In This Issue
The Ides of Autumn Protecting Your Portfolio The Pick of the IPO Crop - Manalta Coal Income Trust, Bell Canada International, CPL REIT Assessing the Tax Shelter Scene - Multi-Fund Income Trust Transmission Problems - One Member's Solution Symbol Correction - TRP New Circulation E-Mail Address
Dear Member,
Labour Day is over, the first day of autumn is just a week away, and
the financial movers and shakers are back from their summer cottages.
All that adds up to a very active fall season on the markets, and one
that promises to be quite turbulent.During the period from Sept. 15 to Christmas, three concerns normally
preoccupy investors:1) Stock market volatility. This is the time of year when,
historically, markets have been notorious for sudden plunges, the most
recent example being 1987.2) IPOs. When markets are on a run, as they have been for the past
three years, new securities issues pour out of the back rooms of Bay St.
and Wall St. in the autumn. These IPOs (initial public offerings) are
actively marketed by the brokerage community, but you may never hear
about the best ones until the deal closes.3) Tax planning. With the end of the year rapidly approaching, people
start to get concerned about the amount of money they will have to pay
to Revenue Canada next April, and search for ways to reduce the amount
through the use of tax shelters.I'll deal with all three of these fall phenomena today, to help you
prepare for what lies ahead.STOCK MARKET TURBULENCE
The volatility continues in New York and Toronto, and even more so in
the Far East. Investors are nervous, overreacting daily to the latest
scrap of statistical data and trying to read the financial tea leaves to
figure out if there is a major crash coming and, if so, when.I once attended a seminar given by the late Dr. Iben Browning, who
contended that stock market movements were directly tied to natural
phenomena such as earthquakes. Very convincing he was too. If he were
alive today, I'm sure he would be having a field day with the Montserrat
volcano, El Nino, and hurricanes threatening California for the first
time in recorded history. Doom and disaster for the stock markets, writ
large in the stars!As those of you who have been members for many months well know, I
believe it is almost impossible to predict when a stock market index
will suddenly break down. Yet it's a question I get all the time - when
will the crash come? Not being blessed with the power to see the future,
the answer is that I don't know. That's why my advice has always been,
and continues to be, to prepare for the worst and hope for the best.
It's the investors who choose to venture too far out on the limb who
risk having it sawed off behind them. Those who hug the trunk can only
be severely hurt if the whole tree is chopped down, something which I do
not expect in the current buoyant economic climate.But having said that, we all know the history of October and stock
markets and it would be foolish to ignore that. So if you haven't yet
taken steps to bullet-proof your portfolio, you should consider doing so
now. In IWB #9727 (Aug. 4), I set out the parameters of defensive
portfolio that would be appropriate for the current situation and still
provide exposure to the stock market in the event the upward momentum
continues. With stormy October looming, you may wish to go back and
review those suggestions again.INITIAL PUBLIC OFFERINGS (IPOS)
There are so many new deals on brokers' shelves right now that even the
most diligent among them are having trouble keeping up. In most cases,
these IPOs have not yet been priced, so I can't tell you at this stage
whether or not they represent good value. However, if you wait until
that information is available (usually about a week before the deal
closes) the most attractive issues will probably be sold out. Here are
three that appear to be among the most promising of the fall season. I'm
not making a formal recommendation on any of them at this stage, but if
any seem to fit your portfolio needs, put in an advance order with your
broker now. That doesn't mean it will get filled, but you may have a
fighting chance.MANALTA COAL INCOME TRUST. This is the hot new royalty trust issue of
the fall - in fact, it is so hot that the word is already out that the
institutions are snapping it up and there will be little left for the
general public despite the fact it will be a huge issue, at $850
million. (See the article in Saturday's Financial Post for more
information.) The deal is similar to the Luscar Coal Income Fund which I
have recommended here previously. The units are being sold on an
instalment receipt basis, which means that the income distribution in
the first year should comfortably produce double-digit yields. Once the
second instalment is paid, the annual yield is expected to fall to the
9% range.Based on the reported strong demand, I expect the receipts to open at a
premium once they begin trading publicly in late September or early
October. So if you are fortunate enough to acquire some of this IPO,
you're probably looking at a quick capital gain of 10% - 20%.If you miss out on the IPO, don't chase after the issue until you
compare the anticipated yield on the trading price with that being
generated by Luscar, which I currently estimate at about 9.1% based on
Friday's closing price of $11.90.BELL CANADA INTERNATIONAL INC. This is Ma Bell's window on the
developing world. BCI provides telecommunications services to emerging
markets, mainly in Latin America (e.g. Mexico, Colombia and Brazil) and
the Far East (e.g. Japan, China, India and Taiwan). The emphasis is on
wireless technology, and the company is involved in both cellular
telephone and cable TV services.The company is already in operation, with revenues of $215 million for
the year ending Dec. 31, 1996 and total assets of $761 million. It is
still a money-loser, however, mainly because of the high cost of
carrying the debt incurred to finance the creation of the required
infrastructure. Loss for 1996 was just over $25 million (57c a share)
and for the first half of 1997 it was almost $27 million (60c a share).So the attraction here is clearly not current profit but future growth
potential. Investors will be counting on Bell's expertise to cash in on
the rapidly-expanding telecommunications needs of these markets and to
move the balance sheet into the black within a reasonable period of
time. That won't be easy. As the company points out in its prospectus
(which should be carefully reviewed by anyone considering this IPO), BCI
is going to require large amounts of capital for the foreseeable future
to continue its expansion program in those areas it has identified as
offering the greatest potential. The company expects the proceeds from
the current issue, along with cash flow and credit access, to provide
the money needed until the end of 1998, but beyond that more borrowing
may be required and/or further stock issued to the public, potentially
diluting the value of these shares.Despite these uncertainties (and many more), IPOs such as this have
been in high demand in recent years as investors scramble for growth.
The shares are to be priced at between $18 and $21, and application has
been made to list them on Toronto, Montreal and NASDAQ under the symbol
BCICF. It wouldn't surprise me to see them move to a premium when
trading starts, but I am sceptical about whether they can stay there if
the red ink continues to flow for a few years. While I wouldn't go so
far as to classify this as a speculative stock (Bell will continue to
own more than 70% of the company after the IPO), it is certainly more
appropriate for aggressive investors who have a long time horizon and do
not need current income. It's not the sort of thing I would put into an
RRSP or RRIF.CPL LONG TERM CARE REIT. We went along for years with only three real
estate investment trusts available to Canadians (RealFund, Riocan, and
CREIT). Now the market is flooded with them, and this has been one of
the most successful.CPL owns and operates nursing homes. You've probably seen ads for their
properties, which go under the name of Central Park Lodges. The REIT
went public last May with an instalment receipt issue, with an initial
payment of $6 and the balance of $4 due in a year. The receipts trade on
the TSE under the symbol CPL.IR and closed on Friday at $12.50, more
than double their IPO price.Earlier this month, the CPL REIT entered into an agreement to purchase
an additional 13 nursing home properties from Versa-Care Limited, the
second largest owner and operator of this type in Canada. As well, the
REIT will acquire the outstanding shares of Versa, which will continue
to own another 16 properties and to manage several others. The proceeds
from this new offering are to be used to finance the deal, which is
worth about $220 million.With this acquisition, it is apparent that CPL is well on the way to
dominating the nursing home market in Canada, a health care industry
niche that would appear to have enormous growth potential given our
aging population. Since the structure of a REIT requires it to pay out
its profits to investors, this provides a unique opportunity to earn
regular income while enjoying excellent capital gains potential as well.CPL management estimates that distributable cash in 1998 will exceed
$20 million, or about $1.7 million a month. By comparison, distributions
prior to the Versa acquisition totalled about half that amount monthly.
I cannot tell you at this stage what the effect will be on distributable
cash per unit, however, since that information will only be available
when the issue is priced. I'll pass it along when I find out more.Of course, the pricing will take into account the current trading value
of the receipts, so don't expect any great bargains by picking it up on
the secondary offering (technically, this isn't an IPO since the units
already trade publicly) beyond saving the commission. But you will have
the advantage of a full year of income on the reduced instalment receipt
price, which should produce a healthy yield, most of which will be
received on a tax-deferred basis. CPL estimates that 90% of 1997
distributions will be not be subject to immediate tax, while 70% of 1998
distributions will be tax-deferred. But remember that for each dollar of
tax-deferred income you receive outside a registered plan, your cost
base for the units will be adjusted downwards. So if you should decide
to sell in future, your capital gain for tax purposes will be
proportionately higher.This secondary issue looks attractive if you need tax-advantaged income
for your portfolio. Which brings me to the third topic for today.TAX SHELTERS
It used to be that fall was open season for tax shelter salespeople.
Real estate partnerships, software deals, movie limited partnerships,
yachts, RVs, even jojoba bean farms, Napa Valley wineries, and Arabian
stallions. I've seen them all wrapped up in neat packages and promoted
as a way to reduce taxable income.But the frenzy is over, due mainly to the determined assault on the tax
shelter industry by the federal government in recent years (IWB #9728).
There will still be some offerings around this fall, of course, mainly
in the energy and real estate sectors. But nothing like what we have
seen in years past.The most attractive tax shelters around today are those like the CPL
REIT and some of the royalty income trusts that offer good current
income on a tax-deferred basis. You (or your estate) will have to pay
the piper some day, but that may not be for many years down the road. In
fact, all legal tax shelters, present and past, are in the same boat. If
the shelter is successful, it will reduce today's taxes but will
generate profits down the road, of which Revenue Canada will take a
slice. The popular mutual fund limited partnerships, which were finally
closed off this year, are prime examples. All the good ones are now
producing steady cash flow that is fully taxed in the recipient's hands.
As I've said before, you can run but you can't hide when it comes to the
tax people.Now comes the sequel to the mutual fund limited partnerships and while
it doesn't qualify as a tax shelter in the traditional sense, it does
offer some significant tax advantages.It's called the Multi-Fund Income Trust. The details have not yet been
made available to the general public and the road shows promoting the
offer to the brokerage industry don't begin until Sept. 22, so you're
reading about it here first.Essentially, what we have here is the concept of the royalty income
trust applied to the mutual fund industry. The plan is to raise between
$100 and $120 million to fund the commissions for back-end load sales
made by six fund companies: Guardian, Global Strategy, O'Donnell, Clean
Environment, Stone & Co. (Flagship funds) and University Avenue.
Investors will receive quarterly distributions from the trust beginning
Jan. 15, 1998.The main difference between this and the limited partnership concept is
that an investment in the Multi-Fund Trust (and others like it to
follow) will not be tax-deductible. However, much of the income (about
90%) will be received on a tax-deferred basis through to the year 2005,
whereas income from the limited partnerships is fully taxed.The issue is coming out on an instalment receipt basis. Total cost is
$20 a unit, with $12 payable at closing (expected to be mid-October) and
$8 on April 30, 1998. The cash flow will depend on several variables,
including the performance of the stock and bond markets and the amount
of mutual fund redemptions in any given year. The standard scenario used
for estimating returns is 10% redemptions and 10% retained market
appreciation annually; on that basis the units are projected to yield
14.4% on a pre-tax basis in calendar 1998 (14% after tax), based on the
full $20 price. Going forward, the pre-tax-yield will peak at 16.1% in
1999 (15.5% after tax) and then start to gradually decline. By 2006,
pre-tax yield will be down to 9.2% (after-tax 4.9%).But long-term forecasts like that can be misleading. A severe slump in
the market would greatly reduce the cash flow from these units. On the
other hand, continued strong performance would drive up the returns and
improve the market value considerably. So there's a large element of
market risk here.Also, you have to look at this trust in the same way as you would an
energy trust with a depleting asset base. Unless something happens down
the road, the payout from the units will eventually erode to zero and
the market value will follow suit. Energy trusts deal with that problem
by acquiring new assets, as we've seen in the case of the recent
Pengrowth acquisition from Imperial Oil. Multi-Fund may do the same
thing - there is provision in the prospectus for the trust to offer
additional units in the future to increase liquidity and fund additional
mutual fund companies. But there is no guarantee, and the whole thing
could simply wind down over time.The advantages are immediate tax-advantaged income, good
diversification (over 60 individual mutual funds will be in the
portfolio), and excellent liquidity - the units are expected to be
listed for trading on both the Toronto and Montreal exchanges so you can
cash out any time, unlike the mutual fund limited partnerships which
lock you in. Also, these trust units are fully eligible for registered
plans as Canadian content. Mutual fund limited partnerships, such as the
Mackenzie Master Partnership, can only be held in RRSPs and RRIFs as
foreign content. As a result, RRIF holders might want to consider adding
some of these units to their plans to enhance cash flow, although in
that case the tax-deferral benefit will be lost.One thing that is particularly appealing to me is the strength of the
companies participating in this offer. Guardian and Clean Environment
offer some terrific mutual funds, with excellent returns. Global
Strategy is making a comeback, and some of its funds now look very
attractive. The O'Donnell funds have some top-notch managers and,
although performance hasn't taken off yet, I expect that's just a matter
of time. Investment dealers are only starting to recognize the
advantages of the Flagship funds offered by Stone & Co., which are
managed by McLean Budden, one of the best in the business. The only weak
sister appears to be University Avenue, which is undergoing a
re-organization.All things considered, I believe this issue offers a good investment
opportunity for people who are looking for well above average cash flow
with significant tax advantages. However, don't lose sight of the risks
involved if we should enter a prolonged bear market. These units should
not represent more than 5% - 10% of your total income portfolio.If you're interested, contact your broker today. This one should sell
out fast.TRANSMISSION PROBLEMS
Several members reported that their broken line problems had been
repaired by the formatting changes we made in last week's issue. But
some are still experiencing trouble. You may be able to solve the
difficulty yourself with some adjustments at your end. Here is one
member's solution."The file looked fine on screen; it's only when I printed that the
problem appeared. This did not occur on the old mailing system, only on
the new system. I observed that it was only the really long on-screen
lines that 'break' or wrap around when the file was printed."My computer is a Pentium 90 clone with 16 megs RAM running Windows for
Workgroups 3.1 as a stand-alone computer (no network). Netcom Canada is
my internet service provider and I was using their built in, default
e-mailer."That, it turned out, was the source of our member's problem. After some
experimentation, here's what she discovered:"I've just printed out the IWB using Netscape's e-mailer, which is a
complete unknown to me; I've never used it before. The IWB printed just
fine. I noticed that the margins are a lot narrower in Netscape than in
Netcom so it looks like my printing problem is due to Netcom's margin
settings. Netcom has a very basic e-mailer and does not provide a
printer setup menu that allows me to set margins. I've spent the better
part of two hours snooping about in various *.ini files trying to find
out where Netcom sets its printer margins with absolutely no luck. It
looks like the easiest solution is for me to use another mailer."I know you've put a lot of time and effort into this problem and I
want to apologize for wasting your time. Hopefully no one else is
trying to use Netcom's built-in e-mailer."So there's one answer. See if it applies in your own case.
SYMBOL CORRECTION
A couple of members have sent e-mails advising me that TSE trading
symbol for TransCanada PipeLines is TRP, not TPL as I had previously
indicated. Sorry for the error, although I think one member's broker was
simply being obtuse when he said he couldn't locate the stock.
TransCanada PipeLines is big enough that any broker should have been
able to execute a trade, even if the symbol was incorrect. I'll make the
change for future Blue Chip Portfolio updates.NEW CIRCULATION E-MAIL ADDRESS
With her move to Newmarket, Ont., circulation director Kim Pape-Green
has now hooked on to Rogers Wave, which she reports is providing
Internet access at dazzling speeds. As a result, her e-mail address has
now changed to kimpape2@rogers.wave.caPlease address any circulation problems directly to her (non-receipt,
change of address, etc.) Some members are sending these to me, which
means several days may elapse before they are dealt with since I don't
always have time to check my e-mail daily.That's all for this week. See you again on Sept. 22.
Best regards,
Gordon Pape