Ryan Bushell, vice president and portfolio manager at Leon Frazer and Associates
Focus: Canadian dividend-paying equities
The fourth quarter was defined by the surprise election of Donald Trump as the 45th president of the United States. The speed with which the financial markets digested the result and formed an opinion contrary to the nightmare scenario that most were predicting just a day earlier was truly breathtaking. Much ink has been spilled trying to predict what the election will mean for both financial markets and the world at large and we will not add to that; we are firmly in the wait-and-see camp. From a purely clinical perspective, our view is that no one person dictates the path of the stock market. Remaining invested in quality companies over time limits downside and produces sustainable returns. Donald Trump will be the 13th U.S. president to take office since we opened our doors in 1939. If he does a good job, there is nothing to worry about. If not, he’ll be gone in four years and the companies we own will continue on regardless. One thing we will say is that the range of possible outcomes has expanded relative to what could have been expected with the status quo. This means there will likely be continued market volatility in 2017 and beyond. Considering the inflationary potential of fiscal stimulus with low interest rates and full employment, however, we are comfortable with the risk/reward tradeoff embedded in our current portfolios relative to other instruments like cash and longer-duration bonds.
We expect another positive year for portfolios in 2017, although we are wary of potential volatility. We have seen elevated upside volatility in markets following the election and we would not be surprised to see corresponding downside volatility (a correction) at some point in the next couple of quarters. The U.S. economy is expanding at the fastest rate since the recession, consumer confidence has soared and the potential for real inflation with a short-term rise in bond yields is palpable. The Canadian economy is likely to get dragged along to some extent, especially if recent OPEC coordination proves credible and oil prices remain sustainably above $50. Longer term, we believe the headwinds to growth in both equity markets and the economy will begin to blow stronger and ultimately bring on the next recession, but we do not feel that will be a 2017 event.
Over the next several quarters, we will be looking to reduce lower-yielding cyclical holdings and add to defensive sectors, like utilities and telecom, with sustainable and attractive dividend yields, especially if their share prices continue to soften. Given the extent to which dividend yields remain above benchmark bond yields, there is considerable cushion for interest rates to rise before they compete with the higher after-tax yields offered by our portfolios. Additionally, given that the size of the bond market is more than ten times the size of the equity market (let alone the dividend payers), a sell-off in bonds could be positive for dividend stocks if even a portion of those proceeds seek income in the equity market.
CANADIAN NATURAL RESOURCES (CNQ.TO) – Most recent purchase $38
CNQ is one of Canada’s largest energy producers with fantastic long-term assets. With the Horizon build largely complete, the free cash profile of the business is attractive and should fuel continued dividend increases. Last year, the company surprised many, including us, by announcing a ~10 per cent dividend increase, showing confidence in their sustainability. More recently, the stock is off on the back of Border Adjustment Tax concerns, especially as it relates to natural gas. We feel confident that this will be a passing issue and that the fundamentals continue to look strong for 2017 and beyond. Buying the shares under the $40 level will likely prove very profitable with a long-term horizon of at least five years.
ALTAGAS INC. (ALA.TO) – Most recent purchase $31
I think I have recommended ALA the last three times I have been on, but we continue to like it. The company is well run and the 6.75 per cent dividend yield is sustainable, and the dividend continues to grow. More recently, the stock has been off on a combination of interest rate fears and a large announced acquisition of WGL Holdings in the Washington DC area. While we are a bit puzzled by the acquisition, we have faith in the management team to deliver. Investors with a long-time horizon and current income needs should own AltaGas.
ENERCARE INC. (ECI.TO) – Most recent purchase $18.50
Enercare is a newer holding in our portfolios. We like the long-term sustainability of the heating-and-cooling business and the transition toward rentals from ownership of furnaces and A/C units. A rental unit costs the company more upfront, so capex will likely be high over the next five years or so as they roll out rentals more broadly. However, longer term a rental unit provides 2.5 times more value. Long-term annuitized cash flows support a growing and sustainable dividend, and the five per cent current yield looks attractive to us presently.
PAST PICKS: FEBRUARY 29, 2016
Another year, another dividend increase, marking over four decades of consecutive dividend increases. Large acquisitions over the past couple of years will need time to be digested, but ultimately this company creates sustainable value for shareholders over time.
SHAW COMMUNICATIONS (SRJb.TO)
This was a controversial pick last year given the significant changes Shaw made in Q1 of last year to enter wireless and divest their media assets, combined with the weak economy in Alberta. The stock was by far the best performer of the group for the period, returning over 24 per cent compared with Telus at 14 per cent, Rogers at 16 per cent and BCE at four per cent.
CENOVUS ENERGY (CVE.TO)
All oil and gas stocks were down and out about this time last year and had a fantastic run into the end of the year before softening more recently. Current concerns related to a Border Adjustment Tax appear unfounded. However, concern about U.S. supply gains is real. We believe that the best Canadian oil sands operators remain competitive with U.S. shale and are set to benefit from narrowing heavy-oil differentials, a possible decoupling of the Canadian dollar from the oil price and increased pipeline capacity in the coming months and years.