China’s booming real estate market

I always have a sneaking suspicion that the Vancouver real estate market is a proxy for Chinese real estate, given the heavily ethnic Chinese population concentrations (especially in Richmond, east Vancouver, and around the Metrotown area in Burnaby).

The government of China released an economic report, assuming it is to be believed, that states the following:

3. Investment in fixed assets increased rapidly and that in real estate continued to accelerate. In the first quarter of this year, the investment in fixed assets of the country was 3,532.0 billion yuan, a year-on-year growth of 25.6 percent, or a drop of 3.2 percentage points as compared with the growth in the same period last year. Of this total, the investment in urban areas reached 2,979.3 billion yuan, up by 26.4 percent, or a drop of 2.2 percentage points; that in rural areas was 552.8 billion yuan, up by 21.0 percent, or a drop of 8.4 percentage points. Of the total investment in fixed assets in urban areas, that in the primary industry, the secondary industry and the tertiary industry went up by 9.7 percent, 22.4 percent and 30.0 percent respectively. The investment in eastern, central and western regions grew by 24.4 percent, 26.2 percent and 30.0 percent respectively. In the first quarter of this year, the investment in real estate development was 659.4 billion yuan, up by 35.1 percent year-on-year, or a rise of 31 percentage points.

Also in the report is the following GDP summary:

According to the preliminary estimation, the gross domestic product (GDP) of China in the first quarter of this year was 8,057.7 billion yuan, a year-on-year increase of 11.9 percent, which was 5.7 percentage points higher than that in the same period last year.

11.9 percent growth. Massive.

Since China’s GDP is around $4.72 trillion if you annualized the above number, this is a huge amount of growth in terms of absolute numbers – about $502 billion. Since the USA’s GDP is about $14.2 trillion, it would be equal to about 3.5% GDP growth in the USA.

To put this in another perspective, Canada’s GDP is about $1.4 trillion and it would be as if Canada’s economy grew by 36% for the year!

China’s economic growth is explosive, and whenever you have economies that are on fire to that extent, the boom and bust cycles will be profound.

Trimming the long-term corporate debt position

Although not a huge fraction of my portfolio, I have trimmed some of my long-term corporate debt position in Limited Brands 2033 bonds, at a yield to maturity of 7.8%. I will be trimming more if the yield goes down to around 7.6%, and eliminate it entirely if the yield goes down to around 7.4%.

The risk-free rate (US government treasuries) for a 23-year maturity is about 4.5%, so the yield spread of 3.3% is not sufficient compensation in my eyes for the level of risk taken.

Limited Brands is a company that is in excellent shape after the 2008-2009 recession. They have about $2.7 billion in debt, compared to $1.8 billion cash on the balance sheet, and yearly free cash flow of about $900 million. Their “big name” store is Victoria’s Secret and they also operate Bath and Body Works. Although they have excellent prospects looking forward in terms of liquidity and solvency (and they have announced they will be giving out a $323M special dividend and a share buyback program, which is not good for bondholders although it speaks to the financial capability of the company to make such a move), I will lower my exposure to their debt as prices continue to rise and look elsewhere to get a better risk/reward ratio for my capital.

I think there is a good a chance as any of US bond yields rising considerably over the next few years, so this trade is also an adjustment with respect to my macroeconomic view of the world. It does lower the yield of my portfolio, but I am happy to keep the cash. It will stay as cash until such a time where I can determine where to deploy it in an efficient manner. Given what I see out of the markets, I don’t anticipate this will be a quick process.

Shaw Communications – Moving into Wireless

An article questions Shaw’s slow entry into the Canadian Wireless market.

RBC Capital Markets analyst Jonathan Allen said the delay gives other new competitors time to gain traction before Shaw is even in the market.

…

“It’s difficult to say whether Shaw launching with LTE is the right move,” Allen wrote in a research note, noting Shaw would be among the first globally to choose this network standard.

My opinion is less questioning – waiting is completely the correct decision. The reason is that there is no first mover advantage in this second expansion of the Canadian wireless domain. With incumbents (Telus, Bell and Rogers being the big three) having a dominant advantage in terms of size, capital and capability, it will be difficult for newcomers to quickly penetrate into the marketplace. My guess is that Shaw will be carefully looking at how Wind Mobile, Public Wireless and Mobilicity perform before doing their own launch.

In the strategic sense, Shaw must get into the wireless space – they have a huge customer base with their cable and internet services, but their expansion into the phone space has been slow, mainly because landlines are now obsolete. A wireless expansion that bridges the internet and voice service seems to be quite a logical move. Their system needs to be able to deliver enough reliable bandwidth to provide both voice and highspeed data service. They will also have the ability to bundle this with their cable packages, and as a result may have better success with market penetration than other providers.

In terms of valuation at a glance, Shaw’s equity appears to be fairly valued. I don’t see a compelling story that would boost their equity price dramatically – it would be an economic miracle if they doubled in five years from their current market capitalization of $8.1 billion. They also are capitalized by $4 billion in debt, supported by roughly $600 million of yearly free cash flow at present. Construction of a wireless network is likely to cost a lot more, so it remains to be seen whether they will decrease the dividend or raise more debt capital to finance it. Shaw does have the advantage of having their billing and customer support infrastructure established, which is something the other new upstart providers are struggling with.

As a company, I have always liked Shaw’s positioning and corporate direction. As an investment, I have never found them compelling. Their common shares will represent a good store of value in terms of their ability to drive cash flows from Canadian’s desire to receive cable and communication services, but I will not project much in the way of capital gains.

Why are mortgage rates going up?

I earlier stated that posted rates are irrelevant, but the change in them is somewhat more relevant. The change in mortgage rates, however, are dictated by the Canadian government bond market.

5-Year Canada Government Bond Benchmark Yield

As you can see, the 5-year government bond yield is at a high for the year – at 3.06%, it has not been this high since October 2008.

Today some of the major banks increased their posted rates to 6.1% from 5.85%. The best market rate you can receive today on a 5-year fixed mortgage, without going through too much hassle, is around 4.25%. This will likely go up to 4.5% soon.

Over the past 5 years, the peak for the 5-year benchmark government bond yield was 4.72% in the week of June 13, 2007. The posted bank rate then was around 7.3%, and a typical market rate on 5-year fixed rates would have been around 5.8%.

As government bond yields continue to increase, mortgage rates will also follow.

Chinese investing in Alberta Tar Sands

It’s making the news headlines that Sinopec, a Chinese “crown corporation” is taking ConocoPhilips’ 9% stake in Syncrude, for US$4.65 billion. This will put Syncrude’s valuation at around $52 billion.

Syncrude is a joint venture company with a strange ownership structure. They are one of the large tarsands miners in Alberta, right up there with Suncor.

What’s odd is that Canadian Oil Sands’ market capitalization is about $15.4 billion at this moment and they only have a billion dollars of long term debt. Canadian Oil Sands’ 36.4% valuation of Syncrude would be worth about $18.8 billion at the rate that Sinopec paid for their 9% stake. Obviously I might be missing something here in terms of valuation (not being able to access Syncrude’s financial statements would be an important part of this), but it seems like Sinopec might be overpaying.

China has accumulated a lot of cash (especially US currency) through exports and are concerned that it will be inflated away and are trying to find places to invest it. One way is through minority investments in other corporations, especially ones that serve the strategic purposes of the Chinese government.