Amazing stock performance from a dinosaur – Cineplex

(I had initially written this entire draft on May 3, 2014 and forgot to hit the “Publish” button when done since I had to rush off to do something else… subsequent to this post, they announced a fairly tepid quarterly result and the stock went down to about $39/share. I have not revised the content of this post, but really, I did write this five days ago!).

Was doing some simple research today. Found this company with the following five-year chart:

cgx

Anything since 2009 has performed well, but this one has gone up nearly in a straight line by about 2.6 times – 22% compounded annually for those interested in that figure.

What’s the company? Cineplex (TSX: CGX).

Intuitively if you had presented me the equity case for this company 5 years ago I would have laughed at you – who the heck goes to movie theaters in these days with Blueray and DVD’s, home theaters, video games, and just almost anything else than sitting in a dark air conditioned room for two hours with a bunch of teenagers armed with noisy cell phones?

The answer is – more than I was expecting. The corporation in 2013 made $660 million in box office revenues and about $110 million in revenues contaminating the minds of its customers with pre-movie commercial advertising. This is in addition to other revenues selling overpriced junk food and the usual sort of things you’d expect from a theater company. At the end of the day, they booked $83 million in income, or about $1.32/share.

Balance sheet-wise, they have a little bit of debt, but it is not ridiculously high (about equal to their 2013 cash flows through operations). The corporation is still in an acquisition mode, consolidating what was previous a fragmented market of small players. As one might expect with a consolidator company, tangible book value is deeply in the negative (about $160 million negative). They pay a monthly dividend of 12 cents per share, or $1.44 annually (roughly $88 million in 2013).

So the stock, at about $41/share or a market cap of $2.6 billion (63 million shares outstanding), isn’t exactly cheap. It would have to go down considerably before I would even be remotely interested in it. But I was just amazed that this business is still afloat in the 21st century and apparently thriving. These sorts of businesses shouldn’t be surviving the internet age.

I always keep in mind to never mix my own consumer preferences with those of others. This is one classic case.

Or perhaps there is a short sale thesis here? I won’t do it, but perhaps somebody else there might look at it.

Genworth MI trading at all-time highs

mic

Since their quarterly report at the end of April 29, Genworth MI is trading at all-time highs. I haven’t had a chance yet to listen to the conference call, but I would expect management signaled that the foreseeable future is relatively stable and that their loss ratio estimates are on the conservative side.

The question is – how much better can things get? No defaults at all in the Canadian mortgage market?

Assuming all things are equal to today, one would expect Genworth to earn about $3.80/share this year and next year this would be slightly higher due to mortgage insurance premium increases. The mortgage premium increase will attribute for a $35 million increase in written premiums in 2014 and $70 million in 2015. This will effectively equalize their current differential between written and earned premiums; earned premiums have been higher than written premiums for the last five years.

Doing some math would lead an equity investor to expect approximately a 10% total return, minus market valuations (P/E, P/B expansion) and other external events (competition, real estate volumes, etc.).

Considering your typical bond investor is going to be lucky to make a decent 5% yield with a A- to BBB risk profile (your typical US$ BBB-rated 5-year bond yield is currently at 5.8%), and Genworth MI’s rating is A-, there is a healthy equity premium associated with the company that would still justify holding the shares. Genworth MI itself just issued 10-year debentures at about 4.25% for 10 years recently. However, the company has long since passed the point where it is bargain territory.

Genworth MI itself is a glorified bond fund, with about $5 billion in assets invested with an average yield of 3.6% and duration of 3.7 years. This, along with the liabilities associated with the mortgage insurance business, is valued at $3.7 billion presently. Given the “if all things are equal” projection, it does make financial sense for the company to still invest in its own equity since there is a good yield spread of about 5% still to be harvested. If you give a “natural” equity premium of 3% then there is 2% left to run – i.e. around $44/share.

I hope momentum and yield investors (speaking of which, is about 3.6% at current prices) actually does that. If and when they do, I will take that opportunity to unload shares.

What is keeping back the market from bidding up the share price are all the obvious factors concerning the general perceptions of over-valuation in the Canadian real estate market and macroeconomic factors, including the Fairfax doomsday scenario. If the commodity sector starts to sneeze and prices decline, then it will have an impact on employment, which will subsequently have an impact on the overall health of the mortgage credit market.

Right now Genworth MI is priced for some fairly rosy days ahead of itself and this bodes well for the general Canadian economy. Are investors right? How long will this last? I don’t know.

Genworth MI, on account of its appreciation over the past 20 months, is still a significant component in my portfolio.

Genworth MI Q1-2014 report

Genworth MI has posted its quarterly report. The company continues to fire on all cylinders – specifically the loss ratio, at 20%, is lower than it has been in a very, very long time. This is a function of record low mortgage delinquency rates (0.12%).

Everything appears to be humming along and the company continues to be a cash generation machine.

Tangible book value is $33.36 per share (which includes other accumulated comprehensive income, but excludes deferred acquisition costs) which is up since the previous quarter.

Written premiums are level from the quarter in the previous year. The revenues are expected to increase 15% due to the increase in pricing of mortgage insurance.

The company’s reinsurance bet on a property market crash not happening in Australia over the next three years seems to be a $6 million dollar bet with a maximum risk of AUD$30 million – they recognized $510,000 in this quarter, I am making a straight line estimate of their premium recognition curve.

There is really not much else to report other than the rather pleasant state of the Canadian real estate loan market. Looking ahead I would expect the company to increase its dividend in the third quarter and perhaps give off a one-time special dividend once the regulatory requirements for minimum capital are set in stone later this year. It remains a mystery whether management will buy back its own shares at current levels (approximately 12% premium to tangible book value), but we will see.

I am long Genworth MI equity from significantly lower costs, but have trimmed the position recently due to portfolio concentration. The business is doing well and it is priced that it will continue to do well.

Canada issues 50 year debt

The government of Canada today issued $1.5 billion in debt with a 50-year maturity. The yield to maturity is 2.96%. For the duration these are amazingly low interest rates. If the Bank of Canada can actually keep the inflation target pinned at 2%, the real rate of interest is less than a percentage point.

Suffice to say, I think this is a prudent move by the government. I wonder when Canadian banks will come up with mortgage products that will let consumers lock in insured 30-year mortgages for 150 basis points above government rates. They do this in the USA, why not here?

I’m also curious to know how much debt the government can issue with these terms before the public market starts to vomit on this much debt. For every seller (the government), somebody out there must want to be long this debt. There is a financial argument about hedging against market volatility (typically bond prices will rise with a reduction in equity prices) and generating some higher semblance of income compared to 1%-yielding cash, but locking yourself in at 2.96% for 50 years? Unreal.

In a very abstract level, the taxpayers of Canada win in this scenario – as long as the pension fund that is buying the debt isn’t the one paying your future defined benefits.

Preparing for a year 2000-type scenario

I am relatively convinced that although the economy appears to be muddling along with a low real growth rate, the markets are pricing in a growth trajectory that is optimistic. We are likely to see increased volatility in the future.

There are some good doomsday type stocks, but perhaps none would be better than Fairfax Financial (TSX: FFH), who have continually prepared for a gloomier future. They have hedged their entire equity portfolio against the S&P 500 and also have purchased CPI-linked derivatives that would profit in the event of a deflation. From Prem Watsa’s annual report, he believes that any credit event in China would cause commodities to collapse (they consume 40-50% of most commodities from iron ore to copper) and it would have an impact on the mining industry. He goes on to state that world iron ore capacity has increased by more than 100% in the last ten years, mainly due to increased Chinese demand.

The excesses in the Chinese real estate market are quite well known and have been reported extensively in the past, but just like what happened in the USA from 2004-2008, it might take some time before any credit events emerge. In addition, the Chinese government has proven to be very adept at managing the situation.

While I don’t profess to if or when such a credit event will happen, if it does occur, it would be very adverse for Canadian investors holding equity and debt in such entities. Fairfax is an interesting bet for a doomsday scenario, but at CAD$470/share they are considerably priced above book value (which is US$339 at the end of 2013 or about CAD$374 at current currency rates). Given the performance of Fairfax’s businesses, one would expect a modest premium over book, but 25% over book seems a bit heavy to swallow. The company also sold 1 million shares at CAD$431 (CAD$417 after expenses) in November, but this was also in relation to their purchase of Blackberry convertible debentures.