CU.PR.C To Reset At 3.40%

Canadian Utilities Limited has announced:

that it has notified the registered shareholder of its Cumulative Redeemable Second Preferred Shares Series Y (“Series Y Preferred Shares”) of a conversion privilege and applicable dividend rates. As a result, subject to certain conditions, the holders of Series Y Preferred Shares will have the right to choose one of the following options with regard to their shares:
1.To retain any or all of their Series Y Preferred Shares and continue to receive a fixed rate quarterly dividend; or
2.To convert, on a one-for-one basis, any or all of their Series Y Preferred Shares into Cumulative Redeemable Second Preferred Shares Series Z (“Series Z Preferred Shares”) of Canadian Utilities Limited and receive a floating rate quarterly dividend.

Effective June 1, 2017, the annual dividend rate for the Series Y Preferred Shares is set at 3.40% for the five-year period from and including June 1, 2017 to but excluding June 1, 2022 and the dividend rate for the Series Z Preferred Shares is set at an annual rate of 2.95% for the three-month period commencing June 1, 2017 to but excluding September 1, 2017. The dividend rate for the Series Z Preferred Shares will be reset each quarter. Both rates were calculated according to the terms described in the prospectus supplement of Canadian Utilities Limited dated September 15, 2011.

Beneficial owners of Series Y Preferred Shares who wish to exercise their right of conversion should communicate as soon as possible with their broker or other nominee and ensure that they follow their instructions in order to meet the deadline to exercise such right, which is 3 p.m. (Calgary time) / 5 p.m. (Toronto time) on May 17, 2017. Any notices received after this deadline will not be valid. As such, it is recommended that this be done well in advance of the deadline in order to provide the broker or other intermediary with time to complete the necessary steps.

The foregoing conversions are subject to the conditions that: (i) if Canadian Utilities Limited determines that there would be less than 2,000,000 Series Y Preferred Shares outstanding on June 1, 2017, then all remaining Series Y Preferred Shares will automatically be converted into Series Z Preferred Shares on June 1, 2017, and (ii) alternatively, if Canadian Utilities Limited determines that there would be less than 2,000,000 Series Z Preferred Shares outstanding on June 1, 2017 after giving effect to conversion notices received, no Series Y Preferred Shares will be converted into Series Z Preferred Shares. If either of these scenarios occurs, Canadian Utilities Limited will issue a news release to that effect on or before May 24, 2017.

Holders of the Series Y Preferred Shares and the Series Z Preferred Shares, as applicable, will have the opportunity to convert their shares again on June 1, 2022, and every five years thereafter as long as the shares remain outstanding.

For more information on the terms of, and risks associated with an investment in, the Series Y Preferred Shares and the Series Z Preferred Shares, please see Canadian Utilities Limited’s prospectus supplement dated September 15, 2011, which can be found under Canadian Utilities Limited’s profile on SEDAR at www.sedar.com.

With approximately 5,400 employees and assets of $19 billion, Canadian Utilities Limited is an ATCO company. ATCO is a diversified global corporation delivering service excellence and innovative business solutions in Structures & Logistics (workforce housing, innovative modular facilities, construction, site support services, and logistics and operations management); Electricity (electricity generation, transmission, and distribution); Pipelines & Liquids (natural gas transmission, distribution and infrastructure development, energy storage, and industrial water solutions); and Retail Energy (electricity and natural gas retail sales). More information can be found at www.canadianutilities.com.

CU.PR.C is a FixedReset 4.00%+240 that commenced trading 2011-9-21 after being announced 2011-9-13. It has been a member of the FixedReset subindex since inception.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., BAM.PR.T and the FloatingReset BAM.PR.W that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

pairs_fr_170503
Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below current market rates, at +0.02% and -0.44%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the CU.PR.C FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of FloatingReset CU.PR.? (received in exchange for CU.PR.C) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 0.50% 0.00% -0.50%
CU.PR.C 22.17 231bp 21.64 21.11 20.58

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, it seems likely that I will recommend that holders of CU.PR.C continue to hold the issue and not to convert, but I will wait until it’s closer to the May 17 notification deadline before making a final pronouncement. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Thanks to Assiduous Reader KC for ensuring I was aware of this!

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