Tax-loss selling

Every year at around this time I scour the list of year-to-date losers because they are more prone to being jettisoned for two reasons:

1. They can crystallize a loss for income tax purposes; and
2. A fund manager does not have to be embarrassed by the presence of that security in their portfolio.

One can debate whether reason #1 or #2 is more powerful.

When looking at a very simple screen of Canadian stocks, it is evidently clear that anything energy and resource related has been disproportionately hammered. There are obvious reasons why this is the case – commodity prices – so these companies don’t require much further research. There are likely a couple golden needles to be picked out of the haystack. Those that can pick them out will be handsomely rewarded with a disproportionate out-performance whenever the underlying commodity recovers. Finding these golden needles will never be an easy process – if it was, other investors would likely be able to identify the opportunity which will impact your returns.

However, when scouring the list of non-energy and non-resource stocks, I get the following, in rank order of greatest loss year-to-date to least, with some very superficial remarks:

1. BBD.B – Bombardier – I’ve written about them in the past on this site. Their common shares are down 70% year to date! Preferred shares seem to be the sweet spot of risk/reward.
2. TTH – Transition Therapeutics – One look at their yearly stock chart can tell you when their clinical trial of their lead development candidate failed.
3. CPH – Cipher Pharmaceuticals – Will need to do some research.
4. SW – Sierra Wireless – January 1, 2015 seemed to be a peak in their stock price which is why they made this list. Perils of technology investing.
5. WIN – Wi-Lan – Patent company that is seeing the business model not be as promising as originally hoped. Not interested.
6. CJR.B – Corus Entertainment Group – Media company with various television and radio interests, facing too much internet competition.
7. TS.B – Torstar – Toronto Star. Print Media. Enough said.
8. AFN – Ag Growth International – An obscure but easy-to-analyze company selling grain equipment to farms across the world. 2015 was a fairly poor year for sales compared to 2014 and they’re going through a management transition, also distributing more cash than they are generating. They might have taken a little too much debt.
9. GVC – Glacier Media – Print Media. Enough said.
10. RET.A – Reitmans – Women’s fashion retailer. Will they go back in style? Were they ever in style? Their balance sheet is in shockingly good position ($165 million cash/marketable securities minus debt or $2.58/share!), and if the company ever learns how to make money with its marketing, the stock has very good potential. They’re not bleeding a huge amount of cash at present. I’m not smart enough to figure out whether management will figure out a winning formula – if they do, it could easily double from present prices.
11. LIQ – Liquor Stores – Razor-thin margins, coupled with acquisition-related debt, leaves an entity that makes some money but is highly susceptible to regulatory actions of the entities it operates in, coupled with their ability to maintain credit (albeit their existing facility is dirt-cheap as it is secured by an inventory that will not depreciate and can easily be liquidated – liquor!). They are paying dividends well in excess of their capacity to generate cash, so be warned that the 12% stated yield is an illusion.

Coal exports – Westshore Terminals

Westshore Terminals Investment Corporation (TSX: WTE) is a holding corporation that owns all the limited partnership units of Westshore Terminals LP. The LP is controlled through a partnership agreement by Westshore Terminals Ltd., and functionally speaking control is held by Westar Management Ltd (not to be confused with another company, Westar Energy, which is unrelated).

The whole reason for the verbose description is that although it may appear at first glance that shareholders of Westshore Terminals have control over its operations, in reality this is a situation where shareholders are in the minority and external actors control the firm. One must always be mindful of the motivations of the controlling entity and whether there is significant alignment with shareholders.

Skimming the documents, I am not entirely sure who controls Westar or the General Partner, Westshore Terminals Ltd., but would assume the present directors of Westshore Terminals Investment Corporation have a say in the parent controlling entities.

Jim Pattison (a very prominent BC businessman that usually keeps his ventures privately held) owns 18.6% of the company as of May 2015. Since then his entity (Great Pacific Capital Corp.) has acquired another 4.1% of the company, according to SEDI disclosures, roughly at an average of $25/share. An early warning report on October 30, 2015 confirmed 22.5% ownership.

The whole Canadian investment world can see this public investment and thus one has to ask what Pattison’s firm is thinking.

Westshore’s entire business is about exporting coal, primarily to Korea, Japan and China/Taiwan.  The coal is majority sourced (58% in 2014) through mines owned by Teck (TSX: TCK.B).

wte-1

Financially, the corporation has been very profitable over the past couple fiscal years – earning about $130 million in profit over 2013 and 2014, and $101 million for the first 9 months of 2015. As the corporation has 73.9 million shares outstanding and is trading at $17.50/share, some simple math will indicate that they are trading at a P/E below 10 according to their historical profitability.

The nature of their coal exports can be divided into the following categories:

wte-2

And here is where we have the problem – steel commodity in China has cratered. There’s various types of indicies and types of steel that you can measure (rolled steel, rebar, etc.) but all indications show that demand is dropping:

wte-3

Adding to the woes of the coal industry is the fact that there is a gigantic supply glut of thermal coal due to western nations suddenly deciding they wish to phase out coal power generation. Taking a look at charts of Peabody Energy (NYSE: PEA), and Arch Coal (NYSE: ACI) should pretty much tell this story. Take a snapshot of their charts before they go into Chapter 11! Or if you don’t wish to waste your money on their equity, Peabody’s senior unsecured debt is trading in the teens – a fairly good sign of imminent capital restructuring.

Teck’s stock has also gotten killed over the past 5 years – an investor’s shares has gone from about CAD$60/share to CAD$5/share today, plus Teck’s corporate debt has cratered – e.g. their senior debt maturing in January 2021 (4.5% coupon) has the following ugly chart:

wte-4

Despite Teck being rated Ba1 (Moody’s) or BB+ (Fitch), their debt is clearly trading in the junk status and one has to start wondering about counterparty risk when your medium-term debt is trading at such high yields (and the nearest liquid issue, January 2017, is trading at a yield to maturity of about 10% presently).

Financially, it just doesn’t look good for coal producers (most of them are deeply encumbered by debt), but does these financial issues reflect the actual economics of Weststar Terminals’ industry which is the shipment of coal?

Weststar does not have any debt on its balance sheet – its primary liability is the $91 million unfunded portion of its pension plan at the end of September 2015. It is primarily functioning as a flow-through operation for its shareholders and to this effect, it has reduced dividends from 33 cents to 25 cents quarterly as it anticipates increasing capital expenses and also anticipating a decrease in coal shipped, according to an October 28, 2015 corporate update.

So we have a perfect storm brewing in the coal world – decreased demand for steel, decreased demand for power generation, and thus lower shipments and lower revenues, spread on a relatively large fixed cost base – suggesting decreased profitability in the future.

This also doesn’t factor in the increasing scrutiny of coal shipments in BC from a political perspective. While the existing provincial government is clearly supportive, there is election risk for the upcoming 2017 election in terms of economic impact.

Westshore does have several advantages that cannot be easily obtained with competition. There are three terminals in BC that are in the same business – Ridley is up north in Prince Rupert, but they are limited in capacity (although well strategically positioned to take coal from mines in the BC northern interior). In the greater Vancouver area, there is Neptune and Westshore – Westshore has a significantly larger capacity, but Neptune is still under its capacity. Neptune is 46% owned by Teck as well, which will put it in conflict with Westshore.

The market has clearly seen all of these negatives and has subsequently “adjusted” the equity value of WTE very dramatically – about 50% over the past 6 months. The question as an investor would be:

1. Financially, what would the “trough” look like for Westshore? Does the underlying entity still generate cash?
2a. Will coal recover from what are decidedly anti-coal government legislative regimes (USA EPA, Germany, Alberta, and now possibly Canada?)
2b. If so, what would the timing be where enough supply has been stripped from the system, and perhaps a recovery in demand?
3. Competitively speaking, how much shipping capacity will the other two terminals in BC represent?

The answer to 2b will presumably rely upon the economic fortunes of Korea, China and Japan, all of which have their own internal issues to deal.

I will leave this post now as an exercise for the reader. No positions as of this writing.

Bombardier paper napkin valuation

Based on the slides on their investor day, looking at their 2020 financial roadmap, if the corporation is seriously able to reach $25 billion in revenues and 7-8% in EBIT, the quick calculation is the following:

$25 billion revenues
* 0.075 EBIT margin
= $1.875 billion EBIT
Less: $750 million interest expense (Assume $10 billion debt at 7.5%);
= $1.125 billion EBT
Less: $298 million (15% Federal + 11.5% QC = 26.5% taxes)
= $827 million net income

At this point they would likely have around 2.3 billion shares outstanding, so this would equate to about 36 cents a share. Just picking a P/E out of the cloud (15) and multiplying gives a $5.40 share estimate, or about 4.2x above existing market value, or about 33% CAGR if we use the full five years starting today.

Of course, for this to happen, a lot of execution risk (technical, marketing) has to be resolved, but management did a fairly good job solving the immediate financing risk – investors and customers no longer have to care whether the company is going belly-up or not (they are not).

I stress this is a total paper napkin exercise. Actual valuations under a more rigorous process can vary by a factor of 10!

Pinetree Capital – another debenture redemption

Previous articles on Pinetree Capital can be found with this link.

Today, they announced a redemption of $3 million in their senior secured debentures out of a total of $9.716 million outstanding. Interest accrued will be another 1.07% on principal. The redemption will be effective January 8, 2016.

The only wrinkle in this announcement is that $1 million of the $3 million principal will be redeemed in equity of Pintree Capital (TSX: PNP) and based on 95% of the weighted average price of trading from December 2 to December 31. So debentureholders will have 10.3% of their debt redeemed in equity of Pinetree Capital.

Based on Pinetree Capital’s equity, they have 201.9 million shares outstanding and are currently trading at 5 cents per share. If trading is around the 5 cent level, Pinetree will be issuing 21.05 million shares, representing a dilution of approximately 9.4% to existing shareholders. If the common shares start trading lower as a result of this announcement, each incremental decrease in trading will result in more dilution to shareholders – a mildly toxic convertible situation. For example, if the weighted average price is 4 cents a share, Pinetree will issue 26.3 million shares with 11.5% dilution. At 3 cents, the issuance is 35.1 million shares (14.8% dilution).

My guess at present is that the common shares will trade around 4 cents as a result of this announcement, but after the issuance of shares there will likely be a supply dump.

What was peculiar is the following quote in the news release:

The issuance of common shares in partial payment of the redemption amount is subject to the satisfaction of certain conditions contained in the indenture governing the Debentures, including the approval of the Toronto Stock Exchange, failing which the total redemption amount will be paid in cash.

I have guessed the motive of the company to do this redemption was to reduce interest expenses, but if they are opting to not deploy cash in exchange for (nearly worthless at this point) equity, then it is constructively like doing a secondary offering in the marketplace at a very low share price.

The other motive for this partial redemption might be management bracing for impact when they take an impairment expense on their Level 3 assets when they do the year-end audit. The deadline for the year-end annual report is the end of March 2016. They still have to abide by a debt-to-assets covenant of 33%. They are at 28% as of the Q3-2015 report. If there is a mild asset impairment then they will breach their covenant. There might be a temporary breach of the covenant (between the December 31, 2015 reporting period to January 8, 2016) which will be cured by this redemption, but investors will not know about this breach until the issuance of the annual report itself as they no longer report monthly NAV.

Pinetree also received a serious setback when Aptose Biosciences (TSX: APS) suspended a clinical trial, taking its stock price down 50% on November 20, 2015. This probably destroyed another $2.5 million in Level 1 assets (of which $14 million was remaining on September 30, 2015!).

In terms of estimating the shareholder value, the primary variable at this point is whether the board of directors has any plans on executing on a recapitalization-takeover of the company, utilizing its massive capital losses for an acquiring entity. I’m guessing this would be worth about 8-10 cents a share, but first they need to get rid of their remaining debt.

General portfolio thoughts leading up to US Thanksgiving

This week is the US Thanksgiving, where non-discriminating consumers go crazy purchasing tangible objects under the perception that they are discounted.

It is quite apparent, however, that floor retail is getting smashed by online retailing. This has been my underlying theory for quite some time and leads me to the theory that avoiding retail-heavy REITs such as Riocan will be a money-saving procedure. If you can’t compete with Amazon, then the entire structure of your business should be examined.

What’s going to be interesting is if this Amazon-ification of retail will impact corporations like Walmart – certainly their equity is being eroded by Amazon, but I think there is a limit to the erosion where people will simply want to look at tangible stuff in a consolidated warehouse environment. The success of Costco is an example of this – eroding Costco would be the holy grail for Amazon and Walmart, but even Walmart couldn’t pull it off with Sam’s Club.

I have been looking for distressed entities and right now anything resource-based (especially energy) is clearly stressed. I still do not find a lot of value in this sector, but there are ancillary businesses that seem to be a case of throwing the baby out with the bathwater. Anything related to bulk dry shipping is also getting killed, but most corporate entities that are publicly traded come from Greece, and this is a country I do not want my money invested in for a lot of reasons.

I still remain relatively defensively positioned. It is odd how my normal investment patterns is to go for capital gains and growth, but every component in my portfolio right now is giving off a substantial amount of income. There will probably be a time to shift to growth but it doesn’t appear that now is that time.