RBC’s contingent income autocalls on Alcoa show value play, high probabilities of call

By Emma Trincal

New York, Jan. 31 – Royal Bank of Canada’s contingent income autocallable securities due Feb. 4, 2021 linked to the common stock of Alcoa Corp. give investors a good chance of getting paid given the depressed value of the stock, according to a portfolio manager.

While the securities may get called early and not participate in the upside above the coupon, their chances of losing capital are reduced due to the low entry and deep barrier, said Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments.

The notes will pay a contingent quarterly coupon at an annual rate of 9.5% if the shares close at or above the 60% coupon barrier level on the observation date for that quarter, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the stock closes at or above the initial price on any quarterly determination date other than the final one.

The payout at maturity will be par unless the shares finish below the 60% downside threshold level, in which case investors will lose 1% for each 1% decline from the initial price.

Sickened price

The price is at multi-year lows at $14.00 a share.

For Kaplan, buying at a deep discount lowers the chances of breaching the barrier. In this case, the 40% contingent protection is already very defensive, he said.

“Alcoa is a well-established company, and the stock happens to trade at record lows,” he said.

“In part it’s because commodities producers have been somewhat weak with the strong U.S. dollar.

“But a lot of it has to do with those fears about the coronavirus, which cause people to worry a lot about China.”

Alcoa, an industrial corporation and the world’s eighth largest producer of aluminum, has seen its stock price drop as a result, he said.

“Whether it’s justified or not, people are over-reacting. They tend to over-react to both good and bad news,” he said.

“Other things like the flu kill a lot more people, but it doesn’t get people excited like China quarantining people.”

The Centers for Disease Control and Prevention estimates that influenza kills between 12,000 and 61,000 people each year since 2010.

Chinese outbreak

The current coronavirus virus scare is already pushing down the share price of stocks in base metals, energy, gas, copper and mining, he said.

“China is a very big consumer of metals, commodities, copper, energy... obviously it has an impact. “But it’s driven by fear. It’s about the headlines,” he said.

“It’s not the first China scare that we’ve had. Remember at the end of 2018, people were worried about Chinese growth slowing down.

The current stock price of Alcoa is down 77.5% from its April 2018 high of $62.35.

This includes a recent 30% drop since the company reported a wider-than-expected quarterly loss on Jan. 15. The announcement precipitated the biggest decline in the stock price since 2018.

Kaplan does not believe the sell-off is related to fundamentals.

“The stock is extremely depressed, and it has nothing to do with earnings. The hype is what’s driving the stock price down, not the fundamentals. What we’re seeing here is an over-reaction that mirrors the entire sector – commodities, metals, energy. A lot of this is driven by the coronavirus headlines,” he said.

Sector, crowd behavior

Softer growth in the industrial sector has not helped, and the same holds true for commodities.

“It’s a particular sector that is not doing well,” he said.

Using a chart overlay, he compared the price action of Alcoa with that of VanEck Vectors Oil Services ETF, an equity exchange-traded fund for oil and equipment services companies. In both cases, the bearish trend began around the same time.

Another factor pushing down the underlying stock price in January has been the tendency of investors to review the performance of the best and worst stocks of the past year.

“It got worse this month because people sold the losers and bought the winners, which is a ritual investors practice at the beginning of every year,” he said.

“It’s not necessarily the best way to invest. But the virus fear happened at the same time and it gave them another reason to sell and to buy Tesla.”

Multi-year low

Looking at the bigger picture – a 35-year chart – is what makes Kaplan relatively bullish about Alcoa.

“The stock has been so much higher before. At the end of 2007, it was trading at around $107. In both 2000 and 2001, it was above $90.

“Last time it was this low was in 1988, more than 32 years ago.”

With such a deep discount, Kaplan expects a quick rebound.

High risk-reward

“This low entry point gives you a cushion in addition to the barrier,” he said.

“The unfortunate thing is that whether it happens in one or two quarters, you have a fairly high chance of getting called.

“If during the next year the price of the shares double, you’re not going to participate in the upside.

“So, if you really like the stock, buy it.”

However more conservative investors seeking short-term gains or income could benefit from the autocallable and barrier features. Unlike owning the stock outright, the notes provide some downside protection.

“This note has a good ratio of risk-to-reward. It gives investors a fair chance to win,” he said.

“Getting in at those levels increases the chances of making money.

“It’s rare to see a note on a stock that’s so unpopular. Your probabilities of winning are unusually high.

“It’s encouraging. I hope issuers will do more of these.”

RBC Capital Markets, LLC is the agent. Morgan Stanley Wealth Management is the dealer.

The notes priced on Friday and will settle on Wednesday.

The Cusip number is 78014K436.

© 2015 Prospect News.
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