Category: Equity

Clearwater Seafoods facing debt crunch

Clearwater Seafoods Income Fund (TSX: CLR-UN.TO) is a financially distressed entity. The fund has an equity interest in a limited partnership. The limited partnership is the operating business that sells seafood. The units are trading at around 80 cents, with a market capitalization of about $23 million. The trust has stopped paying distributions since 2007 and is not likely to pay distributions for a long, long time.

Whenever investing in an income trust, they typically have more complicated ownership structures than corporations. You can usually get a summary of the structure in the first few pages of the annual information form. I have extracted a diagram which illustrates the relationship between the fund and the operating entity:

Whenever I see something like this, I think negatively since usually such structures exist to give certain (usually founding) entities control over the operating assets, but to distribute the economic interests to other parties that is not in proportion to voting interests. In this case, the unitholders of Clearwater Seafoods Income Fund are simply there for the ride by virtue of having a 54% voting interest in a very indirect say as to what goes on at the operating level. As a result, an investor would need extra compensation (i.e. higher reward) for the extra risk that they are taking (the risk that their interests are not going to be in alignment with the people holding the puppet strings).

Clearwater also has a debt problem – as of June 30, 2010 the operating entity has about $218 million in debt outstanding, and of this debt, the trust has lent the operating entity $45 million in exchange for partnership units (they have also done this in other instances with different terms and maturity dates). This loan matures in December 31, 2010. The operating entity also does not generate enough cash, nor are there other assets readily available to pay off the debt. As a result, the company will have to find external financing or find some method to recapitalize the debt.

There is also another $11.3 million loan that is due in September 2010.

In the management discussion and analysis, we have the following paragraph:

In December 2010 Clearwater Seafoods Income Fund has $45 million of convertible debentures that come due. These funds were invested by the Fund in Class C Units issued by Clearwater with similar terms and conditions, including maturity in December 2010. Clearwater also has approximately 1.3 billion in ISK denominated bonds, including CPI and accrued interest that come due in September 2010 (approximately Canadian $11.3 million at July 3, 2010). Clearwater is currently investigating refinancing alternatives and plans to refinance both before the respective maturity dates.

When we look at the market for the $45 million debenture, we see it is trading at 88.5 cents on the dollar. So the market is heavily betting that the debt will be refinanced at relatively favourable terms to debt investors. Recapitalization, however, appears to be out of the question since it would require relinquishing control to the debtholders and the current market value of the units is far too low to make a direct conversion worthwhile. Going into bankruptcy protection might occur if the debtholders and trustees cannot come to a mutually equitable arrangement.

Given the lackluster cash flow from operations, the complexity of the trust and underlying operating entities, and obvious credit risk, I will be watching this one purely from the sidelines to see how this mess gets resolved. My cursory look at the situation would suggest that the debt and equity are both overvalued.

Top Canadian Oil and Gas Producers

The following chart is a brief list of the top-10 sized oil and gas companies in Canada, and their year-to-date performance ended September 1, 2010, not including the impact of dividends (which would be significant in the cases of COS and PWT which distribute most of their income through their trust structure):

Name Ticker %-YTD
Suncor Energy Inc. SU -9.35%
Canadian Natural Resources Limited CNQ -7.63%
Imperial Oil Limited IMO -2.73%
Husky Energy Inc. HSE -16.42%
EnCana Corporation ECA -13.19%
Cenovus Energy Inc CVE 11.66%
Talisman Energy Inc. TLM -13.00%
Canadian Oil Sands Trust COS -14.04%
Nexen Inc. NXY -19.27%
Penn West Energy Trust PWT 6.09%

Cenovus is clearly the winner here – investors are quite happy with parking capital into non-conventional Canadian oil.    It is surprising that Suncor has not fared better, probably due to integration concerns with Petro Canada.  Husky Energy and Nexen have been the worst performers.  Husky has had a significant management change and appears to be in petrochemical limbo with no obvious growth.  Nexen has Gulf of Mexico exposure and this can explain its performance.

It should be important to distinguish the difference between oil and gas – gas commodities have been priced significantly less than oil over the past couple of years, so EnCana and other gas-concentrated producers should lag the oil companies at present.

Finally, there are likely many more analysts out there that follow these ten companies that are much more knowledgeable about the individual companies and their exploration properties, so it is unlikely that by mining the relative price data that there can be any value extracted from this very simple analysis.  It does tell you which companies have had lowered and raised expectations since the beginning of the year, however.

Uranium One now majority controlled

Uranium One’s shareholders voted convincingly in favour of the takeover of a majority stake in the corporation by a Russian “crown” corporation SC Atomredmetzolo (“ARMZ”) with approximately 91.99% of non-ARMZ shareholders in favour of the transaction.

The salient terms of the agreement is that ARMZ will take a 51% majority stake, and pay the rest of the shareholders $1.06/share in a cash dividend. Shareholders, assuming they haven’t already sold at market value, will be in for the ride and will have to make sure that their interests are in alignment with the majority ownership.

This is almost the reverse case of Magna International, where the Stronach family is being paid a considerable sum by the corporation to relinquish its controlling stake.

Investors should always be very cautious in making sure whenever they invest in companies that have majority or near-controlling ownership stakes that their interests are in alignment with the large shareholders. While a majority stake is not necessarily an exclusion criterion to considering a potential investment, it does raise the bar considerably higher. I tend to have a high aversion to majority or near-majority controlled domestic corporations as they can abuse minority shareholders.

The debenture holders, however, should be looking good – Uranium One has a December 31, 2011 issue that has a 4.25% coupon that is a very probability candidate for maturity at par; between the bid and ask, it is trading at 98.5 cents. Once you factor in capital gains, it is a relatively low risk 5% return on investment. Uranium One has another outstanding debenture issue that matures in March 2015 and this one is muddied by the fact that the conversion privilege (at $4/share) is close to the common stock price – this issue is trading at around 105 cents.

It is not likely that the 1.3 years between now and December 31, 2011 will pose much of a credit risk for the initial debenture issue – the corporation is likely to refinance this debt. However, the 2015 debenture has more embedded risk simply due to the time between now and the March 2015 maturity – you never know how much of the company assets will get stripped out. The worst case scenario is that ARMZ will try to to repatriate the assets (mainly agreements to mine and sell Uranium, mostly from Kazakhstan) of Uranium One into some other corporation controlled by ARMZ. You then don’t have to worry about the bankruptcy of a Canadian corporation once the assets have been stripped out of it, and debenture holders and shareholders alike would be left with nothing. It is unlikely this scenario will happen by 2011, but by 2015 it becomes somewhat more likely.

Suffice to say, I won’t be touching the equity or debt of this corporation.

A basic guide on how to do Canadian equity research

Whenever I hear of a publicly traded company, I follow a fairly standard methodology to do some basic research on the firm.

In a perfect world, you try to do research before looking at the share price of the company. The whole idea of the research methodology is to pin down a valuation for the equity (or in some cases, debt) and seeing a stock price contaminates what should be an unbiased analysis. You want to come up with your own valuation, rather than looking at the market’s valuation and then thinking of ways to rationalize the stock price. Unfortunately 9 times out of 10, the first thing I do is pull up the stock quote. I’ve been trying to train myself to no longer do this, but it is really, really difficult to not see a quote attached to an article.

Once I am ready to research, I pull off these documents from SEDAR in this order:

1. If the “nearest” financial report is an interim statement, I pull down the interim financial statements and MD&A document and read them. Doing analysis on this alone is time-consuming, and you look for tidbits in the statement, get an idea of how the company is capitalized and look at the cash situation. If the “nearest” report is an annual one, I read that and the MD&A.

2. Then I read the management information circular, and look at executive compensation scheme, insider ownership, and executive biographies and get a “feel” for who is running the firm, and who is on the board.

Usually by this point, you can come up with a ballpark number and then it becomes irresistible to look at the share price and hence valuation. Which then leaves:

3. Pulling up the stock chart, and then looking at any significant price moves, and then connecting those price moves to various news releases of the company;

4. Reading every news release of the company over the past X years, chronologically, and then looking at the reaction of the stock to what is significant news;

5. Reading the latest annual report (not the glossy version, the dry financial version) with its MD&A, and/or the Annual Information Form, which is also a good document that has information that is not contained in the interim statements;

6. Insider trading is available on SEDI and can influence a decision. While insider selling is not necessarily a negative signal, whenever you see insider buying it gets your attention much more.

7. The company’s website.

Usually by this point you spent many hours of reading and synthesizing information, and should have a pretty good idea as to what makes the company “tick”. Then the next step is to have a sector-wide comprehension and start investigating competitors, and firms up and down the supply chain to get a feel for the economic variables at stake. This is a never-ending process and eventually at some point you cut it off and then make a buy/sell/leave alone decision.

Learning to prune investment candidates at stage #2 is a very good skill to have – I usually set price triggers on those companies, and when the triggers are hit, I get an email and this triggers me to take a second look at the company to see if anything has changed. In the second half of 2008, so many companies were triggering low price alerts that I had a very, very difficult time keeping up with what was literally an avalanche of securities. I probably could have performed better in 2008 had I had more time to look at all the securities that were flashing at me.

Today, there is hardly anything that triggers my low price alerts, so I am using different screens to put some companies on the research queue.

Silly market tidbit of the day – GM

While General Motors is pondering going public again, one should keep in mind that their predecessor company (pre-bankruptcy) is now known as Motors Liquidation Corporation. They had their name changed to not confuse the general public into believing they owned shares in something that might be worth something.

The pre-bankruptcy shares of General Motors, amazingly enough, still trades at 50 cents a share. When all of the court settlements are completed, this will go to zero.

People should study why this is the case – why an asset that is fundamentally worth nothing is trading at something above zero. In addition, short-selling the stock is not as easy as one would think.