Editor’s Note: What follows is the executive summary of the April 2013 issue of Canadian Edge. Thanks for reading. — RSC

In May 2010 I penned an In Brief article entitled The Four Horsemen. I highlighted four factors that were then driving Canadian stocks lower: Environmental backlash from BP Plc’s (London: BP/, NYSE: BP) Gulf of Mexico oil spill, Europe’s unfolding debt crisis, the rapid approach of the trust tax on Jan. 1, 2011, and risk of a global slide into recession.

My prognosis for readers was to stick with our Canadian Edge Portfolio Holdings and to consider adding my two Best Buys, featured in the section that was then called High Yield of the Month.

May 2010 proved to be a nadir for Canadian stocks. The overall Portfolio wiped its losses and finished that year up 40.3 percent. Anyone who bought the pair of featured stocks, meanwhile, has since made 70 percent on their investment.

Here in spring 2013 there are again four horsemen roiling Canada.

The breakout of the S&P 500 Index and the Dow Jones Industrial Average to new all-time highs has made the US the temporary victor in the competition for capital.

Year to date, the S&P is nearly 12 percentage points ahead of the Morgan Stanley Capital International Canada Index.

Activity in much of Canada’s energy patch has slowed sharply in the wake of plunging oil prices, as the lack of transportation infrastructure has created a glut of energy that can’t get to market.

A concerted government effort to squelch a perceived real estate bubble has cooled off other sectors, such as auto sales.

And a higher-than-average volume of dividend cuts has undermined the country’s reputation as income investor friendly.

Global stock markets often weaken in the springtime. For example, May was not the ultimate bottom for many Canadian stocks in 2010.

My advice, however, is the same now as it was then: Stick with stocks that continue to measure up as businesses and consider taking advantage of other investors’ despondency by buying Canada.

Both of this month’s Best Buys—Bird Construction Inc (TSX: BDT, OTC: BIRDF) and Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–are trading well off their highs. But both have proven their ability to weather much tougher times than these, and both are coming off generally solid fourth-quarter results that show every sign of improving further in 2013.

The good news about these four horsemen is none have the potential to wreak as much devastation as those that rode in May 2010. In fact all four may be running out of staying power.

This is hardly the first time a strong US market has drawn investment dollars out of Canada. And it’s not hard to see potential catalysts for a reversal, including any better-than-expected news from China.

Speculative froth in Canadian real estate appears has blown off, with once-sizzling markets in Toronto and Vancouver sliding sharply recently. Bank of Canada Governor Mark Carney has pronounced the need to raise interest rates “less imminent,” even as growth and employment figures appear to be turning up as well.

That suggests at least stabilization the rest of the year, which should turn down the volume of dividend cuts. There’s even reason to believe we’ve seen the worst for the energy sector.

This week the difference between the price of Western Canada Select (WCS) and West Texas Intermediate (WTI) crude oil fell to just USD14 a barrel. That’s down from a record USD42.50 price differential hit Dec. 14, 2012, and is even below the five-year average of USD16.81.

This remarkable decline didn’t come in time to lift fourth-quarter earnings of producers or to prevent a steep decline in profit at most services companies. But it is promising for first-quarter results we’ll start seeing later this month as well as the stability of sector dividends in 2013.

The drop in differentials is in large part due to a massive increase in oil shipments by rail. But more permanent solutions to the transportation crunch are also in progress, as companies move forward on major pipeline projects.

Energy midstream companies are still very much in Canada’s economic sweet spot. But if past proves prologue, we’ll see other Canadian stocks pick up steam as 2013 progresses, particularly in the battered energy patch.

There is one other difference between now and May 2010. That time around almost everything was cheap. This time there are still a number of stocks trading above my buy targets. That may change before these four horsemen ride off into the sunset. But for now it’s important not to chase them.

As we’ve seen time and again over the past several months, even the most relentless buying momentum will eventually hit a wall. And when it does, opportunities abound in great stocks that suddenly no one wants.

Roger Conrad
Editor, Canadian Edge

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Portfolio Update

 

There are no changes to the Portfolio at this time. In terms of overall performance, we’re in roughly the same place as last month, with a handful of poor performers offsetting modest gains in most holdings.

Readers most concerned about current market risk will want to focus on the current lineup of Conservative Holdings. Each posted generally solid fourth-quarter earnings despite some strong headwinds in the broad economy. Several raised dividends as well.

Some stocks still trade above buy targets, and new investors should wait before adding positions. But there are also more bargains in the group than there have been in some months.

Note that Conservative Holdings’ gains would have been a bit higher were it not for the Canadian dollar’s dip this year below parity with the US dollar.

Investors who want to play a Canada rebound later this year will want to own at least a few Aggressive Holdings. Each is leveraged to the health of the North American economy, with the energy patch generally a major factor.

The tradeoff is greater volatility, so long as the four horsemen ride. And there’s also the possibility of dividend cuts for some, if indeed overall conditions should worsen dramatically instead of get better.

Portfolio Update takes a look at technical factors that provide some useful information about our Holdings’ trajectories.

 

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Best Buys

Both of April’s Best Buy selections–Bird Construction Inc (TSX: BDT, OTC: BIRDF) and Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–are Conservative Holdings that have recently become cheap.

Bird is a debt-free provider of construction and engineering services to a wide range of public- and private-sector companies across a full spectrum of industries.

The 5.5 percent dividend increase announced last month is the best possible sign of continued healthy business growth. Bird Construction is a buy up to USD14.

Innergex is a developer and owner of water and wind energy generation. Cash flows are secured by long-term contracts with utilities and provincial government entities, at prices guaranteed by law.

The company’s primary challenge is executing on a large portfolio of projects in coming years, all of which require spending money before making it. But the track record is solid, and Innergex is Renewable Energy again trading below my long-standing buy target of USD10.

Best Buys–which features the top two candidates for purchase in April–is the place to start if you have money to put to work right now.

 

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In Focus

Last month I highlighted companies in the How They Rate coverage universe that had cut dividends following the trust conversion wave of January 2011.

This month I look at the other side of the coin: the 83 How They Rate companies–or roughly half the stocks we cover–that have raised dividends since then.

In general total returns have followed dividend growth. The average return for this list since Jan. 1, 2011, is 34.8 percent versus an average total dividend increase of 37.9 percent.

More illuminating, however, is the wide gap in this relationship between industries–and the massive investment opportunity it offers for the rest of 2013 and beyond.

In Focus takes an in-depth look at companies we cover that have raised distributions during the past two-plus years.

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Dividend Watch List

Two more How They Rate companies announced dividend cuts this month. AvenEx Energy Corp has reduced its payout to CAD0.0225 per share as the result of merging with Pace Energy Ltd and Charger Energy Corp to form Spyglass Resources Corp (TSX: SGL, OTC: None). AvenEx shares were converted on a 1-to-1 basis.

My initial rating on Spyglass is hold. We’ll begin tracking it in place of AvenEx and Pace in the May issue.

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF) has cut its monthly payout to CAD0.07 from a prior rate of CAD0.10.

The entire distribution, however, remains a return of investors’ capital, as the closed-end fund continues to generate no investment income in a weak market for gold and silver mining stocks (93.67 percent of the portfolio). That suggests more dividend cuts are ahead. My advice is still to sell the fund.

Dividend Watch List has more on How They Rate companies whose regular payouts are in jeopardy.

 

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Canadian Currents

Expectations-beating North American employment reports for February have given way to underwhelming jobs-front news in March. It’s still going to be a long recovery.

Canadian Currents has the latest Statistics Canada and the US Dept of Labor reports on March job creation as well as an update on the Canadian dollar’s new status among global currencies.

Bay Street Beat–Fourth-quarter and full-year 2012 earnings reporting season is now complete. Here’s Bay Street’s reaction to the last group of CE Portfolio Holdings to report as we get ready for first-quarter 2013 numbers.

Bay Street Beat has the latest on what analysts are thinking about our favorites.

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How They Rate Update

 

Coverage Changes

China National Offshore Oil Corp, better known as CNOOC Ltd (Hong Kong: 883, NYSE: CEO) has completed its takeover of Nexen Inc for CAD27.50 per share in cash.

The deal was completed March 1, and shareholders of the former Nexen should be receiving their cash very shortly, if they haven’t already. We’re no longer tracking this stock.

Trading in Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) remains halted. There are a number of shareholder suits ongoing against the company. One US law firm participating is Howard G. Smith of Bensalem, Pennsylvania (888-638-4847).

Given how fast this one imploded, no one should get their hopes up for much restitution. But by the same token shareholders have little to lose, either. My advice is still to sell Poseidon Concepts at the first possible opportunity.

Finally, Primaris Retail REIT was acquired by H&R REIT (TSX: HR-U, OTC: HRUFF) on April 4.

Unitholders should have received by now some combination of 1.166 units of H&R and CAD28 per unit in cash depending on their election at the time of the merger. We’ll delete Primaris from How They Rate coverage next month.

Advice Changes

Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV)–To Hold from SELL. The company’s fourth-quarter funds from operations were off by 50 percent on lower gas prices and reduced production. But its key assets are intact, and net asset value of reserves is CAD9.26 per share, nearly three times the current share price. Could this be a takeover target?

Ratings Changes

Big Rock Brewery Inc (TSX: BR, OTC: BRBMF)–To 3 from 2. The company raised profits in the fourth quarter by 64 percent, as it focused on margins over volume sales. That’s a good sign for dividend sustainability, and it earns the company another ratings point.

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.

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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.