Canadian Finance, Economics and Fiscal Analysis
I have been very slowly adding in links to my sidebar in the “Canadian Finance” category. The criteria are as follows:
1. The site author posts with his real identity;
2. The site’s focus is of a Canadian investor’s perspective and has decent content;
3. Site is focused more on fundamentals rather than technical analysis;
4. The site is not too “spammy”.
There are amazingly few sites out there that fit these criteria.
Now that BP has effectively settled with the US Government to the tune of $20 billion and taking out their shareholders’ dividends for the next year, it leaves the question of how Transocean, the owner of the drill, will fare.
I’m guessing that the cessation of risk with BP’s settlement with the US government will not last too long when the government decides to go after Transocean for something. I don’t believe this is correctly priced in the market yet.
One of the smartest decisions Transocean made was relocating its corporate headquarters to Switzerland for tax reasons. Most of the assets of Transocean are international, and thus they can be shielded from US taxation. The ability of the US government to extort money out of Transocean is potentially more limited considering that the only active offshore drilling area in US waters is around the Gulf of Mexico.
I have a mental buy order where I will purchase shares of RIG, but it would require a price trend down in order for the market to reach it.
Fundamentally, the supply of crude oil is limited by the amount of drills available to do offshore drilling, and there are only a few companies on this planet that have the capability of providing such services. Until the field becomes saturated, lease rates should be substantially profitable for the players that are doing it and consequently the shareholders. Higher oil prices will also stimulate more demand for offshore drilling (as well as on-shore development) and are obviously more beneficial to those companies that have unmined oil reserves.
BP has now cut its dividend:
As a consequence of this agreement, the BP Board has reviewed its dividend policy. Notwithstanding BP’s strong financial and asset position, the current circumstances require the Board to be prudent and it has therefore decided to cancel the previously declared first quarter dividend scheduled for payment on 21st June, and that no interim dividends will be declared in respect of the second and third quarters of 2010.
The Board remains strongly committed to the payment of future dividends and delivering long term value to shareholders. The Board will consider resumption of dividend payments in 2011 at the time of issuance of the fourth quarter 2010 results, by which time it expects to have a clearer picture of the longer term impact of the Deepwater Horizon incident.
The Board believes that it is right and prudent to take a conservative financial position given the current uncertainty over the extent and timing of costs and liabilities relating to the spill. BP’s businesses continue to perform well, with cash flows from operations expected to exceed $30bn in 2010 at current prices and margins before taking into consideration costs related to the Deepwater Horizon spill. BP’s gearing level remains at the bottom of its targeted band of 20-30 per cent. In addition, the Company has over $10bn of committed banking facilities. To further increase the Company’s available cash resources, the Board intends to implement a significant reduction in organic capital spending and to increase planned divestments to approximately $10bn over the next twelve months.
This decision has a double benefit to BP – first, it will provide them some mild political cover for not dishing out money to shareholders. In theory, this is a value-neutral decision since the company is effectively investing that capital into its liabilities (either related or not to the Gulf of Mexico oil spill). However, value funds and income funds will likely jettison BP shares for mechanical reasons.
The second benefit is that each quarterly dividend costs BP about $2.63 billion dollars – this money will shore up their balance sheet. Since they have some maturing debt that needs to be paid off, BP needs to conserve cash to avoid a short raid on their stocks and bonds – already their short-term maturities are trading around 7-8% yields to maturity when they should really be trading around 2-3% (i.e. nearly a “sure thing”).
For people that insist on getting into BP, the next couple weeks should be a good time. The exact timing in terms of price is an unknown variable, but I would estimate layering in 25-30 dollars a share (e.g. if it goes down to 28, you will get a 40% allocation).
There is also an off-chance that the US government will introduce some other hidden risk into the equation that would end up tanking the stock price. You would think, however, that most of the risk has already been introduced into the stock price.
Option fans should also consider that the implied volatility for BP is well into the 90’s (very high when compared to its price history).
I have now been asked by many different people about the valuation of BP.
My response to them is the same as before: “I would not bother thinking about this [buying shares] until BP has cut their dividend.”
However, I will offer up a prediction:
Over the course of the next 2 years, $10,000 invested in BP (NYSE: BP) at the closing price of June 16, 2010 will under-perform $10,000 evenly invested in Transocean (NYSE: RIG) and Noble (NYSE: NE). Assume dividends are not reinvested and remains as zero-yield cash.
The analysis of BP has converted from a financial/resource calculation to purely a political risk calculation. The current US administration is very adverse towards their non-donor constituents and while BP has donated scalds of money to the Democratic party in 2008, it is very likely they will still be made into a scapegoat for the Gulf of Mexico oil spill.
I am very interested in the drillers, and I am waiting for one more “shoe” to drop before likely placing some bids. Implied volatility on Transocean would suggest that selling near-the-money put options is a viable strategy for entry, but I am waiting for a price drop before executing on that. This also goes outside of my “don’t invest in companies outside an English-speaking jurisdiction” rule, but there are times to make exceptions and it seems to be close to one.
I also notice that Canadian oil sands companies are getting quite a bid – I am guessing capital is flowing into the politically safe Alberta oil sands. Suncor and Cenovus are the big players here, although there are a couple interesting bitumen plays that have a smaller capitalization worth looking into.
All of these oil investments assumes an implicit risk that the price of oil will at least be stable or preferably increase.
Earlier this week, the Minister of Finance stated that a substantial majority of premiers were amendable to a modest expansion of the Canadian Pension Plan.
Being active on the political end myself, most of the unionists that were at a public meeting on retirement income proclaimed their support to expand the Canadian Pension Plan. This positioning was undoubtedly due to their concerns that defined pension plans from sponsoring companies were only as good as the solvency of the company, while the Canada Pension Plan is effectively guaranteed by the Canadian government. Their arguments, generally summarized, is that the CPP benefit of (currently) $11,210/year is insufficient to live on.
An important point for people to remember is that the Canada Pension Plan, when instituted in the mid 1960’s, was never intended to be an income that people can live on. However, now there seems to be some sort of expectation that governments can fund people’s entire income requirements when they get older. Such expectations cannot be fulfilled without costs.
Already those costs have been reflected into the system. In the mid 90’s, there was a fundamental shift on CPP rates, increasing from 1.8% to 4.95% for both employees and employers. This allowed surpluses to develop and the management of a funded CPP that could compound asset growth and be able to better provide for the aging population.
Putting the CPP into raw numerical terms, if you earned a salary of $47,200 in 2010, you would contribute $2,163/year and your employer would contribute the same. CPP numbers are indexed to the consumer price index, so your contributions would go up over time (as well as your expected benefit when you start collecting CPP). If you work for roughly 35 years at this salary (you can exclude up to 15% of your lowest income-earning years for the purpose of the CPP calculation) you will receive a $11,210/year payment from the CPP until you die. Your spouse will also receive 60% of your CPP payment as a survivor benefit if you die earlier than he/she does.
Financially, this is a fairly raw deal. Pretending, starting at the age of 30, at that you would have put your 2x$2,163 contributions into an investment earning 5% a year. By the time you turn 65, you would have stored up about $414,600 on a pre-tax basis. While 5% interest on this amount alone would be about twice the maximum benefit ($11,210/year), even assuming you earned no return on the capital, you would still have about 37 years before exhausting your asset reserve. The advantages over the CPP are quite obvious.
Another way of looking at this is that you would need to repeat the same procedure at 3.62% return over 35 years in order to be able to create a $11,210 income for perpetuity. The easiest brain-dead way of doing this is investing in government of Canada 30-year bonds, currently yielding around 3.8%.
Anybody having the discipline of investing in very safe return securities should be able to replicate something better than CPP with the capital they would otherwise have contributed to CPP.
So with the proposed “modest expansion” of the CPP, I am guessing the government will propose a 25% increase in maximum CPP benefits, which would likely come with a 25% price tag increase in CPP premiums.
Maybe for people that are not financially sophisticated at all this would be a good option. However, for anybody with the aforementioned discipline, it is a bad deal. I would not consider this “robbery” or “taxation”, however – one of the benefits of having a relatively low payoff at the CPP retirement age is that the fund is solvent, which is more than can be said for USA Social Security, which is a complete financial write-off.
In the USA, for example, a person earning $47,300 a year and retiring at age 65 (note this comes with a penalty provision since their normal benefits begin at age 67) will earn roughly 50% more a year than somebody in Canada. Their premiums are 6.2% of the salary, about 25% higher, paid by the employee and employer, up to a maximum of $106,800. USA Social Security is funded by a trust fund, which the benefit provisions are purely paid for by current workers and does not have a build-up of assets. As a result, social security is very likely to either reduce benefits (by extending the age requirement, or clawing back high-income earners), raise premiums, or a combination of both. Canada is unlikely to do this.