Takes nerves of steel

In the short term, the market is designed to confuse everybody, but understanding the nature of the confusion is paramount.

Apparently in the past couple days, people have been worried “things will last longer than expected”. I have seen a bunch of stocks get dumped indiscriminately, sort of like a second wave of COVID-19 hitting the financial markets. I’m sure some of you have “felt” this mini-tremor as well. Nervous individuals that have bought shares a week ago are underwater, and are reading these headlines and are starting to panic.

This creates volatility and another round of panicked people want to reach for cash.

The problem is that any time you see a trade on the market, the cash gets exchanged from the person willing to buy the stock to the person that wants to dump the stock. The amount of cash remains the same, just that the valuation of the asset (a residual economic slice of the company in question) changes.

Maybe these people reaching for cash are satisfied with it staying around, effectively taking the cash out of circulation of the economy.

But central banks can wave a magical wand, and exchange bonds for more cash. This cash increases the pressure for demands on assets, which mostly makes its way to the stock market since this is the only game in town where you can get an income. Other routes include real estate (which doesn’t make as much income any more since rents are collapsing as we speak), or commodities (which should retain their value, and in some cases even increase in value depending on their demand). Relatively speaking, the cash becomes less significant with increased liquidity in the marketplace.

So in the medium term, this liquidity getting injected into the financial system will dampen volatility. In the short term there are going to be gyrations in accordance to the changes of participants’ psychologies, which is very rapid as the market tries to price in exactly what will be happening as a result of the COVID-19 reaction.

The cliche is that you need to sell when most participants are too bullish (there’s no incremental demand to convert cash to assets at a price higher than the assets), while the converse is true when more people are too bearish. When everybody wants cash at the same time (like during the third week in March) the result is a crash in asset prices and a huge rise in volatility. The difficult part of timing the bottom is that you have no idea when the last person (institution, pension fund, hedge fund, or a brokerage executing a margin liquidation on a poor client) that absolutely wants to convert the last of their asset into cash at any price he/she can get. You just don’t know, which is why you average when things get a little silly.

I wrote earlier sometimes it is better to be lucky than good, but yesterday evening I placed some volatility orders and they were reasonably well timed to correspond with the peak of this mini-earthquake we’ve had over the past few days (which was also instigated by the upcoming Friday being an options expiration Friday, which tends to increase volatility).

The risk-reward dynamic of the market is that if a trade feels good, it probably is a sentiment shared with others in the marketplace, and hence it is less likely to succeed than if you were very worried going into a position. And believe me, shorting VIX looks easy in retrospect but it takes nerves when you see the stock chart rocket up.

Why Canada is getting into trouble

I try to avoid politics in this website other than how they interact with the financial markets (which is a material consideration – don’t face the headwinds of the central banks or federal governments – just ask Albertan oil and gas producers!), but this little interaction in Parliament should be a pretty good indication of the minds of our esteemed Ministry of Finance (MP Pierre Polievre has been a very effective finance critic for the opposition):

(You want the actual answers? Try here.)

I understand what the Minister of Finance is doing from a political angle – he is obviously being given specific advice to not say anything that is clippable in a negative light. So he won’t answer any real questions in Parliament. There are no consequences to not answering questions in Parliament other than public embarrassment, which didn’t seem to hurt the Liberals in the previous election (Trudeau’s blackface, etc.).

Although the USA is blowing more money out the door, one can make the claim that they still have the strongest military and still an extremely powerful economy that, when they actually care about it, can be nearly self-sufficient from a domestic perspective. As a result, they can take ridiculously huge monetary and fiscal actions and will still be in reasonably good shape (inflation would result when claims on currency start flowing in to purchase goods and services, but it would not be a country-ending event). Canada cannot make such a claim as our primary export is natural resources, and we rely on imports for significant amounts of goods. We still have a reasonably decent amount of domestic production, but it is nowhere as robust as the USA. As a result, at the same levels of debt (proportionate to our GDP and population) we are more brittle economically.

Fortunately, the federal entity has had a relatively low amount of debt to GDP, but this is going to change (upwards) very quickly. Our debt to GDP will rise about 15% this fiscal year alone. Canada is structurally unusual in that our sub-soverign entities (i.e. provinces) are relatively more powerful entities than other countries, and as such, to have a proper apples-to-apples comparison, provincial debt should be included with the overall burden – when taking this into light, Canada is slipping into fiscal territory where it should not be going. We’re still miles away from around 1993 where interest expenses on gross debt was a third of our revenues (it was about 7% in the previous year), but it doesn’t take much imagination where you start having a monetary crisis and interest rates skyrocket, and that’ll force some really terrible fiscal decisions to properly regain the confidence of the financial markets.

Unfortunately, by the time that the country has to pay the bills for what is happening today, the people causing the problems will be long gone. It makes Harper’s performance during the 2008-2009 economic crisis (which was in itself instigated by a minority parliament that was going to overthrow him from office if he didn’t spend like mad) look quite good by comparison.

The ultimate irony is if there is enough supply destruction in the US shale market (coupled with lack of capital plus the depletion of the top-tier sites), fossil fuel prices might rise enough to bail out Canada’s energy companies, which would have a positive effect on the country’s finances (and the Canadian dollar). This would be despite the current government doing everything it can to shut them down.

Yellow Pages Q1-2020 – somewhat surprising

Yellow Pages (TSX: Y) posted Q1-2020 today and the results were somewhat surprising (the form of the surprise is “Wow, this is less worse than I was expecting”) – while it is generally well known that the revenues (and subsequently cash flows) are eroding, the rate of decline has generally been lower than my expectations. Management tries to spin it as the “decrease in decline”, and ultimately they will have to figure out how to stabilize the business in order to keep the entity viable, but the management of the decline so far has been superb.

The key metric in my book is customer count, which is down to 147,700 (31,100 less than the previous year’s quarter, a still fairly miserable decline), at an average spend of $2,571 per customer.

Employee count is down from 768 in Q4-2019 to 722 in Q1-2020.

Cash generation remains remarkably good, going from $44.4 million in December 31, 2019 to $70.9 million in March 31, 2020. The material debt on the books is the (TSX: YPG.DB) $107 million debenture which management has re-iterated will call at par on May 31, 2021 (before this date they would have to pay 110 on the dollar, which would be financially a net negative).

With the impact of Covid-19, on the conference call the following remarks were given by the CEO in response to the sole question:

Our — I mentioned that, yes, our bookings have taken somewhat of a hit that will be reflected somewhat in future quarters. We don’t have a quantification for you on that. But it’s in the scheme of things, I would characterize it as modest.

…

And on the biggest surprise to me, frankly, is on our cash collections. Our cash collections have continued virtually extremely significant sign of the strength of the continued virtually sector and the market that we serve and the anticipated health of that sector. Again, there’s no guarantees. We don’t make a guarantee, but I expected there to be large and noticeable declines in our receipts of revenue — receipts of cash from our customers. And if there is any effect, it’s imperceptible, actually.

Interesting colour commentary. The CFO accrued an extra $1.5 million for projected bad debt expense, but relatively speaking that isn’t a lot in relation to the overall business. The market very obviously anticipated some sort of COVID-19 impact, but they probably over-reacted (although Yellow’s customer base is concentrated almost directly in the COVID-19 crosshairs, short of airlines and cruise ships).

Finally, on plan, the company will be issuing an 11 cent per share dividend (about $3.1 million a quarter) – the first dividend in nearly a decade. I don’t think anybody a few years ago would have seen this coming. An interesting quirk – 4 cents will be eligible and 7 cents non-eligible. Accounting-wise, the ability to declare eligible dividends comes from the GRIP pool and this is generated through income taxed at the large corporation rate.

On the pension plan liability, the CEO said during the AGM that the plan has a surplus on a going concern basis:

This is David Eckert, the President and Chief Executive Officer of the corporation. And let me say, I thank you and appreciate that question. We take our obligations to our retirees’ and our pensioners’ defined benefit pension plan very seriously. We pay a lot of attention to that, and we have been working very hard for every dollar that almost every pensioner will ultimately and on a timely basis, be paid. Let me point out that at the time of the most recent valuation of that plan, the plan was actually showing a surplus on a going concern basis. And that assumes that the company is a going concern and is able to continue making payments into the plan. And we have been working very hard, as I think most all shareholders know for years now, to make sure that the company does well and is in a position to make payments on all of its obligations, including the defined benefit pension plan. I will point out that in just the last — we announced this morning that in just the last 9 quarters, as evidence of that, we have reduced our, what we call, our net debt in just 9 quarters from over $350 million to only $28 million. And that’s beneficial to everyone. With respect to your specific question, the voluntary additional contribution that we announced our intention to make this morning, beginning in June of this year, each month through the end of next year, would double our regular required monthly contributions. And those would go from approximately $150,000 a month to approximately $300,000 a month. But let me just reemphasize that at the point of the last valuation of the plan, the plan was actually in a surplus position, ongoing concern basis, and we have every intention, and I think the results of the last few years underscore this. Every intention of having this company continue to thrive as it has in recent times. And thank you for your question.

Looking at the financial statements, the plan is still in the liability column for $86 million, but this is a lot better than it was before (it was greatly helped by an increase in the discount rate from 3.1% to 3.8%). The details come out every annual filing, and at the end of 2019, the fair value of the plan assets were $484 million, while the benefit obligation was $573 million ($89 million liability).

I’ve had to downscale my own financial projection for Yellow due to COVID-19 and the general economic damage that the shutdown is going to cause. Yellow Pages will easily generate enough cash to pay the debentures, but the real question will be what happens to the remaining business. Going forward to 2022 and beyond, there is a very viable case for roughly $40 million/year or so in annual cash generation. Without debt, it makes the valuation easier – a multiple of cash. Again, this depends on the trajectory of the revenue curve and how viable management can make their business.

Now my pondering is whether the company will get on the radar of dividend ETFs. During COVID-19 I did some serious portfolio adjustments so Yellow is no longer my largest holding (it was painful getting proper liquidity) but I still hold some and do not see a reason to blow it out. I think almost everybody else has, so I wouldn’t anticipate supply pressure being extreme – others have likely dumped!

The Bombardier bailout

This is going to be good.

Our illustrious government has figured out a headline-free way to bail out Quebec firms, such as Bombardier, and do it in a ‘governmentally distant’ manner, shielded by a crown corporation business development corporation.

The name of this will be through the Large Employer Emergency Financing Facility (LEEFF).

Reassuringly, money to be loaned will be conditioned upon:

Companies seeking support must demonstrate how they intend to preserve employment and maintain investment activities. Recipients will need to commit to respect collective bargaining agreements and protect workers’ pensions. The LEEFF program will require strict limits to dividends, share buy-backs, and executive pay. In considering a company’s eligibility to assistance under the LEEFF program, an assessment may be made of its employment, tax, and economic activity in Canada, as well as its international organizational structure and financing arrangements. The program will not be available to companies that have been convicted of tax evasion. In addition, recipient companies would be required to commit to publish annual climate-related disclosure reports consistent with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, including how their future operations will support environmental sustainability and national climate goals.

Let the gravy train flow! Bombardier gets another low-interest rate loan of a billion dollars.

Gran Colombia Notes indenture amendment

Gran Colombia Gold (TSX: GCM.NT.U) posted an update to their note indenture regarding the proportional change of the amortization in the event of a redemption or repurchase.

(Attached amendment)

Amendments. Article 4 of the Indenture is hereby amended by adding the following as Section 4.11:

In the case of any partial redemption or repurchase of Notes (for greater certainty, other than pursuant to an Amortizing Payment), the principal amount of Notes redeemed or repurchased shall be proportionately allocated among all remaining scheduled Amortizing Payments set out in Appendix C and shall be allocated to the pro rata reduction of each remaining Amortizing Payment. Within five Business Days of the completion of a partial redemption or repurchase, the Issuer shall deliver to the Trustee an updated Appendix C and Appendix D reflecting the effect of such redemption or repurchase; provided, however, that in respect of the Partial Redemption, the updated Appendix C and Appendix D shall be delivered on the date hereof.

It was not at all clear from the text of the original indenture (indeed, it wasn’t there at all) that the amount of gold held in trust is reduced in the event of a redemption or repurchase.

If you assume that there isn’t a reduction (indeed, there is nothing in the language to suggest that there is a reduction), it dramatically increases the economic value of the notes in periods subsequent to the redemption.

Indeed, on March 26, 2020 you can see my strike-through comments with the said interpretation.

I do not have enough in these notes anymore where it is economically feasible to mount a legal case that this indenture amendment is illegal and that noteholders should receive the full entitlement of gold, unreduced by the redemption.

Indeed, it is going to be somewhat of a moot point, as I would deem it likely the company will redeem for 104.13 on or after April 30, 2021. Even with the reduced amortization, at a US$1,700/Oz gold price, the company will be paying an extra 11.3% on the notes in the upcoming four quarters.

However, if somebody out there owns a few million of these notes, there would be a pretty powerful claim to be made. I suspect that despite receiving an “Opinion of Counsel” from the Trustee that this “defect and inconsistency” wouldn’t be seen as such in the eyes of the court – it instead looks like retrospective contract re-writing, of course in the favour of the issuer.

There is one obvious insider that had to disclose on SEDI that he owns a large volume of notes, but he is unlikely to sue his own company and is likely to claim economic rent through other methods. Any other large holders would probably make due by just settling with the company, away from the public spotlight. The differential amount would not be considered material and likely would not be too visible on the financial statements short of a few extra bucks of legal expenses.

If anybody was wondering, the difference is (at US$1,700/Oz) a total 20.7% payment over the next 5 quarters (April 30, 2020 to April 30, 2021) vs. 13.3% under the revised scheme. This 7.4% difference over the $44.7 million outstanding post-redemption is around a $3 million payment difference (this accounts for the reducing principal amount of the notes over the quarters), not a trivial chunk of change.

Even with all of the regulatory protections of public markets, I’m not surprised to see this happening. I’m happy to have my position reduced and eliminated with the inevitable call-out of notes.