Canada: Eyes on the US

By Roger Conrad • November 9, 2012 • In Brief

Editor’s Note: What follows is the executive summary of the November issue of Canadian Edge. Thanks for reading. — RSC

“The outlook for getting a resolution on the US fiscal cliff is dubious.”

That statement is from the chief foreign exchange strategist of a major Canadian bank, and it expresses a sentiment widely held on both sides of the US-Canada border.

Canada has no real fiscal problems of its own, having largely dodged the worst of the 2008-09 recession. Its unemployment rate is among the lowest of major nations, and investment is booming in its resource patch.

But should the tax increases and spending cuts trigger a US recession in 2013 there could be severe consequences to Canada’s economy and stock market as well as to the exchange value of the Canadian dollar.

The fallout on the US–and ultimate consequences for the politicians who drove the country off the cliff–would be more severe still. And that’s a very good reason to be optimistic a deal will be reached.

Until there’s more certainty, however, we can expect a volatile and very likely down-trending market.

The silver lining is the longer this lasts the better the chance long-pricey Portfolio Holdings will come back into a bargain range. That’s already happened for this month’s Best Buys.

In fact, all but a handful of current Holdings are again trading below buy target and are ripe for purchase by those who don’t already own them.

Other stocks–particularly the higher-yielding fare in the Portfolio–are now wholly unloved and have become targets of dividend cut speculation, though they continue to post solid operating numbers.

Looking across the Conservative, Aggressive and Mutual Fund Portfolios, our average holding is in the black this year by 8.2 percent, in US dollar terms and including dividends. That’s roughly where that number has been the past several months, with lagging performance of commodity price-sensitive picks dragging down some spectacular gains in less risky fare.

I fully expect that return to drop if fiscal cliff speculation isn’t quelled by responsible efforts to reach a deal in the weeks leading up to Jan. 1, 2013. Even in 2008, however, stocks of companies that held it together as businesses recovered their losses.

I don’t see anything close to a reprise of 2008 in the next few months. For one thing, if the US does avoid a fiscal cliff it’s likely all that money pumped into the economy the past few years will at last spur faster growth. That’s precisely what happened in the early 1990s, when the US Federal Reserve was pumping up the money supply to combat a deflationary one-two punch: the 1987 stock market crash and subsequent vaporization of the savings and loan industry.

But just in case things do turn out for the worst, I’m keeping my main focus on recommendations’ ability to grow and keep paying dividends.

Robust results accompanied by dividend increases won’t head of setbacks in stocks if the overall market is in full retreat. But they do ensure our holdings will recover whatever damage they do suffer and then some when the market bottoms, even as they continue to reward us with generous income.

This issue examines both the macro and the micro. In this month’s In Focus feature I look at the US election and what its aftermath means for Canada’s markets. Portfolio Update, meanwhile, has the facts and analysis for our individual recommendations, i.e. how they fared in their third-quarter numbers and what management has said about their outlook for the rest of 2012 and beyond.

Like management of most Canadian Edge Portfolio Holdings, my outlook for the rest of 2012 and beyond is cautiously optimistic. That means sticking with the strongest companies, and picking up new holdings when the market gives us an opening.

Roger Conrad
Editor, Canadian Edge

Portfolio Update

There are no changes to the Portfolios this month. Rather, the big news is the large number of Portfolio companies that have now reported third-quarter results.

I highlight the key numbers and takeaways, virtually all of which are quite positive despite a more challenging environment for many industries.

Best Buys

This section features the two top candidates for purchase in November. Buying these selections each month is a good strategy for starting a portfolio, provided the picks meet your own risk-reward preferences. This section was formerly called High Yield of the Month.

This month’s choices are a current Conservative Holding, RioCan REIT (TSX: REI-U, OTC: RIOCF), which is on the verge of a return to dividend growth after turning in robust third quarter numbers. Its current yield of more than 5 percent is superior to US real estate investment trusts and is paid in Canadian dollars.

The other is a current Aggressive Holding Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), a fast-growing energy producer with a focus on light oil. Its shares now yield north of 7 percent, even as it offers investors explosive long-term growth in output and reserves.

In Focus

The quadrennial verdict in the US is four more years for President Obama and two more for a split US Congress. The upshot is continuity on most issues but a crossroads on others.

I look at a range of them that will impact investors over the next year, including the fate of the Keystone XL pipeline and the prospective US fiscal cliff.

Dividend Watch List

Two members of the Canadian Edge coverage universe cut dividends last month.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF) bowed to weakening market conditions and suspended its payout entirely. The company’s history has been to ramp up dividends when conditions improve and, as it remains a low-cost producer, that should hold true this time as well. Hold Canfor Pulp Products.

Closed-end mutual fund Aston Hill VIP Income Fund (TSX: VIP-U, OTC: BVPIF) cut its monthly payout to CAD0.045 per unit from CAD0.07 due to a shortage of investment income that forced management to rely on capital gains and leverage. Hold Aston Hill VIP.

Canadian Currents

Prime Minister Stephen Harper enjoys a relatively stable political environment 18 months into his majority rule, but there are potential upsets in the offing. He won’t face voters until October 2015, but how he handles fast-approaching decisions on foreign takeovers of Canadian resource companies could impact his standing.

Bay Street Beat—Here’s how the Canadian analyst community has reacted to the initial wave of CE Portfolio Holdings’ earnings announcements.

How They Rate Update

Coverage Changes

We’re adding Dundee Industrial REIT (TSX: DIR-U, no US symbol) to How They Rate coverage this month.

The company was spun out of parent Dundee REIT (TSX: D-U, OTC: DRETF) in early October in an initial public offering. Dundee REIT continues to own 78.9 percent of the REIT, which owns industrial properties.

Advice Changes

Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF)–To Hold from Buy @ 18. The unit price for this restaurant royalties company has moved beyond my target. That’s at a time when insiders have reduced holdings by 10.7 percent over the last 12 months, and competition appears to be heating up.

PRT Growing Services Ltd (TSX: PRT, OTC: PFSRF)–To SELL from Hold. PRT has attracted a takeover offer of CAD4.45 per share from private equity firm Mill Road Capital. The offer is all cash and represents a 26.5 percent premium to PRT’s 20-day volume-weighted average price.

PRT’s current price is within 2 percent of the takeover price, limiting upside, particularly in view of the lack of a dividend. Regulatory approval is likely, and the deal should close in December.

But given the limited upside investors should book the gain. That especially goes for US investors, who by selling avoid potential complications affecting merger proceeds.

Ratings Changes

Atlantic Power Corp (TSX: ATP, NYSE: AT)–To 4 from 5. A reduction in projected cash flow from two Florida power plants where contracts will expire next year doesn’t directly threaten the dividend.

It does, however, reduce visibility of future earnings and shaves a point off Atlantic Power’s rating.

Safety Ratings

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

Payout Ratio–A ratio below our proprietary industry baseline.
Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
Dividend History–No dividend cuts over the preceding five years.

Resources

The following Resources may be found in the top navigation menu at www.CanadianEdge.com:

Ask the Editor–We will reply to your queries via email or in an upcoming article.
Broker Guide–Comparison of brokers for purchasing Canadian investments.
Getting Started–Tour of the Canadian Edge website and service.
Cross-Border Tax Guide–What you need to know about taxes and Canadian investments.
Other Websites–Links to other websites to help you get the most out of your Canadian stocks.
Promo Stocks–Guide to the mystery stocks we tease in our promotional messages.
CE Safety Rating System–In-depth explanation of the proprietary ratings system and how to use it effectively.
Special Reports–The most recent reports for new subscribers. The most current advice is always in your regular issue.
Tips on DRIPs–Details for any dividend reinvestment plan offered by Canadian Edge Portfolio Holdings.