Debt – Page 7 – Divestor

State of the Canadian Debenture Market

I find the Financial Post’s compilation of Canadian exchange-traded debentures to be a very handy list to refer to. It is not comprehensive (there are a few issuers here and there missing) but for the most part is a full snapshot of the market environment.

Looking at the list, I think it is a very good time for Canadian companies of questionable credit quality to be issuing debt. Most of the debt on this list is trading at yields that do not properly represent (my own evaluation of) their risk.

Accordingly my research time is increasingly on the equity side of things in the non-indexed space. A great example of my readings included the Kinder Morgan Canada prospectus, worthy of a future post!

With regards to the debentures, I’ve sorted the debt by yield to maturity and decided to arbitrarily cut things off at 8%:

Issuer	Symbol	Coupon	Maturity	YTM	Pithy Notes
Discovery Air	DA.DB.A	8.38%	30-Jun-18	118.28%	Way behind secured debt, no control
Lanesbourough REIT	LRT.DB.G	5.00%	30-Jun-22	59.10%	Insolvent
Gran Columbia Gold Corp	GCM.DB.U	1.00%	11-Aug-18	43.99%	81% mandatory equity conversion
Primero Mining	P.DB.V	5.75%	28-Feb-20	21.85%	Operational mess, solvency issues
Argex Mining Inc.	RGX.DB	8.00%	30-Sep-19	19.07%	Illiquid, no revenues!
Toscana Energy	TEI.DB	6.75%	30-Jun-18	17.27%	Senior Debt to cash flow is high
Gran Columbia Gold Corp	GCM.DB.V	6.00%	02-Jan-20	15.14%	I own this
Westernone Equity	WEQ.DB	6.25%	30-Jun-20	13.94%	Likely equity conversion June 30, 2018
Entrec Corp.	ENT.DB	8.50%	30-Jun-21	13.02%	Cash flow negative, senior debt high
Temple Hotels	TPH.DB.D	7.75%	30-Jun-17	11.78%	One month to maturity
Difference Capital	DCF.DB	8.00%	31-Jul-18	9.56%	Payback not certain
Temple Hotels	TPH.DB.E	7.25%	30-Sep-17	9.47%	4 months to maturity
Fortress Paper	FTP.DB.A	7.00%	31-Dec-19	9.22%	Never figured them out
Temple Hotels	TPH.DB.F	7.00%	31-Mar-18	8.11%	How much $ does Morguard have?

I really don’t see anything worth locking capital into in this table at present prices. I do own one of these convertible debentures, but it is at a price where I would not buy (or sell) – my purchase price is from much lower prices and it is the only debt on this list that gives a warm and fuzzy “secured by all assets and nobody can step in front of me” arrangement.

I also note that the table is missing Yellow Media and Grenville Royalty which are both trading at 9% and 16%, respectively, but they are both unattractive for various reasons.

Toys R Us – Not for me

Most people are familiar with the Toys R Us franchise of stores – they sell toys and baby stuff. The Wikipedia entry has a good summary.

Their equity is privately held, but they are still required to report publicly because of debt covenants.

Their financial summary is more grim. They are being slaughtered by Amazon and other online retailers, so their heavy physical presence is causing an erosion of sales and pricing power to the point where they are no longer making money during most of the year.

For instance, from the end of January to the end of October (9 months) in both 2016 and 2015, the company does not make money when factoring in amortization (those physical stores and logistics still need upkeep). The interest bite takes an even bigger chunk out of the corporation.

So the Black Friday and Christmas season is critical. It makes the whole year worthwhile in terms of profitability. Even then, in the past couple years it has not been enough to offset losses of the previous 9 months (In 2016 even when factoring in CapEx and interest, they were slightly short of generating cash).

For the most recent holiday season, same-store sales in the all-critical Black Friday and Christmas period were down 2.5% in the USA and more so internationally. This clearly is not a good trend, and one has to ask whether it will continue or whether it was a one-off thing.

I’m ignoring the fact that their balance sheet is a leveraged mess.

Looking at their latest 10-Q, we have an entity in a negative equity situation (negative 1.6 billion), $420 million cash on the asset side and $5.5 billion in long-term debt.

This is a huge mess. The vast majority the debt is secured. There are convolutions of financings behind the various corporate entities under the holding firm, but suffice to say, it is about as leveraged as things get without getting recapitalized. I believe a recapitalization is inevitable.

Somehow, in August of 2016, they managed to convince the 2017 and some of the unsecured 2018 debtholders to exchange their debt for senior secured notes maturing later in time.

It is the 2018 unsecured notes (7.375% coupon) that I was looking at. They mature on October 15, 2018 and there is US$208 million outstanding (about half decided to exchange their debt for 90 cents of par value of secured debt).

The following is a chart of their trading since the exchange offer was floated:

The debt, at the asking price, has a yield to maturity of 11.3%, and a term to maturity of 1.52 years.

This looked like a Pengrowth-ish type situation where you have unsecured debt that may trump the secured debt on the basis of maturity, rather than security. There is a credit facility that has around $630 million remaining that could pay the October 2018 maturity.

Sadly, the risk of a spontaneous credit meltdown is preventing me from purchasing the unsecured debt. One can also make a legitimate case that Toys R Us will burn through enough cash to prevent them from paying off the October 2018 unsecured debt (they have to accumulate inventory for the that Black Friday / Christmas season and this will be when they need the capital the most).

Hence, I will pass purchasing this debt. I’m going to guess it will trade lower over the next 18 months.

Difference Capital – Year-End 2016 Report

I wrote about Difference Capital (TSX: DCF) in an earlier post. They reported their 4th quarter results a couple days ago and their financial calculus does not change too much. They have CAD$29.6 million in debentures outstanding, maturing on July 31, 2018. Management and directors own slightly under half the equity, and thus they want to find a dilution-free way to get rid of the debt.

At the end of 2016 they have about CAD$14.4 million in the bank, plus $60.8 million (fair value estimate of management) in investments. One would think that in 2017 and the first half of 2018 some of these investments could be liquidated to cover the debentures. The situation is similar to the previous quarter, except for the fact that they’ve retired about 10% of their debt in the quarter, which is a positive sign.

Due to their investment portfolio not making any money (they have been quite terrible in this respect), they have a considerable tax shield: $186.3 million in realized capital losses, plus $41.9 million in non-capital losses which start to expire in 2026 and beyond. If you assume that they can realize both of these at half of the regular tax rates (I just quickly assumed 13% for the capital losses and 26% for the net operating losses), that’s $17.6 million.

Considering the market cap of the corporation is $26 million, there’s a lot of pessimism baked in. Mind you, there are a lot of corporations out there with less than stellar assets, a ton of tax losses, and tight control over the corporation (TSX: AAB, PNP quickly come to mind) so it is not like these entities are rare commodities. The question minority shareholders have to ask is whether the control group wants to bleed the company through salaries, bonuses and options or whether they are actually genuinely interested in profitably building the corporation (in all three cases, to date, has not been done).

Pengrowth Energy Debentures – cash or CCAA

A quick research note. Pengrowth Energy debentures (TSX: PGF.DB.B), something I have written in depth about in the past as being one of the easiest risk/reward ratios in the entire Canadian debt market, has reached the “point of no return” with regards to its redemption. They are to be redeemed on March 31, 2017 for cash (and an extra half year of accrued interest at 6.25% annually). For the company to exercise its option to redeem them for shares (of 95% of TSX VWAP), they needed to give 40 to 60 days of notice from the redemption date.

(Update, February 21, 2017: Pengrowth announced they will be redeeming the debentures on maturity at March 31st. Also on their senior debt covenants, it looks like somebody is trying to steal the company… they might be forced into making an equity offering.)

My math says that the next market opening, February 20, 2017, will be 39 days before March 31st.

Barring some sort of mis-interpretation of the legalese, this means that the company must redeem this debt (CAD$126.6 million) for cash. The alternative is CCAA, which I do not deem is likely considering Seymour Schulich would likely have something to say about that particular option (he controls 109 million shares or 19.9% of the company at present). There is no longer any time to negotiate an extension with debenture holders.

This debenture issue was acquired as a result of the NAL acquisition back in 2012. It was originally CAD$150 million but they company repurchased some at a considerable discount to market earlier this year.

Pengrowth is in the middle of a silent negotiation with their senior creditors as they are in covenant troubles. Their senior creditors will no doubt be unhappy with the fact that some company cash is going towards a junior creditor.

Sadly I have no good candidates for re-investment at this time. Suggestions appreciated.

Bombardier credit market completely out of the woods now

Bombardier’s bonds have traded considerably higher since their latest 8.75% bond issue (maturing December 2021) which is now trading at a premium to par.

They have to be looking at this and thinking about securing further long-term funding. It also gives them a lot more negotiating power with the Canadian government, who wants to inject some more money into the corporation (whether they need it or not) for political reasons.

Floating rate preferred shares are yielding 8%, while the fixed rate is yielding 9% (quite the premium to pay for a floating rate). Given the difference between the bond market and the preferred share market, I still believe the preferred shares are trading slightly cheap to what they actually should be.

The equity is also receiving quite a bid as of late, despite the massive warrants overhang in their earlier year government fundings. If they receive another large order for C-Series aircraft (something slightly larger than Air Tanzania), it is quite likely the stock will rise even further.