This is a rambling post.
Downward volatility is the best friend of an investor that has plenty of cash.
You will also see these punctuated by magnificent rallies upwards which will get everybody that wanted to get in thinking they should have gotten in, until the floor drops from them again which explains today.
By virtue of having well over half cash and watching the carnage, I’m still not finding anything in fire-sale range except for items in the oil and gas industry which are having their own issues for rather obvious reasons. Examples: Penn West (TSX: PWT) and Pengrowth (TSX: PGF) simultaneously made announcements scrapping and cutting the dividends, respectively, and announcing capital expenditure reductions and their equity both tanked over 10% today. Crescent Point (TSX: CPG) had a fairly good “V” bounce on their chart, but until oil companies as an aggregate start going into bankruptcy and disappearing, it is still going to be a brutal sector to extract investor value from.
I just imagine if I was one of the big 5 banks in Canada and having a half billion line of credit that is fully drawn out in one of these companies. Although you’re secured, you don’t envy the train wreck you have to inherit if your creditors pull the plug.
The REIT sector appears to be relatively stable. Looking at charts of the top 10 majors by market capitalization, you don’t see a recession in those charts. If there was a true downturn you’d expect to see depreciation in the major income trusts. I don’t see it, at least not yet.
Even when I exhaustively explore all the Canadian debentures that are publicly traded, I do not see anything that is compelling. The last debt investment which was glaringly undervalued was Pinetree Capital (TSX: PNP.DB) – but this was in February. They recently executed on another debt redemption which puts them on course to (barely) fulfilling their debt covenants provided they can squeeze more blood from their rock of a portfolio. I wouldn’t invest any further in them since most of what they have left is junk assets (Level 3 assets which will be very difficult to liquidate). One of those investments is a senior secured $3 million investment (12% coupon!) in notes of Keek (TSXV: KEK) which somehow managed to raise equity financing very recently.
The preferred share market has interesting elements to them as well. Although I’m looking for capital appreciation and not yield, it is odd how there are some issuers that are trading at compellingly low valuations – even when factoring in significant dividend cuts due to rate resets (linked to 5-year Government of Canada treasury bonds yielding 0.77%!). I wonder if Canada’s bond market will go negative yield like some countries in Europe have – if so, it means those rate reset preferred shares will have even further to decline!
I have been buying into the rate resets, especially the lower rated names. I’m comfortable with collecting the income but think there is a big chance for capital gains if rates ever rise again or just stop going down. In many cases, the debt spreads for these names are still very tight while the preferred spreads imply bankruptcy around the corner!
There doesn’t seem to be any clarity on what happens if the 90-day t-bill or the 5-year bond yield go negative but on Atlantic Power’s call in February, they assume that 0% would be the floor for calculating their reset rate. I pulled the question and answer out from the transcript and noted it below.
“Unidentified Analyst
Okay, great. And then on the preferred there was – wasn’t any mention as I see the dividend decline and there was a rate reset. And a couple of questions, where do you see that is obviously they had a severe discount to liquidity preference.
So the implied IRR if there’s going to be liquidity event it would be quite high on those. But also with reset is there any floor in that or if government rates go negative is there a chance where you just use the negative rate as the base to determine the spread?
James J. Moore – President and CEO
Yeah, there’s a spread above that government rate. So and that spread is 4.18%, but I think that that would be the floor to break one negative I don’t think that we get the negative type of spread would be floor of 4.18.”
I’ve been eyeing some of the preferreds in the financial sector but they are still a couple hundred basis points of yield away (calculated for potential 5-year rate resets looming close) before I’d nibble on them. Still, relative to the 1% interest income you’d get in a savings account vs. a higher eligible dividend, one is tempted to deploy cash.
However, I’ll wait. Sort of like how I should have pulled the trigger on BBD a couple weeks later.