It’s no secret that in election campaigns, politics often trumps policy. Consider Canada, now a little more than two weeks into a marathon (by Canadian standards) federal election campaign leading up to an Oct. 19 vote.

While on the campaign trail last week, Prime Minister Stephen Harper unveiled two measures aimed at wooing two highly sought-after voting groups: middle-class homeowners and hopeful first-timers trying to get a foot in the front door of the country’s overheated housing market.

The first is a boost to the Home Buyers’ Plan, which lets first-time buyers withdraw up to C$25,000 from their registered retirement savings plans—similar to U.S. 401(k) plans—to put toward a down payment on a new home. Under Harper’s proposal, the limit would rise to C$35,000.

The second is the restoration of a home renovation tax credit that Harper’s Conservative government first brought in to stimulate the economy during the 2008/09 recession.

Both proposals will likely resonate with their target audiences, but economists weren’t amused. One, David Madani, Canadian economist for Capital Economics, accused the Conservatives of “throwing fuel on the fire.”

“My concern is that you are extending these policies at a time when you know there is considerable overvaluation in the housing market,” he told the Financial Post on Aug. 13. “Clearly markets in Vancouver and Toronto don’t need any more housing stimulus.”

A Tale of Two Markets

Nationally, Canadian house prices have increased 60% since 2000, according to a March report from the International Monetary Fund. The prices are led by big cities like Toronto, Vancouver and Calgary.

The gains have been fueled in large part by cheap mortgage rates, which got slightly cheaper last month, when the Bank of Canada cut its overnight lending rate by 0.25%—the second reduction this year.

In July, the average detached home in Toronto sold for an average of C$996,970, up 13.3% from a year ago. The average price for all homes in the city (including condos) jumped 10.6%, to C$609,236.

That kind of price appreciation prompted government-operated mortgage insurer Canada Mortgage and Housing. to bump Toronto’s market from a moderate to a high risk of correction last week, citing prices that are outpacing growth in disposable income, along with a risk of overbuilding. The move comes after the IMF said in January that Canadian home prices could be overvalued by 7% to 20%.

In Vancouver, meanwhile, the average detached abode went for C$1.14 million in July, up 16.2% from a year ago, while prices for all housing gained 11.2%, to $700,500.

Surprisingly, the CMHC didn’t include Vancouver on its list of overvalued markets. (According to the IMF, the city has the world’s second-least-affordable housing, after Hong Kong.)

“Despite high Vancouver home prices, demand for housing across the price spectrum is supported by a growing population and growth in personal disposable income, as well as by the limited supply of land,” the CMHC report said.

Nationally, prices rose 8.9% in July, but only 4.1% if you strip out Vancouver and Toronto. As a whole, the CMHC said the country’s real estate market faced a low risk of correction.

Experts Split on PM’s Proposals

As for Harper’s promises, not everyone is convinced they’ll have much effect, assuming the Conservatives win the election and implement them.

“I look at this package of policies and consider them really kind of marginal in terms of overall impact,” Tsur Somerville, director of the Centre for Urban Economics and Real Estate at the University of British Columbia, told The Globe and Mail on Monday.

And as Canadian Edge chief strategist Deon Vernooy wrote in the June issue, it’s important to keep in mind that just because the market is overvalued doesn’t necessarily mean a quick correction is in the cards, as overvaluation can continue for a long time and isn’t always enough on its own to trigger a price drop.

But in light of weaker resource production and prices—including but not limited to oil and gas—which influence a big part of the Canadian economy, and with said economy now likely in a technical recession (defined as two straight quarters of negative GDP growth), the state of the Canadian housing market is worth keeping a close eye on.

Four Correction-Sensitive Stocks

Also in the June issue of Canadian Edge, we listed a number of stocks investors should steer clear of in the event of a Canadian housing correction.

They include pure mortgage lenders like Home Capital Group Inc. (TSX: HCG), which caters to borrowers who have trouble getting mortgages from Canada’s major banks, such as the self-employed and recent immigrants.

Other companies to be wary of during a correction include mortgage insurers like Genworth MI Canada Inc. (TSX: MIC).

Canadian banks would also suffer during a sharp correction, but the most affected would be those that do less business internationally and have a larger percentage of their loan portfolios aimed at the domestic housing market. Examples include Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) and National Bank of Canada (TSX: NA, OTC: NTIOF).

The Dividend Champions This Week

By Deon Vernooy

This week we report on one further company result as well as a large acquisition concluded by one of our Dividend Champions.

The loyalty card management company Aimia Inc (TSX: AIM, OTC: GAPFF) reported noisy second quarter results which contained several material one-off items that distorted the results.

Probably the best indication of how the business really performed in the quarter was the 4.1% increase in adjusted profit before interest, tax, depreciation and amortisation as well as the profit margin of 10.2% which was at the best level in 6 quarters. Earnings per share increased by 218% but this included the favourable impact of a C$45.7 million reduction of a card migration provision and a gain on the sale of the investment in Air Canada shares of C$18.6 million.

The operating cash flow and free cash flow declined year-over-year, but the comparable quarter of 2014 included an amount of $83 million received from the Canada Revenue Agency related to an income tax refund. Management now expects free cash flow for 2015 to amount to C$220 – C$240 million which should cover the expected full year capital expenditures of around C$75 million and the dividend payments of C$140 million.

Operationally, the company experienced some setbacks during the quarter as gross billings declined by 6.6% and with the loss of the anchor partner of the Nectar Italia rewards program. Canadian billings were also lower as the heavy 2014 promotional activity of accumulation partners was not repeated in 2015.

Management continues to buy shares back from the market reducing the share count by 7.8% compared to the same quarter a year ago. In total, the company has spent C$570 million over the past 5 years to buy back shares including C$173 million so far this year. The share buyback program is expected to continue.

Management indicated that gross billings could be about 4% lower than previously indicated for the full year but repeated previous full year guidance for free cash flow which is expected to be materially higher than 2014. A high level indication that free cash flow in 2016 should exceed the 2015 level was also provided during the quarterly results conference call.

The balance sheet is very healthy with a debt to capital ratio of 13%. Combined with the strong cash flow, the dividend could be considered very safe. With a current dividend yield of 6.3% Aimia could be bought up to C$14 or U.S. $11.

Brookfield Infrastructure Partners LP (TSX: BIP-U, NYSE: BIP) and its consortium partners have agreed to acquire the Australian container terminal and rail operator, Asciano Ltd for A$8.9 billion (U.S. $6.6 billion) or A$9.15 per share. The 76% cash and 24% equity offer represents a 39% premium on the 30 day average price of Asciano pre the acquisition bid on 1 July. The conclusion of the transaction is subject to shareholder, court and regulatory approvals but is expected to close by the end of the year.

Brookfield Infrastructure Partners (“Brookfield”) will acquire 55% of Asciano for an equity investment of $2.8 billion with the balance of the acquisition price being absorbed by Brookfield Asset Management, Brookfield managed funds and other institutional investors. To finance its portion of the acquisition, Brookfield will issue around 44 million units (a 19% addition to units in issue) and use cash resources and bank loans to cover the balance.

Asciano’s business is a network of port and rail assets in Australia that include container terminal operations in major Australian cities including Sydney, Melbourne, Brisbane and Perth that have a capacity of about 4.9 million twenty foot equivalent units. It also owns port, terminal and supply chain services that support shipping lines, importers, exporters, freight forwarders and customs brokers; and nationwide above rail haulage operations with assets consisting of 664 locomotives and over 14,000 wagons which have the capacity to haul 180 million tonnes of freight and are diversified across coal and bulk haulage, steel and intermodal.

The combination of the container terminals in North America and Europe as well as the rail logistics business in Australia and Brazil already owned by Brookfield with Asciano is expected to create a prominent global rail, port and logistics business.

The share price of Asciano has been in a slow upward trend since 2012 (until the jump caused by the offer) and is currently valued at a 10.5 times 2015 EV/EBITDA. This valuation is more or less in line with other similar companies. Brookfield expects the transaction to double its port and rail profits and to add an estimated 7% to adjusted funds from operations on an annual basis.

Brookfield currently has a U.S.$6.6 billion market capitalization with net debt of U.S.$6.3 billion and a debt to capital ratio of 54%. The transaction is sizeable for Brookfield and the additional debt to finance the transaction will be on top of an already substantial debt load. Brookfield is also in advanced negotiations to acquire further assets valued at around $700 million. The additional 44 million shares issued by Brookfield as part of the acquisition finance (mentioned above) will also serve to strengthen the balance sheet leaving the debt to capital ratio more or less unchanged from current levels.

The assets acquired are undoubtedly of high quality and will combine very well with the current portfolio of assets owned by Brookfield. The Brookfield share price has been under pressure since the transaction has been floated in July and dropped by 4% on the day of the final announcement. At the current price the share offers good value and a dividend yield of 5%. The stock can be bought up to C$56 or US$43.

Happy investing,

Deon Vernooy

Chief Investment Strategist
Canadian Edge