Genworth MI – Q3-2018: Steady with a signaled capital distribution

As long-time readers here know, I cover Genworth MI (TSX: MIC) exhaustively and in a public format. I do not currently hold shares in Genworth MI. You can also read the prior updates here and the Q2-2018 update here.

This quarter had to have been one of the most unremarkable quarterly reports since I remember covering the company, but this is in a “good” rather than bad sense. Q3-2018 was similar to the previous quarter in loss ratios (14%, which suffice to say is very low), and indeed very similar to the Q3-2017 quarter in almost every respect, other than the extra capital on the balance sheet and the slightly reduced share count (90.0 million to 91.7 million in Q3-2017, fully diluted). There was a very small drop in transactional insurance written, but I would deem this as an immaterial change.

There is a very slight uptick compared to last year in insurance written in Alberta and Quebec compared to BC and Ontario, but this is a very minor amount.

The company bought back $50 million of stock (1.11 million shares) during the quarter. They also raised the dividend (as they have done for each year they have been operating) to 51 cents per share from 47 cents per share quarterly. Book value is around $45/share.

The company also increased its credit facility from $200 million to $300 million, which they have left untapped, but this was because of their upcoming debt maturity (5.68% coupon) in June 2020 of $275 million that will come due. Right now this debt is trading above par and it is quite likely they will be able to refinance it, but they are keeping their options open. I also suspect this credit facility (which expires September 2023) is also used as a safety valve in case if something really bad happens in the Canadian housing market.

Most of the interesting information, however, was during the quarterly conference call. The company was talking about how they were in a position in 2019 to distribute $500 to $700 million in capital, and this may go in a combination of share buybacks or special dividends.

One thing that was unlikely, however, was insurance premium increases (they will mirror whatever CMHC offers).

Right now every single variable is favourable for MIC continuing to mint gold with selling mortgage insurance. The economy is good, the housing market in the segment they are most likely to service (first-time homebuyers) is still in very high demand, unemployment is low, etc, etc. When will the party end? Will it?

Canadian oil wipeout

Western Canadian Select is trading at US$17.28 this very moment. For comparison, West Texas is around US$70, and Brent is US$80.

It is well known that Canadian Western crude has a heavy price discount due to the inability to transport it to market. Line 3 (ENB), Keystone (TRP) and Trans-Mountain (KMI/KML, now the Government of Canada) are the only three “quick and cheap” ways to getting it out and these lines are already full.

However, this discount has been much more pronounced over the past quarter and if it continues, it will be financially catastrophic to those companies that are over leveraged and have covenant issues.

The question is to what degree this is reflected in current Canadian oil asset prices. The solvency situation for a lot of companies are likely to get worse than better in the near-term.

It is also amazing how political considerations can stall an entire industry. The survivors will be the well-capitalized incumbents that will pick away strategically at assets of those which are forced to liquidate. Suncor, CNQ and the like with independent channels for energy distribution will pick away at the entrails of smaller, less capitalized competitors.

What I am trying to say here is that small-cap oil, especially those over-leveraged, look to be an incredible value trap on the equity side. There may be debt opportunities here and there, however.

TC Pipelines MLP looks cheap

I’ve written before about TC Pipelines MLP (NYSE: TCP), which is an MLP created by TransCanada (TSX: TRP) consisting of certain US operating gas pipelines.

Today they issued Form 8-K announcing that the FERC hit on their earnings, which they previously estimated was $40 to $60 million a year, will be $20 to $30 million instead.

A bit of history:

At the end of 2017, TCP was earning $252 million net income to its controlling interests, or about $3.60/unit. Their common units were trading at around US$50/unit at this time. Distributions were $1/unit/quarter.

When we work the impact of FERC, on an annualized basis net income will be going down to $220-230 million. This will be about $3.15/unit. Distributions were decreased to $0.65/unit/quarter. Right now the common units are trading at US$29. Management is not increasing the distributions because they want to chip away at debt. It’s kind of surprising considering that this puts the distribution range below where the general partner (TRP) would receive significant incentive distributions.

Risk-free 10-year government bond yields are up about 75 basis points from December 31, 2017 to today, but does this really warrant this much of a haircut?

My guess is that the MLP sector is just highly unfavoured at the moment and that underlying assets are simply too “boring” in relation to cash, which starts to become a more viable option (2-year yields are roughly 287bps at the moment).

But considering the business is very stable (gas pipelines aren’t going anywhere and have significant regulatory burdens to construct, even in the USA), there appears to be much worse places for investment capital. Am I missing anything?

Correlations between rates and equities is reversing

One of the “elephants hiding in plain sight” in 2018 was how the market reacted in February 2018 during the volatility crash:

This chart takes a few seconds to mentally digest, but the key point is that during the beginning of February, the correlation between the 30-year treasury bond yield and the S&P 500 decoupled. Normally market crashes have the tendency of having investors flow capital into long-term treasuries as a safety valve but this did not occur.

What’s happened over the past week is that the 30-year treasury yield has spiked 20bps from roughly 3.2% to 3.4% and the S&P 500 has edged down during that time period. While the equity moves were relatively low (within the bounds of regular volatility), it is increasingly evident that long-term government treasury bonds are no longer being regarded by the market as a haven of safety.

If/when the markets decide to crash, it is quite likely that long-dated treasury bonds will be crashing at the same time and cash/short duration will be the only safe haven when this occurs.

Canadian interest rates are also creeping up as well.

There are going to be bargains here and there, but in general, most investors are going to face some serious headwinds going forward. Cash is king in these situations.

Element Fleet Management

This is a short note – when Element Fleet Management (TSX: EFN) blew its February quarterly report and the stock crashed (and continuing a downtrend that has went on for years), it got my interest. I even put the stock on my quote monitor and watched it. I never pulled the trigger on it, but I do remember staring at the bid-ask when it was hovering around $4 and thinking to myself “this would be a pretty good time to buy”.

Specifically I remember the day in March where they spiked down on a panic dump and thought to myself that the stock would trace down to roughly those lows and I’d be able to get some shares at $3.25-ish. Of course the downward momentum will continue indefinitely! They haven’t even appointed a new CEO yet!

As you can see from the 1-year chart, oops! My fault for being such a cheapskate.

Anyway, this one is now in my “missed opportunities” folder. Won’t be the last.