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This week, we take another look at an excellent, convertible bond issue denominated in Canadian dollars from a quality niche player in the home building materials industry. CanWel Building Materials (CWXZF) is one of the largest distributors of building materials and home renovation products. We first reviewed CanWel in May 2014, shining the light on company that had improved its profits even while Canadian housing starts were declining. CanWel continues its sound performance, increasing operating earnings by 30.8% for 2014 as well as increasing EBITDA 27.7%. Its recent acquisition of California Cascade Industries heralds the company’s entry into the lucrative U.S. building products market. The convertibility feature on this bond offers an added opportunity for bondholders to increase overall return through possible capital gains. Due to CanWel’s continued solid and consistent performance, we have elected to increase our weighting of these high 8.8% yielding Canadian-dollar convertible debentures in both our FX2 and FX3 portfolios.
Canadian currency notes
Canada has the eleventh-largest economy in the world and is one of the world’s wealthiest nations. According to the International Monetary Fund (IMF), Canada’s current national debt is at 86% of GDP, well below the 102.9% of GDP estimate for the United States. With 2.5% GDP growth in 2014 and less debt, Canada is one of only 9 countries in the world with stable AAA ratings. Three quarters of its exports go to the U.S, and it is the single largest supplier of energy to the U.S., which includes oil, natural gas, uranium and hydroelectricity. Considering its large automotive and technology industries, it is no surprise that Canada’s economy mirrors that of the U.S.
About the Issuer
Headquartered in Vancouver British Columbia and established in 1989, CanWel Building Materials Group is one of North America’s largest distributor of building materials and home renovation products serving the new home construction, home renovation and industrial market. CanWel also operates 7 wood preservation plants that produce quality treated wood products. Through its distribution warehouses the company provides a comprehensive range of building products to dealer/ lumberyard and home improvement centers. Builders and homeowners use its products primarily in new construction, repair and remodeling.
CanWel’s customers range in size from small independent lumber yards, to regional building material dealers, and national home improvement chains. These customers include the names of commonly known retailers such as Rona, Home Depot, Home Hardware and Lowes. CanWel also supplies the industrial market servicing firms such as furniture manufacturers, millwork shops and producers of manufactured homes and industrial trailers.
Our last review of CanWel in 2014, showcased a company that continued to thrive in 2013, even in the midst of a declining housing industry within Canada. For 2014, CanWel continued to post impressive year-over-year gains in several areas.
In 2014, CanWel posted operating earnings of CAD $24.2 million as compared to $18.5 million in 2013, an excellent increase of 30.8%. EBITDA also increased year-over-year in 2014, with the company registering CAD $28.7 million versus $22.5 million in 2013, an increase of 27.7%.
CanWel appears to be adept at acquiring small companies with high margins but weak distribution networks, and then, very effectively deploying these newly acquired product lines through its own well established national distribution network. CanWel has continued the use of this strategy with its recent acquisition of California Cascade Industries. CCI offers an extensive selection of products including treated wood, Redwood, Cedar, fascia, and special offerings of branded products to a broad array of customers. This is CanWel’s first entry into the U.S. marketplace. It provides the company solid exposure to the Western U.S. market with a company that has a variety of wood products as well as an established trucking fleet for product distribution.
In addition to gaining access to the U.S markets, this acquisition could help to add significant profits to CanWel’s bottom line. With the current strength of the U.S. dollar versus the Canadian dollar, Canadian lumber will currently be in the neighborhood of 20-25% cheaper than its comparable U.S equivalent. CanWel will now be able, through its CCI affiliate, to offer cheaper Canadian sourced lumber and distribute it through CCI’s established channels. This lower cost product will mean larger profit margins at the consumer end, thus increasing CanWel’s margins.
The Canadian Economy and Housing Market
Although Canada’s economy had mild declines in GDP in the first two quarters of this year (0.8 percent in Q1 and 0.5 percent in Q2), estimates are that the third quarter is stacking up to post an annualized GDP growth rate somewhere between 1.5% to 2.8%.
In addition, Canada’s housing market is poised to post one of its better years in 2015 despite the Canadian economy being hit by the significant shock of plunging oil prices. Earlier this year in July, home sales activity was 3.4% higher than July of 2013, and the second best activity levels since 2009. Continued low interest rates will continue to provide a substantial stimulus for housing demand.
One of the features of this bond that should be considered is the option at any time prior to maturity to convert these debentures into common shares of the company at the conversion price of CAD $12.8 per common share. With CanWel’s stock currently trading at approximately CAD $5.45 per share and paying a hefty 10% annualized dividend, denbenture holders might add to their overall return if the stock continues to increase in value, especially as CanWel continues to look for accretive acquisitions. Regardless of the stock price, the approximately 8.6% yields currently available through the maturity of the bond represent a high return relative to the risks identified.
Another item worth noting for stockholders is CanWel’s solid history of dividend payments. For the past few years, CanWel has consistently paid dividends to its stockholders. In 2014, that dividend was a solid CAD $0.14 per share each quarter. CanWel has continued this level of dividend payments in 2015 for both Q1 and Q2. For bondholder’s this provides an extra measure of security, as these dividends could be suspended if needed in order to meet interest payments on CanWel’s debt.
CanWel has a healthy interest coverage ratio. For 2014, the company registered operating income of CAD $24.211 million and financial expenses of CAD $6.736 million for an interest coverage ratio of 3.6x. For the first 6 months of 2015, CanWel had operating income of CAD $10.490 million and financial expenses of CAD $3.654 million for an interest coverage ratio of 2.8x. Although the interest coverage ratio has decreased in the first two reported quarters of 2015, it should be noted that CanWel’s business is seasonal, with its highest revenues in Q2 and Q3 and lower revenues in Q1 and Q4 due to weather.
As of June 30, 2015, CanWel had approximately CAD $52 million in cash and CAD $137 million available in a revolving loan facility for a total liquidity of $189 million.
The default risk is CanWel’s ability to perform. The company’s underlying solid financial fundamentals along with its historical, recent and forecasted levels of performance show that it has solid cash flow and should easily service its interest bearing debt. It appears the default risk for this relatively short term bond is minimal to its more favorable return potential.
An option that further reduces the default risk of this convertible bond is a conversion of the principal (at par) to CWX common stock at a 5% discount to stock’s 10 day average valuation at maturity on 4/30/2017.
A more difficult risk for us to identify is the geopolitical risk. With that said, Canada is one of the more desired countries for business to operate within, and it’s hard for us to imagine the geopolitical risks deepening from the past few years. Being denominated in Canadian Dollars, this note also exposes bondholders to the Canadian economy and the exchange rate of the loonie.
This convertible bond has a 5.85% coupon yield, paid semi-annually, and carries similar risks to other Canadian-based convertible bonds that we have reviewed, such as 7.5% TransGlobe Energy, 9% 5N Plus and 11.25% IAM Gold.
Summary and Conclusion
CanWel has shown its efficiency at adeptly acquiring smaller players in its market with high margins and less than optimal distribution networks, then effectively deploying these product lines through its own well-established national distribution network. It continues to expand its product offerings and distribution network, positioning itself as a quality niche player. Relative to the identified risks, these convertible debentures, currently yielding 8.8%, offer excellent diversification and yield in Canadian currency, as well as possible additional capital gains due to the bonds convertibility feature. Therefore, we have marked these short, 20-month bonds from CanWel Building Materials Group for addition to our Fixed-income2.com and Fixed-income3.com portfolios.
Stock Ticker: CWX.TO
Price: 5.38 (10/8/15)
Debenture Coupon: 5.85%
Conversion price: 12.8 (bondholder’s option anytime prior to maturity)
Yield to Maturity: ~8.8%
About Durig Capital
At Durig Capital, we provide investors with a specialized, transparent fiduciary service at a very low cost. To obtain higher yields and keep costs as low as possible, we typically bundle smaller retail orders into larger institutional sized orders with many global trading firms and bond platforms. Our professional service enables access to a greater spectrum of bonds, higher yields, and lower price points. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured.
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When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.
Disclosure: Durig Capital and certain clients may have positions in CanWel Building Materials 2017 notes.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this CanWel bond call our fixed income specialist at 971-327-8847
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