Saturday, December 13, 2014

Bought 2 LINN Energy LLC 8.625% Senior Unsecured Bonds at $81 (4/15/2020 Maturity)/Bought 50 ARESF at $12-REIT Basket Strategy

Big Picture: No Change

Stable Vix Pattern (Bullish):

Recent Developments:

GE's Board of Directors increased the quarterly dividend by 5%. The new quarterly rate will be $.23 per share, up just one cent. The ex dividend date will be 12/18/14. I am not reinvesting the dividend. Based on my total average total cost per of $20.13, the new penny rate raises my dividend yield to 4.57%. I currently own 531+ shares.

Crude oil futures fell to the lowest level since May 2009 last week. The decline accelerated last Friday after the IEA cuts its 2015 global growth number by 230,000 barrels per day to 900,000 barrels a day. December:- IEA releases Oil Market Report for December That forecast would result in consumption of 93.3 million barrels per day, up from the 2014 current estimate of 92.4M barrels per day. The market is oversupplied with 94.1Mb/d in production during November.  I am estimating that supply will not match demand until early next summer at the earliest, unless OPEC agrees to cut production which does not appear likely.

WTI and Brent have lost about 45% of their values since peaking in early summer. The January 2015 future's contract for WTI Crude dropped $8.03 per barrel or 12.2% last week to close at $57.81. Energy & Oil Prices

The DJIA declined 678 points or 3.8% last week. The S & P 500 lost 73 points or 3.5%.

Recently Received Year End Fund Distributions: I really do not appreciate large year end distributions. Does a fund distribution add to my net worth? The net asset value is adjusted down to reflect the distribution amount. The distribution creates a tax obligation. Short term capital gains are taxed at the highest marginal rate. A long term capital gain still generates a 15% tax payment, assuming the taxpayer qualifies for that rate as I do.

I recently sold out of the Royce Micro Cap Fund (RMT), when its discount narrowed to just 3% and in advance of a $2.19 per share distribution. Item 2 Sold 433+ RMT at $12.76-Average Cost Per Share $7.91 (12/9/2014 Post) After going ex dividend on 12/11/14, the shares closed last Friday at $9.79. I may start buying back small lots when the discount expands to over 12% again. The discount last Friday had expanded to -8.85%.  

The only way for me to come out ahead is that the reinvested dividend generates a return after tax in excess of the tax liability associated with that payment. In a bull market, that can and often will occur. A bear market will simply cause a loss in value of the original dividend used to buy more shares that later go down in value.

I may own a fund in two different accounts, reinvesting the dividend in one account and taking cash payment in the other.

I have taken the capital gains distributions for the Matthews Pacific Tiger (MAPTX) fund in cash, since I first acquired shares over a decade ago. I view that approach as a way to harvest gains without having to sell shares. As shown in the snapshot below, I received a $256.53 cash distribution from that fund.

The Permanent Portfolio (PRPFX) is another long term holding that is mostly out-of-sight, out-of-mind. That fund is sort of my disaster hedge, with its large and relatively constant allocations to gold and silver bullion, treasuries, investment grade corporate bonds, Swiss government bonds, natural resource stocks and REITs, and what it calls an "aggressive growth" portfolio that is more accurately called a value tilt. This is the second year in a row where PRPFX has paid a large capital gain distribution. The 2014 long term capital gain dividend was $2.9 per share.

At least these funds only classified a small amount as short term capital gains. Most of the ordinary income dividends will probably be classified as qualified.

Permanent Portfolio Fund (PRPFX)

Matthews Pacific Tiger Fund  (MAPTX)-Taken IN CASH

Matthews Asian Growth & Income Fund MACSX)

Matthews China Dividend Fund (MCDFX)

Total 4 Funds:
Long Term Capital Gains: $1,132.27
Short Term Capital Gains: $13.42
Ordinary Income: $226.51
Total: $1,372.2

I have elected to keep my China Fund (CHN) shares notwithstanding the 4th $3+ per share annual distribution. I am reinvesting the dividend.

Adams Express has already gone ex dividend for its year end distribution and I will receive that dividend in cash. Adams Express ($1.03 per share)

The Swiss Helvetia has a big one that has not yet gone ex dividend. I am reinvesting SWZ dividends, and this distribution will take me over a 1000 shares. The Swiss Helvetia Fund ($2.195 per share on 900+ shares)


Canadian REITs have taken a bad tumble over the past few weeks, with several of them hitting new 52 week or all time lows.

As far as I can surmise, some investors have concluded in typical group think fashion that Canada is about to fall into an abyss, never again to see daylight or prosperity, due to the most recent sharp decline in crude prices. All is lost, bad now and will never get any better.

Tenants will abandon their leases in droves, just prior to jumping off tall buildings en masse. That is a really scary thought.

My unrealized losses in the Canadian REIT sector now exceed my realized gains in 2014. I thought that I was doing pretty good until the herd decided that Canada was going kaput. I am exaggerating just a little bit here.

Many of the Canadian REITs are now yielding over 9%, and some are now over 10% yields, based on their recent share prices. All of them pay monthly distributions.

The carnage inflicted in the Canadian REIT sector has caused the Old Geezer to become more timid with his purchases.

When I last bought Artis, discussed below, I used my CADs to buy 300 units on the Toronto exchange.

Having sold that lot 300 unit lot at C$15.71 on 9/12/14, I managed to generate only enough courage to buy 50 ordinary shares traded on the U.S. pink sheet exchange and priced in USDs for the reasons discussed hereafter.

1. Bought 50 ARESF at $12 (Equity REIT Common and Preferred Stock Basket)(see Disclaimer):

Snapshot of Trade: I bought the ordinary shares priced in USDs that are traded on the U.S. pink sheet exchange: Artis Real Estate Investment Trust (ARESF)

Closing Prices Day of Trade: Friday 12/12/14

ARESF: $12.02 -0.28 (-2.28%)-Ordinary Shares Priced in USDs
AX-UN.TO: C$13.92 -0.24 (-1.69%)-Ordinary Shares Priced in CADs

Currency Conversion on Day of Trade:

Security Description: Artis Real Estate Investment Trust (AX.UN:TOR) is a diversified Canadian REIT that owns office, retail and industrial properties in Canada and the U.S., with a focus on Western Canada. 

As of 9/30/14, Artis had 244 properties in its portfolio with 25.6M square feet of leasable space. Portfolio occupancy stood at 96%.

On a net operating income basis, Artis had a 51.9% weighting in office buildings, 23.8% in industrial properties and 24.3% in retail properties.The U.S. properties provided 22.6% of net operating income. (page 4 Third Quarter Earnings Report)

Property Map: Portfolio Map

U.S. properties are concentrated primarily in Minneapolis and Phoenix and Denver to a lesser extent.

It owns 40 properties in Minneapolis consisting of 4 office, 6 retail and 30 industrial properties Pictures Those properties accounted for 13.4% of net operating income YTD through 9/30/14.

The company owns 6 office and 1 industrial property in Phoenix. Pictures

Three office buildings were owned in Denver.

For assets owned in the U.S., the U.S. funds are converted back into Canadian Dollars which produces "largely unpredictable foreign exchange gains and losses on our income statement" which impacts "results from operations, as well as the other comprehensive income".  For the three months ending 9/30/14, Artis booked an unrealized gain in "other comprehensive income of $32.5 million, a large number due to the size of our U.S. portfolio". Page 3 Q3 2014 Results-Earnings Call Transcript | Seeking Alpha

A list of properties, with occupancy rates can be found at page 5 of the last earnings report.

As of 9/30/14, the weighted average interest rate was 4.09%. The weighted average term was 4 years. Total debt to gross book value stood at 48.6%. The interest coverage ratio was 2.8 times. Page 12 Investor-Presentation

AFFO per unit has risen steadily, though slowly, from C$1.15 per unit in 2012 to an estimated C$1.22 in the 2013 third quarter. The AFFO payout ratio was 87% in the last quarter, which is high, but still within the high end of my comfort range. (page 14) The consensus 2015 estimate is for AFFO C$1.28 per unit.

Based on the closing price of C$13.92 last Friday, the P/AFFO based on the C$1.28 estimate would be 10.875 which I view favorably.

As of 11/6/14, the consensus estimates were as follows: net asset value per share was C$16.51; implied capitalization rate of 6.7%; and consensus target price of C$17.16 (page 18)

Distributions: The monthly distribution rate is currently C$0.09 per share. 

The distribution will be converted from CADs to USDs after a 15% Canadian withholding tax. At the exchange rate from last Friday,  C$.09 would buy $.0777 before the adjustment for the Canadian tax.

For owners of ARESF, and assuming the distribution rate remains constant at C$.09, it is important to keep in mind that a decline in the CAD after a purchase results in a dividend cut, while an increase in the CAD's value operates as a dividend increase.

Given the currency fluctuations, it is impossible to compute a dividend yield. The dividend yield would be about 7.77% at a total cost per share of $12, assuming no dividend change and a constant currency exchange rate that produces a $.0777 monthly rate for ARESF unit holders. The actual annualized yield will depend on the conversion rate for each monthly dividend payment.

Link to Distribution History

Prior Trades: My prior trades were made on the Toronto exchange which requires an explanation of how profits are reported by my broker, an issue that is avoided when the investor buys the ordinary shares using USDs on the U.S. pink sheet exchange.

For a U.S. taxpayer, the taxable profit reportable on a 1099 by the broker will not be determined by the investor's profits in CADs. Instead, both the cost basis and the proceeds will be converted from CADs into USDs. If the CAD declines in value against the USD during the period of ownership, the U.S. taxpayer will realize a lower taxable profit than the amount actually realized in CADs. Different permutations of that scenario could also apply. The investor might have a profit in CADs and a loss in USDs, for example, or a loss in CADs and a profit in USDs.

Since I sold a number of Canadian REITs earlier this year, my reportable tax profit was less than my CAD profit due to the decline in the CAD during my ownership period.

One example is provided by my disposition of 300 Artis shares bought on the Toronto exchange using my CADs. I sold those shares in Toronto and received C$397 more than I used in CADs to make that purchase. My reportable USD profit was $6.92. The accounting related to currency conversion for tax reporting purposes eliminated about C$390 in profits.

Snapshots at Item # 1 SOLD 300 AX-UN:CA at C$15.71 (9/26/14 Post)-Item # 1 Bought 300 of Artis REIT at C$14.36 (9/28/13 Post)

Last Friday, I could have bought the ordinary shares in Toronto at a lower price than that previous September 2013 purchase.

Prior to the foregoing round trip, I had flipped two 100 share units back in 2011, realizing a total gain of $281.27 (snapshot in both prior linked posts).

Recent Earnings Report: All amounts are in Canadian Dollars. For the quarter ending 9/30/14, Artis reported revenues of $125.425M and AFFO of $42.128M or $.31 per shares:

The AFFO calculation can be found at page 24. The AFFO number subtracts from FFO reserves for capital expenditures, reserves for leasing costs and straight-line rent adjustments.

Page 9 Third Quarter Report.pdf

Third Quarter Financial Statement.pdf

Q3 2014 Results - Earnings Call Transcript | Seeking Alpha

I will use the AFFO numbers, rather than FFO, when making a valuation judgment.

Rationale: Both the dividend yield and valuations are good in my opinion. I noted the consensus P/AFFO was 10.875. The P/FFO would be lower. The average P/FFO for American REITs was 17.8 in November 2014, page 3 Lazard_US RealEstate Indicators Report

I can never predict how long irrational pricing will continue. I thought that investors had lost their collective minds in 1998 and had gone berserk. Yet, prices continued to rise through 1999 and into 2000. The same kind of mindset was prevalent in March 2009, when investors were pricing securities based on an economic scenario that had already been eliminated through the collective actions of central banks and governments. Common Valuation in Bear Markets: It is Bad and Will Never Get Better (3/22/09 Post)


(1) Currency Conversion Issues: The following discussion is fairly typical whenever I buy a foreign security.

The ARESF price is linked to the ordinary share price priced in CADs as converted into USDs. If the CAD continues to decline against the USD, the ARESF shares will underperform the ordinary shares traded in Toronto and priced in CADs. The CAD has been declining in value, so I would expect to see ARESF underperforming the Toronto listed shares priced in CADs which is the case as shown by this two year chart:

That chart looks like the stock decided all of a sudden to jump off a cliff.

The USD priced ordinary shares will outperform the ordinary shares priced in CADs when the CAD has gained value. To show how this works, I looked at a five year chart for the CAD/USD. I noted that the CAD was rising in value between 7/1/2010 to 7/29/12. I then entered those dates as the time period for another comparison chart:

Putting side all other currency conversion issues, the buyer of ARESF would want the CAD to rise against the USD after purchasing shares.

The worst scenario for the ARESF owner, which I simply call the double whammy, is for the CAD to continue declining against the USD and for the ordinary shares priced in CADs to decline in price at the same time.

The best scenario is for the CAD to increase in value after the purchase and for the ordinary shares priced in CADs to increase in price at the same time.

In my opinion, I prefer to buy foreign securities when the USD has significantly risen in value against the relevant foreign currency and the ordinary shares have declined significantly in local currency terms for non-fundamental reasons.  Both of those conditions have now occurred with ARESF, unless one believes that Canada is in for a long term economic decline. The current declines in the CAD and the ordinary shares priced in CADs may be far from over too. I can not predict the future. When and if I believe that I can, I would hope my family appoints a conservator to manage the money.

Stocks, Bonds & Politics: Strong U.S. Dollar + Weak Market=Time to Start Looking Overseas (6/1/2010 Post)

Stocks, Bonds & Politics: International Trading and Currency Risks (7/11/2010 Post)

(2) Investor Perception about the Canadian Economy: As noted earlier, the Canadian REIT sector decline gathered momentum as energy prices accelerated their decline. A persistent long term decline in crude oil prices will have a negative impact on Canada's GDP. I suspect more of that negative impact would be felt in the Alberta and Saskatchewan provinces.

Canadian banks may be negatively impacted by increased credit risks. Several western Canadian governments will have less revenues.

For the Ontario and Quebec provinces, the overall impact would probably be positive as consumers have more money to spend due to lower heating and gasoline costs. Investors have already overreacted in a major and irrational way when pricing Canadian REITs, in my opinion. When the herd starts engaging in group think that assumes Armageddon is near, fear has gained control over the rational Left Brain decision making process.

Recessions will take a toll on REITs. It remains to be seen whether Canada will slip into a recession. Recent economic numbers are generally positive. Gross domestic product, expenditure-based (quarterly);  GDP growing at 2.8% pace-CBC News (11/28/14 dated article)

3. Company Description of Risks: Every company that I buy regularly produces a summary of risk incident to its operations. Generally, an investor can find those risks in an Annual Report. Artis describes those risks starting at page 22 of its 2013 annual report: Artis-REIT-2013-Financial-Report.pdf

Future Buys/Sells: Sometimes, when I purchase foreign ordinary shares on the pink sheets, my broker converts the shares to the ordinary shares priced in the local currency. That ends up being a cheaper way to buy the foreign security, since the commission is more than 50% lower than the cost applicable for Toronto trades. This will not happen until I own 100 shares and may not happen at all. I have to trade round 100 share lots in Toronto.

When and if the ARESF price sinks below $11.5, I will consider buying 50 more shares and another 50 below $11.

I do not have a target price. Most likely, I would sell the highest cost lost first to lower my average cost per share, and then buy that lot back whenever it would reduce my average cost per share. If my shares are converted to the symbol used in Canada, then I would only average down with a 200 share lot, using my existing CAD stash to fund the purchase, given the C$19 commission rate.

2. Bought 2 LINN Energy L.L.C. 8.625% Senior Unsecured Bonds at 81 (Maturing on 4/15/20) (see Disclaimer)

I have started up again my junk bond basket strategy. I have been explaining my reasoning in comments made at SA in Land of Milk and Honey Instablog #51 | Seeking Alpha.

I will be focusing on junk E & P bonds that have been smashed in price. I have non-energy names on my monitor list, but want lower prices before buying. This is an EXTREMELY HIGH RISK STRATEGY. I EXPECT DEFAULTS. The goal is to cover the losses caused by defaults with profits on bonds issued by companies who survive to pay off the bond at maturity or earlier.

Snapshot of Trade:

Bought 2 LINN $1,000 Par Value 8.625% Senior Unsecured Bonds at $81 
Company and Security Description: Linn Energy LLC (LINE) is well known to income oriented investors. A large number of articles, pro and con, are written about the common shares. Linn Energy, LLC | Seeking Alpha One authored published an article at Seeking Alpha claiming that LINN would have "strong cash flow for years" in order to pay distributions to the common unit owners. I am going to refer to those "units" as "shares" hereafter.

LINN Energy, LLC-Homepage

LINN Operations-Homepage

Q3 2014 Earnings Release

LINE 10-Q for the Q/E 9/30/2014

I have not owned the LINN common shares since 2010: Sold 100 LINE at 25.90 (6/26/2010 Post)(profit snapshot=$971.97) As an owner of the senior bond, the payments being made to the common shareholders are a negative.

The common shares have been smashed pretty good in response to the crude oil price decline: LINE Interactive Stock Chart When I bought the common shares, the price had already been smashed for the same reason.

Since I own a senior bond, I only care about receiving my interest payments when due and par value at maturity. I am consequently uninterested in the debates about whether the common shares have hit bottom or whether the distribution will be maintained or cut to those common share owners.

The following snapshot explains the basic terms:

The bond is currently rated well into junk territory: B1 by Moody's and B by S & P. This bond was originally issued in a private placement back in March 2010. LINN Press Release

I would anticipate ratings' downgrades before the current down cycle runs its course.

This bond is listed in LINN's last SEC Filed 10-Q at page 11. Total long term debt, less current maturities stood at $11.010+B as of 9/30/14. Three billion of senior notes are scheduled to mature before 2020, with the first being a 6.5% senior unsecured note maturing in May 2019 with an outstanding principal amount of $1.2B. Another note in the principal amount of $1.8B matures in November 2019. LINE 9/30/2014 10Q

I view it as more likely than not that this bond will become cheaper, unless there is a major reduction soon in OPEC's production limits. The future is however not knowable with any certainty. I certainly do not know now how much cheaper.

What was knowable last Friday? I could buy just 2 bonds in my Vanguard brokerage account, which is unusual. Fidelity's order book required a minimum 5 bond purchase and at a slightly higher price than 81. I do not want to buy more than 2 bonds from a single E & P issuer, so I can not be too picky when I buy when the best price allows for a 1 or 2 bond buy. I also know that I will have almost a $400 profit provided LINN survives to pay off this bond. I would even appreciate an optional early redemption at a premium price.  I also know that this bond was trading at over 115 last May, and that the 81 price is about 30% lower than that high price last May. FINRA Chart

What is not known and is ultimately unknowable now? I can only guess how long oil prices will remain low and how LINN will adapt to potentially unfavorable future scenarios. Consequently, I could lose some or even most of my principal that would be offset to some degree by interest payments received prior to a default.

Rationale and Risks: I hope to buy a number of E & P junk bonds at deep discounts to par value over the next several weeks. The timing will in part depend on when I am able to buy a 1 or 2 bond lot. I will be checking the order books at least twice a day.

The rationale is that yields have become enticing.

The YTM of the LINN 2020 is 13.703%. Yield to maturity assumes that the bond will be paid off at maturity.

The current yield is about 10.65% ($8.625 dividend by $81)

My best estimate is that a 10%+ annualized yield will beat the S & P 500 return over the next five years, possibly by a wide margin. If I can harvest a 10% or higher annualized yield, and have a net profit on the junk E & P bonds, no matter how small, then I am reasonably confident that this high risk junk bond strategy will outperform SPY over the next five years. I could even afford to have a small net loss on the bonds, since all of them will have greater than 10% current yields, and still exceed a 10% total annualized return.

The risk is a default. Credit risk is the risk. The risk is heightened by two events occurring at the same time: a decline in crude prices and money flying out the door to the common share owners. Hopefully, if distributable cash flow turns negative, LINN will cease making distributions to the common share owners in order to avoid a default on its senior debt obligations that would probably quickly lead to a bankruptcy filing. After a BK, interest payments on debt obligations cease of course, and it becomes a question of how many cents on the dollars are available for the unsecured senior creditors.

I am not concerned about interest rate risk for a bond maturing in April 2020, particularly given the low inflation forecasts embodied in the 5 year treasury TIP. The break-even spread for the 5 year TIP closed last Friday (12/12/14) at 1.2%:

Subtract Yield on the 5 Year TIP= .33%
Daily Treasury Real Yield Curve Rates

From the Yield of the 5 Year Non-Inflation Protected Treasury= 1.53%
Daily Treasury Yield Curve Rates

The average annual CPI increase would need to be 1.2% over the next five years for the 5 year TIP buyer to break-even with the buyer of the non-inflation protected 5 year treasury.

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