In This Issue
Merger mania and the banks Riocan REIT (REI.UN) Warning for Visa card holders Webscan - TechWeb Members' Corner - What to do with $175,000; Trailer fees and conflicts of interest; Blue Chip Portfolio or Bissett Canadian Equity? Updates - Livent (LIV), Hurricane Hydrocarbons (HHL.A) IWB Member Page Upcoming seminars
Dear Member,
It's the 1980s all over again! Merger mania is sweeping the continent
with mega-marriages taking place in almost every industry you can point
to. The markets have become so shell-shocked at the news of one giant
union after another that investors almost seemed to shrug off last
week's announcement that CIBC and TD Bank will be joining forces,
government approval permitting (and after a lot of soul-searching in
Ottawa I expect that it will be forthcoming). After a quick run-up on
Thursday, when rumours surfaced of Canada's second colossal bank
amalgamation, the share prices for both stocks settled back Friday once
the announcement was made. CIBC closed the week at $55, up $4.60 over
the previous Friday, a 9% advance. TD shareholders didn't fare quite as
well, gaining $3.60 on the week, a 5.5% move.I've been reluctant to add any bank stocks to the IWB Blue Chip
Portfolio because I felt they were overpriced. However, it is now clear
that we are moving into a new era of bank valuations, where the rules
are being completely rewritten. So I intend to go back for another look,
to see if I can find any value in this turbulent sector. If and when I
do, you'll be the first to know.In the meantime, if you are holding any bank shares I suggest you keep
them. There's no telling how high they may rise in this crazy market.RIOCAN REIT (REI.UN)
There is a gap in the IWB Income Portfolio which I have been meaning to
remedy for some time. That deficiency is the lack of exposure to the
strengthening real estate sector. A good income portfolio needs to be
diversified across a range of sectors, to reduce risk. So the time has
come to add a real estate investment trust (REIT) to our mix.My choice is one I recommended several years ago in The MoneyLetter, and
which continues to produce excellent returns for investors, the Riocan
REIT. It trades on Toronto under the symbol REI.UN.I like Riocan for two reasons. First, and most important for our Income
Portfolio, it has been a dependable source of tax-advantaged cash flow.
Second, it is aggressively managed and offers more capital gains
potential than many of the other REITs on the market.Riocan is Canada's largest REIT, with a market cap of more than $750
million. It specializes in neighbourhood malls, and owns assets across
the country. The Trust recently completed a new $100 million plus
underwriting, the proceeds of which were used to acquire 11 shopping
centres in Ontario and Quebec from Burnac Corporation. The properties
included Lawrence Square in Toronto, Cambrian Mall in Sault Ste. Marie,
Dougall Plaza in Windsor and several Super Carnaval centres in and
around Montreal.The acquisition is typical of the way Riocan goes about its business.
The Trust actively seeks out properties within its area of real estate
expertise that management believes can be acquired at a reasonable
price. Capital to complete the transaction is then raised through the
issuing of new trust units. On the surface, this would appear to dilute
the value of existing units but that has not been the case as Riocan has
been able to enhance the cash flow and the value of the new
acquisitions.The rapid growth of this Trust over the past couple of years shows up in
the balance sheet numbers. At the end of 1996, Riocan was showing a net
carrying value of $316 million for the land and buildings it owns. By
the end of 1997, this had more than doubled, to $677 million. Obviously,
management has been moving quickly to take advantage of the turn-around
in the retail real estate cycle before prices got out of hand.As you might expect, the Trust's earnings statements reflect this asset
growth. Rental revenue jumped from $38.8 million in 1996 to $86.8
million in 1997. Net earnings went from $15.2 million to $36.4 million
in that time.This did not translate into a doubling of per unit distributions,
however, because of the issuing of new shares to finance acquisitions.
However, income per unit rose from $1.30 in 1996 to $1.55 in 1997, a
healthy 19.2% increase.Plus, there are excellent tax advantages to be had. These arise from the
ability of REITs to shelter part of their payments to unitholders
through the use of capital cost allowance (CCA), which is simply the
depreciation on the buildings they own.In 1997, CCA sheltered 97c of the $1.55 distributed for each Riocan
unit, or about 63% of the total received. Another 12c a unit was taxed
at the favourable capital gains rate, while the rest was fully taxable.Keep in mind that any tax-sheltered income you receive from a REIT will
require you to adjust your cost base for capital gains purposes.
However, the net effect is still to defer taxes for several years. Even
when you (or your estate) do have to pay, the rate will work out to be
much less than if the money had come from interest income.Riocan unitholders have also benefited from some excellent capital gains
over the years. When I first recommended this Trust in The MoneyLetter
in March, 1994, it was trading at about $12 a unit. The shares split 2
for 1 earlier this year, and closed Friday at $10.90. So on a
split-adjusted basis, they've gained 80% over the four years, while
throwing off excellent cash flow.RBC Dominion Securities projects an annual yield of 8.4% from Riocan
over the next three years, based on the current price. Their one-year
target price on the shares is $12.50 and the three-year target is
$13.50. (If that doesn't seem very exciting based on the current price,
remember we're not buying a growth stock here. We're buying an income
security.)We will purchase 1,000 shares of Riocan for the IWB Income Portfolio at
the current market price, for an initial investment of $10,900. Using
the RBC Dominion projection, we'll look for a yield of 8.4% this year.One word of warning for ultra-cautious investors. In theory at least, a
REIT unitholder could be subject to unlimited liability if something
should go terribly wrong with a property (such as an environmental
disaster). Nothing of the sort has ever happened, and REITs carry what
should be more-than-adequate insurance coverage to ensure it never does.
But that theoretical disaster possibility remains. There have been
reports the federal government plans to take action to take REIT
investors off this particular hook, but it hasn't happened yet.CREDIT CARD WARNING
If you have a Visa card, you may want to exercise some caution in using
it outside Canada. Most cardholders are not aware that Visa hits them
with a 1.8% "administration fee" on all foreign currency transactions.
This is on top of the profit the card company makes on the conversion
rate.That extra charge can add substantially to the cost of using Visa
abroad. It means that for every $1,000 you put on the card, you're
paying an additional $18 to the company. If you're only on a short jaunt
to the States, that may not concern you. But if you're taking an
expensive foreign trip or you're a snowbird who uses the card for food
and other personal expenses while you're in Florida for several months,
that fee can add up.If most of your travel is to the U.S., one alternative is to get a U.S.
dollar card that bills all transactions in U.S. currency. Open a U.S.
dollar account, either in Canada or the States, and pay off the balance
from there. Unless you have U.S. dollar income, you will still have to
pay for currency conversion, but you'll escape the 1.8% extra charge
that Visa has chosen to tack on.Another option is to use MasterCard. The last time I looked, they did
not have a comparable fee. But ask first to be sure.WEBSCAN
With all the questions that have been coming in about the millennium bug
and what is being done about it, I was gratified to get an e-mail
message from an IWB member who is staying right on top of this issue,
telling me of an Internet site that has all the latest information.It is called TechWeb (The Technology News Site) and you can access it at
http://www.techweb.comThere's all kinds of fascinating stuff there including the day's top
technology stories, ratings of new software products, reports on
high-tech stocks, company reviews and more.For the latest on the millennium bug and the most recent doom and gloom
predictions from the experts, simply enter Y2K in the search box on the
home page. The featured story last week reported the results of a recent
survey taken in the U.S. by the Gartner Group. It found that Y2K systems
failures rose five-fold between December and March, and that the costs
of getting a fix are skyrocketing. An analyst with Gartner is quoted as
saying that total Y2K costs, including lost business opportunities and
litigation, could run as high as US$4 trillion! Scary stuff!MEMBERS' CORNER
The questions keep pouring in! Let's get to the latest batch, starting
with one that came out of a dinner-table conversation.Q - I was at an Easter dinner last week, and a relative asked me for
some advice. They recently came into an inheritance of some $175,000. He
wants to invest in the market, but is unsure because the market is
currently so high. His question to me was, should I go in now, and if
so, what should I buy? He also asked, if he went in now, should he buy
all at once, or in stages. He only wants to deal with mutual funds,
since he has no stock picking ability.A - This is the type of question I'm seeing more frequently. We're just
at the beginning of what is predicted to be the largest generational
transfer of wealth in history, as well-off parents die and baby boomers
inherit. It's been called the "trillion dollar generation". Some experts
argue the amount will actually not be that high in Canada, saying that
the parents will spend a good chunk of their accumulated wealth before
they go. But whatever happens, there will still be a lot of cash
involved, even after Revenue Canada grabs its share.In this case, my answer is fairly straightforward. Assuming there are no
debts to be paid (the best use of inherited money is almost always to
reduce debt), I would recommend this person go to a high-quality mutual
fund company and place the money in a diversified portfolio with them.
Names like Phillips, Hager & North (offices in Vancouver and Toronto)
and Bissett (Calgary) immediately come to mind. Both are no load
companies and both have a fine record for performance and integrity.Market timing should not be an issue here, since the gentleman that
inherited the money admits he is not an expert on the subject. So leave
that to the professional managers you hire when you make the investment.
If the portfolio is properly balanced between equity and fixed income
securities, timing should not be a major concern.Q - Most of my retirement money is tied up in mutual funds through a
financial planner. Could you comment on whether financial planners act
in the client's best interests when they choose mutual funds.As I understand it, they get paid directly from the mutual fund
companies by trailer fees, which I believe is mixed up in the MER of
that fund somewhere. So he may be putting me into his pet funds that
have higher MERS (not necessarily high returns), which in turn pay him
higher fees. - S.R.A - Almost all mutual funds pay trailer fees to a sales representative.
These annual payments are based on the market value of the units you
hold and are theoretically to compensate the sales person for
"servicing" your account on an on-going basis. But they also serve the
purpose of discouraging a rep from switching you out of one fund and
into another for the sake of keeping the commissions flowing in.Whether or not you agree with the idea, it has become industry standard.
It doesn't matter whether the rep is a financial planner, mutual fund
discount house, full-service broker or discount broker, they all collect
these fees, which do indeed inflate a fund's MER (management expense
ratio). In most cases the fees are pretty standard (0.5% annually is
typical). However, some no-load funds pay less (yes, no-loads do pay
these fees in most cases) while some funds that are trying to establish
a position in the marketplace pay more. You can find the exact amount
for the fund in which you are interested in its prospectus.An argument can be made that a fund paying higher trailers will create a
conflict of interest situation. So you should certainly find out what
fees the sales person is collecting and, if they seem high, ask why he
or she is recommending a particular fund.However, putting clients into poor-performing funds in order to jack up
trailer fee payments would be very short-sighted on the part of any
financial advisor. Most fully understand that their best interest lies
in maximizing portfolio returns for their clients. The reasons are
obvious. Good results often lead to even more money coming their way
from other accounts the customer may have elsewhere. Plus, a happy
client is far more likely to give you referrals than a disgruntled one
is.The bottom line is that you should satisfy yourself that your financial
planner is doing the best possible job to improve your returns while
keeping risk to a minimum. If he or she is doing that, forget about the
trailer fees and MERs.Q - I have been following your Blue Chip Portfolio with particular
interest. Would you be able to comment on the pros and cons of these
choices within an RRSP versus a top mutual fund choice such as Bissett
Canadian Equity? - P.C.A - Well, let's see. The Blue Chip Portfolio gained 22% in its first
year. The Bissett Canadian Equity Fund (which gets a top $$$$ rating in
my Mutual Fund On-Line Database) gained 42.5% in the year ending March
31. It's pretty clear where the advantage lay.However, it's really an apples and oranges comparison. The Blue Chip
Portfolio contains a limited number of stocks which are purchased on a
buy-and-hold basis, following the Warren Buffett approach to investing.
Also, it is still in the process of being built and most of the holdings
have been in the portfolio for much less than a year. If we were to look
at what would have happened to the same amount of money (say $10,000)
invested in Bissett Canadian Equity and the one stock held by the IWB
Blue Chip Portfolio at the beginning of April, 1997, the value of the
Bissett investment would have been $14,250 at the end of March. The Blue
Chip Portfolio held only EdperBrascan over that full one year period, so
$10,000 invested there would have been worth $14,500. By the time you
factored in commissions, it would pretty well be a wash.But, as I said, it is really an apples and oranges comparison. However,
if you only have a limited amount of money to invest, I suggest you go
with the mutual fund for greater diversification. Remember, however,
Bissett's initial minimum is $10,000 per fund.UPDATES
LIVENT INC. (TSE: LIV. Originally recommended in IWB #9704, Jan. 27/97,
at $16. Closed Friday at $14.) Unless you've been on holiday on a remote
tropical island, you cannot have missed last week's big news regarding
this company. Garth Drabinsky, the creative genius who built the company
from literally nothing, is out as CEO. In his place, the board of
directors has installed a powerhouse new management team headed by show
business giant Michael Ovitz and New York money man Roy Furman. All
sorts of nice things were said about Drabinsky's on-going importance to
the company (he will be vice-chairman and creative director) and the
importance of maintaining Livent's ties with Canada. But the reality is
that the entire structure of this company has changed and, from an
investor's point of view, much for the better.The writing was clearly on the wall when Livent posted a $44.1 million
loss in 1997, due mainly to a big, unexpected fourth quarter writedown
of $39.7 million which covered such items as pre-production costs,
corporate refinancing and the like. Ovitz brought with him a pot of
money (US$20 million) plus some top managerial talent including the
well-respected David Maisel, who takes over as president.Livent's appeal was in the breadth of Drabinsky's vision. He wowed the
show biz world by taking old architectural gems of theatres and
refashioning them to suit modern audiences at huge expense. He produced
brilliant re-stagings of such classic musicals as Show Boat, made
Phantom of the Opera a mega-hit in Toronto, created original hits like
Ragtime, and is in the process of staging new shows using themes as
diverse as Bob Fosse's musicals and the Dr. Seuss books.But lurking in the background, there was always a suspicion that the
financial side of the company would somehow get out of control, even
after Livent turned in a tidy $11 million profit in 1996. The final 97
results indicate that's exactly what happened. Drabinsky and his
partner, Myron Gottlieb, needed a bail-out, which Ovitz provided - but
at the price of control.What now? I don't know but this is a company with a lot of valuable show
business assets and there are now people at the top who have a
well-established record in parlaying that kind of situation into
profitability. The investment community certainly liked the news of the
change, pushing up Livent stock by $3.60 to $14.75 when trading resumed
after last Monday's announcement. The shares slipped back a bit during
the week on profit-taking, but the end result was still a strong gain.Action now: Hold. Since we don't know where Ovitz and friends will take
Livent from here, holding on (or buying in) is something of a leap of
faith at this stage. However, I think the prospects are much improved
for good downstream results from this stock. If you have shares in your
portfolio, I suggest you keep them.HURRICANE HYDROCARBONS (TSE: HHL.A. Originally recommended in IWB #9707,
Feb. 17/97, at $6.45. Closed Friday at $9.30.) The company recently
issued financial statements for the six months to Dec. 31, which
disappointed investors somewhat as they fell short of previous
forecasts. The results show net profit of US$15.9 million for the
period, and US$27.8 million for calendar 97. The latter figure came in
US$2.9 million below forecast. Earnings per share were US$0.65, compared
to a forecast of US$0.72. Cash flow was US$1.35 compared to US$1.44
forecast.The company blamed the shortfall on a 10-day shutdown of their central
oil processing facility in the fourth quarter to allow for modifications
to increase capacity in anticipation of higher production "in the near
future".On the good news side, Hurricane announced that McDaniel & Associates of
Calgary have increased their estimate of the company's proved and
probable reserves in Kazakstan to 429 million barrels, as of Jan. 1.
That's up 10% from the September 97 estimate of 389 million barrels.
The company also said that production for the first three months of 98
averaged 55,000 barrels a day, compared to just under 45,000 for the
three months ending Dec. 31.Action now: Hold/buy. The share price softened on the financial news,
but should move back up as better results come out for 98. Maintain
your positions. New members may buy at the current level.IWB MEMBER PAGE
The IWB Member Page no longer has a separate address. It is now accessed
directly through the Member Section of my web site. Go to the home page
at http://www.gordonpape.com and click on the member log in button. Your
user name will be the first 20 characters of your e-mail address. Your
password will be your surname. If you have any problem, contact Kim
Pape-Green (address below) or Kendrew Pape (kpape@istar.ca)The Member Page contains the current issue, a list of available back
issues and special offers available only to IWB members. Do drop by.SEMINARS
I will be easing my way back on to the speaking circuit in May with two
dates scheduled at the Centennial Ballroom of Toronto's Inn on the Park
Hotel, just down the street from my home. The first is on May 14 and the
second on May 20. Both will feature a new seminar I've been preparing
for the past few weeks, which is titled Your Money and Your Future. In
it, I will be covering a number of financial issues, including
investment strategies, mutual funds, taxes, retirement planning and
education savings.These will be the first seminars I will be holding since the difficult
session of radiation therapy I went through during the winter, and they
are the only ones I have scheduled for this spring. Once I'm able to
assess how well my voice holds up, I'll decide on whether I will accept
a limited number of dates for the fall. So if you'd like to take in one
of these sessions, this will be your only opportunity for a while.The sponsor of both seminars is Patrick Wong of Fortune Financial, whom
I have worked with in the past and know to have a sound, conservative
approach to money management. Admission is free, but you have to call
(416) 412-4314 to reserve a place. Both events start at 7.30 p.m.That's the story for now. I'll be back with you next Monday, April 27.
Best regards,Gordon Pape