February 8, 2015

Boston Pizza Royalties Income Fund is updated and rated Buy at $21.80 to yield 5.6%. It it somewhat like a perpetual preferred share except that the cash distribution can be expected to increase at perhaps 1 to 2% annual but could fall in the event of deflation in menu prices or if the restaurants, or eating out in general, fall out of favor.

On Friday, the S&P 500 and Toronto were each down 0.3%

However our stock picks had a good day and most were up. Canadian Western Bank was up 2.2%, Boston Pizza was up 2.6% after releasing a good earnings report. Bank of America was up 3.3%.

Earnings reports will be coming in hot and heavy in the next few weeks and this will no-doubt affect individual stock prices when the earnings and/or outlook are different than expected.

I have not looked at RioCan in over one year but I found it strange that the rate reset pref shares on the list above are at $21.90 in this low interest rate environment while the actual Trust units have done very well. I would have thought that the REI.PR.A shares are good value at $22, as they yield 6.0%. It seems that rate reset pref shares in general fell in January as interest rates plummeted. It appears that market “spread” for such shares has widened as the Canada bond yield fell.  The five year Canada bond is at 0.68%, this RioCan pref would reset at 262 basis points above that or at 3.3% and that may explain the price drop, presumably the market yield on this type of pref is well above 3.3. I think I have just talked myself out of thinking that these pref shares are good value at $22. I had thought hat the rate reset shares would tend to trade back to $25 when the rates reset unless the particular company was seen as less risky. But it seems that as the 5 year Canada bond rate has plummeted the market yield on 5 year rate rest pref shares has not similarly plummeted. If it had these shares would likely be somewhat over $25 at this time. I certainly agree that any thing like 3.3% is a low yield on a pref share. But what is truly bizzarre is the 0.68% yield on the five year government of Canada bond. 

The bottom line is that if the five year Bank of Canada interest rate stays at 0.68% then the dividend on these shares is going to be cut from the current $1.3125 to $0.825 on March 31, 2016 in order to yield 3.3% on a $25 price. If the market yield on such shares at that time is 4.0% then the price would be $20.625.

Maybe the market yield on such shares will fall. After all homeowners can get five year mortgages at under 3.0%

At this point anyone buying the RioCan pref shares can not count on them being repurchased a by the company at $25, cannot count on the market price going back to $25 on the reset date and has to understand that at the current Bank of Canada 5 year rate, the distribution on these shares would be cut to 82.5 cents on the reset date in just over one year.

It seems that the market price of these shares will rise if government interest rates rise and that is the opposite of what normally happens to a fixed income instrument. But a rate reset share is not a fixed income investment it seems. 

At this point I am liking the Boston Pizza units a lot more than these rate reset shares.