Canada – Page 34

Dog days of Summer

August is the month that the market (including myself) takes a break.

Thus, any action you see in the marketplace should be taken with a grain of salt.

I am in the camp that the next macroeconomic foot to drop will be related to the onset of inflationary pressure, but in order to see this you need a very spontaneous change of mentality amongst market participants that cash is something to be throw into assets, as opposed to cherished because of high uncertainty in terms of US government policy. There has been a lot of money throw into the economy, but the money has not been sloshing around – it has been saved up in the balance sheets of financial corporations. When this money eventually gets released, it will be ugly.

However, the bond market, where you can lend your money to the US government at 2.91% for 10 years, seems to say otherwise.

It is very difficult to predict exactly when this phenomenon will occur, or whether I am just another kooky market analyst that has no idea what he is talking about. There is one element that I think everybody can agree with – the sheer amount of government debt will be crippling unless if there is some sort of monetary inflation, whether now or later. It is very unlikely that the government will be repaying this debt with equal-value or deflated-value (i.e. higher purchasing power) dollars.

In the meantime, I continue to wait patiently and observe where the currents are going. My current answer is that the money is swimming to income-oriented securities and since my portfolio has been loaded with these since early 2009, I will be waiting for appropriate exit opportunities. Even after all of the investment managers turn off the autopilot switch on their portfolios when they return home this September, I don’t think it will be the end of the universe for fixed-income securities. This is fortunate since some positions are at the upper range of my price bands and I don’t want to needlessly dispose them in calendar year 2010 exclusively for tax reasons. Although taxation is important, it should not dominate the decision to sell a security above fair value.

Canadian mobile service market heats up

Rogers has just fired their own broadside with the introduction of another virtual mobile service, Chatr, which feeds off of their own phone network (very similar to Fido, another Rogers-owned company).

It is very obvious with their pricing structure, and the cities that they are in that they are strictly trying to wipe out Wind Mobile and/or Mobilicity off the face of the planet. What’s hilarious is that Wind Mobile has no spectrum license in Quebec (other than the Ottawa-Gatineau area), and Rogers/Chatr’s service offerings are identical to the locations offered by Wind Mobile – Vancouver, Edmonton, Calgary, Toronto and Ottawa. On Montreal, they stated:

“We’re working out some translation issues in Montreal, but it will very soon be our sixth market,” Chatr’s senior vice-president Garrick Tiplady said in an interview.

Translation issues indeed! More like “There’s no rush since our competition isn’t there!”

You can be sure as Wind Mobile expands to other cities and/or expands their coverage in their existing cities, that Chatr will come up with “service enhancements” to incorporate those areas into their own “home network” as well.

Their pricing plan is, for the most part, identical to Wind Mobile’s structure, with the most notable exception that on Rogers/Chatr’s $35 plan, they charge 25 cents to recover your voicemail, and they charge for incoming text messages.

Since the coverage areas between Chatr and Wind is nearly identical, I have no idea who would sign up to them.

As I stated in a previous post, the new entrants to the Canadian wireless market are not going to be making any money. The only reason why Rogers is doing any of this is to bankrupt Wind Mobile and Mobilicity – Rogers/Chatr’s offering adds absolutely no value whatsoever to the Canadian mobile marketplace other than wasting consumer’s time as they have yet another offering to review.

Fine-tuning my BP model

About two weeks ago I stated to exit “between $45 to $50/share”, but there have been a couple significant events between now and then and the price response I’ve judged – one is the departure of the CEO (which was to be expected for his very lackluster performance in this whole matter – he did not care, and won’t be caring after a massive severance package payout) and the accrual for the project (approximately $32 billion dollars) which was roughly what I had expected (my estimate was $40 billion). Note that this amount is not a cash amount, but rather it is an accrual expected to be paid out in the future. If the oil spill is less damaging than expected, they will reverse this in the future and take a gain.

Because of income tax provisioning, the after-tax cost to shareholders will be less than this.

Also you can be sure that other, less performing projects will be thrown under the bus – this is always something to be aware of when companies make massive charge-outs. Tech companies doing mergers back in the internet boom were infamous for doing this, and was a reason why such financial statements looked better – if you keep on taking “one time charges”, your continuing operations will look great!

Since predicting the price of BP has been much more of a political game than financial, I believe being able to compile both sectors into a blended decision is one of my competitive strengths in the marketplace. Upon retrospection, I believe my initial price estimate for BP was high, and will now lower my exit parameters to “$42 to $47” per share. I would hazard a guess that it will get into this range by year’s end as the public consciousness fades onto other issues – such as the impending war in the Middle East (due before Obama’s exit in 2012) and how the US Congress will end up making themselves look like even bigger fools in a mis-guided attempt to save their collective skins in the November mid-term elections. The collateral damage that both events will leave should erase the BP oil spill from our short-term memories.

Since the price target is not materially above BP’s existing share price, the risk/reward ratio is not tremendously good. Obviously back a couple months ago when oil was still gushing in the Gulf, the risk was much higher. The “emotional” feel of this story is a fairly good lesson on the rule of the stock market – you don’t see low prices without risk. If you see what you think is a low price, but can’t see what the risk is, then chances are there is a hidden risk out there you are not aware of. Find out what it is before buying.

Finally, on the issue of collateral damage, Anadarko (NYSE: APC) and Transocean (NYSE: RIG) which had a 25% residual interest in the project and the drilling contractor, respectively, have both gotten killed in this crisis. They both look like better risk/reward ratios than BP is at the moment.

Income trust conversions and RRSPs

On January 1, 2011 there will be a slew of Canadian income trusts that will be converting to corporations. In addition to these, all other income trusts that are not related to real estate will have their distributions taxed. Either way, the dividends or distributions will be considered eligible dividend income for a Canadian investor.

This means that for those investors that have these instruments in an RRSP that what was previously given off as income will now be heavily favoured with respect to taxation, and will be relinquishing the tax benefit by keeping these securities. The obvious action would be to swap these securities with equivalent cash at the beginning of 2011. You can then populate the RRSP by purchasing the relevant income-bearing securities when the market timing is convenient.

A middle-income bracket investor in BC (between $41k and $72k) that is able to shift $1,000 of dividend income from the RRSP to a non-registered account, and swapping into the RRSP $1,000 of straight income will be saving approximately $284.10 at tax time.

It is worth thinking about this procedure throughout the second half of 2010 and see if one can purchase income-bearing instruments if/when the market conditions are appropriate. It is also a good time to think about portfolio balancing.

What is making life difficult for most income investors is that income investing (such as going for dividends or securities with larger-than-GIC yields such as preferred shares) is coming back in vogue with the retail investing arm. Such securities are being purchased without consideration of underlying value in the company’s ability to pay such income. An example would be the equity of Rio-Can, which is the largest Canadian REIT; although I believe their income payouts (6.88% on a $20.05 unit price at present) is stable, in terms of valuation, investors are purchasing something that appears to be more than fully valued and will likely not provide material upside on income payouts.

If/when the debt market seize up again, such securities will look significantly more attractive than they are today. Chasing yield when the going is good involves much more risk than chasing yields in the middle of a crisis.

Why RESPs are not a popular product

I extensively analyzed RESP’s in an earlier post, coming to the conclusion that a person is likely better to wait until the last moment that they are convinced their children will be heading to upper-level education before opening one.

The Globe and Mail is reporting how RESPs are having a rather lacking participation rate and goes into detail why this may be the case. I believe the explanation is simpler than this, and it boils down to two reasons:

1. People do not have disposable income to invest in an RESP, and are choosing to allocate it elsewhere for more immediate priorities;
2. Opening up an RESP leads to potential losses, and people would not want to lose money on their children’s education fund compared to their own investments – ergo, they will be sticking to extremely safe fixed-income products, and given the interest rates available, it is not really worth it at the moment.

There are plenty of scholarship funds out there that try to prey on people that fall under category #2; unfortunately for those that read the fine print, they will likely be throwing away their money on these conceived structured products that are designed to enrich the scholarship fund managers.

The government is trying to promote RESPs to lower income individuals by offering significant incentives to putting money in them. For example, if you earn less than $40,970 in a year, you will qualify for the Canada Learning Bond, which is a “free” $500 plus $100/year that your income is below that level into the RESP. If your income is less than $38,832/year, your contributions will be eligible for a 40% match by the government for the Canada Education Savings Grant, as opposed to the 30% or 20% brackets if you make more income.

Many lower income individuals are usually too busy working to pay attention to any of this and thus will not be taking advantage of money of these benefits. This is even assuming they are not falling under category #1, mainly that they do not have enough disposable income to be thinking about RESPs for their children.