Income Trust Pick: The Brick Income Fund (BRK.UN)
The Brick Income Fund (BRK.UN) is in the process of making a large scale recovery. I recommended this stock a couple of weeks ago as a potential candidate for a TFSA account. The stock is up only slightly; however, I am becoming more and more bullish on this stock for the long term.
In Canada where the Brick Income Fund operates under logos such as The Brick, and United Furniture Warehouse, sales have been slow; although, this can been seen as partially the result of a slow housing market. When housing sales decline I would assume in all probability so do furniture and appliance sales. If you have read any of the new housing sales reports in Canada then you should be very familiar with the fact that over the past month housing sales have been the highest every on record.
When I think of people moving to a new home I am always rethink my last move when I asked the moving guys, “do you want my old couch and TV.” Of course they responded yes and then went on to say that during moving season they are given so much furniture because people like to move into a new place with new things. I believe this to be the norm so with the latest housing sales data I suspect the Brick Income Fund will be flush with cash by the fall and able to weather a further decline in sales if this recession is not over and if the recession is over then distributions will definitely be on the mend.
For more insight into the current situation at The Brick Income Fund refer to the Globe and Mail news article dated August 14th, 2009 titled ‘The Brick Putting its House in Order’ The article highlights many of the blunders that have led the company towards bankruptcy over the past year.
According to the article, some of these blunders were ramifications due to the company’s poor response to a liquidity squeeze, inventory shortages, and poor demand forecasts. These mistakes included cost cutting through layoffs of sales staff and slashing ad spending, which further decimated sales revenue.
The article then goes on to highlight some of the changes being made by the newly appointed CEO-Bill Gregson. Mr. Gregson has a track record for saving retail chains as the previous CEO of Forzani Group (Largest National Sporting Goods Retailer in Canada). With a $25 million life line provided by The Brick Income Fund’s largest shareholder and a $130 million loan from GE Capital, the new CEO has some room to manoeuvre. Now that the liquidity crisis has been abated the plan is to replenish inventory in stores, beef-up the sales force, and bombard the public with advertising.
If you are still looking for opportunities for your TFSA definitely take a closer look at BRK.UN
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Stellar pick, amigo!
Really enjoyed this. Good in depth analysis!
Like the pick, but went for the warrants instead. Speaking of which, why would warrants (exercisable at $1 for 5 years) not trade at a premium to the shares (less exercise price?)
I'd think that the stock at $1.68, then warrants should be at $0.75 at least? What happened to the efficient market hypothesis … or is it just that its Canada … where nothing is efficient?
Recall that a warrant has intrinsic value if the share price is above the warrant exercise price. It is only sensible to exercise warrants if they have intrinsic value – in other words; the share price is above the exercise price.
The reason the warrants may be trading at is discount could be that they are not immediately exercisable or any potential profit will disappear with the costs of trading. Further, if the trust begins paying dividends again you will not be able to collect thru the warrants unless you exercise.
As a result you may want to just sell them in the warrant market and pick up the trust units.
since there will now never be any distributions is this still a good choice for TFSA
Yes, I still think it is a good pick because when there is a conversion there is likely to be a tax consequence, but by holding it in the TFSA you will not experience this. Further, from the recent Q3 update this company has gained significant cash flow and liquidity. As a result, the Brick is now able to fight a potential further decline in future sales.
What would the tax consequence be on conversion.
What would the tax consequence be on conversion of income units to corporation shares
The best information for tax consequences on this subject would be directly from the Revenue Canada website; however, they do not explain it very well.
If you go to http://www.mondaq.com/article.asp?articleid=88004 you will find a good analysis. I will paste some comments from their site below: At the time the SIFT Legislation was announced, the Department of Finance announced that rules (the "Conversion Rules") would be enacted to allow entities that were affected by the SIFT Legislation to convert into taxable Canadian corporations without any adverse tax consequences to them or their unitholders. The Conversion Rules were subsequently enacted into law on March 12, 2009 and contemplate the conversion of an income trust into a taxable Canadian corporation through either a unit-for-share exchange with a corporate successor (the "Exchange Method") or a distribution of shares of a corporate subsidiary by the income trust to its unitholders on redemption of the trust units (the "Distribution Method"). The Conversion Rules also provide for a tax-deferred wind-up of an income trust after it is taken over by a taxable Canadian corporation, which can allow the purchaser to offer unitholders a rollover on an exchange of income trust units for shares of the purchaser. It also allows the preservation of tax basis where the assets of the income trust have a tax cost greater than their fair market value.
So it seems there will not be a taxable consequence as long as the conversions are done according to the method described above; however, were told during the Conservatives election campaign that they would not be altering the income trust taxation structure and look what happened. I know a number of retirees that had a major wipe out of their portfolios after the suprise legislation was announced.
Correct me if I am wrong, As far as I can understand The Brick had a net profit of around 17.9 million in the fourth quarter of 2008 before a goodwill impairment charge of $196.9 million, and an impairment charge of $44.6 million.
To demonstrate a clear turnaround they would have to post a net profit greater than 18 million in this current fourth quarter of 2009 as there is no more goodwill left to be impaired. Since in the third quarter the net profit was only 3.6 million before special charges it would have to do exceedingly well for the net income to jump five fold from 3.6 to 18 million. Any clarifications would be welcome.
The brick posted a deficit of $569,106,000/- in its latest third quarter balance sheet under UNITHOLDERS’ (DEFICIT) EQUITY on page 3 of
http://media.integratir.com/T.BRK.UN/financials/Brick%20Fund%20FS%20Q3%202009%2011%2004%2009%20-%20FINAL%20-%20ld.pdf
it also posted a net profit of 0.5 million ie average of 2 million per annum. If it is able to maintain its improved performance it will take 235 years to wipe out the deficit of $569 million from its books and complete the turnaround.
Any clarifications would be welcome
The thing with deficits is that they are not exactly as you would think. Let me clarify, in many circumstances a deficit will be held on a balance sheet as an asset? Yeah, there is obviously an off-setting transaction occurring on the liabilities side, but what this allows the company to do is reduce taxes going forward until the deficit is written off. Remember any of the write-downs the banks have taken over the last year?
Obviously you don’t want deficits to occur, but this does contribute to the value of a company. Ever hear of a company being bought by another because they had significant write-downs on their books. It’s seems counter intuitive, but this is how the tax system works.
I even know a number of personal investors that run their accounts through a holding company that have engaged in a similar process. This is the process, you took major losses last year (sold assets at a loss), since the government doesn’t tax losses you have the benefit of carrying those losses forward against any future earnings. One person I know well at the trough of the market after mayhem spun his negative experience into a positive, “at least I won’t have to pay tax for the next 5 years” he said.