Friday, March 2, 2012

Convertible Debentures

As some of you may have noticed I am a big fan of dividend stocks. However I have reached a stage where I feel the need to diversify into some fixed income instruments. It is a shame to earn eligible dividends inside and RRSP, Then get taxed as income when I ultimately melt down the RRSP. I figured might as well make my RRSP portfolio more conservative and in the mean time stick it to the man by forgoing the double taxation.

I want to reduce my volatility, at the same time I get the feeling that REITS are over priced. How much more can they appreciate, when REI.UN is paying 5.2% what is the point of holding it when you can buy a safer corporate bond instead. The returns are getting too thin, too many people are chasing yield with REITS and dividends stocks.

A Convertible debentures is basically an unsecured bond, meaning bond holders get paid first, then Convertible Debentures, then stock holders. You might be wondering what the word Convertible stands for. well good question. It means you can convert your bonds into shares at a pre determined price. Similar to an option call. you can trade in your bonds for shares at a pre determined strike price.
lets look in detail at one of my picks.

This Debenture INN.DB.E pays you 6.27% in interest (today it is trading at $98.75 per $100) so it is at a slight discount. and is convertible at $8 a share.

Now consider this.
You could buy the common shares of INN.UN today at $5.44 and earn %7.35 yield.

But think is it worth it? will you risk your capital for an extra %1.08 a year? when you can get %6.27 with these debentures, your capital is safer, you will not lose a cent unless the company is bankrupt. your dividend is safe, because it is not dividend it is interest, The company cannot cut it otherwise they would be in default.

In this case the debenture makes a better investment in my opinion. Now the good stuff is not over yet. lets say the stock rises back to its pre-recession level of  $10 well, you can convert your debenture at $8 a share and sell the shares. you get to participate in the upside too.

The financial post has a good list of convertible debentures.

Convertible Debentures are sold by face value, so you would buy say $25,000 face value of INN.DB.E for $98.75 per $100 you would pay $24687.5 for it plus commission plus accrued interest to the seller.

The debentures pay interest twice a year. on the same day-month of the maturity date and 6 months after. eg The debenture I mentioned would pay on sept 30 and march 30.

These were my picks
NAL is an energy company, it was my top pick The NAV (value of oil per share) is higher than the conversion price of the debenture so collect 6.25% interest don't risk your capital and hope for the stock market to let you convert the debenture for some extra profit.
INN.UN and SRQ.UN and RMM.UN are REITS, they are smaller ones, so they pay more interest. The principal is safe because it is backed by real estate. and if the REIT craze continues they will pay off.
I added STB in there because the interest rate was good and it came at a good discount. I wanted to get something non energy and non REIT and not economy related so I added it. Also the CIBC analysts 18 month price target was above the conversion price so there is potential for gains there too.

Fixed Income
per $100
Market Mix %
SCOTT'S REIT CONV UNSEC SUB DEB Maturity Dec 31 2014 Coupon 7.7500-CAD25000$99.97$24,992.50

NAL ENERGY CORPORATION SUB DEB CONV UNSECURED Maturity Mar 31 2017 Coupon 6.2500-CAD25000$100.00$25,000.00

INNVEST REAL ESTATE INVST TRUST SUB UNSEC CONV DEBENTURE Maturity Sep 30 2017 Coupon 6.0000-CAD25000$98.75$24,687.50

RETROCOM MID-MKT REAL EST INVEST TR. CONV UNSEC SUB DEB Maturity Jun 30 2018 Coupon 5.4500-CAD25000$98.00$24,500.00

STUDENT TRANSPORTATION INC CONV SUB UNSEC DEBENTURE Maturity Jun 30 2018 Coupon 6.2500-CAD25000$95.7875$23,946.88

Total (CAD)$123,126.88

Now this part of my RRSP portfolio is less volatile. and I believe the ~6% interest it earns will beat inflation.

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