Welcome to Media Co-op Investor!
The Media Co-op Investor Series aims to help the general public understand the stock market, how it works and the major companies which benefit from it.
Every two weeks we examine an element or term in the stock market, how the Toronto Media Co-op has done fake-investing in companies on the Toronto Stock Exchange as well as highlighting specific large Canadian Companies, why their price has gone up and down and what they are all about.
To learn more go here.
This Weeks Term: Derivatives
Derivatives came into prominence during the financial crisis, however they have been around for a lot longer than that and are an integral element of the financial markets. They are also reallydifficult to explain.
While most people have now heard of credit derivatives which were largely responsible for the great financial crisis there are many other types of derivatives which make up massive parts of the financial system.
As a simple definition, derivatives are simply an agreement between two parties to buy something now (a mortgage, commodity, currency), betting on how it will do in the future. The agreement is called a 'derivative' because it is based off of or 'derived from' something called an underlying asset. One of the most common and well known example of a derivative is a 'future'.
A futures derivative contract on oil would look something like this: one party would agree to pay for oil (the underlying asset) in the future at a specific price. Buying the future is not the same as buying the oil, it may not even exist yet. But the people making up the contract are agreeing that the oil will be bought in the future at a specific price. This 'future' can be traded on the open market like a stock or bond, but remember, it's not the 'oil' itself which is being traded; it is the derivative, the contract to buy the oil at a specific price. The same type of arrangement can occur for shares, currency and other commodities.
While other types of derivatives like swaps (swapping the benefits of different financial instruments) and options (buying an agreement giving the option to buy or sell a stock, bond, commodity at a certain price) are more common, the most talked about derivative recently is of course the credit derivative.
With a credit derivative, you are betting that credit owed today will be repaid in the future. Credit derivatives exploded in the last ten years as a popular financial instrument mainly because of the explosion in money (and by extension, debt) created by banks.
Massive amounts of debt in the US, created by aggressive (and as it turns out, risky) mortgage lending was pooled into piles of thousands of mortgages by mortgages brokers, banks and other investment agencies. These pools were then sliced up, like thin slices of pie and sold to buyers in exchange for consistent payments which were generated by people paying their mortgages. One slice might contain pieces of thousands of mortgages. As long as revenue was coming in from people paying their mortgages credit derivatives buyers would get their payment. If one or more of the thousands or mortgage payments didn't get paid though, the consistent payment would be lower, or, worse case scenario, non-existent.
Remember people who own a credit derivative don't actually own the credit or debt. The debt itself is still owned by the group who put the pool together or the original bank. Buyers are simply agreeing to buy part of the risk betting that the mortgage will be paid back. If people pay, the buyer gets a payment; if there's a default on some of the debt though, you might lose some or all of your investment.
While futures are seen as risk-reducing instruments, we now know that credit derivatives were extremely unregulated, poorly put together and risky as hell.
In 2008 the global derivatives market was estimated at close to $800 trillion in face value, 11 times the size of the entire world economy. This is because many derivatives cancel each other out (for example contradicting futures contracts that oil will go up or down) and because they reflect values that may turn out to not be real (for example buying an option on wheat, and then not using it).
One more note. If you think about this stuff long enough, it starts to closely resemble gambling.
That's because it is.
What we invested in this week
This week we tracked the largest Canadian consumer stocks. We theoretically-bought about $1000 worth of each company on September 15th.
How we did this week
Meh. While our resource rich stocks are giving a return of 10%, our consumer stocks are bringing in a return of only 2.8%. Better than playing the bond markets, but not great.
Compare these stocks to the S/P 500 and we're doing particularly bad. With the exception of a few gem-companies, it seems that Canadian staples and manufacturing goods are not going to be bringing in a lot of dough this year.
Around the world, the collapse of Greece and Ireland has all eyes on Spain and Portugal. For those of you perplexed as to why this may be, its because of bond yields.
When a government, any government, needs money they go to a bond market and ask for it. Greece and Ireland had no problem raising money, however as concerns about their economy grew, the cost of bonds went through the roof. As of last Friday Greece has to pay an 11.89% interest rate on the money they borrow, Ireland - 9.37%; Portugal - 7.17%.
While paying for the debt won't happen until later, if the cost of debt continues to rise and the countries need it to operate, the fear is that institutions will become so afraid of future default that they will simply stop lending. This prospect is why Greece and Ireland accepted bailouts and the austerity measures that came with them. However both Greece and Ireland have cried foul over the following question: why has the cost of debt risen so much? Were their economies really in any worse shape than say, the US? Conspiracy theories abound.
Back in Canada, Scotiabank, profiled in October, had its most profitable year ever. Oh Joy. Royal Bank, TD and CIBC on the other hand saw their profits go down. Cameco, profiled last month, raised it's dividend by over 40%.
Outside of the buy and sell world of stocks and bonds however, everyday Canadians are still behind the 8-ball. Unemployment is down across the board to 7.6%, however most new positions being created are part-time. Over 11,000 full-time positions were lost in November and areas such as suburban Vancouver, Victoria and Kitchener, saw unemployment go up.
Add that to continual flip-flopping on the recovery of the economy, serious concerns about Canadian credit card and auto-loan debt and a drop in Canadian house prizes and well...things might get a little rough.
Todays Companies: Saputo Inc and Bombardier Inc
What better time to discuss Saputo Inc than right after they have had a massive cheese recall. Listeria concerns have lead to a recall of close to 150,000 kilograms of cheese in the last week. They had a similar recall earlier in March.
Saputo started in 1954 in Montreal by Giuseppe Saputo. It is the largest dairy processor in Canada and 12th largest in the world. It also has extensive operations in the US, UK and Argentina.
While the elder Saputo was responsible for the first cheese shop for the family, his son, Lino was responsible for capitalizing on the pizza-cheese boom of the 1960's which grew the company. Lino became chairman and president in 1969 and eventually CEO in 1998.
You've probably bought a Saputo product: they own Dairyland Canada, Dairyworld foods and Neilson Dairy as well as a series of confections and over 30 brand names. In the last 15 years that company has aggressively expanded purchasing US-based Stella foods, Quebec-based Culinar Inc. and Canadian Agrifoods International Co-operative.
Though they have always denied it, the family has been accused of having mafia links since the 1970's, and as late as 2007. On occasions Saputo has been prevented from operating because of these supposed links. A Globe and Mail article in 2007 stated that "The Pennsylvania Crime Commission in 1980 said it had established direct links between G. Saputo & Sons Ltd. and the Joseph Bonanno criminal organization."
In 2001, many smaller farmers cried fouls when Saputo struck a deal with Wal-Mart to exclusively supply dairy products to the big-box giant thereby squeezing out local farmers.
In March it closed an Ontario plant affecting 190 workers in an effort to consolidate all it's GTA operations into Vaughan. Another 24 Quebec workers got the axe in May.
Saputo is also connected to the Federal governments decision to close prison farms in 2010. The New Brunswick and Nova Scotian prison farms produced milk for their own populations but will now be supplied by a group of companies that also include Saputo.
We bought shares of Saputo for $34.97 in September. The shares are up to $36.97 for an increase of 5.7% or $40.
Like Saputo, Bombardier Inc, is also having a bad-news week after orders for its corporate jets were not as strong which makes sense as many media co-op members have also had to hold off on buying a jet this year. Kidding.
Bombardier is one of the largest and best known Canadian conglomerates in Canada and one of only four industrial stocks in the TSX S/P 60. While consumer companies generally sell goods you buy at the store (for example cheese and dairy with Saputo), industrial stocks generally make large machinery. In Bombardier's case, they focus almost exclusively on aircraft and other transportation equipment although they also dabble in recreational equipment and finances.
Created in the 30's by Joeseph-Armand Bombardier in Quebec, Bombardier cut its teeth making industrial snowmobiles. In the 1970's it moved into train technology buy buying a series of European companies.
It moved into aerospace after buying Canadair in 1986, another crown corporation which was actually bought from the US. In fact, a wide array of controversy has surrounded Bombardier's aerospace division mainly due to is subsidization by the Canadian government and role as a military contractor.
Free-trade mantra aside, Bombardier Areospace exists only due to major government subsidization. It got major subsidies from the UK when it bought a bankrupt airline. It also got incentives from Vermont for opening a plant there. Canadian government subsidies directly supported subway car sales to New York City. In fact the Canadian government has been shelling out hundreds of millions over the years to keep Bombardier afloat and is directly related to it's growth.
According to a 2005 McLeans article, "In the 1970s, Montreal mayor Jean Drapeau awarded a subway contract to the then-floundering snowmobile company. In the mid-1980s, Bombardier scooped up Canadair from the government for just $123 million. Later, it would receive the maintenance contract for Canada's fleet of CF-18 fighters, despite a lower tender from a Winnipeg company. [In 2005] the government authorized US$230 million in loans to two subsidiaries of near-bankrupt Delta Air Lines to complete purchases of Bombardier jets."
Improper tendering accusations continue to pop up. The Quebec government took a lot of flack for giving Bombardier a subway car contract without proper tendering in 2005, delaying the project until this year. Meanwhile, lobbyists in Toronto have also complained of similar unfair tendering practices with Toronto streetcars as part of the Transit City initiative of the last mayor.
Although it has recently gotten out of the Canadian military contractor business, it was extremely active in NATO training and military exporting to other countries. For example it exported close to half a billion dollars ($CDN) in contracts in 2000 to countries such as Singapore, Mexico, Italy, Denmark and Australia.
Though Bombardier is one of Canada's largest publicly traded companies, worth close to $20 Billion and one of only 11 Canadian Fortune 500 companies, it has been on the ropes in the last decade due to bad investments. It's share price has fallen from around $25 to roughly $5 in that time.
In 2008/09 they laid off 4300 employees.
We bought Bombardier Inc. Class-B shares in September for $5.15 a pop. They've dropped to $4.58 or 11% for a loss of $57.
Archive
September: Potash Corp
September #2: Suncor and ARC Energy Trust
October: Shoppers Drugmart and Barrick Gold
October #2: Scotiabank and Power Corporation of Canada
November: Cameco Corp and TransCanada Corp
