December 22, 2015

The S&P 500 was up 0.9% on Tuesday and Toronto was up 0.4%.

The five-year government of Canada bond yield was down to 0.72% on Monday and edged up to 0.75% on Tuesday. This very low yield continues to keep rate reset preferred shares trading at low prices since the dividend will reset at the reset date based on the five year Canada bond plus a contractual spread. For rate reset prefs that are trading at low prices I would favor those that have a longer time before the reset date. Those could provide a capital gain in two possible ways: 1. If the five-year Canada yield rises in the intervening months and years then the reset dividend could be more attractive. 2. If the five-year Canada bond yield remains low in another two or three years then perhaps the market yield on preferred shares will return to close to the 4% level reflecting what might then be an expectation of relatively permanently low rates. I am hoping for scenario number 1. On the other hand capital losses are always possible if the credit condition of the issuing company deteriorates.

Q4 is coming to a close. Many companies are going to report large currency gains and losses. U.S. multi nationals like Costco, Walmart, Fedex, Berkshire and Visa will see negative currency impacts.

Canadian companies that sell into the U.S. or that own subsidiaries in the U.S. will benefit from the lower Canadian dollar. This includes Stantec, Onex, Element Financial, and TransForce.

Bombardier and Couche-Tard are interesting in that they are Canadian companies that report in U.S. dollars because they do the majority of their business in U.S. dollars but also do substantial business. The lower Canadian dollar will have a negative effect on their reported earnings but when translated back to Canadian dollars the impact would be poitive. This should be beneficial to the Canadian dollar share price.

Canadian Tire which sells in Canadian dollars exclusively but which faces buying about half or more of  its products in U.S. dollars should be negatively impacted by the lower Canadian dollar. This is particularly true because Canadian Tire has not raised its prices (at least it had not as of Q3). So far, it has managed to overcome the dollar impact by working on its purchasing strategies and also by cost cutting. It also had a certain amount of hedges. I strongly suspect that the sharply lower Chadian dollar will finally start to hurt Canadian Tire by Q4 unless they can raise prices to compensate. Some of the same comments apply to Dollarama but I understand it has already raised some prices and with its strong growth and given its products may be in a better position to raise prices without scaring away customers.

All of the companies mentioned may have some hedging in place. But as Canadian Tire stated a year ago. Hedging only provides a “glide path”. Hedging is generally not done for more than a year in the future and so it only delays currency impacts. It simply can’t permanently eliminate the impact. Hedging is expensive and ties up balance sheet assets or borrowing capacity and so it is rare to go much beyond one year or certainly beyond two years. Hedging can also leave a company at a disadvantage if the currency moves in the other direction. Competitors could have a beneficial currency move that the hedged company has hedged away.

Some companies do have a certain amount of natural permanent hedge where revenues and expenses are both in a foreign currency. In that case it is the profit that will not be permanently hedged.


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