selling. For instance, if a stock is delisted from a major stock index, there will be a point in time where mechanical index funds will be forced to liquidate such stock, causing an increase in supply usually resulting in a lower price. Another variant of this is that the underlying ETF containing the stock is contracting its assets under management and the stock is required to be sold. This is one of the residual fears of passive investing – if ETFs are invested in financial products that are inherently illiquid, it will cause more price volatility. A nimble trader can take advantage of such downswings, although be forewarned there are many algorithmic traders looking exactly for these types of price dislocations – once you see it, it’s likely too late to act on it.

b) Fund policy required liquidations. For instance, if a bond fund is required to hold investment grade bonds, but a rating agency downgrades an issuer’s corporate debt into junk, the bond fund in question will be forced to liquidate the bonds, usually after some grace period to avoid a stampede to the exit. Another example are dividend funds that have a mandate that requires their funds to be invested in dividend-bearing securities – if a company decides to change its capital allocation strategy and cut dividends to zero, I usually wait a little bit before investing because there is usually a period of time where funds try to dump supply of such companies into the market. Another interesting variant we are starting to see is ESG-related divestitures, such as the divestment of fossil fuel companies in funds, or thermal coal divestment.

c) Margin liquidations. During significant market downturns, leverage forces leveraged funds to liquidate, which causes price decreases, which in turn requires them to liquidate more, etc. An extreme example of this were volatility ETF fund liquidations that occurred in February 2018 (thinking about the XIV ETF).

d) Required financing raises. This is where a company is floated on the market because the underlying entity requires capital. Two examples of this are Genworth MI (TSX: MIC) which was performed to raise money for Genworth Financial post-economic crisis, and AltaGas Canada (TSX: ACI) which I already wrote about being one of my worst misses that I did not take a stake in.

Ultimately if you want to capitalize on anything on the above, the supply pressure created by forced selling has to be in sufficient quantity and in a short enough timeframe to occur at a velocity that will create a low price. We saw a lot of this in the 2008-2009 timeframe, and more closer to present, in early 2016 and late 2018. When these forced liquidations occur, being on the opposite side of the trade at the right time can result in significantly excessive returns. As always, timing is important, and doing your research in advance and having a ballpark notion of valuation greatly assists in reducing the fear factor when you see a very ugly stock chart.

In particular, if a company has fundamental strength but is being subject to forced selling (which in itself could be caused by excessively negative sentiment), it can create highly profitable circumstances. Watch out for these situations.

Updates on TSX Traded Debentures list

I have been keeping the TSX traded debentures list actively updated for my own investment purposes and hopefully you find it useful as well. A few mistakes here and there slip into the spreadsheet, and when doing a sweep, there were enough changes to note:

1. Premium Brands first two debentures issues were initially listed as non-convertible, but I noticed that PBH.DB.E was trading at a negative yield to maturity and I was wondering what was going on, and indeed their debentures are all convertible. What had happened was when reading the financial statements it is not entirely clear they were convertible, nor their annual information form, but I had to dredge up the press releases in the 2016 offerings to get the proper conversion prices. Fixed!

2. I completely missed Polaris Infrastructure’s debenture offering (TSX: PIF.DB), which was done in April of 2019 and up-sized in May 2019 to its present $25 million size.

Sweeping the list, many marijuana-related entities’ debt are trading at discounts, but I am not finding any compelling value with anything I see. Perhaps any of my readers see things differently?

Pier 1 Imports

Pier 1 Imports (NYSE: PIR) is a retailer of home furnishings. It’s a stock I check up on once in awhile but never considered buying it.

In a classic case of “do not confuse consumer markets preferences with your own”, almost every time I walk into the place (which is usually once a year to see what sort of junk I do not want in my living room) I walk out thinking to myself how this place exists as an entity. This thought of mine has been for nearly a decade. The company has defied my expectations for quite a long time.

From the 10-K: “During fiscal 2019, the Company sold merchandise imported from many different countries, with approximately 60% of its sales derived from merchandise produced in China, 16% in India and 17% collectively in Vietnam, the United States and Indonesia.”

60% of its sales derived from China? Uh-oh, watch out for those cost of goods sold rising!

It looks like it finally might be happening – their last quarterly result for the November 30, 2019 quarter was very lacklustre. Gross profits were 31% of revenues, but SG&A expenses were 42%, which translated into a $59 million dollar hole for the quarter when factoring in depreciation and interest expenses.

They then came to the realization they need to close down half their stores to cut costs.

On November 4, they also appointed their CFO to replace the old interim CEO. I’m sure the executive suite is having a lot of fun right now.

A year ago, PIR had just over $600 million in the “retained earnings” line item on their balance sheet. That is down to $295 million. Current assets are less than current liabilities, and the company is drawing down its revolving line of credit – currently $96 million is borrowed, and they can take out another $158 million – until April 30, 2021 when a separate term debt facility matures.

So this is clearly a race against time – about 15 months – they need to shut down unprofitable stores, and get to the point where they can start building credit again to extend their credit facilities.

In terms of raw valuation, PIR only has 4.1 million shares outstanding, so when doing the math on their $5 stock price, you’re betting on them simply not Chapter 11-ing themselves out of their situation, which is a very high probability outcome at their current trajectory. Leases and debt commitments have to be honoured, and Chapter 11 must look awfully alluring for management.

Back in the glory days, the year ended February 2016, they generated over a hundred million in free cash flow. In February 2017, it was $72 million. In February 2018 that went down to $13 million. When fashion goes against you, watch out!

I would then make a contrast with the company that used to be known as Restoration Hardware (NYSE: RH) that somehow managed to become a $200 stock because they successfully realized that retail is either about the upper-upper end (just click on their “RH New York” video and contrast with PIR), or the lower end (think Dollarama and Walmart!) and anybody inbetween will get killed, like Pier 1.

Or, you might get lucky with Pier 1 just because the valuation is so cheap at present – sort of like a Francesca’s (Nasdaq: FRAN) when the stock quadrupled after an unexpectedly profitable quarterly report.