Category: Canada

This headline passed by my radar: Japan Tobacco Wins Court Protection in Canada Over Smoking.

In both US and Canadian jurisdictions, governments have been engaging tobacco companies in civil litigation over the undisclosed risks of smoking. The majority of drama settled in the late 90’s in the USA, but things in Canada have taken longer.

According to the article:

The lawsuits were in favor of smokers seeking damages for addiction and smoking-related diseases, who argued they were never warned of the risks.

There are no longer any Canadian publicly traded companies that deal with the tobacco industry, although you can invest in Philip Morris (most associated with the Marlborough brand) in the USA.

However, this gets me thinking – 20 years down the line, when rampant consumption of marijuana is determined to be a cause of the breakdown of the brain’s normal functioning in older age, will governments decide to go after marijuana companies for not disclosing this hitherto undisclosed risk of consuming too much THC? What about second-hand smoke, which is more abundant than ever on the streets now that marijuana is legalized?

I try not to allow politics or morals interfere with objective investment analysis, but the double standard that is applied between tobacco and marijuana is amusing, to say the least. When marijuana is no longer in favour, watch out!

I note the TSX index is down about 7% year to date.

The interest rate rises are finally starting to hit the markets with asset price drops. Some items are finally hitting my radar in terms of the watchlist and my research queue.

In particular, what has caught my attention are the drops in equity prices in certain REITs.

There is a double-whammy: higher interest rates result in higher interest expenses (when firms have to refinance debt or pay floating rates) and because of higher costs of capital, asset prices will decrease (which also get reflected in balance sheets due to IFRS fair value adjustment rules – rules that make income statements appear even more un-readable for untrained eyes).

I also don’t know whether this is correlated in anyway to the plummeting in oil prices, but as a consequence, most oil stocks have gotten killed in the past month. This is reminding me of what happened to a lot of companies in the December 2015 to February 2016 meltdown that took some Canadian preferred shares to double-digit yields. The environment is a lot different, however. Making money on asset appreciation is much more difficult in an environment when the cost of capital is rising and money is being drained out of the system at an increasing pace. The most similar analogy is trying to make head-way on a sailboat when the winds are blowing against you at increasing speeds – it is still possible to move forward, but you have to zig and zag to get to your upstream destination.

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.

This chart has grabbed my attention over the past couple weeks:

The market is trading CAD up presumably on hopes that Canada and the USA can iron out some sort of trade deal on the NAFTA front. I’d be skeptical. The politics does not work very well for both President and Prime Minister for a quick agreement.

The other drivers of the Canadian currency are interest rates and the state of the commodity markets, and relative to the USA, neither appear to be favouring the Canadian dollar at the moment.

That said I do not pretend to understand all the nuances of Canadian dollar trading, so perhaps some other enlightened individuals can chime in.