Sherritt Restructures its Debt
Earlier this year Sherritt International, a Canadian mining company, announced plans to extend its debt maturity by 3 years in order to weather the current commodity downturn. Out of the $720,000,000 debt that will get the extension, $5,000 of it is owned by me. 😀 A couple of years ago I purchased some Sherritt bonds for $5K with the expectation that I would be paid 8% interest rate every year until maturity in 2018, at which point my principal will be returned to me.
But last week I received the following online message from my discount broker.
I always knew this was a potential possibility. Making 8% investment return a year comes with a fair chunk of risk. I can understand the plight of the mining company. I first realized Sherritt was in trouble when the value of my bond dropped 38% last year, and prepared myself or the worst. Sherritt’s profits are tied to the underlying commodity that it’s trying to sell. The price of nickel has dropped to just under $5/pound today, compared to $12/pound 5 years ago.
The 3 year extension would provide breathing room for Sherritt as it waits for nickel prices to recover. “Upon completion of the extension, there will be no maturities until November, 2021,” said David Pathe, Sherritt chief executive, in a statement. “People have confidence that commodity prices will one day be higher than today, but nobody can say exactly when that will happen, so they all saw the value in ensuring that we have time for plans to come to fruition.”
I’m not sure how I feel about this news. On the one hand I’m glad I haven’t lost my initial $5,000 principal. Sherritt hasn’t missed a single payment yet on the money I lent them. And if I can continue to earn 8% a year on this debt for 3 additional years then that’s probably not such a bad thing. 🙂 There’s not many alternative investments I can think of that will produce this kind of yield.
But on the other hand, markets can remain weak longer than companies can stay solvent. Like most of its peers, Sherritt is losing money every quarter. It may be true that commodity prices will recover some day, but if prices remain depressed until 2021 then things can get really ugly. 😕 Hopefully the smaller miners will go out of business first to slow global production before something really bad happens. Relatively speaking Sherritt happens to be one of the largest nickel mining companies in the world. Overall I agree with the company’s decision to extend its debt maturity, making the best out of a crummy situation.
New Investment: Firm Capital (TSE:FC)
Also last week, I noticed I had some excess cash loitering around in my Canadian RRSP account. I automatically reinvest most of my securities through DRIP. But I keep all my bonds in my RRSP and bond income doesn’t DRIP. So over time the cash builds up in my account. Since I don’t like to have idle money lying around I decided to put that money to work.
It’s hard to find an undervalued stock in today’s market so I went with a mortgage investment corporation instead of a traditional company. Unlike most stocks, MICs generate profit from debt because they are in the business of lending. They tend to be less volatile than the TSX Composite index and offer juicy yields. I already own a few other MICs, but this time I purchased 200 shares of Firm Capital Mortgage Investment Corp, for $2,780. I did not contribute any new savings to my RRSP to do this.
FC pays 7.8 cents per unit every month, which it has maintained for many years. This equates to an attractive 6.8% yield! With 200 shares I should be able to DRIP this security and receive one extra unit every month, plus have some left-over residual cash. 🙂 With this new purchase my annual passive income has increased by $190. 😀
Random Useless Fact:
How much due diligence did you do on FC? 26% of your investment in a Canadian Mortgage Funds sounds high to me given the low interest environment, bubble characteristics of the Canadian housing market and declining economics. Canada’s real estate has been rising for 35 years as mortgage interest rates fell from 20% to 2.5%. A correction is likely to come and most of the people working at these Companies have never experienced a bear real estate market. Leverage kills these companies as their equity is a small percentage of assets. Probably better to buy US Mortgage funds where they have at least experienced one bear market in the last decade.
Comparing it to other mortgage funds in both Canada and the U.S. I have found that FC is relatively stable, and performed better than a handful of similar U.S. companies like DX, WMC, EFC, and NLY (which I already have.) Like you said, for most companies in this business leverage will kill them because their equity is a small percentage of their assets. But as of the latest Q1 2016 report, FC appears to have only 48% debt to investment ratio, or LTV. So on average it has more equity than debt, which I believe is important. I have not found any U.S. mortgage funds yet with similarly low leverage. But I’d consider buying them if I get new information. I can’t predict when a bear market will happen. But I currently don’t see any signs for house prices to correct in Canada in the near future. Interestingly during 2009 when the national real estate price fell due to the recession, FC held up really well and managed to produce over 10% annualized return to investors. Meanwhile, traditional REITs, which are equity based saw their share price drop with the rest of the stock market because the value of their… Read more »
I’m personally a bit surprised that the company decided to extend the maturity on their debt. Most experts believe that we are in a “lower-for-longer” interest rate environment, so they likely could have refinanced at a lower rate at maturity in 2018.
Just my two cents!
I think that’s true. Maybe Sherritt didn’t want to refinance because of the inherent risks involved with the business and sector in general. For example, even though interest rates are low for investment grade debt, investors will still demand a premium for junk bonds. So maybe it didn’t feel confident that it could refinance at a lower rate even now.
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