Maple Leaf Memo
Worries over a softening US economy spurred investors this week to seek comfort in the Dow Jones Industrial Average’s heavy concentration of defensive stocks, pushing the Dow to record highs. The same impulse led Canadian investors to flock to the safety of financial and telecommunications shares and their dividend yields.
But unlike the Dow, the Toronto Stock Exchange’s S&P/TSX Composite Index is unlikely to test new highs as a result. The gravity exerted by the S&P/TSX Composite’s heavy grouping of oil and gas companies, which have been clobbered by falling oil prices, will prevent that.
The oil and gas sector accounts for about a third of the TSX’s overall weighting, and the index seems to mirror almost every move in oil pricing. It followed oil to record highs earlier this year and has subsequently retreated along with crude.
Defensive stocks–including financials, telecommunications and utilities–traditionally offer attractive dividends and provide a safe return in times of economic uncertainty. Rotation into these sectors has been ongoing for a number of weeks as US economic indicators have continued to look soft. While the S&P/TSX Index’s energy group has lost 13.2 percent in the past month, the equally weighted financial index has seen a rise of 6.5 percent. At the same time, the overall index has lost 2.7 percent.
The market increasingly believes that the US Federal Reserve, and to a lesser extent the Bank of Canada, will begin cutting rates early next year to prop up the economy. The key US rate is now at 5.25 percent, while in Canada it’s 4.25 percent.
As retail investors flee income trusts, institutional investors are stepping in to take up the slack. Sharply dropping prices at some funds have prompted strategic buyers to move in and boost stakes in the trusts they think will hold value long term. One reason institutions can find bargains in the current environment is that prices of income trust units tend to plunge when distributions are trimmed, and they drop even more when the distributions are suspended completely. It doesn’t matter what underlying asset value or liquidation value there may be in the companies; retail investors tend to flee when their yield is threatened.
Barbara Gray, an analyst at Blackmont Capital in Vancouver, British Columbia, calculated that companies that have completely suspended their distributions trade at an average discount of 77 percent to the price at which they did their initial public offering (IPO).
The S&P/TSX Capped Income Trust Index was off about 10 percent for September. As retail investors flee income trusts, institutional investors have stepped in to take up the slack. With many income trusts discussing distribution cuts, retail investors looking for high yields have become skittish and are selling.
Dropping prices at some trusts have prompted strategic buyers to move in. The institutional players can come in and pick up things at a good value. Institutions can find bargains in the current environment because prices of income trust units tend to plunge when distributions are trimmed, and they drop even more when the distributions are suspended completely. It doesn’t matter what underlying asset value or liquidation value there may be in the companies; retail investors tend to flee when their yield is in jeopardy.
IPO Market Slowing
With fewer new income trusts coming to market, the value of Canadian IPOs dove about 67.5 percent in the third quarter from the average of the first two quarters of 2006 and 75 percent from the third quarter of last year, according to a survey by PricewaterhouseCoopers Canada.
The value of new issues on Canadian equity markets fell to CD650 million in the latest quarter from an average of about CD2 billion in the first two quarters of 2006 and CD2.6 billion in the third quarter of 2005. The sharp slide reflected a drop in new income trust offerings. Income trusts accounted for just CD374 million of the latest total, but CD2.5 billion of the year-earlier total. In previous surveys, income trusts have represented the majority of new issues.
A total of 94 new corporate and income trust issues with a total value of CD4.7 billion came onto Canadian exchanges in the first three quarters of this year. The equivalent figures for the first nine months of last year were 87 issues, totaling CD5.4 billion. Slightly more than CD3 billion of the 2006 year-to-date total were new income trust units.
The RoundupNews is light this week as we prepare for another earnings season.
Business Trusts
Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) has entered into an agreement to acquire a hazardous waste and industrial cleaning company from TransForce Income Fund (TSX: TFI.UN, TIFUF). The company, a division of Services Matrec, provides collection, treatment and disposal of industrial wastes; soil and water treatment services; and on-site industrial cleaning services. Newalta is paying CD31.8 million for the company, which generates annual revenue of CD20 million. This is Newalta’s third acquisition in three months as it continues to expand operations eastward into Quebec. Buy Newalta Income Fund up to USD30.
Real Estate Trusts
Retirement REIT (TSX: RRR.UN, OTC: RRRGF) has entered into an acquisition and support agreement with Public Sector Pension Investment Board (PSPIB), which could cause PR Capital Corp–a new company controlled by Paul Reichmann, former partner in the real estate investment trust–to boost its bid. The PSPIB proposal values Retirement REIT units at CD8.35 each, for a total deal value of CD2.8 billion. A special committee of the Retirement REIT board has unanimously recommended accepting the PSPIB bid.
PSPIB has the right to match competitive offers, and the proposal includes a CD19 million termination fee. PSPIB is a Canadian crown corporation established to manage employer and employee contributions made after April 1, 2000, to the Federal Public Service, the Canadian Forces and the Royal Canadian Mounted Police pension funds. The offer of CD8.35 per unit in cash represents a 7.2 percent premium over the last unit closing price on the TSX and a 10.9 percent premium over the volume weighted average price of the units during the last 30 trading days. Sell Retirement REIT.