Category: Issue Comments

These issues are currently rated P-2(low) by Standard & Poors, which today placed them on Credit Watch Negative:

At the same time, Standard & Poor’s placed its ratings, including its ‘BBB+’ long-term corporate credit rating, on parent company George Weston Ltd. on CreditWatch with negative implications.
     “The CreditWatch placement reflects the magnitude of challenges faced by Loblaw,” said Standard & Poor’s credit analyst Don Povilaitis. These challenges include substantially lower profitability, supply chain difficulties, significant senior management changes, a new corporate structure which involves substantially reducing the number of employees at head office, and a material goodwill impairment charge.

…
The ratings on Loblaw and George Weston, which has a 62% equity interest in Loblaw, are linked and jointly influenced by the respective credit profiles. The ratings on the two companies are likely to move in tandem, as Loblaw represents a significant portion of George Weston’s revenues and earnings, and is therefore a key driver of George Weston’s overall performance.

This is due to Loblaw’s announcement of lower earnings and goodwill impairment:

Basic net earnings per common share for the fourth quarter, before taking into account a charge with respect to an expected goodwill impairment, were $0.16 compared to $0.73 in 2005. For the year, basic net earnings per common share, before taking into account a charge with respect to an expected goodwill impairment, were $2.12 compared to $2.72 in 2005.
    The Company has performed its annual goodwill impairment test analysis. Based on this analysis, it is anticipated that the carrying value of the $1.5 billion of goodwill associated with the acquisition of the Provigo business in 1998 is impaired. As a result, the Company expects to record in the fourth quarter an initial estimate of a goodwill impairment charge, which the Company estimates to be in the range of $600 million to $900 million, in its audited consolidated financial statements for the year ended December 30, 2006. This is a non-cash charge that is expected to be finalized and adjusted as necessary in the first half of 2007. This expected charge will result in a negative impact to basic net earnings per common share for the fourth quarter and the full year of $2.19 to $3.28 per share. After the impact of this charge, the Company expects to record a basic net loss per common share in the range of $2.03 to $3.12 in the fourth quarter. For the year, after the impact of this charge, the Company expects a basic net loss per common share in the range of $0.07 to $1.16.

There has as yet been no announcement from DBRS, which rates the issues at Pfd-2(low).

Update, 7:50pm EST DBRS has announced that Weston is “Under Review with Negative Implications”.

TransCanada Corporation today announced that:

it has entered into an agreement with a syndicate of underwriters, led by BMO Capital Markets, RBC Capital Markets, and TD Securities Inc. under which they have agreed to purchase from TransCanada and sell to the public 39,470,000 Subscription Receipts.The purchase price of $38.00 per Subscription Receipt will result in gross proceeds of approximately $1.5 billion. The net proceeds of the offering will be used by TransCanada towards financing the proposed acquisition of the American Natural Resources Company and ANR Storage Company (collectively, ANR). TransCanada announced the acquisition of ANR together with the acquisition of an additional interest in Great Lakes Gas Transmission Limited Partnership for a total of approximately US$3.4 billion, including US$457 million of assumed debt, on December 22, 2006.

TransCanada has also granted the Underwriters an option to purchase up to an additional 5,920,500 Subscription Receipts at a price of $38.00 per Subscription Receipt at any time up to 30 days after closing of the offering.

On closing of the ANR acquisition, the Subscription Receipts will automatically be exchanged on a one-to-one basis for common shares of TransCanada without any further action on the part of the holder and without payment of additional consideration.

Readers will recall that DBRS placed these issues Under Review with Developing Implications in December:

DBRS estimates that, on a pro forma consolidated basis, the Company’s debt-to-capital ratio (62% on a DBRS-adjusted basis as at September 30, 2006) would rise to 69% on a 100% debt-financed basis.

However, given new common equity worth $1.5-billion against a total price on the acquisition of about CAD $4-billion, it would appear that the debt-to-capital ratio will be materially unchanged … but note that I have not done a credit analysis or read any fine print!

I’ll update this post when we see what DBRS has to say.

Coastal Income Corp has announced (via CCN Matthews) that:

it will redeem all of its issued Senior Preferred shares (TSX:DIV.pr.A) on March 20, 2007. The redemption will be made in accordance with the Fund’s articles and results from a retraction of the Capital shares. Shareholders need not take any action relating to the redemption; the Fund’s transfer agent CIBC Mellon will automatically redeem the shares on March 20, 2007 and deposit cash proceeds directly into shareholder’s accounts equal to $25.51071, representing $25.20 per share plus $0.31071 per share representing accrued and unpaid dividends. Post the redemption, the Senior Preferred shares will no long be listed on the TSX.

The closing quotation today was 25.67-00, with 3,400 shares trading, all in the 25.96-00 range.

I mentioned this issue in the post Mean-YTW on SplitShare Index Goes Negative!

Hat-tip to the reader who brought this to my attention!

It has been announced that Great-West will aquire Putnam Investments for CAD 4.6-Billion.

In response, DBRS has placed the entire corporate structure on credit review with developing implications: GWO (which includes CL and GWL), PWF and POW.

Standard & Poors has taken a much more nonchalant approach, affirming the current ratings.

According to GWO:

Funding for the transaction will come from internal resources as well as from proceeds of an issue of Lifeco common shares of no more than CDN $1.2 billion, the issuance of debentures and hybrids, a bank credit facility, and an acquisition tax benefit securitization.

This transaction might possibly explain the mystery of CL.PR.B, which has still not been called. If they have to push through a lot of net issuance, they’re probably not too enthusiastic about calling the old stuff – CL.PR.B has 6-million shares outstanding, so redeeming it at $26.00 would add $156-million to the amount of gross issuance required.

Similarly, it is possible that the resources devoted to the GWO.PR.E / GWO.PR.X Issuer Bid will be reduced.

For the other companies in the group, the transaction may affect, for instance, the chance of PWF.PR.J being redeemed early.

One may take a lot of views and play with a lot of scenarios. Me, I’m just going to assume, as always, that the worst scenario – in life, love and investing – is most likely.

After their initial attempt to make quorum failed, Faircourt tried again and was able to get approval from the preferred security holders and the Capital Unitholders.

The merger is expected to close on or about January 31, 2007, and the continuing security will be FIG.PR.A.

Update 2007-1-31 : Yet another press release! Everything has been completed.

I had lunch today with an industry professional who expressed doubt over my fears (expressed by my according a high weight to Yield-to-Worst) that PWF.PR.J would be redeemed early. So, first, let’s look at the situation – the redemption schedule is:

Since the closing quote on January 25 was $26.82-88, this give rise to the following information from the pseudoPortfolioReportBox:

Perhaps the exact dates, third decimal places and probabilities are arguable, but I think the basic facts above can be agreed by all practitioners.

So, in the HIMIPref™ analysis, the Yield-to-Worst is given a large weight in the REWARD_CLASS_YIELD component of valuation. In addition, the issue is tagged with the tradeSizeCalculationNotes tag of “14” indicating

If pseudoModifiedDurationWorstBid is less than minWorstBidPseudoModifiedDurationBuy, buySize and sellSize are set to 0.

Therefor, HIMIPref™ will not, given current market conditions, recommend the purchase of PWF.PR.J, since the internal calculateTradeSize function will always return a buySize of zero.

My companion said this is a load of hooey. PWF.PR.J has the lowest annual dividend of any of the Power Financial issues and therefore, if they redeem anything, it will be something else. Therefor, investors may assess this issue on the basis that it will survive until its softMaturity … maybe with an allowance for the risk of an early call, to be sure, but the default case is a pre-tax yield of 3.45% until 2013.

Well – I disagree. By me, the worst case is the default case. Remember, a pessimist is an optimist with experience. But let’s look at some details:

First: I agree that PWF.PR.J has the lowest coupon of any PWF issue … readers may confirm this by looking at the appropriate rows of the table on prefInfo. But let’s have a look at some of the details of these issues:

Now … first off, let’s just guess that PWF could sell new retractibles with a $0.90 coupon. This looks kind of skimpy, but consider the CGI.PR.C, issued last March with a $0.975 coupon, and MFC.PR.A, trading to yield 3.13%, and of course the yield-to-retraction on the PWF.PR.J themselves of 3.45%. In light of this, a coupon of $0.90 on a new retractible doesn’t look all that much out of place.

New perpetuals … well, Sunlife, an equally rated credit (by DBRS) is in the process of selling (or has sold, depending on the terms of their underwriting!) perpetuals with a coupon of $1.125.

If, instead of looking at the gross coupon on PWF’s preferreds, one looks at the savings achievable by refinancing with an issue of similar characteristics, then a lot of the PWF.PR.J cheapness to the issuer disappears.

And that is still not the end of the story! When we look at the Annual Report for 2005, we find a note that regular readers will have got thoroughly sick and tired of by this time:

Effective for fiscal years beginning on or after November 1, 2004, CICA 3860, Financial Instruments — Disclosure and Presentation was amended to require obligations that an entity must or can settle by issuing a variable number of the issuer’s own equity instruments to be presented as liabilities rather than equity. On January 1, 2005, the Corporation adopted the amended standard retroactively with restatement of prior periods. Some of the Corporation’s ($300 million) preferred shares were reclassified from Shareholders’ equity and some of the subsidiaries’ ($1,366 million) preferred shares were reclassified from Non-controlling interests to Liabilities and the associated preferred dividends were reclassified to Financing charges in the Consolidated Statements of Earnings. The change does not have any impact on earnings per share or net earnings available to common share holders since preferred share dividends were previously deducted from net earnings in determining net earnings  available to common shareholders.

The moral of the story being: for reporting purposes, PWF.PR.J is a BOND, not a component of equity, and will get lumped in with bonds when reporting the all important coverage ratios.

So let’s have a look at some bonds. The Great-West Lifeco bond, 6.14% of March 2018, is currently indicated at a spread of 68bp over the Canada 4% 2016. The Canada 4% 2016 are (or were, anyway, at the time the indications I’m reading were prepared) trading to yield 4.208%, so we can say the GWL bonds of 2018 are trading to yield, oh, call it 4.90%.

Now … the important thing about preferred dividends is that the company has paid tax on them. This is an area in which I will not pretend to any great expertise, but let’s just assume, for the sake of an argument, that the company’s average tax rate (disclosed in Note 8 of their annual report) of 26% is equal to the marginal rate they would save if they magically converted the dividends on their retractibles to interest on bonds and were entitled to deduct it. We’ll make this a more familiar by calculating 1/(1-0.26) = 1.35 and calling this the equivalency factor … fortunately, this is pretty close to the Equivalency Factor for Fat Cat Ontarians of 1.4x that I normally use for illustrative purposes.

So … getting back to PWF.PR.J … commencing 2008, the company will, effectively, be borrowing $25.00 at an annual rate of a dividend of $1.175, less the annual saving (a reduction in deemedDividend to the shareholder, so I presume it costs the company extra as well) of $0.25, for a net cost of $0.925. This is an annual rate of 3.7. Multiply by the company’s equivalency factor of 1.35x and this is the equivalent, as far as their treasury department is concerned, of 5%.

AND, I’ll point out, the pref will only be 4-year money. They can issue 10-year paper for 4.90%. You are the treasurer. What do you do?

So, let me summarize my position on PWF.PR.J:

• Since it is retractable, the proper benchmark as far as the company concerned is a bond, not other prefs.
• 10-year bonds can be issued at a net cost lower than the 4-year pref
• At the very least, the chance that the PWF.PR.J holder will get called early and experience the worst-case scenario is significant.
• Analysis, schmanalysis. We’re fixed income investors here, and we hate risk, especially risks that depend on the day-to-day tone of the market and decisions made on the basis of an individual company’s capital structure
• There are issues out there that carry significantly more yield
• Even if we know, absolutely for certain, that the issue will hang on until the day before retraction, the yield is only 3.45%. At an equivalency factor of 1.4, this is an interest-equivalent of 4.83%.
• Why don’t we simply buy a bond that yields this much, that has better credit protection? Just because the PWF.PR.J is classed as a bond-equivalent for balance sheet purposes, we don’t move closer to the front of the line if the company runs into trouble.