The Payout
The New Flyer income deposit security (“IDS”) consists of one common share and a C$5.53 principal 14% subordinated note. The monthly distribution currently consists of a C$0.03298 cash dividend and a C$0.06453 interest payment on the note, for a total monthly distribution of C$0.0975. At the closing share price $7.79 on June 10th, that's a 15% yield.
Unfortunately, the increasingly competitive environment means the company will need to cut payments to IDS holders. Investor worries surrounding the upcoming decision seem to have driven the recent price drop from the C$11.50-12.00 range to the current price below C$8.
Strategic Options
New Flyer's board is in the process of evaluating a number of strategic options, both to better cope with the cyclical nature of the industry and the unsustainable distributions.
No matter what the structure, New Flyer is an excellent value company at the current price. I like the income security nature of the current structure, and would be happy to hold the New Flyer IDS at current prices even if the dividend is reduced to zero, but I'd also be comfortable if New Flyer converts to a more traditional equity structure.
If the current IDS were somehow converted into straight equity trading at the same price (C$7.79), the P/E ratio would be about 8, after taking into account the reduced earnings due to the loss of the interest tax shelter!
The Q1 2011 book value per share was US$2.36 or C$2.32, so the combined book and principal value of an IDS is C$7.85, above the current stock price. For a company that will almost certainly continue to pay the interest on the subordinated note until the notes are called, this seems like a bargain. The interest payment alone amounts to a 10% yield at C$7.79!
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Wednesday, June 29, 2011
Saturday, June 25, 2011
Cover yourself with call options on the Canadian banks!
The stocks of the Big Six Canadian banks as a whole have experienced a good run after recently posting solid quarterly earnings. The S&P/TSX Canadian Banks Index, an Index that tracks the Canadian banks, recently broke above its pre-crisis high. While this could be bullish for the group, a failure to hold above this level could potentially send the index lower. Its Relative Strength Index (RSI), a technical indicator, has moved slightly beyond a 70 reading, which tends to indicate that, near-term, it’s overbought.
A Canadian bank covered call strategy can protect some of the downside protection, while still maintaining exposure to the Big-Six Canadian banks!
For hedging purpose in flat and down markets I purchased the BMO Covered Call Canadian Banks ETF (ZWB/TSX), which carries a management fee of 0.65% and an annualized yield of about 10 %. A covered call is generally attractive to investors bullish on an equity or sector but who expect the security to trade within a narrow range while the covered call is in place. Utilizing a covered-call strategy on the Canadian banks allows investors to retain exposure to Canadian banks while also maintaining some downside protection. Potential weakness in the performance of the stocks of Canadian banks will be partially offset by the premium earned selling call options. In addition to the underlying dividend yield of the banks, call option premiums collected will also enhance the overall yield of the strategy.
The BMO Covered Call Canadian Banks ETF (ZWB) is an actively managed fund that holds Canadian bank stocks or units of the BMO S&P/TSX Equal Weight Banks Index ETF (ZEB) and writes covered call options on the underlying securities depending on market conditions. The call options written are slightly out of the money and are rolled forward every month upon expiry. The underlying portfolio is rebalanced twice annually.
Since its inception in January 2011, the fund has made monthly distributions totalling $0.512. Tax advantaged distributions are a mixture of dividends from the underlying portfolio and option premiums, which are taxed as capital gains.
I expect Canadian banks to stay rangebound. Valuations and returns for the next year or so will be driven by dividend increases because the underlying valuations have largely returned to pre-crisis levels. Therefore I would expect ZWB to outperform in flat and down markets and ZEB to outperform when bank shares are advancing sharply.
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