G.I. Capital Corp. Portfolio Report for February 2012
Benchmark represented by: 40% i-Shares Scotia Capital Universe Bond Index, 20% TSX Composite Index, 40% MSCI World Index, in CDN$. Note: The composite portfolio includes all relevant medium risk portfolios thatmeet the composite guidelines. Composite returns include dividends and are net of all fees.Past performance is not indicative of future returns.
We added to our high yield strategy in February, buying the seniorsecured notes of Patheon, a company that we have had an equityposition in for some time. Patheon is a contract manufacturer for thepharmaceutical industry, with operations in Canada, the UnitedStates and Europe. The company has been undergoing a difficultturnaround, where they are resizing capacity to better suit demand.The notes carry a coupon of 8.625% and mature in 2017. Our entrypoint of $89 (we typically try to buy below par value) results in a yieldto maturity of 11.5%. Although the company has struggled tocomplete the turnaround in a timely fashion, and revenue growth hasbeen stagnant, the fundamentals for the notes are good. Patheon hasgenerated $73-92 million/year in EBITDA (earnings before interest,taxes, depreciation and amortization) over the last four years, whichequates to a debt to EBITDA ratio of ~3.5. In addition, the notes arein first position in the capital structure and are secured against theassets of the company, which as of Jan 31
2012, had roughly ~$525million in net tangible assets, versus $287 mil in debt.While we are quite satisfied to wait until maturity on this investment,there exists some positive optionality embedded in the terms of thenotes. The notes are callable by the company in April 2013 at$106.47. Should they call them, this would result in a return of ~29%.
It’s difficult to precisely assess whether the bonds will be called
ornot, but given the markets thirst for yield, and its oscillation between
“risk on” and “risk off” modes, there is a reasonable chance that the
company will be able to refinance at lower rates, which would compelthem to call.And finally, we note that insider buying has been fairly active, withover $2million worth of shares being purchased in the last sixmonths, most of which was by the CEO. We have found this to be afairly reliable indicator of where the fortunes of a company areheading.On the sell side, we exited our position in ACE Aviation, after thecompany announced that they would be winding the company up,and distributing the cash and securities that it holds to shareholders.Although this has been a very successful position for us, we hadbeen waiting for this event for some time. Still, we were surprised tosee how high the shares rallied on the news. The spread between themarket price and what would ultimately be distributed was only 5.5%
and given the company’s guidance that only 65
-78% would bedistributed in the next few months and the balance would not bedistributed until sometime in mid 2013, we felt it was best to sell inthe market and take the cash now.
BenchmarkS&P TSXS&P 500*MSCI WorldGoldOil-WTIUSD/CADExchange Rate**Cdn Bondishare (XBB)DistressedDedicatedShortConvertibleArbitrage
-0.53%-11.07%0.00%-7.61%9.57%8.49%-2.38%9.12%-4.24%3.85%1.13%* The returns are calculated in the currency of the holding; **Monthly average exchange rate of USD to CAD; Source: Globefund, CSFB/Tremont
In Toronto, the more economically sensitive sectors performed wellincluding consumer discretionary, energy and financials finishing themonth up 5.5%, 2.5% and 3.4% respectively. On the down sidematerials, industrials and consumer staples were the worstperformers dropping 1.8%, 0.9%, and 1.3% respectively. Gold stocksdid some damage to the materials sector as gold shares fell 3.2% onthe back of the drop in bullion of 2.96%. The speculation of QE3 hadbeen one of the factors that pushing gold higher. However, theFederal Reserve Chairman, Ben Bernanke, failed to signal thatanother round of Quantitative easing was required.Globally, Japan was the best performing market with Europeanbourses also continuing their run. In February, the Japaneseeconomy continued to rebound from last y
ear’s Tsunami. The
economy was led the electronics and auto sectors. The Nikkei indexrose by 10.5% while the German Dax was up 6.1% and the FrenchCAC was up 4.7%.The Canadian dollar had a very strong month appreciating by 0.89%vs. the USD. The appreciation was supported by renewed appetitefor risk and further expectation for an economic recovery. The priceof oil, which appreciated by 8.6%, also supported a strongerCanadian dollar.The European financial crises received a bit of a reprieve as thechairman of the European Central Bank, Mario Draghi, bought thebanks time to sort out some of their problems. Draghi understoodthat the European economy is in recession, following very weakeconomic numbers for the fourth quarter of 2011, and requires aboost. The European Chairman allowed the European banks toborrow money at the very low rate of 1% for a three year term. Intotal, the ECB has lent out close to one trillion Euros through theoperation known as the Long Term Refinancing Operation (LTRO).This operation is helping European commercial banks to safeguardtheir balance sheets. Since this program started in December 2011,the S&P 500 is up 9.8%, and hence, the program has served itsintended effect of calming the markets. In addition, the yields onsovereign debts of larger countries, such as Italy and Spain havefallen under 5% and 5.36% respectively for the first time since lastsummer. The next issue to consider for Europe is French and Greekelections scheduled for the April- May timeframe. If the elections donot go well for the incumbent, the markets will have a problem.The other issue to consider is a slowdown in China. The Chinesegovernment has just reported the 2012 growth target of 7.5% vs.8.0% forecasted previously. That slowdown is substantial, especiallygiven the size of the Chinese economy and the influence it has on therest of the global economy.The global economies are facing some serious headwinds, but thenext quarter should show if we are coming out of a recessionaryenvironment, or if in fact things are getting worse.