If you run a website that is materially (let’s define this as 75%+) about Canadian finance, please feel free to comment with a link below. I’m refreshing the links on the right-hand side of the desktop screen. I’m always curious as to who is writing and today’s highlight for me was the guy running Reminiscences of a Stockblogger. Judging by his writing, I think he is an excellent analyst.
TC Pipelines (Trans-Canada Pipelines) MLP and FERC Ruling
Today was a very interesting day for TC Pipelines MLP (NYSE: TCP) which is the USA MLP arm of TransCanada Corporation (TSX: TRP).
They were heavily impacted by a March 2018 FERC ruling concerning the calculation of regulatory revenue rates for oil and gas pipelines – essentially they were not allowed to incorporate the income tax expense of their unitholders into their rate calculations. Not surprisingly, the stock crashed in March (along with most other MLPs) and when TCP announced the subsequent consequence in their next quarterly report (May) they crashed even further. It is fairly evident by the stock chart when these moments occurred:
Today, the FERC partially backpedaled on this change announced in March for natural gas pipelines only (nothing mentioned on oil pipelines). According to my read of the commissioner’s details, they came to the conclusion that the underlying natural gas pipeline legislation had technical issues which did not allow them to enforce the previous order. Putting a long story short, they came to the conclusion that this change would be considered retroactive rule-making and hence they did not have the authority to implement the change. They provided a mechanism where gas pipelines could voluntarily consent to changes in exchange for the commission to not review their rates within a certain time period, but I doubt MLPs will exercise this if such changes are adverse.
This is effectively a reversal of the decision unless if Congress decides to intervene in the matter. Considering the perpetual dysfunctional mess in Congress and them not touching the underlying legislation to correct this matter, this is a huge victory for natural gas MLPs.
Finally, the rationale for TCP MLP dropping from $50 to $25 in the first place has completely evaporated – although interest rates have increased somewhat (causing some headwinds in the MLP price due to simple spreads over the risk-free rate), one can make an argument that the price should be restored close to previous levels. In other words, there is an argument to be made that the price should go even higher.
The FERC ruling does not appear to affect crude oil pipelines (this is a very loaded sentence).
The disclosure I will make is that I own call options in TCP, which bypasses messy taxation issues of foreigners owning USA MLPs.
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Addenda:
Very quick valuation notes, TC Pipelines (NYSE: TCP)
Units outstanding: 71.3 million
General Partner: (TSX: TRP), owning approx. 23% of the entity
Distributable cash flows, 2015/16/17: $290/313/310
GP/Incentive Distribution Rights: 2% below $0.81/quarter, 15% to $0.88/quarter, 25% above $0.88/quarter
Top-line Revenues/Equity earnings (2017): US$446 million.
Debt: $2.3 billion, staggered across various term facilities/bonds. Refinancing available, will pay slightly more interest in rising-rate environment when rolling over debt. YTM on May 2027 unsecureds: 4.7%
Paper napkin valuation: $310 million / 71.3 million units, $4.35/unit, $35@12%, $42@10%. Does this warrant a 700bps or 500bps spread over debt? Historically was trading around $45-$50 (MLP sector was ‘more sexy’, perceived as ‘ultimately safe’, etc.)
Previous distributions were $1.00/quarter, but post-FERC, reduced to $0.65/quarter, citing debt ratios and anticipated reduction of revenues.
Protected: Q2-2018 Performance Report
Canadian Dollar, Genworth MI and Residential REITs
This will be a rambling post in no particular order.
1. The Canadian dollar has tumbled with Donald Trump beating the war drums on the trade portfolio:
This will keep going lower and lower until the Government of Canada realizes that a lower currency doesn’t mean you’re more competitive when you’ve basically killed your own industry. Normally there is correlation between oil prices and the Canadian dollar but this linkage has now been considerably more muted because of WTIC to Alberta oil differentials. Investment has been flowing away from Alberta/SK oil and everything is on maintenance mode.
This will clear the way, however, for the Bank of Canada to raise interest rates another quarter point.
Domestically, this is going to be a disaster for general Canadian standards of living. It seems to be that our largest urban export is continuing to be real estate.
2. Speaking of real estate, bearish market participants in Genworth MI are going to face a short squeeze:
I’m not sure why anybody would want to use Genworth MI as a proxy for Canadian housing when there are so many more other investment vehicles to express this sentiment, ones that are trading well above book value and are making nowhere close to as much money as Genworth MI is on their insurance portfolio.
I’ll send a “hat tip” to Tyler, who writes infrequently at Canadian Value Stocks, for the brief mention of my continuing analysis of Genworth MI. The best analogy I can give is “picking up hundred dollar bills in front of a steamroller” instead of the usual cliche of “picking up nickels”. Genworth MI is claimed to be poised to have a giant collapse, but the variables required to make that happen seem distant at this point in time. Hint: Pay attention to China.
3. Speaking of real estate, the most hyped investment seems to be mortgage REITs and also residential REITs. The cap rates received by purchasers are incredibly low. Example press release linked here, key quotation in the first paragraph:
Northview Apartment Real Estate Investment Trust (“Northview”) (TSX:NVU.UN) today announced that it has agreed to acquire a 623 unit portfolio of six apartment properties (the “Acquisition Properties” or the “Acquisition”) from affiliates of Starlight Group Property Holdings Inc. (“Starlight”). The aggregate purchase price of the Acquisition Properties is $151.8 million (excluding closing costs), representing a weighted average capitalization rate of 4.5%.
A 4.5% cap rate? Do I even need to open a spreadsheet to know that the purchasing side of the transaction is wholly reliant on capital appreciation of the underlying properties for this to make financial sense?
The big favourite in this market is Canadian Apartment Properties (TSX: CAR.UN) and they probably can’t even believe how much their equity has traded up over the past year. They did a secondary at $35.15/unit and probably feel like idiots since just three months later they’re trading at $43/unit.
We drill down into their financials and see that from the last quarter, extended to 12 months, their normalized funds flow through operations (recall that accounting rules will add gross amounts of volatility in REITs due to mark-to-market rules when properties are re-appraised and this difference will be added or subtracted from income, making standard income statement comparisons incomprehensible without going through mental gymnastics) results in a net yield of about 4.3%.
An investment in CAR, therefore will expect to receive 4.3% plus the variable components of changes of rental amounts, property values, financing and operating expenses, and vacancy rates. Will these variable components be enough to give a rational equity investor a higher rate of return as surely nobody would want to take equity risk for a measly 4.3% gain?
Bombardier Yield Curve
It has been awhile since I’ve posted the progression of the Bombardier debt yield curve, but clearly things have stabilized at the investment grade quality level:
The corporation itself has also raised half a billion (US$) in an equity offering, and has warrants outstanding to purchase shares of its class B stock which are now well within the money. This will be another CAD$500 million that will go to their treasury when it is exercised. Solvency-wise, the company looks like it is once again on stable footing now that the liabilities associated with the C-Series jet has been dumped off to Airbus.
I will likely discontinue my Divestor coverage of Bombardier after this post. The story is over. A few years ago, people were selling down their preferred shares to ridiculously high yields (22%) on the premise that they were not going to be able to stay solvent while they financed their C-Series jet. This was a classic time to capitalize on the cascade of emotional negative sentiment towards the corporation. I even got a media mention for this.
I’m still holding onto my Bombardier preferred shares, although strictly from a valuation perspective, I would not be buying them at the existing price. However, due to the unrealized capital gain and the fact that I have nothing else better to invest my cash with, I will be holding my holdings indefinitely.