Score 8% Yields With CanWel Building Materials 3 Year Loonie Bonds

May.20.14 | About: CanWel Building (CWXZF)

Summary

High 8% yields in very short (3 year) maturity bonds, denominated in Canadian dollars.

One of Canada's largest distributor's of building materials, and Canada's exclusive distributor for Boise Cascade Engineered Wood Products.

Convertibility feature lowers default risk and allows a possibility for additional upside to overall returns.

Product you want, people you trust.

This week we look at CanWel Building Materials Group's (OTC:CWXZF) convertible debenture, denominated in Canadian dollars and maturing in April of 2017, as the loonie is a currency that we think may be positioned to strengthen against the greenback and the slightly discounted price of this bond is currently indicating a yield to maturity of about 8%. In addition to this, the possibility exists of increasing this already respectably high yield through the capital gains its convertibility feature allows for, as explained further in this review. Although this issue is unrated by major credit rating agencies, it exceeds the strict criteria that we have utilized to achieve and maintain our highly successful and thus far perfect "no defaults" bond record. Furthermore, we are impressed that this well managed construction materials distributor has increased profits even though home starts in Canada declined. We are therefore targeting these short maturity CanWel convertible notes for a new position within our Fixed-Income2.com and Fixed-Income3.com global income portfolios.

Canadian currency bond

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), the 2013 forecast for Canada's debt puts it at 87% of GDP, well below the 108.1% of GDP estimate that puts the United States 7th highest out of the 30 most advanced economies. With 2% GDP growth and less debt, Canada is one of only 11 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.

The Issuer

Established in 1989 and headquartered in Vancouver, B.C., CanWel Building Materials Group is one of Canada's largest distributor of building materials, home renovation products and related hardware. CanWel manufactures its own internal products and is Canada's exclusive distributor for Boise Cascade (NYSE:BCC) Engineered Wood Products, as well being a major distributor in Canada for many other better known name brand products, such as Dow Building Solutions, Owens Corning (pink insulation), Malarkey Roofing Products, James Hardie Siding, Rubbermaid and many more. This Canada wide distributor of building and building related products, with its already established lines of distribution and customer relationships, is very well positioned to launch its own internal manufactured much higher margin products. 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. This seems to be the ongoing and highly successful model for increasing the Company's profits. CanWel's assets now include six operating treating plants, three planer facilities, and 18 distribution centers strategically located across Canada.

We like companies that are profitable

Each time that we have considered CanWel Building Materials, one of the most impressive features we have observed is its improvement in profits, even while building construction across Canada was declining. According to the Canadian Mortgage and Housing Corporation (the "CMHC"), the seasonally adjusted annualized rate for Canadian housing starts was 187,923 in 2013 compared to 214,827 in 2012, a decrease of 13%. It also was one of the coldest winters we could remember, affecting large amounts of Canada. Yet, net earnings for the year ended December 31, 2013 were $9.1 million compared to $7.6 million in 2012, an increase of 19.7%. It also evidenced strong execution with a gross margin percentage of 11.0% for the year, an increase compared to the 10.8% achieved in 2012. For the year ended December 31, 2013, operating earnings were $18.5 million compared to $15.6 million in 2012.

FINANCIAL AND OPERATING RESULTS

Fiscal Year Ended December 31,

all currency numbers are millions of CAD

2013

2012

2011

Sales

725.8

710.6

692.9

Earnings before income taxes

12.0

10.3

0.5

Net earnings (loss)

9.1

7.6

(0.7)

Net earnings (loss) per share (basic and diluted)

0.16

0.13

(0.01)

Total assets

278.0

256.7

237.3

Long-term debt

119.5

87.0

50.9

Number of shares outstanding

57,342,881

58,587,138

60,779,352

Click to enlarge

Strong Production Growth Prospects

The company is able to introduce new products through its established distribution network, which greatly enhances its ability to outperform. Even though the US did have an expansion in their 2013 housing starts, Canada had a decline and a very harsh winter. Nevertheless, CanWel's earnings significantly improved. We prefer owning debt in companies that are able to increase profits even in tougher times.

Interest Coverage Ratios

Finance costs for the year of 2013 was CAD$6.59 Million ($6.06 Million in USD) , while earnings from operations was about CAD$18.455 Million ($17 Million in USD), indicating a healthy interest coverage ratio that's about three to one.

We like companies that have good balance sheets

CanWel's debt of CAD$119.5 Million ($110 Million in USD) appears to represent about 4.4% of the nearly CAD$269 Million ($247 Million USD) enterprise valuation currently given it by the equity markets. While its debt has increased substantially over time, it remains well within our criteria for a very sound balance sheets. The company repurchased and cancelled a total of 1.3 million convertible debentures in 2013

We like higher yields

One of the more unusual features that also should be considered here is the bondholders option at any time (prior to maturity) to convert these debentures into common shares of the company at a conversion price of CAD$12.80 per common share. This strike price represents a strong 36% annual appreciation from its current price of CAD$5.10. However, it's worth noting that its stock price did trade well over double its current price in 2011, less than a year after these debentures were first issued. Giving further consideration to our previous history of finding well executing Canadian companies that are notably undervalued, which is subsequently validated when purchased by much stronger players, we think any significant increases in CanWel's production could just as easily restore the equity markets confidence in this company and return it to its former highs. Regardless of its stock price, we believe the near 8% yields currently achievable through the maturity of the bond represent a high return relative to the risks that we can identify.

Risks Considerations

The default risk is CanWel's ability to perform. While the major credit rating agency do not appear to have rated this convertible debt, we have reviewed the company's underlying financial fundamentals and believe that its historical, recent and forecasted levels of performance show that its good cash flow should easily service its interest bearing debt, and it is our opinion that the financial default risk for this relatively short term bond is minimal relative to its much more favorable return potential.

An option that further reduces the default risk of this convertible bond, should at its maturity the company decide not to pay off or roll over the debt, 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 hardest 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.

One of our main concerns was the position related to the US housing market. Considering last year's poor numbers in Canada and the appearance of improvements in the US market, this relationship may not be as correlated as we first thought, and we now see CanWel's strategic combination of building products and well defined distribution as providing sound diversification to variances in the housing market.

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 the Neo Materials/MolyCorp (NYSE:MNP) Convertibles, the Brigus Gold/Primero (NYSE:PPP) Convertibles, and Transglobe Energy Convertibles. Two of these companies were bought out by substantially bigger players, giving our clients large gains much sooner than we initially targeted or anticipated.

Summary and Conclusion

CanWel's core business model is performing well. We see its ability to increase cash flow from new products, both organically and through new acquisitions, while maintaining an adequate balance sheet as it expands its distribution network for major brands, to be quite refreshing. All things considered, it is our opinion that this company has established itself as a substantial niche player. Relative to the risks that we can identify we believe that these CanWel convertible debentures offer great diversification and a high yield in Canadian currency, as well as the possibility for further capital gains due to its convertibility feature. Therefore, we are marking this short, 37 month, 7½% yield, Canadian dollar instrument from CanWel Building Materials Group for addition to ourFixed-Income2.com andFixed-Income3.com portfolios.

TSX Stock Ticker: CWX.TO
Price: 5.10 (5/16/14)

Bond Coupon: 5.85%
Maturity: 4/30/2017
Conversion price: 12.80 (anytime prior at bondholder's option)
Ratings: NA
CUSIP: 13874XAA1
Pays: Semi-annually
Price: 94.45
Yield to Maturity: ~8%

Disclosure: Durig Capital and certain clients may have positions in CanWel Building Materials 2017 bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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.


Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.