Category: Canada

I notice Susan Brunner has a good summary of some talks she attended at the Toronto Moneyshow. If she ever comes to Vancouver (or even if she is reading this), I will extend an invitation for coffee.

I know the Moneyshow (formerly Financial Forum) comes to Vancouver annually in February and I always make it a point to attend simply because if there are any dominant themes, I usually then yellow-flag them as a sign that the investment thesis has reached public saturation.

Just judging from Susan’s remarks, one can take the following as consensus:
– Negative on the US; all mentioned some form of a medium to long-term bear market with little equity returns;
– Government bonds over-valued (yields too low);
– Yield-bearing securities, including Canadian Banks, and various sorts of income trusts that will be converting to corporations, and in general anything with sustainable yields with a prevailing view of deflation;
– Some projected inflation. There seems to be a division of people in both camps;
– We are in the middle of a natural resource bull market for roughly the next decade;
– Most growth opportunities will be offshore in developing countries;

So these expectations are probably priced into the marketplace. It is a matter of determining whether things will actually occur as market participants are pricing, or whether the scenario will deviate.

Indeed, if the world believes that commodities are going up, there is a chance that demand could be even higher than expected. It is the equivalent of making a small-odds bet on a probable event – you will still be rewarded for getting it right, just not as well rewarded for betting on something very obscure and mis-priced that turns your way.

The Bank of Canada has left the overnight target rate at 1%. The announcement is here.

Key quotation:

The global economic recovery is entering a new phase. In advanced economies, temporary factors supporting growth in 2010 – such as the inventory cycle and pent-up demand – have largely run their course and fiscal stimulus will shift to fiscal consolidation over the projection horizon. While the Bank expects that private demand in advanced economies will become sufficiently entrenched to sustain the recovery, the combination of difficult labour market dynamics and ongoing deleveraging in many advanced economies is expected to moderate the pace of growth relative to prior expectations. These factors will contribute to a weaker-than-projected recovery in the United States in particular. Growth in emerging-market economies is expected to ease to a more sustainable pace as fiscal and monetary policies are tightened. Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery.

To translate this into everyday English, the Bank of Canada believes that the growth in the economic recovery is now leveling, and that it is not entirely certain what the next stage will be. They are reading the same tea leaves that everybody else is reading.

Inflation in Canada has been slightly below the Bank’s July projection. The recent moderation in core inflation is consistent with the persistence of significant excess supply and a deceleration in the growth of unit labour costs. The Bank judges that the output gap is slightly larger and that the economy will return to full capacity by the end of 2012 rather than the beginning of that year, as had been anticipated in July. The inflation outlook has been revised down and both total CPI and core inflation are now expected to converge to 2 per cent by the end of 2012, as excess supply in the economy is gradually absorbed and inflation expectations remain well-anchored.

The Bank of Canada will be putting the brakes on further interest rate increases until 2011 at the earliest. I do not project a December rate increase.

Three month corporate paper is yielding 1.17%, and three-month treasury bills are yielding 0.89% yesterday. Today, this will decrease a little bit.

More important are the spread to longer term bonds, which 5 years will yield you 1.95% and 10 years will yield 2.76%.

The Canadian dollar is once again at par with the US dollar – if you are performing currency transactions, just remember to get the CAD-USD vs. USD-CAD conversions correct!

The currency rise has not as much to do with the Canadian dollar rising as it does with the US currency depreciating – the world is strongly reacting to the imminent quantitative easing 2 that the federal reserve is apparently planning on to spur inflation.

In an interesting development, SNC-Lavalin (TSX: SNC) has announced that it will be exercising its right to first refusal in purchasing the CPPIB’s 10% stake in the 407 Highway.

SNC is now forming a new corporation, which will sell shares in a company (Transaxio) that has its ownership interest in the 407 Highway.

The only reason why SNC would do this is if they suspect that the CPP’s purchase was undervalued – so it will be interesting to see what the corporation will trade at when it goes public.

This will also be the first time people can directly take an ownership interest (although effectively a non-voting interest) in the 407 Highway.

The CPP Investment Board announced it is buying a 10% stake in the operations of Highway 407 in Ontario – which is a toll freeway that is the outer loop of Metropolitan Ontario, a suburban route serving roughly Brampton to Markham.

The 10% stake is costing the CPP CAD$894 million. The CPP will also be acquiring another 30% stake by virtue of taking over Intoll, an Australian company, for roughly CAD$3.3 billion.

Is Highway 407 worth $9 billion total?

What is interesting is that the organization must report to SEDAR. Looking at their 2009 annual financial report, the 407 Highway has a debt of $4.8 billion, cash and equivalents (restricted or free) of $670 million, and equity of negative $1.08 billion. Not a stellar balance sheet, although the bonds themselves have a very long maturity profile and averaging about 5.7% interest.

On the income side, you have $560 million in revenues, and $116 million in operating expenses, leaving a yearly operating surplus of $444 million. Interest expense is another $275 million. Ignoring the other line items (depreciation, amortization and other capital expenses, plus taxes), you are left with an annual surplus of about $170 million.

Not that I like to criticize billion-dollar fund managers like the CPP Investment Board, but they obviously have something more strategic in mind if they are going to be spending this much money for a large minority equity stake at a price that appears to be 50 times present cash flows. There are a few mitigating factors, however.

The first is that Metropolitan Toronto is likely to grow, and with that is likely an increase in the suburb population – thus, traffic should increase. An increase in traffic also means the ability to increase tolls, which the organization does not need political authority to perform. The other deals with inflation-proofing: a toll highway is relatively insensitive to inflationary increases since you have little competition.

On the opposite side, if oil prices increase dramatically, or commuting takes a different shape, toll highways may not be a good business to be in.

Finally, there is political risk involved – if the CPP was able to take over a majority of the 407 operations (they are close with 40% currently), there will be a lot of pressure by the Ontario government to be able to lobby the federal government to recapture the rights to the highway. Although the CPP is an independent entity created by the federal government, one wonders how much political influence there would be.

In any event, the 407 Highway reverts back to the Ontario government after the 99 year lease expires. Although this lasts until 2098 (88 years from now) and I likely won’t be alive to see the end, there is a finite lifespan to this company.

The CPP is a very powerful player domestically with its $130 billion in assets – just over the scale of the Ontario Teacher’s Pension Board, which controls $96.4 billion in assets.

Is the CPP blowing this much money on a toll highway worth it? I think they overpaid, but they are probably just as desperate for yield as most investors are currently. This is possibly their best candidate to deploy $900M in cash, which is a telling statement on the entire marketplace.