Maple Leaf Memo
Spirit of ’76
It’s prime time for 30-years-ago-today stories on both sides of the US-Canada border. Not since November 1976–before the Toronto Blue Jays had played their first Major League Baseball game, the same month Reggie Jackson signed a five-year, $3.5 million free agent contract with the New York Yankees–had the loonie traded at parity with the greenback.
(Canadian English, like American English, uses the slang term “buck” for a dollar. Because of the appearance of the common loon on the back of the dollar coin, which replaced the dollar bill in 1987, the word “loonie” was adopted in Canada to distinguish the Canadian dollar from other currencies.)
What happened last week is a culmination of a long-building reality. The Canadian dollar has steadily climbed from an all-time low against the US dollar of 61.79 cents US established on Jan. 21, 2002. That rise coincides with the steep climb for energy-related and other resource commodities.
Canada’s economy is deeply rooted in stuff–such as oil, gas, basic and precious metals and wood–that collectively accounted for 13 percent of GDP in 2005.
And a global economic boom, fueled largely by growth in Asia, has led to unprecedented demand. Things will probably slow into 2008, but what’s happening in China, India and other less mature but still loudly emerging neighbors will define the 21st century global economy.
It may slow down, but domestic consumption is a happy fever. You can keep it down for a while, but it always wants to come back. Pursuing needs is dreary; chasing wants is intoxicating.
That the Federal Reserve saw fit to double expectations and cut the fed funds target and the discount rate by 50 basis points rather than 25 is a sign it’s a little more concerned about the next act in the mortgage market tragicomedy. A new wave of adjustable-rate loan resets will crash in the next six months. The Bank of Canada, meanwhile, has kept its equivalent rates stable.
As a result, the spread between US and Canadian interest rates widened, making Canada a more attractive place for German, Japanese, American and other foreign investors to put their money.
The high Canadian dollar will increase the number of cross-border shopping trips as Canadian consumers come to the US to buy clothes, shoes and electronic gear. Many goods in Canada haven’t been reduced yet to reflect the rising Canadian dollar. And the high loonie will hurt Canadian manufacturers who sell goods in the US.
The major downside risk for Canada–its dependence on the US economy–is mitigated by the Fed’s determination to keep at least resource spending at high levels.
In November 1976, oil prices were at record levels, gold prices had tripled during the past five years, and the Canadian dollar wasn’t packing nearly as much purchasing power on the store shelves as it was on the currency exchanges. That sounds a lot like today.
But the rise in commodity prices is a long trend that, because of emerging Asia demand and recent Fed action, shows no signs of reversing or even slowing. And Canada’s economic house is in good order: The country sports twin current account and fiscal surpluses.
Back in the waning days of the Ford administration, Canada was running a deficit that would soon gallop off the track, and its current account was in deficit, representing 3.8 percent of GDP.
Canada’s federal government has been in surplus for more than 10 years, and the current account is in surplus–2 percent of GDP. The US, as has been well documented, has substantial fiscal and current account deficits on both books.
Canada’s twin surpluses provide support for the loonie, support that didn’t exist in 1976.
Falling commodities, less-positive interest rate spreads between the two countries and the election of separatist premier Rene Levesque in Quebec in November 1976 sent the loonie skidding all the way to January 2002.
Tax Treaty Changes
Canadian Finance Minister Jim Flaherty and US Treasury Secretary Henry Paulson met in Quebec last Friday to sign an updated Canada-US tax treaty. The new agreement includes the elimination of a 10 percent withholding tax on interest payments made by borrowers in one country to lenders in the other.
The 10 percent withholding tax impeded the flow of capital between the two countries and the efficient functioning of capital markets. Its elimination should lead to increased investment and reduced costs of capital.
The new treaty should most immediately benefit Canadian companies that borrow from US banks. Many US lenders require Canadian borrowers to “gross up” their payment so that they pay the full interest plus the withholding tax that the banks are required to pay to the Canada Revenue Agency.
Another provision extends treaty benefits to limited liability companies (LLCs). An LLC will generally be entitled to take advantage of reduced withholding tax rates set out in the treaty in respect to certain types of payments, such as interest and dividends.
Canadian tax rules had treated US LLCs as corporations. The new agreement will recognize LLCs as partnerships–flow-through entities that pass earnings to partners to be taxed in partners’ hands–rather than as corporations. US LLCs will no longer face double taxation.
This raises interesting questions regarding Canada’s treatment of income trusts. The minority government’s 2007 federal budget essentially eliminated the flow-through benefits of the trust structure by imposing a tax on distributions. Exempting LLCs operating in Canada from Canadian corporate tax seems to contradict the trust decision.
The treaty will enter into force once it has been ratified by both the Canadian and US governments.
The Roundup
Oil & Gas
PrimeWest Energy Trust (PWI.UN, NYSE: PWI) is being acquired by Abu Dhabi National Energy Co PJSC for CD5 billion in cash. Abu Dhabi National Energy, better known as TAQA, is paying CD26.75 per unit, a 30 percent premium over PrimeWest’s Sept. 21 closing price.
It’s TAQA’s third Canadian acquisition since May. The deal is expected to close in late November.
The news is bullish for holders of the former Shiningbank Energy Income Fund–which merged into PrimeWest earlier this year–as well as other holders of the heavily gas-weighted trust. Based on a current exchange rate of near parity between the US and Canadian dollars, it represents a huge premium of close to 40 percent on PrimeWest’s pre-deal price. That wipes out much of the past year’s pain.
The all-cash bid limits downside risk, and we have until the planned Nov. 30 shareholder vote for a counterbid to emerge. That could happen if natural gas prices bounce back. And PrimeWest has pledged to maintain its 25 cents Canadian monthly distribution until the deal closes. Hold PrimeWest Energy Trust.
Vermilion Energy Trust (VET.UN, VETMF) and joint-venture partners Verenex Energy and Bordeaux Energy have shut down the Orca-1 oil and gas exploration well. The companies terminated the well after drilling hit a “thick sealing element” at the well in the Aquitaine Maritime Exploration Permit about 30 kilometers offshore of Bordeaux, France.
Bordeaux said in a release that “preliminary evaluations of mud log data, logging while drilling data and an analysis of well cuttings do not indicate the presence of hydrocarbons in this primary objective.” Vermilion, the operator of the well, will continue to drill for an expected 48 hours in hopes of discovering a secondary target. If none is detected, the well will be abandoned.
Vermilion’s net effective capital exposure is estimated to be approximately CD9 million, less than 3 percent of projected 2007 cash flow, based on an expected gross well cost of CD55 million. Vermilion has said the results of the Orca-1 well “will have no impact on Vermilion’s operations, its strong balance sheet or its ability to maintain its strategic direction including the current capital program and distributions.” Vermilion Energy Trust remains a buy up to USD38.
Electric Power
Boralex Power Income Fund’s (BPT.UN, BLXJF) special committee has ended its sale process, begun in March, blaming a slump in financial markets. The special committee stressed that the decision to end the process isn’t a reflection on the fund’s financial situation, which it described as favorable, nor does it impact the mission to pay stable, predictable distributions. Continue to buy Boralex Power Income Fund up to USD10.
Primary Energy Recycling’s (PRI.UN, PYGYG) board of directors is deferring declaration of the September cash distribution (normally payable at the end of October to holders on record on Sept. 30). Primary’s forecast for third quarter results depends on the findings of its Harbor Coal inventory survey, and it can’t accurately forecast its ability to meet senior debt and subordinated note indenture requirements.
Primary is negotiating with its Harbor Coal customer to amend contract terms that would improve the predictability and stability of its financial results. If the amended contract becomes effective for the third quarter, Primary anticipates being in compliance with its financial covenants and satisfying the tests required to pay cash distributions.
If financial results are determined under the existing unamended contract, Primary may not be able to satisfy its covenants, making it impossible to pay distributions without waivers from lenders and noteholders. Primary intends to make another announcement about its distribution in early October; the distribution announced Aug. 21, 2007, for payment Sept. 28, 2007, will still be made. Hold Primary Energy Recycling.
Business Trusts
CI Financial Income Fund (CIX.UN, CIXUF) has made an unsolicited CD2.36 billion offer to buy DundeeWealth, a CD20.25-per-share offer that represents a 52 percent premium over DundeeWealth’s Monday closing price. CI will pay with units at an exchange ratio of 0.75 CI unit for every DundeeWealth common share.
Bank of Nova Scotia made a CD608 million friendly offer for an 18 percent stake in DundeeWealth last week. CI Financial plans to proceed by way of a takeover bid, which it should be able to mail to shareholders in early October.
The completion of the transaction will be subject to conditions, including CI acquiring not less than 66.67 percent of the outstanding DundeeWealth common shares. CI Financial Income Fund is a buy up to USD26.
Oceanex Income Fund (OAX.UN, OCNXF) is being sold to South Coast Partners LP, a consortium of investors, for more than CD200 million. South Coast’s offer is for CD19 per unit; the total cash outlay is CD166 million, and South Coast will assume Oceanex’s debt to bring the total value to more than CD200 million.
The cash offer represents a 15.2 percent premium over Oceanex’s Sept. 18 close. Oceanex’s board supports the offer, but the fund is able to seek or respond to other bids until Oct. 29. South Coast can match any higher offer.
Oceanex will pay South Coast CD2.1 million if there’s a breakup before Oct. 29, CD5 million if a deal is accepted after Oct. 29. Hold Oceanex Income Fund.
Natural Resources Trusts
Fording Canadian Coal (FDG.UN, NYSE: FDG) units established a 52-week high above CD38 after Teck Cominco more than doubled its stake in the coal producer to just below 20 percent Monday. Teck bought 16.65 million units, an 11.25 percent stake, for CD599.4 million in cash, or CD36 a unit. Teck’s direct and indirect stake in Fording is now about 19.95 percent.
Fording owns 60 percent of the Elk Valley Coal mining partnership in Western Canada, the world’s No. 2 exporter of metallurgical coal used in steel production. Teck owns the remaining 40 percent.
“Teck Cominco has acquired the units for investment purposes and has no plans to acquire any additional units of Fording,” Teck said in a statement. Fording Canadian Coal is a buy up to USD35.
SFK Pulp Fund (SFK.UN, SFKUF) cut its distribution by 60 percent because of the Canadian dollar’s gain against the US dollar and costs to repair a generator at the trust’s largest pulp mill. The payment to unitholders will be cut to 2 cents Canadian a unit from 5 cents Canadian.
The loonie’s 14 percent rally this year has eaten away at the value of SFK’s US dollar-denominated sales when converted back to the Canadian currency. Wood pulp is traded in US dollars.
SFK’s Saint-Félicien mill has experienced a failure in a component of the main turbo generator. Management currently estimates that additional repair costs and electricity purchases of approximately CD3 million for this generator will be incurred in the coming months. SFK Pulp Fund remains a buy up to USD6.
It’s prime time for 30-years-ago-today stories on both sides of the US-Canada border. Not since November 1976–before the Toronto Blue Jays had played their first Major League Baseball game, the same month Reggie Jackson signed a five-year, $3.5 million free agent contract with the New York Yankees–had the loonie traded at parity with the greenback.
(Canadian English, like American English, uses the slang term “buck” for a dollar. Because of the appearance of the common loon on the back of the dollar coin, which replaced the dollar bill in 1987, the word “loonie” was adopted in Canada to distinguish the Canadian dollar from other currencies.)
What happened last week is a culmination of a long-building reality. The Canadian dollar has steadily climbed from an all-time low against the US dollar of 61.79 cents US established on Jan. 21, 2002. That rise coincides with the steep climb for energy-related and other resource commodities.
Canada’s economy is deeply rooted in stuff–such as oil, gas, basic and precious metals and wood–that collectively accounted for 13 percent of GDP in 2005.
And a global economic boom, fueled largely by growth in Asia, has led to unprecedented demand. Things will probably slow into 2008, but what’s happening in China, India and other less mature but still loudly emerging neighbors will define the 21st century global economy.
It may slow down, but domestic consumption is a happy fever. You can keep it down for a while, but it always wants to come back. Pursuing needs is dreary; chasing wants is intoxicating.
That the Federal Reserve saw fit to double expectations and cut the fed funds target and the discount rate by 50 basis points rather than 25 is a sign it’s a little more concerned about the next act in the mortgage market tragicomedy. A new wave of adjustable-rate loan resets will crash in the next six months. The Bank of Canada, meanwhile, has kept its equivalent rates stable.
As a result, the spread between US and Canadian interest rates widened, making Canada a more attractive place for German, Japanese, American and other foreign investors to put their money.
The high Canadian dollar will increase the number of cross-border shopping trips as Canadian consumers come to the US to buy clothes, shoes and electronic gear. Many goods in Canada haven’t been reduced yet to reflect the rising Canadian dollar. And the high loonie will hurt Canadian manufacturers who sell goods in the US.
The major downside risk for Canada–its dependence on the US economy–is mitigated by the Fed’s determination to keep at least resource spending at high levels.
In November 1976, oil prices were at record levels, gold prices had tripled during the past five years, and the Canadian dollar wasn’t packing nearly as much purchasing power on the store shelves as it was on the currency exchanges. That sounds a lot like today.
But the rise in commodity prices is a long trend that, because of emerging Asia demand and recent Fed action, shows no signs of reversing or even slowing. And Canada’s economic house is in good order: The country sports twin current account and fiscal surpluses.
Back in the waning days of the Ford administration, Canada was running a deficit that would soon gallop off the track, and its current account was in deficit, representing 3.8 percent of GDP.
Canada’s federal government has been in surplus for more than 10 years, and the current account is in surplus–2 percent of GDP. The US, as has been well documented, has substantial fiscal and current account deficits on both books.
Canada’s twin surpluses provide support for the loonie, support that didn’t exist in 1976.
Falling commodities, less-positive interest rate spreads between the two countries and the election of separatist premier Rene Levesque in Quebec in November 1976 sent the loonie skidding all the way to January 2002.
Tax Treaty Changes
Canadian Finance Minister Jim Flaherty and US Treasury Secretary Henry Paulson met in Quebec last Friday to sign an updated Canada-US tax treaty. The new agreement includes the elimination of a 10 percent withholding tax on interest payments made by borrowers in one country to lenders in the other.
The 10 percent withholding tax impeded the flow of capital between the two countries and the efficient functioning of capital markets. Its elimination should lead to increased investment and reduced costs of capital.
The new treaty should most immediately benefit Canadian companies that borrow from US banks. Many US lenders require Canadian borrowers to “gross up” their payment so that they pay the full interest plus the withholding tax that the banks are required to pay to the Canada Revenue Agency.
Another provision extends treaty benefits to limited liability companies (LLCs). An LLC will generally be entitled to take advantage of reduced withholding tax rates set out in the treaty in respect to certain types of payments, such as interest and dividends.
Canadian tax rules had treated US LLCs as corporations. The new agreement will recognize LLCs as partnerships–flow-through entities that pass earnings to partners to be taxed in partners’ hands–rather than as corporations. US LLCs will no longer face double taxation.
This raises interesting questions regarding Canada’s treatment of income trusts. The minority government’s 2007 federal budget essentially eliminated the flow-through benefits of the trust structure by imposing a tax on distributions. Exempting LLCs operating in Canada from Canadian corporate tax seems to contradict the trust decision.
The treaty will enter into force once it has been ratified by both the Canadian and US governments.
The Roundup
Oil & Gas
PrimeWest Energy Trust (PWI.UN, NYSE: PWI) is being acquired by Abu Dhabi National Energy Co PJSC for CD5 billion in cash. Abu Dhabi National Energy, better known as TAQA, is paying CD26.75 per unit, a 30 percent premium over PrimeWest’s Sept. 21 closing price.
It’s TAQA’s third Canadian acquisition since May. The deal is expected to close in late November.
The news is bullish for holders of the former Shiningbank Energy Income Fund–which merged into PrimeWest earlier this year–as well as other holders of the heavily gas-weighted trust. Based on a current exchange rate of near parity between the US and Canadian dollars, it represents a huge premium of close to 40 percent on PrimeWest’s pre-deal price. That wipes out much of the past year’s pain.
The all-cash bid limits downside risk, and we have until the planned Nov. 30 shareholder vote for a counterbid to emerge. That could happen if natural gas prices bounce back. And PrimeWest has pledged to maintain its 25 cents Canadian monthly distribution until the deal closes. Hold PrimeWest Energy Trust.
Vermilion Energy Trust (VET.UN, VETMF) and joint-venture partners Verenex Energy and Bordeaux Energy have shut down the Orca-1 oil and gas exploration well. The companies terminated the well after drilling hit a “thick sealing element” at the well in the Aquitaine Maritime Exploration Permit about 30 kilometers offshore of Bordeaux, France.
Bordeaux said in a release that “preliminary evaluations of mud log data, logging while drilling data and an analysis of well cuttings do not indicate the presence of hydrocarbons in this primary objective.” Vermilion, the operator of the well, will continue to drill for an expected 48 hours in hopes of discovering a secondary target. If none is detected, the well will be abandoned.
Vermilion’s net effective capital exposure is estimated to be approximately CD9 million, less than 3 percent of projected 2007 cash flow, based on an expected gross well cost of CD55 million. Vermilion has said the results of the Orca-1 well “will have no impact on Vermilion’s operations, its strong balance sheet or its ability to maintain its strategic direction including the current capital program and distributions.” Vermilion Energy Trust remains a buy up to USD38.
Electric Power
Boralex Power Income Fund’s (BPT.UN, BLXJF) special committee has ended its sale process, begun in March, blaming a slump in financial markets. The special committee stressed that the decision to end the process isn’t a reflection on the fund’s financial situation, which it described as favorable, nor does it impact the mission to pay stable, predictable distributions. Continue to buy Boralex Power Income Fund up to USD10.
Primary Energy Recycling’s (PRI.UN, PYGYG) board of directors is deferring declaration of the September cash distribution (normally payable at the end of October to holders on record on Sept. 30). Primary’s forecast for third quarter results depends on the findings of its Harbor Coal inventory survey, and it can’t accurately forecast its ability to meet senior debt and subordinated note indenture requirements.
Primary is negotiating with its Harbor Coal customer to amend contract terms that would improve the predictability and stability of its financial results. If the amended contract becomes effective for the third quarter, Primary anticipates being in compliance with its financial covenants and satisfying the tests required to pay cash distributions.
If financial results are determined under the existing unamended contract, Primary may not be able to satisfy its covenants, making it impossible to pay distributions without waivers from lenders and noteholders. Primary intends to make another announcement about its distribution in early October; the distribution announced Aug. 21, 2007, for payment Sept. 28, 2007, will still be made. Hold Primary Energy Recycling.
Business Trusts
CI Financial Income Fund (CIX.UN, CIXUF) has made an unsolicited CD2.36 billion offer to buy DundeeWealth, a CD20.25-per-share offer that represents a 52 percent premium over DundeeWealth’s Monday closing price. CI will pay with units at an exchange ratio of 0.75 CI unit for every DundeeWealth common share.
Bank of Nova Scotia made a CD608 million friendly offer for an 18 percent stake in DundeeWealth last week. CI Financial plans to proceed by way of a takeover bid, which it should be able to mail to shareholders in early October.
The completion of the transaction will be subject to conditions, including CI acquiring not less than 66.67 percent of the outstanding DundeeWealth common shares. CI Financial Income Fund is a buy up to USD26.
Oceanex Income Fund (OAX.UN, OCNXF) is being sold to South Coast Partners LP, a consortium of investors, for more than CD200 million. South Coast’s offer is for CD19 per unit; the total cash outlay is CD166 million, and South Coast will assume Oceanex’s debt to bring the total value to more than CD200 million.
The cash offer represents a 15.2 percent premium over Oceanex’s Sept. 18 close. Oceanex’s board supports the offer, but the fund is able to seek or respond to other bids until Oct. 29. South Coast can match any higher offer.
Oceanex will pay South Coast CD2.1 million if there’s a breakup before Oct. 29, CD5 million if a deal is accepted after Oct. 29. Hold Oceanex Income Fund.
Natural Resources Trusts
Fording Canadian Coal (FDG.UN, NYSE: FDG) units established a 52-week high above CD38 after Teck Cominco more than doubled its stake in the coal producer to just below 20 percent Monday. Teck bought 16.65 million units, an 11.25 percent stake, for CD599.4 million in cash, or CD36 a unit. Teck’s direct and indirect stake in Fording is now about 19.95 percent.
Fording owns 60 percent of the Elk Valley Coal mining partnership in Western Canada, the world’s No. 2 exporter of metallurgical coal used in steel production. Teck owns the remaining 40 percent.
“Teck Cominco has acquired the units for investment purposes and has no plans to acquire any additional units of Fording,” Teck said in a statement. Fording Canadian Coal is a buy up to USD35.
SFK Pulp Fund (SFK.UN, SFKUF) cut its distribution by 60 percent because of the Canadian dollar’s gain against the US dollar and costs to repair a generator at the trust’s largest pulp mill. The payment to unitholders will be cut to 2 cents Canadian a unit from 5 cents Canadian.
The loonie’s 14 percent rally this year has eaten away at the value of SFK’s US dollar-denominated sales when converted back to the Canadian currency. Wood pulp is traded in US dollars.
SFK’s Saint-Félicien mill has experienced a failure in a component of the main turbo generator. Management currently estimates that additional repair costs and electricity purchases of approximately CD3 million for this generator will be incurred in the coming months. SFK Pulp Fund remains a buy up to USD6.