Blessed by the Potato

There are a lot of questions and confusion about the TFSA out there, which I find surprising since to my mind it’s basically the most straight-forward tax-sheltered account the government has ever created. You put $5000 in. You get to invest in whatever you want (plain jane savings/GICs, stocks, bonds, mutual funds of same, even split it up and do a bit of each at different institutions as long as the total is < $5k/yr) and it grows tax-free. You can take it out whenever you want, tax-free. The next year, you get $5000 more room, and any room you didn’t use in prior years (or got back due to withdrawals). That’s about it.

But still, people have questions, so on the CMF I tried to explain it in a different way:

Think of the TFSA like rabbits in your backyard. The government is your parents at the front door. They say you can bring 5 bunnies into the backyard every year. Beyond that, they’re looking out at the front door, so they don’t care what happens in the backyard.

You can have your bunnies reproduce like, well, bunnies, you can put them all in one big pen or a bunch of different ones. It doesn’t matter, as long as no more than five ($5k in) bunnies goes past your parents per year.

If you need to take a bunny out for some reason, like to bring it to show and tell at school, your parents will remember you took that bunny out and will let you put it back in the next calendar year and not count it against your $5k limit per year – it’s not a new bunny. (recontribute withdrawals) Even if you did really well at bunny farming and want to bring all 40 of your bunnies to school with you, your parents will count them up and let you bring those back in the next year without counting against your new year’s limit of 5 bunnies.

If you don’t handle your bunnies well and they all die, your parents don’t want to hear about it, you can’t bring in any more bunnies.

It was a pretty crazy month+ on the market. The overall indexes didn’t have huge swings in them, but I saw a number of stocks I watch (but don’t own) swing all over the place +/- 10%, with several-percent changes day-to-day. Part of me started to freak out at the apparent increase in volatility, but for the most part I just rode it out. Some key points:

Let’s start with Priszm, the troubled operator of KFC restaurants in Canada. I’ve written about Priszm many times before, in large part because I think it’s an interesting story with a lot of lessons to learn (and in no small part because I lost a lot of money on it, so it’s a very personal, painful lesson). Today’s update to the saga is that they’ve sold off over half their locations. The Ontario and BC restaurants were the “core” of their business in many respects, as Quebec has always been a bit of an oddball, and there just aren’t many restaurants in the other provinces (432 total, 232 for sale). So it looks like this is about it for the Priszm story: this is quite likely the first step in a wrap-up of the business. The amount they’re getting for the sale lines up with roughly half of the P&E and franchise rights values on the balance sheet, so they’re likely getting nothing back for goodwill. If that’s the case, then there’s not likely any value left in the equity.

In an effort to conserve cash as the company prepares for the traditional KFC sales decline during the winter season, Priszm withheld its continuing fee that was payable to the franchisor on December 7, 2010, as well as its debt interest which was payable to its senior debt lender on December 10, 2010. […] Priszm is also in the process of obtaining a forbearance from its senior debt lender relating to the debt interest which was payable to its senior debt lender on December 10, 2010.

Here we go, the end times are nigh. I’m actually surprised that they didn’t make this payment: I figured the default would come at the end of the month.

Canexus (CUS.UN) had another good, consistent quarter — most critically for me, demonstrating that their new technology upgrade is actually working (it’s always a worry with me that big capex spending on new technology for plants won’t actually deliver the efficiencies promised — see Opti). Despite that news, the stock barely budged, so I went out and bought more. It’s now roughly 9% of my portfolio, has an 8% yield, and the payout ratio (now that all that capex is coming to an end) is down around 50%, which means that distribution should be quite safe going forward. The big open question is what the end-game is here for Nexen. Nexen owns the lion’s share of Canexus, and is reported to be looking to sell its share. Would that go to the public market, or would another player (one of the pension funds?) instead try to take the whole thing private?

Other than that though, I’ve been a seller as stuff has been rising. I had an ask in on Imris (IM), but then got blindsided by the sudden share issue and NASDAQ listing (I thought it would have taken way longer to set a price and open — or at least that it would happen one morning, rather than halfway through the trading day!). So my nice-looking gain there has been wiped out, but I’m fairly confident it’ll get back up there. I do worry about why they were raising more money after finally starting to turn a profit — leaving their core competencies? I’ve also got a high ask sitting on IPL.UN (kind of the opposite of a stink bid).

Basically, the theme is that the rest of the market suddenly has a hard-on for yield, and with many trusts dropping to ~8% yield, I’m happy to take the capital gains now, and plow the money into the broader index. Indeed, aside from keeping some money in cash to cover the costs for finishing my PhD (another semester of tuition, and hopefully soon a few hundred dollars in printing and binding costs), I haven’t really found anything else I like to buy in my active portfolio, so I’m sending the money off to the indexed side of things.

One final note for the active portfolio: Freddie Mac reported its third quarter, and the results were incredibly obtuse. The numbers looked very promising for the bull case on the preferreds: delinquency rates are improving, non-performing loans have stabilized, and though they took more provisions for credit losses this quarter, it looks like they should be fully reserved at this point (a ~30% severity should be in the ballpark). However, the politics are still terrible and looking worse: I’ve made the point before that capital reserves are there to keep a company out of the shit pile, and once its in government protection, it doesn’t make sense to borrow money at usurious rates to maintain that margin-of-safety: the government becomes the margin-of-safety. Yet here FRE came up $58M short, and for the dollar amounts involved here, that’s basically a rounding error on a neutral quarter — next quarter they should start making progress towards paying back the treasury. Yet rather than overlooking the immaterial deficiency in their capital ratio, or just making them borrow the $58M from the government, the conservator requested an even $100M. This makes no sense at all, except if indeed the government is trying to make a profit from FRE at the expense of the other stakeholders. So even though the credit numbers look to be getting better, I think that the political risk is alive and well, and if anything is even more clearly negative.

It’s been a hell of a few weeks. Thesis progress has been exceptionally slow. Diet has been downright terrible for similar reasons. The snow is ridiculous here: something like 4′ has fallen since Sunday. The height of the snow on the lawn isn’t quite that high, as it’s settled and compacted, but I’m calling it 4′ as I measured 3′ of snow after the first day and a half of solid snowfall, and had to clear another foot or so after shovelling that away. And now to top it all off I’m sick. I think I’ll cry if I end up writing better while hopped up on cold medicine.

After the first 24 hours of snowfall, and halfway through the third round of shovelling:

Then, against all reason and goodness in the universe, it continued to snow all through the following day:

And while the worst of it is over, it’s not completely over yet. It’s going to snow at least a little (up to a few inches) for each of the next 5 days, according to the forecast.

First up in the links, the 4th edition of the Canadian Real Estate Blog Carnival. As an update to my post in that, Wayfare tells me that the landlord has reimbursed us for most of the materials cost of the work we did (I believe everything we had receipts for).

Nova Scotia proposes mandatory organ donation. I tend to agree that the default should be “donor”, but it’s an ethical minefield for a number of reasons.

Another person (Prem Watsa this time) starting to question how far Chinese demand can take commodity prices.

A hilarious episode of BNN’s Market Call Tonight last night, as a real estate broker called in to rant about why rates can’t go up for 10-15 years. His logic is that a rate increase would cause a real estate crash, so it can’t happen. That reminds me of some other backward-thinking, such as the Globe article some time back that said Toronto rents were going to go through the roof in the next few years, because otherwise investors buying condos at today’s prices couldn’t make a profit. I find it hard to believe that some people are so wedded to the real estate only goes up meme that it becomes totally tautological as they use it as a justification for other calls… but there we have it.

Ellen Roseman reports on a case of a real estate agent abusing the buyer’s agreement.

I already had a quick note on the December TFSA strategy, but CC also has one for you.

David at Toronto Realty Blog points to an article about questionable spending at MPAC. He then comments on how wildly variant the MPAC assessments are relative to actual sale values in Toronto. I then point out that getting the absolute valuation of properties isn’t important to MPAC, since it’s only the relative valuation that matters (though perhaps it is fair to poke them for playing their tax-payer funded Wiis since they don’t do a great job there, either). The city doesn’t collect more tax when property values go up. Instead, the tax rate is adjusted so that their total revenue figure comes out: they basically take the total budget, divide it by the sum of all property values (assessments), and that gives them the tax rate for the year. The MPAC assessment is just for determining relative taxation. You can check that by looking up what the property tax rates were over the past few years. The tax rate actually went down from 2005-2006, and 2008-2009-2010. Under each of those boxes for the year is an example calculation, where you see that despite the changing tax rates and property values, the total tax grab goes up fairly consistently by about 2-3%/yr, which is I’d wager about what the typical Torontonian has experienced. When I am finally redeemed and property values do turn around… property taxes won’t. The mill rate will just be adjusted up to compensate for the lower assessed values so that the take remains the same.

Indeed, there’s a good reason for MPAC to consistently under-assess: there’s a cost of dealing with challenges. People who believe that the assessment should have some relation to the actual sale price will think that they’re getting a steal when the assessed value is below recent comparable sales, and not appeal the assessment when it comes in low. However, I don’t want to leave off with the impression that MPAC is doing all right — though they only need to get the relative valuations right, there are far too many stories out there about how they’re not doing even that much. And indeed, checking up on whether the relative assessments are correct would be easier if the absolute measures were at least close.

Winter has arrived: last night the wind was howling and the rain was freezing. A big swing in temperature from just a few days ago. Things are just going horribly right now: I’m not even halfway towards my writing goal for my thesis this week, despite spending all kinds of time staring at the screen and wishing it was over. The diet’s been shot to hell as I run out the last of the Halloween candy. Plus last night was a new low: with the rain and the cold and the wind I didn’t feel like walking to work, but driving seemed silly considering it’s only a 10 minute walk. So, I rationalized it by driving out to pick up a pizza, and then taking that to work. Two fitness goals killed with one stone!

Do you know what I like?

Puppies.

I’m walking in to work and it’s as cold out as it will be the day in hell when I finish my thesis (i.e.: frozen over), and I’m basically freezing my nuts off and cursing the very sudden arrival of winter winds. There’s this guy walking along at a perfectly normal pace, and trailing behind him are these two tiny puppies. They’re hauling ass just trying to keep up with him, falling all over themselves if they catch up and try to jump on his leg, and just generally enjoying the hell out of life. I’m freezing, that guy is freezing, and these tiny puppies who should have no body heat left to them are just having a blast out in the wide world, just super-excited to be outside.

Conclusion: Puppies are awesome.

Sometimes, life’s little lessons are both obvious and fantastic.

The Globe had an article on travelers choosing to head to US airports to take flights, and discussed/blamed airport taxes this weekend. There are a lot of people from here that go to Detroit for flights, as it is cheaper to drive down there than take a flight out of London or Toronto most times. Significantly cheaper, since it does take gas or bus fare to get down there, as well as the hassle of crossing the border. So, is that price difference attributable to taxes as the article suggests? “Pearson, which holds the dubious distinction of charging the world’s highest fees for planes to land, paid more than $140-million in rent last year.” That sounds like a lot, but Pearson saw 30 million passengers last year. The math is simple: the airport tax amounts to less than $5 per ticket. Believe me, I’m not driving to Detroit for five bucks. The price differential is coming from somewhere else. Maybe it’s the other fees the airport is charging, rather than the government, but I suspect more blame can be pointed at Air Canada than Pearson (though the article did discuss other government subsidies in the US).

Canadian Financial DIY shows that beta is not the best measure of downside risk.

In an aptly titled article, “Priszm’s recipe for disaster”, Canadian Business magazine looks at the troubled operator of KFC restaurants in Canada. You may recall that Priszm was my single worst stock pick since I started doing my own research (yes, even my zero-or-hero bet on Freddie Mac preferreds are doing better). IMHO, Priszm’s “recipe for disaster” was two-fold. First, they didn’t have control over vital parts of the company’s budget: Yum brands (the owner of the KFC rights) did. They had the usual trick of deferring capital spending (i.e.: renovations) and claiming that since depreciation was a non-cash expense, they could pay out so much of their cashflow. Normally, that works in the trust model, if the depreciation expense you can claim doesn’t reflect the reality, so you can indeed defer/reduce capital spending. Unfortunately, it turned out that to renew the KFC franchise agreements, Priszm had to agree to renovate its locations, whether they needed it or not. That put them in a bit of a bind, not having been saving up for that all along. The second issue was that they had an interest-only loan (something I did not catch when evaluating them earlier on), and it all rolled over at once. So when lending is tough (e.g.: now) they face a liquidity crisis. I wasn’t impressed with the communication to investors about that issue, but communication issues aside, that looks to be the biggest risk facing the company right now. Either they find a new lender (and the clock is ticking — they’ve already arranged for one extension, which runs out in a month), or they could find themselves defaulting.

I think the big take-away lesson there is to avoid balloon payment schemes: it’s much easier to roll small portions of your debt, even if you have to suffer high interest rate spreads, when conditions are tight. And, if it comes to it, aggressive focus on reducing the debt could mean a company could pay off the debt as it matured, as long as the amount maturing in a given year was within its capabilities. Many lending covenants will keep companies to something like a 5 to 1 debt to earnings/EBITA ratio, so if the loan maturities are evenly spread out over 5+ years, it should be possible to become debt free by paying off the loans as they mature (by suspending dividends/capital reinvestment spending/deferring maintenance etc). Priszm’s one big loan strategy deprived them of that option.

Back to the issue of depreciation, it’s really an interesting one, and something that’s fairly important when looking at whether or not a trust’s payout is sustainable. The accounting rules provide guidelines for what depreciation figures to use — and it is important to have some kind of standard, or it would be all too easy to manipulate the books by just choosing a figure for depreciation that suits your mood. But a standard figure for depreciation is going to be perfect for almost nobody. Take computers for instance. At home we have here a powerful desktop system I use for everything from gaming to doodling to running MATlab scripts (as well as blogging, checking email, etc). The price curve of computers is such that all that power didn’t come cheap, and two years later that computer’s likely worth maybe 30% of what I paid for it, as now it just has the power of a typical mid-range desktop system. Wayfare on the other hand just has a little netbook for doing word processing and surfing the internet (and because it’s light and portable), and even though it’s also two years old now, it’s probably still worth at least half what she paid, since it’s still perfectly suited to achieving those goals. Similarly, you’ve probably seen lots of workplaces with downright ancient technology that still serves their purposes fine, even though it was long ago depreciated to zero on their balance sheets.

So, one example to think about: Canadian Helicopters (CHL.UN) is one company I like a lot – they’re paying out a decent amount of cash, and they’re earning that even under GAAP earnings. They amortize their helicopters at 4%/yr, straight-line (that is, after 25 years, the helicopters are recorded as having $0 value). I’m told though that a helicopter is far from worthless, even after 25 years. Though they didn’t say how old the helicopters were, in 2009 CHL sold 11 helicopters (plus some land) for $30 million. It’s unfortunately not spelled out how much of that was for the helicopters, or how old the units were when sold (likely fairly old since the buyer is reported to be replacing them within 2 years), but the end result was a reported one-time gain of $1.4M on the sale. Anyway, my point is that here’s a company that’s likely getting close with their amortization figures, or potentially even over-reporting depreciation (that is, their assets may be worth more than their balance sheet indicates). Though I have a “full position” in CHL at the moment, and though it’s been up a fair bit this year (I generally prefer buying stocks when they’re down), I’m thinking of getting more for this reason. The biggest issue is that its largest few clients make up a large part of their revenues, and can be fickle — Ornge took over their own operations, and for the NWS work, CHL lost out in the last round of bidding. That was offset a bit by picking up more work in Afghanistan, but now a very large part of their business is focused there.

Jim Chanos makes the case to CNN that China’s in a construction bubble. What to do about it? How will that affect the fertilizer and oil stories for China?

Michael James reminds investors that a good reason to limit trading is because of the opposition. I have to wonder if they’ve got room for another almost-PhD on their team :)

The folks at CMT report that TD’s Ed Clark supports a return to 25-year amortizations being the maximum. I’d support that: though it might be nice to have a 35-year amortization as an option for when times get tough, it’s just too tempting for enough people to make it troublesome, plus, it’s a systematic risk issue. After the first 5-year term (about the amount of time the average person goes before picking up and moving again), a person with a 35-year mortgage has only paid off about 7% of their loan. Combined with a minimum 5% down-payment, and it doesn’t take much of a move downward in house prices at all for that person to find themselves in negative equity (or effective negative equity, where their equity is not enough to allow them to sell the house and cover closing costs without finding additional funds). On a more traditional 25-year mortgage, almost 13% of the principal will be paid down in that first 5-year term. [Note that this is an interest-rate dependent calculation: I put 4% into the mortgage calculator, but higher rates result in even less principal paid down: at 6%, the paydown becomes 5% and 10% for the 35- and 25-year amortizations, respectively]

The WikiLeaks release is making waves. I know that they are themselves very secretive about where they get their information from, perhaps to protect their sources, but I have to wonder how they’re getting so much information. I also wonder if they think through what they’re doing. Scott Gilmore had an oped in the Globe examining that issue. A commenter also pointed out that these kind of full, plaintext releases may compromise cryptography. I think that modern techniques in use by governments will still be strong even with a number of cases of cryptotext and plaintext to work with, but I think it may be a question worth asking, especially if there’s a concern of a player with a long memory breaking transmissions from long ago (the news says the releases date back to 1966).

Do you have cash/GICs in your TFSA? Wish it was stocks/bonds/mutual funds you were sheltering instead? Or are you invested in an account with one institution and want to move it without having to pay transfer fees? This may be a good time to withdraw from your TFSA so you can recontribute in the new year. This is known as the December Shuffle.

Any withdrawals you make from your TFSA get added back to your TFSA room the following calendar year. This makes the December Shuffle handy: you can withdraw near the end of December, wait just a few days for January to roll around, and deposit back into your TFSA at a new institution.

You can of course transfer at any point during the year you want to, but many institutions charge more for a transfer than they do for a withdrawal, which makes this strategy useful in that way. PC Financial for example, charges $50 to transfer your money out to another TFSA, but you can make (at least, AFAIK) one free withdrawal per year. And trying to withdraw and re-contribute can mean waiting a long time outside of the TFSA at other times of the year — a withdrawal in January may mean waiting almost a whole year until you can put it back in the following January.

Remember that you’ll get another $5000 of TFSA in the new year [at the time of this post; $6000 as of 2021], so be ready to contribute (and potentially re-contribute) in January.