1. Basics
Preferred shares usually are not good candidates. They offer rate might be a little higher than bonds but usually without mature date. Also interest on preferred shares are paid as dividend but not interest. It is after tax and can't count as expense by the company. Usually they are offered at $25 par value and a fixed interest rate. Price of preferred shares is often like bonds: when interest rate goes up, price goes down to make yield goes up to match higher interest, and vice versa.
However, since 2009 to 2010, there are new type of rate resets and floater which now account over 60% of preferred share markets. Floaters use 3 months Canadian T-Bill rate as base rate and plus an fixed rate of 1% to 4% based on the company's credit. Resets will use 5 year Canadian government bond rate as base rate and plus an fixed rate as well. Resets will only change rate every 5 years. Many companies issue resets and floater at the same time and make them exchangeable to each other at the rate reset date.
The creation of floater and resets is to protect the investor against the low interest rate caused by 2008 crash. Everyone expect the interest to go up at 2010. However, pre-2008 crisis, the 5Y Gov Bond Rate was around 4%. At 2010, it is around 2.5%. And now it is only 0.65%. Since 2015, it is time for rate resets of many preferred share. I guess all the companies are pretty happy that they can pay 2% less dividend in the next 5 years. But the preferred shares price dropping quite a lot because of the low rate. Most interesting ones are the those who are trading between $10-$15 which will rebound a lot once interest rates goes up.
Preferred shares are rated by DBRS and usually a RDF-2 is a good company which currently should yield below 5%. an RDF-3L seems the lowest we can invest which might yield around 10% now.
2. Thoughts
(1) One benefit of preferred shares is the dividend which is way more tax friendly than interest. As eligible dividend, the tax rate could be -2% if income is less than $30k. But if include Ontario health care premium, it might not as good as it looks. Needs more study on this part.
(2) I think there is way higher chance of a higher interest rate in next 5 years. The low rate can't last forever, I am assuming 2.5% base rate at 2021 which is around 2% higher than current. For the next 5 years I estimate 5Y rate: 2017: 0.8%, 2018: 1.0%, 2019: 1.5%, 2020: 2.0%, 2021: 2.5%.
(3) The return on preferred share is combined of dividend and capital appreciation. I would like to put more weight on capital appreciation than dividend income.
(4) Usually an RDF-2 will yield 5% at issuing time. If base rate is 2.5%, it will be base+2.5%. If now it is the time to reset. The new rate will be only 3%. To make up the same 5% yield, the price would be $15. Assume at 2021 the base rate will be back to 2.5%, the price goes back to $25. Including the dividend, the annualized return would be close to 15%.
(5) Besides the interest rate ETF, the preferred shares are very good candidates to hedge interest raise. If selected carefully, the return could be very attractive although might be as good as common shares.
3. Risk
(1) The interest rate goes even lower. However, the down side are pretty limited which can't be below zero I feel.
(2) The interest rate will last for the next 5 years. In this case, preferred share price will not change much but we will still be able to collect the dividend return.
(3) The individual company might suspend dividend payment or go bankrupted. This needs careful selection of preferred shares and diversify.
4.Links
http://www.theglobeandmail.com/globe-investor/investment-ideas/bull-market-in-despondency-offers-opportunities-in-preferred-shares/article28748446/
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AIMIA INC PREF SERIES 1(TSE:AIM-A)
AIMIA INC PREF SERIES 2(TSE:AIM-B)
AIMIA INC PREF SERIES 3(TSE:AIM-C)
Aimia Inc(TSE:AIM)
1. Basic
(1) Current price: A:$10.74, B:$10.36, C: $14.00. Credit rating is RDF-3H. Current Yield 10%-11% A: Reset date: 31/3/2020, Reset rate: 5YBond +3.75%. C: Reset date 31/3/2019. Reset rate 5Y Bond + 4.2%. Reset yield 9%-10% if 5Y Bond rate stay the same. The AIM-B is a floater and can be converted to A at reset date. Its rate is 3M T-Bill + 3.75%.
(2) Aimia is a spin off of Air Canada. Its major business is aeroplan. It has quite strong FCF generation of $200m/year. However, it pays $140m in dividend annually. And bought back a lots of shares last year. On the balance sheet, it has $400m in cash and around $650m in debt. Negative tangible book value.
2. Thoughts:
(1)For A: Assume 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 6.25%, to make the same 10% yield, price should be $15.25. Added dividend the AR is 16.5%.
(2)For C: Assume 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 6.7%, to make the same 8.82% yield, price should be $19.05. Added dividend the AR is 16.5%.
3. Risk
(1) Its contract renewal with Air Canada at 2019 might get bad terms.
(2) The major banks might cut aeroplan rewards and affect the company.
4. Links
New Position: Aimia Preferred Shares
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CANACCORD GENUITY GROUP INC PREF A(TSE:CF-A)
CANACCORD GENUITY GROUP INC PREF C(TSE:CF-C)
Canaccord Genuity Group Inc(TSE:CF)
1. Basic
(1) Credit rating is RDF-3L. CF-A: Current price: $11.07. Current Yield 12.4%. Reset date 30/9/2016. Reset rate 5Y Bond + 3.21%. Reset yield 8.72% assume no rate change. CF-C: Current price: $13.51. Current Yield 10.64%. Reset date 30/6/2017. Reset rate 5Y Bond + 4.03%. Reset yield 8.66% assume no rate change.
(2) Cannacord has investment bank and brokerage business. Its revenue and income is kind of volatile through the finance crisis and recent oil down turn. However, its FCF-WC is roughly stable at $30m-$80m/year. Currently dividend is suspended on common share. Has $1B cash equivalence and no debt. Tangible book value $400m compare to $200m in preferred shares.
2. Thoughts:
(1)For CF-A: Assume 5Y later at 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 5.71%, to make the same 8.72% yield, price should be $16.37. Added annual dividend of $0.965 after reset the AR is 15.5%.
(2)For CF-C: Assume 5Y later at 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 5.51%, to make the same 8.72% yield, price should be $15.6. Added annual dividend of $0.965 after reset the AR is also 15%.
3. Risk
The company might suspend preferred dividend as well.
4. Links
Cannacord Genuity Preferred Shares
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AIMIA INC PREF SERIES 1(TSE:AIM-A)
AIMIA INC PREF SERIES 2(TSE:AIM-B)
AIMIA INC PREF SERIES 3(TSE:AIM-C)
Aimia Inc(TSE:AIM)
1. Basic
(1) Current price: A:$10.74, B:$10.36, C: $14.00. Credit rating is RDF-3H. Current Yield 10%-11% A: Reset date: 31/3/2020, Reset rate: 5YBond +3.75%. C: Reset date 31/3/2019. Reset rate 5Y Bond + 4.2%. Reset yield 9%-10% if 5Y Bond rate stay the same. The AIM-B is a floater and can be converted to A at reset date. Its rate is 3M T-Bill + 3.75%.
(2) Aimia is a spin off of Air Canada. Its major business is aeroplan. It has quite strong FCF generation of $200m/year. However, it pays $140m in dividend annually. And bought back a lots of shares last year. On the balance sheet, it has $400m in cash and around $650m in debt. Negative tangible book value.
2. Thoughts:
(1)For A: Assume 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 6.25%, to make the same 10% yield, price should be $15.25. Added dividend the AR is 16.5%.
(2)For C: Assume 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 6.7%, to make the same 8.82% yield, price should be $19.05. Added dividend the AR is 16.5%.
3. Risk
(1) Its contract renewal with Air Canada at 2019 might get bad terms.
(2) The major banks might cut aeroplan rewards and affect the company.
4. Links
New Position: Aimia Preferred Shares
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CANACCORD GENUITY GROUP INC PREF A(TSE:CF-A)
CANACCORD GENUITY GROUP INC PREF C(TSE:CF-C)
Canaccord Genuity Group Inc(TSE:CF)
1. Basic
(1) Credit rating is RDF-3L. CF-A: Current price: $11.07. Current Yield 12.4%. Reset date 30/9/2016. Reset rate 5Y Bond + 3.21%. Reset yield 8.72% assume no rate change. CF-C: Current price: $13.51. Current Yield 10.64%. Reset date 30/6/2017. Reset rate 5Y Bond + 4.03%. Reset yield 8.66% assume no rate change.
(2) Cannacord has investment bank and brokerage business. Its revenue and income is kind of volatile through the finance crisis and recent oil down turn. However, its FCF-WC is roughly stable at $30m-$80m/year. Currently dividend is suspended on common share. Has $1B cash equivalence and no debt. Tangible book value $400m compare to $200m in preferred shares.
2. Thoughts:
(1)For CF-A: Assume 5Y later at 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 5.71%, to make the same 8.72% yield, price should be $16.37. Added annual dividend of $0.965 after reset the AR is 15.5%.
(2)For CF-C: Assume 5Y later at 2021 the 5Y rate is 2.5%. Then at that time the reset rate would be 5.51%, to make the same 8.72% yield, price should be $15.6. Added annual dividend of $0.965 after reset the AR is also 15%.
3. Risk
The company might suspend preferred dividend as well.
4. Links
Cannacord Genuity Preferred Shares
