The Dissonance of Disaster: Making Money in the Patch

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In this very special back to school edition:

  • Feature: The Dissonance of Disaster: Making Money in the Patch
  • Trading notes: Real Resources, Saxon Financial, Penn West Energy Trust, Primaris Retail REIT
  • Market Guy Mailbag: Pengrowth A vs B units; resources on yield
  • Market Guy’s Closing Bell: The return of Amanda, Kevin andSqueeze Play

The Dissonance of Disaster: Making Money in the Patch
Earlier today the Globe and Mail Business section ran an article looking at the “winners and losers” in the wake of the hurricane Katrina tragedy. Among the obvious winners identified were the energy companies. Although not expressed in the article, the latent message was that business will continue, irrespective of what is going on in the world. As I read the article, I started thinking about the energy sector, human tragedy, and how to conduct myself as an investor.

I like to think of myself as a person with a social conscience. Politically I’m probably a “red tory” which means that those on the left can find redemption for my soul whereas those on the right won’t accuse me of eating granola and wearing sandals with socks. I don’t hate people as much as those on the far right, but I don’t like people as much as those on the far left. In other words, I’m smack-dab in the middle, the prototypical Canadian of today. But here’s the thing: Is it possible to have a conscience and take great pleasure from the run-up in energy prices? Quite simply, there isn’t an investment today that relies more heavily on human misery. Let’s review a short list of events that are positive for energy investments:

  • Hurricanes
  • Terrorism and jihads of any kind
  • Sabotage
  • War
  • Fear
  • Panic
  • Mass hysteria
  • Accidents and associated explosions
  • Strikes
  • Political unrest
  • Swarms of angry locusts

It’s all misery, but it’s all positive for oil. If you’re heavily invested in the patch, then you’ve driven by gas stations and the “$1.20 a litre” signs and it barely registers on your radar screen. The other day I was speaking with a colleague at Carleton who once raced from a departmental meeting to check the price of his energy puts and calls. His face lit up as we discussed oil’s spike past $70. My buddy Dick in Edmonton is from Ottawa, but now works for the Alberta government. I know he’s become an Albertan because he’s ready to join a militia to prevent Ontario and Quebec from sucking profits away from King Ralph. In any event, I’m sure both men would agree with the following assertion: If you can make enough on your energy investments to offset the extra cash it takes to fill up the car and heat the house, then you’ve successfully constructed a hedge against one of the more annoying forms of personal inflation. They would likely add that there is nothing to be gained by having your declining personal wealth added to the list of human misery. In other words, an investor has to do what an investor has to do. It’s not suggesting that one needs to think as Jack Larkin, the famed investment banker from the 1990s series, Traders. When informed of a devastating mudslide affecting thousands in South America , he offered, “What grows in a mudslide?” Rather, it’s about being faithful to the central purpose behind portfolio construction: to improve one’s circumstances.

  If you’re like the Market Guy, you miss the crazy antics of Jack, Sally and Adam over at Gardner Ross Cunningham.

All of this reminds me of Leon Festinger (1957), who believed that we experience feelings of discomfort when our behaviour is inconsistent with our attitudes or when we hold two conflicting attitudes. He called this state of psychological tension, cognitive dissonance and it’s one of my favourite theories from social psychology. It makes sense for us to become uncomfortable when we become aware of our inconsistencies. For example, “I am a good person” vs. “I am making money from tragedy” are fundamentally incompatible beliefs and likely to produce tension. What’s more interesting are the tactics we may use to reduce the tension:

  1. We may change a belief that is creating the tension. For example, we could switch to “I’m not such a good person” but that would likely result in problems of another sort. A more likely option would be something like “I’m not really making that much money” or “I’m really investing in economic expansion, not oil or tragedy per se.”
  2. Add a belief that is compatible with our pre-existing thoughts. For example, you might suggest that “Making money is what investing is all about.” I like this one.
  3. Change our behaviour. One option would be to stop investing in the energy sector. For me, this is not going to happen. A more realistic option is offered by Mark in Peterborough who says that he plans on taking some profits (specifically, paring back on Encana and Peyto) and donating some of the money to the Red Cross and a couple of other charities.

For myself, I expect to engage in several of the above and will be using the dissonance-reduction combo to help me navigate my way through the patch. I expect the belief that “many factors influence the price of oil, all of which are out of my control” will figure prominently in my psychology. Speaking of taking profits.

Trading notes
Real Resources (RER on the TSX)
I’ve sold 1/3 of my remaining position in Real Resources at $23.51. The shares were originally purchased in the summer of 2004 at a price of $7.40 (see MG#21). With no dividend to speak of, Real had became somewhat of an oddity within my portfolio. When I initiated the position, I was speculating on the direction of energy prices and was hoping that Real would convert to the trust structure. Well, the talk of conversion petered out, even though daily production achieved levels at which so many others had made the switch. But in the final analysis, who cares? The price of oil advancing to over $70 was good enough to send Real’s stock price soaring well over 200% in one year. That made it easy to pare back the holding for a second time. I won’t lie to you.I’m very pleased with myself about this one and plan on being insufferable for at least a week.

  When you get one of these, bask in its glory..soak up every moment of the joy.

Saxon Financial (SFI on the TSX)
In the last edition of MG, I mentioned placing an expression of interest in the initial public offering of Saxon Financial. Well, I received 100% of the requested allocation at $16.50 and was pleased with its strong debut on the TSX. The shares popped to $19.50 but have since traded back to just a few cents over issue. Fair enough. I’m holding based on management’s track record and a shift to lower MER fund offerings.

Penn West Energy Trust (PWT.UN on the TSX)
Earlier this summer, I initiated a position in Penn West Energy Trust at $29. Formerly a traditional exploration and production concern, it recently converted to the royalty trust structure. With roughly 100,000 barrels of oil equivalent per day this one is huge and should be a lock for inclusion in the TSX index. Many in the investment community are adopting a “wait and see” attitude, given some of the lukewarm results that have plagued several other recent conversions. There are also some question marks regarding PWT’s capital efficiencies. These factors have combined to hand the trust a lower than average valuation when compared to the leaders in the sector. Penn West has the following attributes:

  • a payout ratio of roughly 50%, lower than average for the group
  • originally targeted payout ratio of 60%, leading some to speculate that a distribution increase or special payout is in the offing
  • management has expressed willingness to pursue a NYSE listing, which would provide an opportunity to capture some of that tasty American capital.
  • it has the largest undeveloped land base in the sector
  • a balanced production profile with roughly 52% oil and 48% natural gas
  • based on my purchase price of $29, a yield just shy of 11%; current trading yield of just over 9% (it’s jumped $5 since my purchase)

Beyond the obvious effect of energy prices, the risk is that Penn West has trouble adjusting to the trust structure and fails to address the capital efficiency issue fast enough to soothe investors. In any event, with all of the plusses, I’m willing to assume this risk for now.

Primaris Retail REIT (PMZ.UN on the TSX)
I initiated a position in Primaris Retail REIT via a secondary offering of units at $14.85. Here are a few characteristics of the REIT:

  • managed by Oxford Properties, one of the most experienced names in the sector (external management contract)
  • 731 tenants, with no one tenant representing more than 5% of annual rents
  • 14 properties in 12 markets
  • overall occupancy stands at just under 97%
  • have been hard on the acquisition trail and can add more debt, if necessary
  • recently announced a distribution increase
  • payout ratio of roughly 85%
  • geographic diversification, with assets spread across 6 provinces
  • focus on mid-market properties in the large centres (e.g., Toronto and Calgary ) and dominant properties in the secondary centres (e.g., Kelowna and Guelph )
  • recent quarter showed a solid increase in AFFO
  • trades at a substantial discount to Riocan and Calloway in terms of P/AFFO
  • based on my purchase price of $14.85 a yield of 7.7%

I believe that many of the larger names in the sector have become very expensive. Therefore, I’m becoming more interested in some of the lesser-known, more value-oriented plays. Initiating a position in Primaris is consistent with this philosophy.

The Market Guy Mailbag
The mail continues to flow in and I’m getting behind. So without further delay, let’s see what’s in the Market Guy Mailbag. As always, when considering my responses, keep in mind that I’m just a putz with a website.

Letter #1: Ken writes:
I was wondering if you have any understanding of why the Pengrowth A trust units are “worth” 50% more than the Pengrowth B trust units.  The A units are the ones held by people living in the USA , and the B units are the ones held by Canadians. The company split the units into A and B in anticipation of governmental requirements about how much of a trust company can be owned by foreigners before the company no longer qualifies for the trust company’s Canadian tax benefits. 

The two kinds of units receive exactly the same distributions (so the yield is a lot less for the more valuable A units).  I asked the company PR people why the A units sell for 50% more than the B units and the reply, basically,  was that the A units are more popular in the USA than the B units are here in Canada .  That hardly seems possible. Do you have any understanding of this?

From my understanding, the Pengrowth PR folks are giving you the correct information. It’s all a matter of supply and demand. There are so few of these products for sale in the large US market, while there is plenty of product available in the small Canadian market. I also visited some investor discussion boards heavily populated by American investors and the A vs. B issue seems to be a popular topic. The punch line of their discussion seems to be “if only we could get in on the B units!” If they could, they’d swarm all over the B’s, subsequently driving the yield right down to the A level. Given the relatively high level of confusion, I’d say Pengrowth hasn’t been very successful at explaining the dual-class to investors. I even saw an “expert” on ROB-TV’s Market Call get this wrong, which had me cringing at the TV more than if forced to watch 5 minutes of Jay Leno. I can’t remember who was hosting that day, but if it was Jim O’Connell, he should have slapped the guest silly. I’m guessing this would never happen, but it should. Jim seems like too normal a guy. Can’t you picture having him over for a BBQ? For some reason I have a mental image of him standing by the BBQ, saying something positive about the potato salad, and then offering, “so, did you purchase that tank or are you going with the propane exchange?” This has nothing to do with anything.

Letter #2 Denise writes:
Where can I find listing of all dividend yielding stock or REITs units only, etc (for TSX). Newspaper,  website  …?

Norm Rothery’s Stingy Investor site has everything nicely organized for you:

Note the links on the left of the page under “high dividend yield.” Just select the index that you’re interested in, and it will take you directly to globeinvestor’s data sheets.

Another way of doing it is to visit directly. Under Investor Tools select Market Indexes, select the index group of choice along with “price report % change.” This will bring up a list of several indices. Select the index of choice and then organize the output by clicking on “dividend yield”.

For REITs, considering visiting the Trust Centre and clicking on their REIT price report link on the right side of the page.

Market Guy’s Closing Bell
The 80s had Hall & Oates. The 90s had Ren & Stimpy. The current decade has Kevin and Amanda. September 6th marks the return of Amanda Lang from maternity leave and Kevin O’Leary from summer vacation to staff the helm of ROB-TVs best program, Squeeze Play. Billed as a show about “money, power, and politics” I find it to be smart, informative, occasionally funny, and a compelling hour of television. And with the return of Kevin and Amanda , I can barely contain myself. Now I can abandon my count of how many times Libby Znaimer uses the word “interesting” (“this is interesting” or “here’s what I find interesting” or just plain “interesting”). Vegas had it on the board with the over/under pegged at 10 per hour. With Amanda back we can return to good conversation, great questions, smooth segues, and someone who isn’t afraid to challenge Kevin.

Thank goodness all will be as it once was and the natural order will have been restored

The two hosts seem to genuinely enjoy being in the studio together, even though they often disagree. Their chemistry adds so much to the show and brings a sense of humour that is typically missing from business programming. Amanda was clearly missed when other hosts were brought in on a rotating basis. On some nights Kevin had that “get me the hell out of here” look on his face and I fully expected him to suffer a psychotic break. Now he’ll be content, fresh, and ready to resume a tandem that clearly brings out the best in each other.

Kevin approaches every situation and every guest with a “how can I make money from this?” angle and it helps keep the show focused. On September 6th, I’ll be focused on Squeeze Play. The show will be running from 5-6pm weekdays. As a side note, Market Gal is convinced that I have a crush on Amanda, so I’ll have to play this up as much as possible. I had to listen to her lengthy account of what it was like to attend Mama Mia so it’s payback time.

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets…so do your homework before making any investment decisions. He’s up for tenure this year, which means he’s close to a lifetime supply of stationary! Life is never stationary over