February 17, 2015

On Tuesday, the S&P 500 was up 0.2% and Toronto was up 0.1%

Stantec and Canadian Tire were each up 2.0%. Couche-Tard was up 2.2%, Liquor Stores N.A. was up 5.3%.

Meanwhile the RioCan pref shares REI.PR.A were down 3.2% to $21.23. These are rate reset shares and will reset to the five year Canada bond rate plus 262 basis points on March 31, 2016. Based on today’s five year Canada bond yield of 0.42% the new dividend would be 3.04% of $25 or 76 cents, down from $1.3125. On that basis it may be logical for these shares to trade at $21.23.

However, this implies that the spread on these pref. shares over the five year Canada has risen from 262 basis points to 316 basis points.

It seems to me that if the five year Canada bond is going to stay at 0.42% then investors may (reluctantly) conclude that more like 3.0% is reasonable on a five year rate reset pref. If so, these pref. shares may return to the $25 range.

I am not sure why the spreads (over the five year Canada bond) on these  rate reset prefs should be so much higher than previously.

I do know that spreads on five year bonds have not widened and that the yield on high quality five year corporate bonds is in the area of 1.25%.

At this time last year I was buying five year rate reset prefs as an alternative to holding cash. In some cases they soon rose to the $26.00 range and I sold so that worked out well.

The lesson learned from seeing these rate reset shares drop well below $25 is that, really, there is no substitute for cash. When cash is paying 1.25% and you reach for a 4% yield you are no longer in something as reliable as cash or a short-term deposit.

The bottom line for me, is that I may grab some of these RioCan pref. shares at the $21.23 range if I decide I have enough cash to do so. It’s not as safe as cash but I suspect it will work out better than cash over the next year.

I notice the new Burger King / Tim Hortons company, Restaurant Brands, is out with a big loss for Q4 due to the merger costs and they probably also got absolutely hammered on the lower Canadian dollar. It seems they lost $514 million on revenues of $416 million (which is impressive in its own way). I have no opinion on Restaurant Brands as an investment but honestly I would not mind seeing them fall on their faces. The stock was up 8% today because the same-store sales and revenue were quite strong. I know one person who is definitely making money on this deal and that is Warren Buffett (Berkshire Hathaway) because the pref shares he has in this deal have to pay out even while the company loses money. Similarly, so far, 3G is losing money on the Heinz deal while Buffett is making money.