The race for cash

The VIX index has been wildly dancing around, but as I write this it is roughly at around 50% at the moment.

April 16, 2025 futures (the predicted VIX 6 trading sessions later) has it at about 34%.

(Update: by the time I started penning this draft to when I hit the publish button, the numbers changed to 45% and 32%, respectively)

We are seeing a continuation of policy disruption and the realization that traditional structures that have existed are crumbling before our eyes. With the elevation of risk, prices are dropping and we are also seeing a deleveraging occurring.

It is always instructive to remember that whenever a transaction is performed, that no cash or assets are lost or created in the process – instead, the price of the asset is marked to whatever the transaction price is. The power of double entry accounting ensures that “Newton’s Law of Accounting” is followed at all times – assets equals liabilities plus equity.

Say your personal balance sheet looks like this:

Assets
Cash – $100
Stocks – $900 (10 shares of XYZ @ $90, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $500

Your own personal balance sheet has a gross debt to equity ratio of 100%, or net 80% with cash. Your loan agreement with the bank is a gross debt ratio of no more than 150% or a net debt ratio of no more than 100%.

Some other market participants decide to panic and take down the trading price of XYZ down to $60 because they want to raise cash.

Now your balance sheet looks like this:

Assets
Cash – $100
Stocks – $600 (10 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $200

This is a result of a $300 loss in the value of the stock (whether it is ‘realized’ or ‘unrealized’ does not make a difference here). The loss flows directly down to equity. Now your gross debt to equity ratio has ballooned up to 250% (net 200%) and your bank is calling you asking you to normalize your debt ratios. So you sell half your stock:

Assets
Cash – $400
Stocks – $300 (5 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $500
Equity – $200

The transaction is a transfer of 5 XYZ in exchange with $300 cash from another participant. The gross debt to equity ratio is still 250%, but the net is now down to 50%. You then pay off a couple hundred dollars of debt to abide by the gross debt to equity ratio covenant:

Assets
Cash – $200
Stocks – $300 (5 XYZ @ $60, mark-to-market)

Liabilities + Equity
Debt – $300
Equity – $200

Now your gross/net debt to equity is 150% and 50%, respectively, which is within the bank covenant.

No cash or shares of XYZ were created in this equation. Instead, what happened is that your shares went to somebody else’s balance sheet in exchange for them giving you some cash. However, the payment (and extinguishment) of debt reduced the quantity of assets in the overall system – you gave $300 cash to a bank, which had your debt as an asset on its balance sheet – it performed an asset conversion (a loan to you to cash), while your balance sheet experienced a significant reduction.

Effectively this is what is happening – debt ratios get triggered with asset price drops and this forces cash to be raised – the pressure to liquidate further accelerates the asset price drop.

In other words, the anatomy of a margin call.

Fundamentally, asset prices are supported by cash flows provided by such assets, tempered by factors such as risks of business prospects and what one can get as a risk-free alternate. This does create a bit of a speculative outpouring where you get participants saying that assets such as common shares of NVidia will grow their earnings 25% annually for 10 years straight and the like – and when conditions change to thwart those expectations, the asset price corrects accordingly and those that have borrowed to pay for the stock will be forced to reverse course.

The net result is that those that are over-leveraged will have their assets taken away from them in a washout scenario. This applies to traders, but also to financial institutions that make bad loans and have an inability to abide by their regulatory limits.

It goes to show that high debt environments create huge amounts of volatility – Uncle Warren has preached about this for ages in his Berkshire letters. The irony is that those that have the highest amount of debt will have the highest amount of success relative to their equity – until a washout will take them out. This is best described in Greek mythology in Icarus, who was given a great gift of wings that could make him fly, but was cautioned to not fly too close to the sun otherwise they will melt – and indeed he crashed down to earth. High amounts of debt cause similar results.

When there is a race for cash, participants try to unload whatever is liquid – stocks, bonds and other alternatives. We see on a day like today that Gold is down 2%, and the two main cryptocurrencies (Bitcoin and Ethereum) are down about 6% and 13%, respectively. However, the world’s leading liquid cash substitute, US treasury bonds, typically a safe haven during equity market declines, have their futures down about 2.5% at present. Presumptively, today can be characterized as a race for cash. The race for cash provides opportunity for those that do not have to raise it – and timed well, can result in outstanding returns.

It is still far from the 2008-2009 days where I remember seeing corporate debt securities of credible and stable entities (e.g. telecom firms) trading at 15-20% yields. 2016 was also another ripe environment for fixed income (I remember the preferred share market was ripe with credible double-digit yields at the time). Perhaps my expectations are still too lofty for these types of returns in a 2025 environment that has been bathed in liquidity – if we receive a continued contraction in liquidity, there might be enough forced selling out there to make it happen. We will see.

It is psychologically damaging to see the equity component of the portfolio flailing so badly in this spiral (should I have gone 75% cash instead of 50%?), but I can only imagine how it would be if the portfolio was leveraged long – the financial stress would be considerable. I took a lot of chips off the table a couple years ago for this reason. I would only want to put those chips back on the table when it would seem to be crazy to do it – and believe it or not, it doesn’t seem like that yet, despite the fact that we live in crazy times (the causes of the increasing mental insanity can be the subject of another future post).

Tariffs v3.0

Things are starting to get interesting. The S&P 500 is down over 10% now from the mid-February peak and I am sure participants are getting a little skittish about asset pricing.

When things go crazy, it always helps to distill things to fundamental finance and economics and try to pick winners and losers.

One is that assets with higher risk are priced lower.

If your cash flows are 10, 10, 10, … to perpetuity, in a 10% rate environment, the asset will be worth 100. If the cash flows instead are 8, 12, 3, 17, -4, 16, etc., but still averaging 10, all things being equal that asset will be worth less than 100. One operational reason is that if a bank wanted to loan you money for your operation, there might be a chance you would blow a covenant. At the very least, you could take less leverage than the first “stable” operation.

Second, higher returns come from lower pricing.

Using the above example, if you managed to obtain the first asset at a price of 80 instead of 100, you would be sitting on a 12.5% return forever. If you bought it for 120, your return would be 8.3% instead.

Third is that a trade tariff is taxation.

Money that otherwise would go into the input is diverted to government. Governments, not known to being the most productive entities with capital, will likely reduce the overall efficiency of the economic engine.

Fourth – concepts of price elasticity

There are some items of trade that are crucial and have no substitutes. For these inelastic products, an increase in price will have no subsequent diminution in demand. Typically gasoline has been one of these products, but even then there is substitution effects with electric vehicles, or taking public transit, or just driving less. An even less elastic market would be basic food consumption – people need to eat to survive. The most elastic products would be semi-luxury products such as designer clothing and other completely discretionary purchases.

The seemingly “on again, off again” nature of the US administration has rapidly increased the perception of risk, hence lower prices (for financial assets). For price-elastic industries (which are most of them) this is going to have a marked decrease in overall demand due to increasing prices (of the consumable). As the aggregate demand drops, this will also have to corresponding boomerang impact of suppressing prices and create a negatively reinforcing loop. Despite revenues and profits decreasing, the amount of leverage employed to support decreasing profitability will result in a deleveraging shift.

Essentially this might be the start of the unwinding until central banks decide to employ the “plunge protection team” when opening up the monetary spigots once again. We are nowhere close to the conditions where the central banks will go full-blown QE, but you can be sure they are watching in regards to the stability of the financial system if we start hearing rumours of firms going under.

In Canada, we have the short-term rate likely to drop to 2.5% on their April 16 policy meeting. The yield curve has been a shallow “U” shape for some time, a change from the persistent inversion seen a couple years back. However, the introduction of quantitative easing is slowly back on the radar, both in Canada and in the USA – Canada has stopped their tightening, while the USA has slowed down theirs. This has been more gracefully implemented than what happened in 2009 and 2020.

Unlike what happened with Covid-19, I do not have a good radar as to where the opportunity is. I still continue to remain very defensively positioned with a high magnitude of cash, but many of my selections that I have taken small positions I have faced losses with.

The timing is going to be tricky. In bear markets, the bull rallies are usually quite monstrous in magnitude but very short-lived. Valuation-wise, we still have a lot of the S&P 100 in nosebleed territory and the perpetual EPS growth estimates are likely going to be tapered down significantly, which completely busts the rationale for high P/E valuations.

If I am using the year 2000 playbook, this has yet to still play out on the downside. There will be sharp rallies luring participants back in, thinking the worst is over. Cash is a defense – out of all the stupid decisions I made over the past couple years, I do not regret this one.

Tariffs v2.0

This will be a short one.

I stand by everything I wrote back on February 2, 2025 on the matter. So far this post is aging well.

BoC will drop rates 25bps on March 12, 2025 (to 2.75%) and April 16, 2025 for a 2.5% policy rate after April’s rate cut. Prime will go to 4.7%.

Pay attention to the yield curve – 5yr GoC is at 2.63% and this is going to open up the spigots for more government spending. Prime example – British Columbia today announced their budget, and the year-to-year projected change in debt is $23 billion, on a $84 billion revenue account (page 11, “total debt”).

With this much government spending they can barely keep the economy afloat – and it is going to be the same for the rest of the country. As we know, government spending is rarely directed towards the most productive recipients and the population is going to continue to wonder why their standard of living will continue to decrease.

First casualty in the USA-Canada trade war

(Update, February 24, 2025: Looks like TFII won’t be moving after all) – MONTREAL, Feb. 24, 2025 (GLOBE NEWSWIRE) — TFI International Inc. (NYSE and TSX: TFII), a North American leader in the transportation and logistics industry, today announced that based on feedback from shareholders received to date, TFI International will remain a Canadian corporation and will not pursue its previously-announced intention to re-domicile from Canada to the United States.

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There are two major (ground, not rail) transportation companies publicly traded on the TSX.

One is Transforce, now TFII (TSX: TFII) and the other is Mullen Group (TSX: MTL).

TFII used to be mostly domestic and focused in eastern Canada, but now they are about 70% USA in revenues, with their masterstroke being the acquisition of UPS’s Freight operations in January 2021.

Mullen Group has been western Canada-centric and aside from a relatively small non-asset based logistics operation in the USA which they acquired a few years ago, they are primarily domestic Canada. Their initial evolution stemmed from the service of oilfield industries (pipelines, drilling and the like) to a very credible and profitable freight, LTL (less than truckload) and warehousing operation, with the original oil and gas logistics business being continually de-emphasized over time.

Both companies have excellent CEOs that are able to articulate, evolve and have good crystal balls to see where the future is headed.

Unfortunately, for Canada, it is very apparent from both companies they view Canada as a zero-growth market.

In TFII’s most recently quarterly report and conference call, in addition to reporting under expectations (the market swiftly took the stock down about 25%) they announced that they were going to move their corporate headquarters to the USA. The relevant snippet in the conference call:

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Ken Hoexter (analyst)

Okay. And then just to re-domicile. Any tax implications on that? Is that just moving headquarters? Where are you going to be moving? Is there any follow-on implications for that?

Alain Bedard (CEO)

Ken, I think this is an evolution of TFI. So if you look at 5 years ago, we listed TFI into the New York Stock Exchange. And we were able to do that through what they call an NGDS, okay, exception, right? But this exception will disappear the minute that our shares that are owned by U.S. shareholders okay, the minute that we go above 50%, then this is not going to work. So we have to go to the SEC and then we have also to be U.S. GAAP.

So it’s part of an evolution, okay? But at the end of the day, if you look at TFI today, okay, for head office. We have people working in Canada. We have also people working in the U.S. We have people in Montreal, in Toronto, Calgary, we have people in Chicago. We have people in Minneapolis.

So we are all over the place in North America with our head office crew. So to me, it’s just like an evolution, okay? Because our business is now today about 70% U.S. domestic 25% Canadian domestic and about 3% or 4% or 5% transborder. So it’s just — and with the next M&A, okay, we just announced a small transaction in our MD&A with that and with the possibility of us doing some more M&A in the U.S., like we said at one point, we will invest $3 billion to $4 billion. It’s going to be in the U.S. It’s not going to be in Canada.

So our revenue will creep up to about 80% to 85%. So it’s just an evolution, but we’re not moving head office. We’re not moving people from, let’s say, Toronto to, I don’t know, Chicago. Every member of the TFI head office is staying where they’re at. So that’s what we call TFI, TFI International. It’s because we’re a Canadian and U.S.

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We look at Mullen Group’s conference call and the relevant snippets are here:

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Walter Spracklin (analyst)

Okay. No, I appreciate that color. On — in your outlook this year, you put $150 million in there for M&A that you’re going to allocate toward M&A. I don’t think you’ve done that before, Murray. And is this because you’re more — like is this something you see imminent, or is it just something that you’re kind of plugging in there because you’ve done it in the past? I’m just curious as to why you elected to include that? And do we assume it’s spread out across the year?

I’m trying to gauge your $350 million because if $350 million in EBITDA is $150 million in M&A investment, then that could be maybe $30 million of your EBITDA forecast for this year is associated with M&A. And if you do a deal at the end of the year versus at the beginning of the year, obviously that $30 million is going to vary. So I’m just trying to get a better sense of — do we look at your guide as being kind of more $320 million and then anywhere from $0 million to $30 million in acquisitions, depending on when you deploy it. Is that the right way to look at your guide for this year?

Murray Mullen (CEO)

Well, I think if you assumed — I think the reason we put in the $150 million is because the auditor told us we had to. So it’s just full disclosure is that it had to do. The auditors are all panicked because of tariffs. Oh, my God, the world’s going to end. No, it’s not going to end, but the auditors — I think that all came from them and then said, well, how do you get to that? Well, we’re not changing our outlook because we said, look, if we’re going to get — we think we’ll get to $350 million, but we got to do acquisitions to get there because we don’t think the market will give us $350 million. We think the market will be about the same as last year.

Just like we — I highlighted, for 3 years we’ve been $2 billion, $2 billion and $2 billion. Well, it might be 4 years because I don’t see any growth in demand. So let’s assume that we’re about the same on same-store sales. And that’s about $330 million. That’s about what we did. Of course. $330 million, $335 million, pick your number and then we do acquisitions. And I said, well, we’ll probably get to [ $23 million ] and $350 million. But we didn’t do any acquisitions out of the gate, it’s just the timing. So, but to get to $350 million, most likely we got to deploy $150 million of all that dry powder that we’ve got.

So, yes, I mean, if you’re doing acquisitions, you got to deploy capital. And if we’re going to add $300 million of revenue or $200 million, you got to spend some money. So that’s the math on it. That — that’s our — no, I think the question is, where are we going to spend it? Where are we going to invest shareholders’ money? Well, most likely it’s not S&I, or we’ve always said we love the LTL business and if we can find tuck-in acquisitions, we’re doing them because that’s how you drive margin improvement as you get more critical mass and you put your technology in play.

But I’d tell you, depending, I’m being coy right now, but it really depends on Canada’s response to how we’re going to be competitive with the Americans. If Canada doesn’t get its act together, and by this I mean the politicians and Canadians to say, we’ve got to invest and get capital coming into Canada, we’re going to turn our attention to the U.S., which implies our U.S. segment, U.S. 3 business.

So I don’t know for sure, but I can tell you, Canada, get your act together or on behalf of our shareholders, I’m going to put our money to work in the U.S. where we think if they’re going to win, we got to follow the money. So I think a lot has to do with public policy, Walter and they better start — they better bringing getting capital employed in Canada again if we want to get this economy to grow. That has nothing to do with me. I’m just pointing out the obvious.

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David Ocampo (analyst)

Murray, I just want to circle back on one of your last comments there on capital deployment. If you guys would start to direct that more to the U.S. If Canada doesn’t get their act together. If I look at your strategy so far, it’s mostly just been asset light through the 3PL business that you guys do have. So are you thinking something more of the same in terms of capital deployment if you do start to deploy more assets down in the U.S. or are you thinking something on the asset side, which would probably require a lot more scale than you’ve deployed in the past?

Murray Mullen

Well, I think David, that’s all under discussion right now, and we’re going to present our thesis to the Board. I’ve been reluctant on it, but when things change, you got to change. And it’s pretty evident with the Trump administration that — well, there’s 2 things. Number one, it’s pretty evident Canada’s losing the capital investment game already. Just look at our Canadian dollar, it’s worth nothing. And then if the Trump administration accomplishes what they want, which is they win and we lose, well, we got to follow the money. So we’re looking at that very, very closely David, I don’t know for sure yet, but I have to change my thought.

If Canada is not a place to deploy capital, I’m not going to deploy it here. It’s no different than in 2012 from a strategic standpoint. The rules changed in the energy space. We were once dominant in the energy business, S&I, oilfield service. Okay, well it changed and we pivoted away from it. I hope I don’t have to pivot away from Canada, but I got to do what’s best for our shareholders. And if pivoting away is required, our shareholders should know I’m going to do what’s best for them.

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There were other lines in the call, but you get the idea – when CEOs of companies that are major leading indicators of economic activity (freight transportation is one of them) are basically saying that they’re not going to be dumping any more capital into the country, you know there is a huge problem.

TFII’s corporate HQ move to the USA is an evolution and part of their strategy they likely foresaw a decade ago, and now Mullen Group is slowly getting into this game as well. As productive capital drains away from Canada, it makes the Canadian bargaining position continually weaker. Please note when I say “productive capital”, I mean capital in the form of machinery, manufacturing and most importantly human innovation – what I do not mean is capital in the form of real estate development, something we already have in huge excess!

I believe the Harper administration saw the big picture when it came to negotiating position and the necessity of attracting productive capital investment (e.g. at one point our corporate tax rate was significantly lower than that in the USA) – and indeed there was one point where we had US entities parking capital into Canada. With the growth of taxes and regulatory compliance costs (both soft and hard), needless to say the only entrants of any scale that come here are done so with the explicit backing of government (e.g. green energy project subsidies, or significant tax credits for film companies) as in most cases this is the only way that such investment is economically viable.

The net result of this is that unless if you are being assisted by the tailwinds of government, it will be difficult to make money. As governments are not known to be efficient capital allocators and are very susceptible to influence, this makes society less efficient and poorer as a result. Initially, the degradation is not noticed, but over time the economic neglect is increasingly more noticeable – post-Covid it became really obvious and this disparity will continue to get worse and worse. Brace yourselves!

Suncor firing on all upgraders

The turnaround in Suncor (TSX: SU) after Rich Kruger took over has been remarkable. It has almost been like a Hunter Harrison story.

Financial metrics at Suncor have been as good as it gets, with 2024 generating about $9.5 billion in cash flow, or $8 billion if you make some adjustments for working capital.

Using the $8 billion figure, Suncor has 1.25 billion shares outstanding, so $6.40/share in free cash flow. Market value is around CAD$55/share at present.

The balance sheet is mostly de-levered with about $7 billion of net debt. They intend to keep it at around the $8 billion level.

The capital allocation after capital expenses is currently going toward an approximate $3 billion/year dividend and the rest of it dumped into a share buyback.

If Suncor was trading as an income tax-free income trust like in the old days where income trusts were freely traded, they’d be generating about 15% distributions on their cash flows. With a 23% combined federal-provincial tax, that goes down to about 11.6% net on market cap.

At $55/share, the buyback is an acceptable use of capital, especially when measured against the cost of their 10-year debt (5.6% pre-tax at present).

The risks are fairly well known – regulatory (although the pendulum is definitely swinging on the environmental policy front), geopolitical (Suncor is relatively better positioned than Cenovus with respect to potential US tariffs on crude), and the commodity market (will oil crash?).

The biggest risk is that they spend money on a really stupid acquisition. Their most recent large profile acquisition (consolidating the remainder of the Fort Hills oil sands project from Teck and Total Energies) was a remarkably good one.

On the flip side, the upside is fairly contained – the company is operating at capacity.

Hence the valuation dilemma – will there ever be a catalyst to warrant a valuation that takes the company from ~12% after-tax to 10, or 8%?

It is too cheap to sell, but since zero growth and volatile commodity companies tend to be out of vogue at present, too expense to purchase.

Still, in theory, if everything remains equal, by this time next year, the company’s shares plus the dividend distribution should take the total value of a share purchased today at $55 and turn it into roughly $61, a lot better than a risk-free 3% on short term cash.

From an engineering and operational perspective, Suncor is a very exciting company doing really amazing things with gigantic volumes of dirt and water – it is truly a modern version of energy alchemy they are performing. Few people appreciate the magic that is being performed with these energy companies.

Financially, however, they are starting to resemble REITs. Whether this is a good or bad thing, I do not know.

I remain long on a moderate position taken shortly after Kruger took over. I am not expecting fireworks from this position, but take solace in having some degree of exposure to perpetually rising prices and having something better than cash silently raking in those free cash flows.