Blessed by the Potato

Home Capital Group (TSE:HCG) is an interesting company that draws very polarized views. On the one hand, there are a great many people out there who love it without digging any further into it than “it pays a growing dividend.” One of my favourite bits of astounding logic from a HCG bull when researching it was “there is no housing bubble because house prices didn’t go down last year.” On the other hand, many bears seem to stop their analysis at “there is a housing bubble, and they’re an alt lender, therefore short.” I wanted to dig into it a bit more to see if it might be worth shorting.

My main questions were: How vulnerable is it to a housing correction? What does the mortgage mix look like, what’s the credit profile and payment history of their borrowers? How are they funded, are there any debt covenants, and what capital reserves do they have? I’m not terribly comfortable with the idea of shorting something, so if I’m going to start to get really bearish on housing, I want to make sure that this is going to blow up good and proper before betting against it. Basically, reduced earnings and growth won’t be good enough: they’ll have to be forced to eliminate the dividend at the very least under a modest correction scenario for me to be comfortable shorting it — as only after they kill the dividend will the pool of surface-analysis dividend growth investors move to sell it.

What I found in a preliminary investigation is a company that is growing like stink. “Ah-ha,” I thought, “they must be spending crazy amounts of cash to advertise and give the brokers enough kick-backs to send all the business their way.” No — they have a ~30% efficiency ratio, which they claim is industry-leading (spot check: half that of BMO’s — lower is better).

Hmm, well, if they’re drumming up business and not spending money to do it, then I thought “they must have poor credit quality as they’ll just take everyone who shows up at the door. So their default rates must be awful, especially if they’re not paying any appraisers.” Wrong again: their default rate is quite low (on par with the banks right now), and even in 2009 barely breached 1% (good for an alt lender, about 3X worse than the national average at the time).

Only one option left I can think of: they’re attracting the best alt credit risks to them by discounting their rates, and people are seeking them out on a price basis. No again: they have a higher return on equity and net interest margin than BMO, despite holding more capital in reserve. A spot check on mortgage comparison sites puts them at about 3.5% for a 5-year rate vs BMO at 3.6% and the lowest-price entry at 3.4%; they’re amongst the most expensive on variable rates.

Well, it’s an enigma. I know they’re small (~5-10% of a big bank) which leaves more runway for growth, but this is unbelievable: they grow fast, without seeming to pay for it in any way (profitability, portfolio risk/defaults, leverage). Any insights into the secret of taking market share from the big 6 banks without spending money to do so? Part of the really low efficiency ratio is that they just do mortgages: branch staff to sell mutual funds and take deposits cost a lot for not much revenue; on the flip side, they don’t have the economies of scale for advertising (but that first factor will dominate). Maybe their business plan is too inherently wonderful, their management team is full of wizards, and I am a fool to even consider shorting such a beautiful business, housing bubble or no.

Or maybe there’s something I just don’t understand. I’m leaning towards ignorant skepticism at this point, and welcome corrections and explanations.

In our most recent hydro bill, we received one of those little propaganda pamphlets explaining why our electricity bill has to go up again. In it is this little statement:

“For most Canadian households, electricity makes up about 1% of the household budget. In fact, one penny per dollar powers many things that we simply take for granted: lights; appliances; air conditioning[…]”

And then right be side that is a little city-to-city comparison, pegging a typical 1000 kWh Toronto Hydro bill at about $135.72 (ours usually comes in ~$100/mo; elsewhere they say a typical Toronto Hydro customer usage is 800 kWh/mo, which would scale to $108.58). Now combine those two pieces of information and you have Toronto Hydro saying that a household budget is $13,572/mo or $162,864/year (or using the slightly lower monthly usage, $130,291/year). That’s quite a bit above the actual household pre-tax income, let alone the spending budget.

They provide the source as Stats Canada, so of course I had to go fact check on them. In the table the total Canadian household expenditures for 2011 is given as $956B, with electricity at $17.4B. The percentage of the household budget that electricity represents is then 1.8%, which should be rounded up to 2%, not down to 1%. Even then it seems too low, putting the annual household spending budget above $70k, over $90k with that 1000 kWh bill — at about the level of pre-tax household income, rather than the spending budget. I’m pretty sure electricity likely makes up even more of the household budget than that.

Looking at the Stats Can data, we have a parent category for electricity called Housing, water, electricity, gas and other fuels. Now I couldn’t find detailed notes explaining this category, but here’s my best inference: the total should be right, but the subcategories might not be fully broken down. Within that Housing, water, electricity, gas and other fuels category are Paid rental fees for housing and Imputed rental fees for housing. We know from all the studies of the Canadian housing bubble that the ownership rate is about 70%, and that it should be the more expensive slice of the market that falls under the ownership umbrella, thus imputed rent should be a fair bit more than 70% of the total of rent paid and imputed rent. At $48B and $142B it is, but just by a bit: rent makes up about 25% of that total. My suspicion is that there are some people with all-inclusive rents whose electricity is lumped under that subcategory rather than electricity proper, under-reporting the amount Canadians spend on electricity.

Anyway, at the very least the Toronto Hydro pamphlet should have rounded to 2% (small numbers either way, but you know, double what they said).

Continued from yesterday…

Calories are loyal. If someone buys a meal, the calories in the food belong to them. If you try to steal a bite, the calories will run away from that bite and stay with the group, remaining loyal and whole to the person who bought the food. Yes, free food is also calorie-free.

Calories can’t swim, at least not in water (gravy and syrup are a whole other matter). This is why drinking lots of water is a hot diet tip. However, it makes us question the wisdom of not eating while swimming: calories would never follow you into the pool.

Pile the calories up and leave them. One good way to avoid calories is to scare them away into one pile on your plate, for instance by making soft yet menacing banging noises with your fork. Then, leave a few bites behind. The calories will have piled into those last few bites. Babies know this instinctively, and will smash, shake, and scream at their food during mealtimes… and then never, ever eat the last bite of anything.

“Light” means that some of the calories have been removed from the food. The remaining calories are thus lonely and feeling vulnerable. This makes them more likely to want to make friends with your hips. To compensate for this you should build up the self-esteem of any “light” foods before eating them by praising and encouraging the calories. Make light conversation, complement them, maybe even sing a soft, cheerful song. Once the “calorie reduced” food has been built back up, the other methods will work again.

Air of course has no calories, and to a very close approximation Rice Krispies are 100% air, so they’re calorie-free. With a small extension of the principle, anything largely made up of puffed rice is also calorie-free. For example, Whatchamacallit bars. A similar principle is at work with popcorn and whipped cream.

Did you know that calories get sleepy? Calories get very set in their ways, and don’t adjust well to changes in their sleeping schedule. This is why it’s important to get a good breakfast early in the morning: not only is it a good start to your day, but it’s also so you can sneak up on the calories when they’re too tired and sleepy to make you fat. Of course, you have to find the right calories for that.

Some calories go to bed early, while others are all-night party animals. This is why drinking Coke and eating nachos and chocolate at night will always make you fat, because those are night-time foods. But, those same foods make excellent breakfast selections. Breakfast-for-dinner, or Brenner is always a good idea for the same reason. Plus, who doesn’t love waffles at midnight?!

Calories are little things that live in food. They’re tasty and give your body energy. Things without any calories aren’t really food at all. In small amounts, calories are great things. Trouble arises when large groups of calories get together though. They start getting mischievous ideas, and once inside your body avoid getting burned, instead turning into fat — which is not what we want. There are a great many resources out there to help you diet, to find ways to count the calories in things, and limit how many you allow to get together at once in your body. But why give them that kind of power over you? Did you know that calories are just as afraid of you as you are of them? This handy guide will show you the many unknown facts about calories so that you can keep them in line and eat whatever you want — without getting fat.

First, threaten your food. It’s never polite to threaten other people, but calories aren’t people. Severe threats or growling noises can scare away calories, and other people at the diner. Just be sure to leave them a safe place to run to, or they’ll be back with a vengeance! (True for both groups).

Calories are afraid of heights. If you put your food in a high place, such as on top of the fridge, the calories will get scared and jump out. This is best facilitated by giving them a ramp or ladder to climb down from. Calories are small, with hundreds of them fitting into a single cookie, so even a piece of thread looks like a grand staircase to them. They’ll have no trouble making their way down if they’re scared enough of being up high. Even if they have to jump. They hate heights that much, and do not have logical responses to stressful situations.

A corollary to this is that food in low places may collect the fleeing calories from the food in high places. This is why even when you’re following your diet and only eating the lettuce in the crisper drawer of your fridge, you always seems to gain weight anyway. The calories from your butter have snuck down there! Lettuce, by the way, is secretly evil. Under controlled lab conditions, it presents itself as largely free of calories, hardly associating with them at all. But out in the wild real world, lettuce readily aligns itself with calories, harbouring them and building them up within its nested leaves as some kind of highly fortified barracks, turning those mindless loitering calories into a highly trained force to be handled with extreme caution and delicacy.

Calories have weak grips. If you shake your food before you eat it, you can loosen up the calories and even shake some out entirely! They can’t hold on to the delicious food with their weak grips, and will fly away. A good way to facilitate this is to break your food in half: the calories will just come pouring out! Combine this tip with the previous one, and shake your food above your head — just watch out for crumbs and sloshing.

Calories go on vacation. They don’t want to work at making you fat any more than you want to work on TPS reports when on vacation. Take them out for a nice trip by the river, and lay out a picnic under a shady tree. Who can think of work in situations like that?

To be continued tomorrow…

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Almost three years ago I created a video called Little Known Facts About Calories. I had planned to make a whole series of such videos, but the first two had such a cold reception and so few views that I gave up — making those flash videos is a fucktonne of work, and after three years it still hasn’t even hit 100 views (though to be fair the subsequent installments would have been easier after I had climbed partway up the Flash learning curve and had created the base shapes for the calories and other elements). So here, with minimal editing and embellishing, are the notes that would have formed the basis for the planned ten-episode run (would have been about 6 minutes of animation all-together).

Sandi Martin of Spring (the blog) has stormed onto the PF blogosphere. I’ve added her to the blogroll on the side there, but wanted to point you to a few posts in particular.

In my book I recommended TD Waterhouse as the go-to place for new index investors, largely because of their low-cost, easy e-series index funds and because then you’d have a decent brokerage account you were comfortable with when it came time to “graduate” to ETFs. Not long after the book was e-published, a number of other brokerages (e.g., Scotia) came out with free-to-trade ETFs, presenting a competitive alternative to TD Waterhouse. People wrote to me asking if my recommendation had changed, and while I couldn’t be as singular about it, I would still recommend TDW. It was a bit of waffling about simplicity (the list of free-to-trade ETFs is fairly daunting, and misses the usual recommendations), a bit about customer service (which even if you only need it once is still important if you’re a new investor trying to get something going and you don’t even know what it is you’re trying to ask for), and a bit about e-series allowing you to optimize/maximize your investing with monthly savings plans thanks to a low minimum and the ability to invest in arbitrary increments. Sandi managed to articulate this very well in a recent post:

“…you’ll find a lot of reviews that talk about “$9.95 trades” and “great research tools”. Those features just don’t matter […] Your wish list is heavily slanted towards the cost to invest in, hold, and rebalance a portfolio of index funds, and the minimum purchase requirements for regular investment plans. “Ease of use” doesn’t even make the list, and neither does “research and education” or “personal rate of return tracking”…”

Now of course she recommended my book in this post on mutual funds, so that is going to get a link. It’s also a nice, succinct piece on why people should look to boring index investing.

She’s got a series on avoiding “the useless retirement plan” (start here), building off her experiences working at a bank.

And she mentions the deceptive “may” in the HST instructions in this post on the matter. Well we got caught in that same confusing wording, and seeing that others are also having problems with it means its time to write someone to get it fixed. So I wrote an email to my MP and a letter to the CRA (Taxpayer Services Directorate; Canada Revenue Agency; 395 Terminal Avenue; Ottawa, ON K1A 0L5), copied below:

Dear [My MP];

I’m writing you today in regards to some confusing instructions at the Canada Revenue Agency. For small businesses that collect HST, after reaching $3,000 in tax for a fiscal year the Canada Revenue Agency requires quarterly tax installments, rather than annual payments. However, the instructions say:

“If you are an annual filer and your net tax for a fiscal year is $3,000 or more, you may have to make quarterly installment payments throughout the following fiscal year” [emphasis mine] http://www.cra-arc.gc.ca/E/pub/gp/rc4022/rc4022-e.html

That “may” has caused some confusion for business owners and freelancers within my own family, as well as other cases I have recently heard of in the community. The CRA requires quarterly payments once the $3,000 threshold is reached, and does not send notice, instructions, reminders, or a payment schedule. If quarterly installments are not made, they levy interest. Yet the instructions do not make it clear that it is up to the small business to remit quarterly without further instructions — indeed, the “may” suggests that they would not have to remit quarterly unless directed otherwise.

This confusion is exacerbated by the contrast with income taxes, where the CRA does explicitly direct the taxpayer when and how to remit quarterly when they are so required.

I am not asking for the tax law to be changed, but rather for the procedures and instructions to be clarified to prevent this common error from occurring. Two potential solutions that come to mind are:

1. Change the procedure to include a notice period, and have the CRA lay out a schedule for quarterly HST installment payments (as with the income tax).
2. Change the instructions to make it clear that small businesses must remit quarterly, and should not expect advanced direction from the CRA.

Thank you for any help you can offer in fixing this for other small business owners. I want to mention that my own situation has long since been cleared up, so I do not need any personal help with HST. I have sent a similar letter to the Taxpayer Services Directorate of the Canada Revenue Agency.

Sincerely;
[Me]

Please feel free to take from this, put it into your own words, and help make a small change that can save administration work at the CRA and penalty interest and headaches at numerous small businesses.

As an aside, it makes me wonder how apropos it is that the address for suggestions is on terminal avenue…