February 23, 2016

Tuesday’s action had the S&P 500 down 1.3% and Toronto was down 0.6%.

Most stocks were down but Bombardier was up 4.8% and Toll Brothers was up 3.8% on its earnings release. I thought Toll should be up more than that. Perhaps it will rise again tomorrow as analysts digest the results and outlook.

Our report for Canadian Tire will be updated soon and it will be rated either Buy or (lower) Buy. It’s a strong company.

AutoCanada announced that it is selling a Infiniti / Nissan dealership in Newmarket Ontario. They say they got an unsolicited offer and that this allows them to pay some debt and also rid them of an obligation to build a separate Infiniti dealership at a time when they are being cautious with capital spending. They did not say if there is a gain so I suspect possibly a modest loss on the sale. Still, I don’t think this is particularly bad news. Instead it shows that the company is actively managing the business and reacting to the realities of the market at this time. Nevertheless the market may react negatively.

A detailed comment on Rate Reset preferred shares:

Rate reset preferred shares were down on the order of 4% in a few cases today.

There seems to be a disconnect between what companies are willing to pay on Rate reset preferred shares and the yield that investors demand. Also a disconnect between the yield on these versus five year bonds.

I talked to RioCan today and they confirmed that they chose to redeem the preferred series A preferred shares at $25 because they had the money to do and the rate they would pay was more expensive than they would pay on debt.

Due to the reset feature, and the low yield on 5 year government bonds, these shares would have been reset to pay only about 3.4% on a $25 face value. Just prior to the surprise announcement that they would be redeemed at $25, they were trading at about $16 which would be a yield of about 5.3% (after the March 31 reset).

RioCan believed that, upon reset, most holders would have taken the floating rate option with an initial yield of 3.1%.

Recently issued rate reset preferred shares are yielding about 5.5% or higher.

The disconnect that I see is that while investors won’t buy rate reset shares unless they yeild about 5.5% or higher, RioCan was not interested in exercising its right to keep these shares outstanding even at 3.4% fixed or 3.1% floating.

Perhaps RioCan feared most investors would take the floating optional then rates would rise.

Meanwhile Investors want 5.5% on the fixed resets because they fear rates will go even lower, possibly negative and the resets will be even lower.

Overall, with a five year government bond paying 0.60% and high quality five year corporate bonds paying 2.2% to 3.3%, rate reset shares that yield 5.5% and qualify for the dividend tax credit would seem more attractive. But, of course, the bonds have the advantage of a known maturity price.

Overall the rate reset shares on our list that are down in price, Canadian Western Bank preferred and Enbridge preferred seem attractive to me. But I also thought they were attractive at higher prices. These shares could fall even further if negative interest rates become a reality. For that reason I would prefer Boston Pizza to these, but I hold some of each.




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