Business Insolvencies Up

Canadian Business Insolvencies Were Up 33.8% YoY in Q1-22

Last week, Canadian Lawyer magazine reported business insolvency filings were up 1/3 over the same quarter last year. That’s the highest year over year increase in 31 years (i.e. since 1991). Bankruptcy filings are regulated and recorded by the Office of the Superintendent of Bankruptcy

By now, most COVID restrictions have been lifted, but so have the government support programs. That means businesses (and individuals) are on their own. Expect some hiccups as they adjust to the new realities like supply chain re-alignments, staffing and product shortages, a war in Ukraine, etc.

“With inflation now at a 30-year high, the conditions are ripe for further business insolvencies. Business owners and inhouse counsel should prepare by consulting with an insolvency professional as early as possible” said Jean-Daniel Breton, chair of the Canadian Association of Insolvency and Restructuring Professionals.

Those business owners who are susceptible to economic shifts should consider holding some or all of their financial assets with an insurance company. Provided their structured properly, assets held with an insurer (i.e. in an insurance contract) are typically exempt from creditors. That’s because government and the law decided long ago that “insurance” is a societal good. Most common law provinces are on side with the exemption.

In February 1996, the Supreme Court decided a landmark case in Royal Bank vs. North American Life Assurance Co. The case surfaced because a doctor in Saskatoon fell on hard times and couldn’t pay his rent. The landlord sued and the doctor declared bankruptcy. When creditors attempted to seize registered (RRSP) assets that were held with North American Life Insurance company, the Saskatchewan court “exempted” these assets. The case was appealed by the Royal Bank of Canada all the way to the supreme court (seems lenders don’t like the idea of some assets being exempted – especially by life insurance companies).

In their ruling, the Supreme Court of Canada based their conclusion on three critical issues:

#1 – The assets in question were governed by provincial Life Insurance legislation.

#2 – The owner had designated a preferred class of beneficiary (i.e. family member).

#3 – There was NO evidence of a “fraudulent conveyance.”

Viewers may want to view this You-Tube video…


Margin of Safety

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. SO, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. IF you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches about the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety.”

Warren Buffett, 1997 Berkshire AGM

Over the past few days, I’ve been posting the first quarter operating results of top ten REITs from our property portfolio.

Most of the REITs have reported satisfactory results. They’ve all survived the pandemic and now they’re emerging as expected. Revenues, Net Income, FFO (Funds from Operations), SPNOI (Same Property Net Operating Income) and Occupancies were up for the most part. Outstanding rents have been recovered. Most are proceeding with further development of their pipelines.

A couple of exceptions bear note. Figures at H&R REIT were a bit abnormal. Last Summer, H&R REIT sold the Bow to affiliates of Oak Street Real Estate Capital. “The Bow” is one of the tallest buildings in Western Canada and it was a crown jewel in H&R’s property portfolio. Then, they spun off a large division of their enclosed shopping centres (including Orchard Park Shopping Centre). Those properties now trade as Primaris REIT (listed on the TSE under PMZ.UN). As a result, H&R’s results weren’t “normalized.”

Also, Allied Properties REIT – which focuses on Office properties had occupancies dip below 90%. Not everyone is in a hurry to return to the office. But, Allied’s brick and beam properties appeal to younger professionals – especially in the digital, high tech and telecommunications sectors. They’re desirable locations to work and they should start to see occupancies return closer to capacity.

Hence, I was curious. Given that most operating results have been “normalized,” how was the marketplace valuing these REITs compared to their book value /unit – a figure that’s meant to represent current or fair market value (FMV).

The table below lists the results of my inquiry. On Wednesday, May 18, all of our REITs were all selling below book value. Theoretically, the properties could be sold into the market place and unit holders would realize a gain on the difference between the REITs unit price and the underlying assets. In some instances, those discounts were 30% or more. An unweighted average suggests the top ten holdings are selling about 20% below their fair market price in aggregate.

I’ve also included their debt ratios as a means of gaging how leveraged they are (higher debt levels erode unitholders’ equity during downturns). Most are conservatively financed with debt ratios ranging between 21.5% of assets (Granite) and 46% of assets (Smartcentres).

In his book, The Intelligent Investor, Ben Graham talks about 2 concepts central to his approach to investing. The first is the idea of “intrinsic value.” He suggests investing (not speculating or trading) should involve independently reviewing the business attributes of a securities issue (i.e. future cash flows, etc.) and assigning a value to that enterprise. That value might ultimately represent what a prudent or reasonable person would pay for the property or business in a private business transaction.

Then, recognizing that errors could be made with assumptions, calculations, etc., one should leave a “margin of safety” prior to committing capital. By buying at a discount to intrinsic value (i.e. a margin of safety) an investor helps to protect against downside and a permanent capital loss. It’s how one preserves capital.

It’s impossible to predict what the capital and real estate markets will do over the short term, but for patient, long term investors, a portfolio of REITs might represent a solid opportunity to enhance your and your family’s wealth.

Further Reading

What You Can Learn from My Real Estate Investments by Warren Buffett. Published in the February 24, 2014, edition of Fortune magazine. If you can’t access the article, it can also be found on page 17 of the 2013 Berkshire Hathaway Annual Report under “Some Thoughts About Investing.”


On Wealth and Happiness

A most interesting opinion piece in today’s New York Times entitled,  The Rich Are Not Who We Think They Are. And Happiness Is Not What We Think It Is, Either,” written by Seth Stephens-Davidowitz .

The author suggests:

  1. Of the top 0.1 percent of wage earners in America – those earning $1.48 million per year, most of them draw income from owning a regional supply business like an auto dealership or a beverage distribution company. Yes, there are celebrities, actors and athletes who make piles of money given their talent and notoriety, but three times as many affluent taxpayers make the majority of their income from business ownership. Salaries don’t make people rich nearly as often as equity does.
  2. The nature of those businesses tends to be dull and boring including: auto repair shops, gas stations, business equipment contractors, etc. Their businesses tend to endure because they  provide goods and services that meet long term needs and demands.  This tends contrasts “sexy” businesses like salons, cosmetic stores, record stores, and clothing stores. These “sexy”  businesses have a limited life expectancy. On average, they typically fold after 2½ – 4 years.
  3. Another important feature of their businesses is their ability to avoid ruthless price competition – either through a monopoly or a regional advantage, etc. For instance, more than 20 percent of auto dealerships in America have an owner making more than $1.58 million per year. Those dealerships have legal protections; state franchising laws that give auto dealers exclusive rights to sell cars in a territory. Same for many beverage distributors, which act as middlemen between alcohol companies and stores and supermarkets.

His findings are not unlike the conclusions drawn by Thomas Stanley, author of the 1990s classic, “The Millionaire Next Door.”

The advantages of business equity isn’t lost on the owners. Most of them are happy to maintain the status quo. Turnover is minimal (i.e. don’t be looking to purchase one of these businesses at a discount anytime soon).

The author then asks, “If pop culture is right in suggesting getting rich is a path to happiness?” I’ll examine that in a subsequent blog. For now, I’m going to see if I can find a cheap distribution business.

About the Author:

Seth Stephens-Davidowitz graduated from Harvard in 2013 with a PhD in Economics. His work has focused on using big data sources to research behaviours and attitudes. Using “big data” sources, his essay explores who are the rich in America and what relationship wealth plays in happiness (not for the faint of heart).