September 29, 2015

S&P 500 up 0.1% and Toronto up 0.2%.

Bombardier was up 7.0% on comments from the Quebec government that Bombardier’s contribution to the economy is highly valued by the government and the company would be supported (though there were no specifics). That is of course positive. But one should remember that the company and its jobs could possibly be supported in ways that fail to protect equity share owners.

Valiant was down another 4.4%. As I hear stories about price gouging I think back to my reading of its reports. I don’t remember the company indicating that its strategy was to raise prices on drugs. I thought it high-lighted “synergies”. In any case this latest news is another reason for me not to trust this company. It seems bizarre that the United States would not have any regulation at all on drug prices. That would seem to be an invitation to gouge in certain cases. Traditional economic logic is that monopolies need to be regulated as to price. And Valiant has a monopoly for certain drugs. The whole notion that Valiant was suddenly worth more than the Royal Bank seemed a little strange to me.

My previous order to add to my Boston Pizza position which I had placed last Wednesday at $17.26 was filled today. I continue to marvel at the ability to buy this with a 7.5% yield. Recall this is a top-line entity which simply collects a portion of the franchise fee and distributes it to owners of Boston pizza Royalty. It’s basically a toll booth on all food orders at Boston Pizza. A long as people keep eating at Boston Pizza the toll will be paid. And if the volume of people or the menu prices rise over time then the “toll” (the franchise fee) rises. (The opposite is true as well of course.) I am not seeing much chance of down-side for those buying at this price and holding, though there are never any guarantees.

I have mentioned insider buying at this entity. About ten insiders bought in August at prices from about $16.50 to $18.00. Two of them added a bit more in September at about $17. The entity itself has been buying back shares since August 21 (after it took a long break from doing so) and has paid about $16.80 to $17.50. The entity is buying relatively small quantities but this still seems like a positive indicator.

One thing that the plunge in this entity and in particular the plunge in rate reset shares has demonstrated is that there is no substitute for cash. If you absolutely need the money back for spending in a short period of time (like a year or two or less) or if you are absolutely unwilling to chance any loss in market value then you must restrict investments of that money to cash and cash equivalents including savings accounts GICs and government guaranteed investments of the required term. But for those willing and able to stomach some risks then the various rate reset preferred shares that have declined in value and entities like Boston Pizza Royalties that have declined in price would seem like good choices. With rate reset preferred shares though, one has to be aware of the reset date and the yield that would result if the five year bank of Canada bond yields stays around its current level of about 0.8%.

Consider the Enbridge pref share that we last rated as (higher) Buy at $19.27. These have now declined to $16.85 paying $1.10 and yielding 6.5%. The negative part is that the reset dividend could be in the order of 84 cents at about the current 5 year Canada rate. But that would still be a 5.0% yield at the current price. And the reset does not happen until December 2019 or about four years. So, one scenario is that you pay $16.85 today. You collect about $4.40 in dividends over the next four years and then the yield falls to about 5% on your original $16.85 if interest rates remain at todays low levels. And if rates are still near-zero in 2019 then I expect the market yield on pref shares will be less than 5% and so the price on these shares could rise.

But almost everyone is expecting interest rates to rise in which case the reset dividends could be closer to today’s $1.10 in which case I would expect the value of these shares to rise. So, I am just not seeing much chance of down-side here if held for the four years.

Then again, I did not in any way expect the fall to $16.85 either.  And perhaps these share prices could drop even further as people sort of capitulate or do some tax-loss selling. But to me the price already looks irrationally low.

And one more thing to add to this lengthy post: Costco came out with earnings after the close that looked very strong. Same store sales figures were hurt by lower gasoline prices (which should not affect the profit) and due to currency impacts on Canadian and other international locations. Adjusting for those two items the same-store growth was stellar at 6%. I notice already some stories that suggest Costco “missed revenue estimates”. Well, one can spin this negatively if they want but at a quick look I think the report was strong. I think it is appropriate to adjust for currency and gasoline prices in looking at same-store growth trends. I would not however adjust the earnings for that (because the lower gasoline prices and the exchange rates might stay where they are) but in any case the raw earnings per share were up a healthy 9%.

By the way, one segment that will be hurt by the lower gasoline prices is credit card companies (Visa, mastercard and Amex) . Their take at the pump is generally some fixed percentage of the price of gasoline and so their revenue from gasoline retailers declines at lower gas prices. I am not sure if that is all material to them overall but it is a negative.


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