Category: Canada

A minor tax note for Canadian investors

Canada Revenue Agency rules state that the settlement date, not the trade date, is the determinant of when you have disposed of a security.

Hence, if you wish to liquidate stocks on the public exchanges and have these transactions count for the 2018 tax year, you have until the close of trading on December 27, 2018 to do so for the trade to settle on December 31, 2018.

I would expect given that Q4-2018 has been one of the worst performing in quite some memory, that this would be a consideration for many investors to have the CRA share their losses in 4 months (when filing for taxes) than 16 months later.

Continued market meltdown

I note the TSX index is down about 7% year to date.

The interest rate rises are finally starting to hit the markets with asset price drops. Some items are finally hitting my radar in terms of the watchlist and my research queue.

In particular, what has caught my attention are the drops in equity prices in certain REITs.

There is a double-whammy: higher interest rates result in higher interest expenses (when firms have to refinance debt or pay floating rates) and because of higher costs of capital, asset prices will decrease (which also get reflected in balance sheets due to IFRS fair value adjustment rules – rules that make income statements appear even more un-readable for untrained eyes).

I also don’t know whether this is correlated in anyway to the plummeting in oil prices, but as a consequence, most oil stocks have gotten killed in the past month. This is reminding me of what happened to a lot of companies in the December 2015 to February 2016 meltdown that took some Canadian preferred shares to double-digit yields. The environment is a lot different, however. Making money on asset appreciation is much more difficult in an environment when the cost of capital is rising and money is being drained out of the system at an increasing pace. The most similar analogy is trying to make head-way on a sailboat when the winds are blowing against you at increasing speeds – it is still possible to move forward, but you have to zig and zag to get to your upstream destination.

Canadian oil wipeout

Western Canadian Select is trading at US$17.28 this very moment. For comparison, West Texas is around US$70, and Brent is US$80.

It is well known that Canadian Western crude has a heavy price discount due to the inability to transport it to market. Line 3 (ENB), Keystone (TRP) and Trans-Mountain (KMI/KML, now the Government of Canada) are the only three “quick and cheap” ways to getting it out and these lines are already full.

However, this discount has been much more pronounced over the past quarter and if it continues, it will be financially catastrophic to those companies that are over leveraged and have covenant issues.

The question is to what degree this is reflected in current Canadian oil asset prices. The solvency situation for a lot of companies are likely to get worse than better in the near-term.

It is also amazing how political considerations can stall an entire industry. The survivors will be the well-capitalized incumbents that will pick away strategically at assets of those which are forced to liquidate. Suncor, CNQ and the like with independent channels for energy distribution will pick away at the entrails of smaller, less capitalized competitors.

What I am trying to say here is that small-cap oil, especially those over-leveraged, look to be an incredible value trap on the equity side. There may be debt opportunities here and there, however.

Canadian Dollar vs. US Dollar

This chart has grabbed my attention over the past couple weeks:

The market is trading CAD up presumably on hopes that Canada and the USA can iron out some sort of trade deal on the NAFTA front. I’d be skeptical. The politics does not work very well for both President and Prime Minister for a quick agreement.

The other drivers of the Canadian currency are interest rates and the state of the commodity markets, and relative to the USA, neither appear to be favouring the Canadian dollar at the moment.

That said I do not pretend to understand all the nuances of Canadian dollar trading, so perhaps some other enlightened individuals can chime in.

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?