PIM: Diversified Income Portfolio / FuelCell Energy Series B Preferreds

Paul Borisoff - Oct 04, 2017


The Diversified Income Portfolio* was up 1.6% in September – and is now up 6.7% in 2017.  In comparison our benchmark was up 0.5% in September and is now up 1.9% in 2017.  Over the most recent 12-month rolling period the portfolio is up 9.0% compared to our benchmark which is up 2.2%.

* These returns are reported as a composite, time-weighted, rate-of-return (gross of fees, net of transaction charges) for all accounts in this mandate.  Long-Term Returns/Benchmark Numbers will be reported in our Quarterly Updates.

After rebounding 1.4% in August the Canadian bond market was hammered again in September finishing the month down 1.3% (as measured by the FTSE TMX Canada Bond Index - 60% of our benchmark).  Year-to-date the Canadian bond market is now up 0.5%, and it is down 3.0% over the last year.

Investment grade corporate and government bonds which dominate many conservative portfolios, and typically 40% to 60% of balanced funds, are continuing to present investors with  significant challenges in regard to generating income and acceptable returns.  This may very well remain the case for the foreseeable future.

However, as pointed out many times in the past, there are many other types of alternative cash generating investments that continue to offer attractive risk/return scenarios to small institutions and retail investors - which we seek out with this portfolio. 


Recent Portfolio Changes:

During September we reduced our exposure to Cargojet Inc. from 3.0% of the portfolio to 1.0% at $50.65 per share (1.5% yield) – locking-in a 76% gain on this portion of the position.  As previously noted we acquired this share position via a convertible debenture that we originally bought in April 2014 – the Cargojet Inc. 5.50% 30JUN19 issue - that we were forced to convert into shares at $28.75 in June this year.  Note, we continue to hold a 1.8% position in the Cargojet Inc. 4.65% 31DEC21 $58.65 convertible debenture which we acquired at 104.70 earlier this year - and closed the quarter at 110.00.

We also reduced our exposure to Whitecap Resources to 1.5% of the portfolio from 2.8% at $9.75 per share (2.9% yield).  Whitecap had moved up 8.6% in September and our sale locked-in a 6.9% gain on this portion of the position.   Note, we recently added some higher quality energy related exposure to the portfolio in August – Parkland Industries ($25.82: 4.5% yield), AltaGas ($27.69: 7.6% yield), and Enbridge Inc. ($49.33: 4.9% yield) which closed the quarter at $25.38, $28.74 and $52.12 respectively.  


We increased our exposure to the Tricon Capital Group 5.60% 31MAR20 $9.80 convertible debenture from 0.9% to 1.8% of the portfolio at 110.50 in September – which closed the quarter at 113.49.  Our average cost is now 105.25 as we bought the original position in February 2013 at par value (100).  Note, we additionally have exposure to a 4.2% position in the Tricon Capital USD $ 5.75% 31MAR22 $10.46 convertible debenture which we bought at 102.42 this year – and closed the quarter at 105.50 (this position is showing down 4.0% at quarter-end due to the increase in the Canadian dollar relative to the US dollar though).  The 12-month consensus price target on Tricon Capital was $13.45 as of October 2nd (Bloomberg).

Special Situation:

We bought a new ~1.5% position in FuelCell Energy’s Series B Cumulative Perpetual Convertible Preferred shares at USD $280.00 in September.  These shares pay USD $50.00 per year (currently yielding ~17.9% via quarterly dividends) – and are convertible into common shares at $141 per share at the option of the Preferred shareholder (a long way off -  and not why we purchased this position at this time).  The Series B Preferred shares were issued originally at USD $1,000 per share in November 2004 and are current in regard to all expected dividend payments.  FuelCell Energy was founded as the Energy Research Corporation in 1969, and in recent years has been focusing on selling and developing large scale fuel parks for utility customers, and “behind the meter” power plants for customers such as Pfizer that require a high level of power reliability and resiliency.  After many years of losses, and repeated and significant dilution to common shareholders, breakeven and profitability are now within sight after the company recently received in excess of $1 billion of new and incremental global project awards. 


FuelCell Energy’s Series B Preferred Shares have liquidation preference of $64 million ($1,000 per share) over the common shareholders in the event the company is wound up at some point in the future.  Additionally, if a “person” or “group” acquires directly or indirectly 50% or more of the total voting power of all classes of capital stock Series B Preferred shareholders can require the company to redeem the shares at $1,000.  This is a possibility - as we believe that ExxonMobil will be acquiring a significant stake in the company at some point in the future.  ExxonMobil has been granted multiple patents in recent years incorporating Molten Carbonate Fuel Cell Technology into multiple aspects of the oil and gas industry, and other industries such as steel production.  Interestingly ExxonMobil just started a media campaign in recent days (including 15 and 30 second TV commercials) featuring “Fuel Cell Carbon Capture” as a potential “Unicorn” solution to capturing CO2 from power plants in an economical way.  I have previously estimated that FuelCell Energy owns 90% of global Molten Carbonate Fuel Cell intellectual property – and find it difficult to come up with a realistic scenario where ExxonMobil does not secure an interest in the base technology at some point given their apparent high level of interest in multiple aspects of the technology.  Please see our attached recent report for further information.

We expect FuelCell Energy’s Series B Preferred Shares to appreciate significantly (possibly back to the $400 to $600 range) if the company reports better quarterly results over the next few quarters or if a large visible third party such as ExxonMobil were to take a significant interest in the company (would not have to be in excess of 50% to see a major impact on the Series B Preferreds).   If the company continues to lose money over the next few years it is the common shareholders that are going to be impacted via significant further dilution – and not the Series B Preferred shares.  Note, FuelCell Energy has historically had no problem raising additional capital as required to keep the lights on.  The company also has producing power plant assets under contract with long-term power purchase agreements (15-20 years) with highly rated organizations such as Pfizer on its balance sheet valued at multiple times higher that the current value of our discounted Series B Preferred share exposure.

Summary:

At month-end the portfolio’s cash position was sitting at ~6.9% and our convertible debenture exposure was approximately 37.3%.  Total Cash and Fixed Income exposure including our four 3rd party specialty fixed income manager positions was ~70.1% at quarter-end.  

We continue to strongly believe that the portfolio’s composition and flexibility offers a substantially improved risk/reward trade-off compared to an “income portfolio” relying only on government bonds and pure stock market exposure to drive returns and income. 

Please note that our next summary and quarterly commentary will be available by Friday, October 13th.  In the meantime, please do not hesitate to contact me if you have any questions or concerns.

Sincerely,

Paul J. Borisoff
Senior Vice President,Portfolio Manager, Senior Investment Advisor

Canaccord Genuity Wealth Management

609 Granville Street, Suite 2200, Vancouver, BC  V7Y 1H2
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E: paul.borisoff@canaccord.com | borisoffcoxwealth.com