Kinder Morgan Canada / Q2-2019

Skimming the Q2-2019 financial results of Kinder Morgan Canada (TSX: KML) –

Entity is 30% owned by the public (roughly 35 million shares outstanding) while Kinder Morgan (USA) owns roughly 81 million shares.

Because the public only owns 30% of the operating entity, even if the company reports $10 million in earnings, the public effectively receives $3 million. The $7 million is a “minority” interest (of course, this is no longer a minority!).

When looking at the first half of the year, we have the following (and I have highlighted the relevant area in a box).

The entity is pleasantly profitable – $43 million in net income for the first half.

However, the preferred shareholders (entirely held by the public) get the first slice of income. Their take is $14.4 million. This leaves $28.5 million for the entire entity. Kinder Morgan’s slice is $19.9 million. This leaves $8.6 million left for the 34.9 million shares that are publicly trading on the TSX – about 24 cents per share for the half.

Do some quick math – 48 cents a year for a stock now trading at CAD$12, which is a net return of 4%. It’s obvious this isn’t strictly about income, there is some pricing potential in the assets.

The preferred shares are at around 5.6%, and also get priority when KML finds a buyer at an acceptable price for their Canadian assets. The CAD$550 million is a drag on KML’s balance sheet, but they are virtually first-in line (as KML got rid of most of their debt after the Trans Mountain Pipeline sale).

For the most part, the income stream is stable. There will be some reductions in 2020, but otherwise they will easily cover the preferred shares.

I bought some preferred shares in early June as a cash parking vehicle. This is a very low risk, low reward type situation where you can watch paint dry for a maximum upside of par – and in the meantime, you can clip your coupons.

Ray Dalio / Paradigm Shifts / Gold

Ray Dalio doesn’t need much description, but his latest post (which can generally be summarized as: the party is changing tone, buy gold) gives one consideration.

Why just gold?

In theory, if dollar devaluation is the name of the game, then I would think that any natural resources that have future demand would be eligible for consideration – especially since most of these companies (thinking fossil fuels) have huge debt loads. The debt becomes cheaper due to the dilution of underlying currency, and the underlying commodity becomes more valuable in nominal terms.

The post would also suggest that the low rate environment will continue and asset prices will continue to be pushed higher (and yields lower) – hence, if cash is trash, leveraging via margin would be opportunistic (one could have made this argument right after the economic crisis as well).

I would also think firms with in-demand fixed infrastructure (e.g. wireless telecoms) will reasonably retain value in such an environment.

Interactive Brokers – Sports Betting

Interactive Brokers (IEX: IBKR), in terms of their competitive positioning, has always been a cut above the mainstream retail brokerages. Their advantage in technology and automation (which results in significantly reduced costs) has been whittled away over the past decade by competition (indeed, commission-free trading has enabled most retail brokerages to rip off their customers on execution slippage yet give the appearance of cheapness), but they continue to find ways to experiment with new ways of finding new markets.

One is broaching the connection between sports betting and securities trading – there are characteristics in common with both branches.

A press release on July 1st announces that IB has a sports exchange where people can trade (imaginary money) futures on sport event outcomes.

“We expect this promotion to attract customers who may be new to the Interactive Brokers platform, and who are more familiar with spectator sports than they are with the financial markets,” said Thomas Peterffy, Chairman of Interactive Brokers.

“Our intention is to teach people about the probabilistic nature of markets, trading and investing. We are illustrating this by our Simulated Sports Betting Exchange where each winning bet pays 100. A player who assesses a team’s chances to win at, say 40% may want to buy a bet at less than 40 or sell it at more than 40. As more information emerges and as the event gets under way, these odds will change and the price of the bet will begin to fluctuate, similar to the price of a stock,” Peterffy said.

“By partaking in this promotion, our players will learn about our platform, how to trade and make investments and how to keep track of their finances, all while being entertained. We are betting that many of these participants will also try our free demo brokerage account and that eventually many will become Interactive Brokers’ clients,” he added.

People that are successful in the virtual sports betting will be able to receive an IB account with up to $1,000 in commission credits (first million people to do that). They are given a virtual account of USD$1,000 in currency, and if they accumulate USD$1,000 in virtual profits they can use that to offset commissions in a future IB account.

It is a fascinating promotion, to say the least. I’d expect nothing less from IB.

I don’t do sports betting but I can easily see the connection between the two.

Gran Colombia Gold notes

A brief update on TSX: GCM.NT.U – the company is required to sell 3,900 ounces of gold on the open market, take the first $1,250 of the sale price and amortize the notes, and the remainder gets distributed to noteholders.

Gold today is roughly US$1,410 an ounce, so I calculate that noteholders will receive an extra 0.79% premium on their notes this quarter, assuming that is the average sale price.

(Update, July 16, 2019: Price received was US$1,412.40/ounce, thus the premium is 0.81%)

If the price of gold remains steady for this quarter and the subsequent 3 quarterly transactions, the total premium received will be an extra 3.53% par value on the notes – the same amount of gold (3,900 ounces) is amortized over a smaller principal of notes as they are amortized, so each quarterly payment becomes slightly larger (0.85%, 0.91% and 0.98%, respectively) – sort of like the effect on EPS of a company executing a share buyback with fixed earnings. This commodity-linked debt amortization arrangement is very uncommon in exchange-traded fixed income securities.

In my estimation, there is a high probability that the notes will be called out shortly before April 30, 2021 for the 3 year government of Canada bond yieldUS Treasury Note yield plus 100bps, so this can be used in your YTM calculations. At par and present gold values, right now investors are looking at about a 13% YTM on senior secured debt, but this will fluctuate depending on gold and 3 year bond yield pricing.

(Update, July 16, 2019: The above paragraph is totally incorrect. Please see the comments below for elaboration.)

Unfortunately for people interested in getting in, the notes have been trading lately above par, which will reduce the yield to maturity.

I have a full position in these notes and I am not interested in adding as they are amortized.

Re-visiting Canadian preferred shares

Back on June 24, 2019 I put a notification out that Canadian preferred shares were looking interesting, but really flubbed with the timing. At the time 5-year government bond yields were 20 basis points less than today.

Sadly my sense of market timing let me down and I was only able to procure a 1% position in a rock-solid issuer’s preferred shares. Too bad – was looking at deploying a significant amount of cash there but this one got away from me. Early June perhaps was the time to get in.

It’s pretty obvious a bunch of institutional money stampeded into the market and this gets bubbled into algorithmic purchases of these securities, which typically have quite large spreads.

In general, however, I do note that physical infrastructure preferred shares (e.g. energy, Brookfield, etc.) exhibited a much higher price increase than financials – the typical rise for a physical infrastructure preferred share trading at 2/3rds of par value has been around a dollar, while the financials have had about half of it. In most instances, securities trading with “minimum rate resets” have been ridiculously overpriced, but there was one that looked reasonably attractive for “boring capital”.

If 5 year yields drop again we could see prices on preferred shares drop again – I’d welcome it. In the meantime I’ll look elsewhere.