The COVID quarter where everything gets written off

Most companies have a fiscal year corresponding with the calendar, and most of them will be reporting April to June results in the last week of July and in early August.

Q1’s results were in the onset of COVID-19, so results were only partially affected (the sanctions required due to the pandemic really only took effect in the middle of March).

Q2 will contain the full brunt of the economic consequences of COVID-19.

The results posted are going to be horrible for a lot of companies, especially on a GAAP basis. You’re going to see a whole bunch of write-downs of various assets that have been lingering on balance sheets for far too long, but Q2 will be the best time to formally impair them and get past mistakes out of the public consciousness.

The markets are not going to care. This has long since been baked in.

The next consequence of this is that you’re going to see headline computer generated metrics from company financial statements (price to earnings, EPS, etc.) over the next twelve months get wildly misstated due to the inevitable Q2 reporting of losses. This will also affect ROE/ROA, growth percentages, and almost anything relating to earnings in the calculation.

As a result, stock screens looking for value will be twisted unless if forward-looking adjustments can be made. A common forward-looking metric is “consensus analyst estimates”, but this figure is what an investor is looking as a rough short-term measuring stick in relation to the price the market is offering (indeed, if something looks ‘cheap’ solely on the basis of price to consensus analyst estimates, I’d view that much more as an alarm bell than a reason to buy).

The contamination of financial data coming from the COVID quarter will be the worst since the 2008-2009 financial crisis. While individual stock selection is always important, the COVID quarter should create an even better environment for stock selection than other times.

Tailored Brands: Not looking good

Tailored Brands (NYSE: TLRD), retailing as Moore’s in Canada, filed on Form 8-K that they were not paying their unsecured debtholders:

On July 1, 2020, The Men’s Wearhouse, Inc. (“Men’s Wearhouse”), a subsidiary of Tailored Brands, Inc. (together with Men’s Wearhouse, the “Company”), elected not to make the interest payment due and payable on July 1, 2020 of approximately $6.1 million (the “Interest Payment”) with respect to its 7.00% Senior Notes due 2022 (the “2022 Senior Notes”). Men’s Wearhouse has a 30-day grace period to make the Interest Payment before such non-payment constitutes an “event of default” under the indenture governing the 2022 Senior Notes (the “Indenture”). If an event of default under the Indenture occurs as a result of such non-payment, it would result in a cross-event of default under both the Company’s term loan facility and asset-based revolving credit facility (collectively, the “Credit Facilities”). Men’s Wearhouse has elected to enter into the 30-day grace period with respect to the Interest Payment. During the grace period, Men’s Wearhouse may elect to pay the Interest Payment and thereby remain in compliance with the Indenture.

On July 1, 2020, the Company made its scheduled interest payments required under the Credit Facilities and therefore, as of the date hereof, is current with respect to its interest and principal payment obligations thereunder.

Per their last financial snapshot, and 10-Q, it appears they have approximately $1.2-$1.3 billion in senior debt, coupled with $174 million in unsecured notes, which last traded at 7 cents on the dollar. The company itself, by virtue of drawing its asset-backed facility, has about $200 million in cash (and approx. $90 million in restricted cash) in early June.

It looks like they are engaging in a “Mexican Standoff” strategy that will not go very well for everybody involved – implicitly they are trying to get the unsecured noteholders to concede with the threat that they will go to zero in a Chapter 11 proceeding. The question is what price has been negotiated?

The company, similar to most other retailers, has massive lease liabilities and even if they resolve the unsecured debt situation, still has to face that challenge.

Dilution on interest payment election

Stuart Olson (TSX: SOX), for various reasons, is not in the greatest of financial health. They have $87 million in senior debt outstanding, and an unlisted debenture of $70 million. The company is currently cash flow negative and had to obtain a relaxation on their debt covenants due to COVID-19.

On Sunday they announced:

CALGARY, AB, June 28, 2020 /CNW/ – Stuart Olson Inc. (TSX: SOX) (“Stuart Olson” or the “Company”) announces that it will pay the $2,450,000 June 30, 2020 interest payment on its 7.0% Convertible Unsecured Subordinated Debentures (the “Debentures”) through the issuance of shares from treasury pursuant to the agreement of the holders of the Debentures and a corresponding supplement to the indenture for the Debentures. The shares will be issued at a 20% discount to the five day volume weighted average trading price of Stuart Olson’s shares ended June 29, 2020. The Toronto Stock Exchange has conditionally approved the issuance, subject to customary post-closing filings.

The 5-day VWAP puts them at 73.14 cent per share, or approximately 3.35 million shares to be issued for this interest payment, which means that whoever holds the debentures will own about 10.6% of the company. A pretty heavy price to pay for the remaining shareholders, but the alternative is even more glum – it all goes to the creditors. I’m somewhat surprised the shares didn’t trade lower today (no positions).

A great money-making ETF vessel is closing

Retail holders of the TVIX exchange-traded product were getting ripped off by institutional investors for years. Sadly this product, which has a market capitalization of $1.2 billion dollars (and a management expense ratio of 1.65%, so not a trivial money-maker for the issuer) will cease trading on a public exchange on July 10. The notes themselves will still exist, but operate in a “wind-down” state which means that there is going to be quite a bit of havoc in terms of its market value vs. the underlying index it is supposed to track.

TVIX leveraged its asset value into futures contracts of the two front-end months of VIX. As of June 23, 2020, 79% of its notional value was in July VIX futures and 21% in the August month. This gyration of selling the short-month and longing the second month was an excuse for institutional shareholders to siphon money from ETF holders that were silly enough to hold onto it for more than a one day period. Incidentally, other futures-linked ETFs (e.g. commodity ETFs such as USO) exhibit the same characteristics.

To put an amount on this, at a VIX value of 34, to maintain a double exposure to $1.2 billion notional value of volatility, the TVIX fund would have had to hold about 55,700 contracts of July VIX futures, and 14,800 contracts of August VIX futures. 111,000 futures contracts in July traded today.

The effective closure of the TVIX ETF, which was the largest volatility ETF, might work for the benefit of other volatility ETFs. It might also increase the volatility of volatility futures (wrap your head around that one).

My guess is that Credit Suisse is getting skittish on this product blowing up on them in a catastrophic manner.