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

Covering a universe of stocks and running a portfolio derived from that universe is no easy matter.

Of course there are some stocks that make it seem so, such as Pembina Pipeline Corp (TSX: PPL, NYSE: PBA), Keyera Corp (TSX: KEY, OTC: KEYUF) and Cineplex Inc (TSX: CGX, OTC: CPXGF), which consistently grow their businesses, build value for shareholders and spin out consistent, reliable and growing dividends.

But even with these Conservative Holding stalwarts, and with Aggressive Holdings that pack similar gear, such as ARC Resources Ltd (TSX: ARX, OTC: AETUF) and Vermilion Energy Inc (TSX: VET, NYSE: VET), the task remains, on a quarterly basis, to read, understand and evaluate the numbers management reports and what they say about what they mean.

In a way the process is simple: Read, reflect and run the numbers through the analytical framework established by the Canadian Edge Safety Rating System.

With a universe of 160-plus stocks, this work is rigorous, time-consuming and not easy. But it is simple. It’s what I get paid to do, and it’s why you read this newsletter.

It’s true that complex formulas and algorithms can be shown to mathematically outperform the market over time. It’s equally true that such methods often fail too.

What we’ve practiced here since July 2004 is an approach based on fundamentals and building wealth over the long term, with an emphasis on ground-up, company-by-company research supplemented by a learned appreciated for macroeconomic trends.

A long-term, buy-and-hold focus is our primary bulwark against emotionalism and the short-term and portfolio-breaking decision-making it can engender.

At the same time, in recent months we’ve tried to acknowledge the fact that we have in some cases held on too long to stories, recommitting ourselves to following our established discipline that the numbers, on a quarter by quarter basis, will be our guide, and if there be deterioration in the underlying business we be gone.

We’ve also established a broadly diversified portfolio, including energy, utility, financial, consumer discretionary, real estate investment trusts, materials, telecommunications, health care, transportation and industrial companies.

Another primary driver of action-based advice is our adherence to buy-under targets that incorporate value metric as well as potential for one-year total return, including price appreciation and dividends paid.

Generally speaking we don’t advise “averaging down” in stocks that have, for whatever reason, slipped a little or a lot, as we don’t want any particular holding to become too dominant a presence in the portfolio.

By the same token, though we want our winners to run, we also advocate taking some profits off the table from time to time to protect gains and for allocation to other selections in a way that preserves portfolio balance.

We’re not into newfangled financial vehicles. We prefer traditional equities, issued by companies that run easy-to-understand, so-simple-a-caveman-could-get-it businesses. We cover a few funds, only because they provide efficient means for investors who want extreme convenience. But we like to do our own stock-picking.

Steering clear of the “newfangled” means avoiding initial public offerings too. We like a trading history, and, of course, as dividend-focused investors, we like to see a trail of dividends over time. And we also like to see a backlog of public filings and the history of financial and operating performance they detail.

We’re not into generating huge brokerage fees for our readers, another virtue of our buy-and-hold approach. We’re not traders; we’re investors.

This is all part of an ongoing process that culminates in a monthly issue the first (sometimes second) Friday of every month.

Leading up to this month’s issue my thoughts were preoccupied by Atlantic Power Corp (TSX: ATP, NYSE: AT), the longtime CE Portfolio Holding that since late 2012 has spun it tail into all-time lows on the Toronto Stock Exchange.

We established a specific framework for Atlantic apart from its CE Safety Rating measurables, four out of five of which the company has met. Over the past two days, Thursday evening, reading the post-market-close earnings announcement, and Friday morning, listening to and digesting management’s commentary and answers to analyst questions during its quarterly conference call, I’ve gone back and forth on what to do with Atlantic Power.

My “thin-slice” reaction, as Malcolm Gladwell might call it, was to dump it from the Portfolio. My more considered reaction, as you’ll find in this month’s Portfolio Update, is to maintain a “hold” rating and keep, based on my observation that we know the downside–we’re experiencing it–that management is taking aggressive steps to cut costs and reduce debt and that the portfolio of assets the company owns are of high-quality, contracted to regulated utilities, and may be of interest to larger entities.

Management’s model, built around its No. 1 priority of reducing debt, its No. 2 priority of optimizing its power plants and the resultant No. 3 priority of reducing its cost of capital so growth becomes a viable option again, assumes a dividend rate at the current level.

This is not a leap of faith. We’re not relying on any gut instinct or any elusive hope. It’s based on an evaluation of where Atlantic Power, trading as it is at an extreme discount to the value of its assets, can go from here.

There’s a well-known novel of the 1960s by Richard Farina titled Been Down So Long It Looks Like Up to Me.

The analogy that can be drawn from that title to illuminate our Atlantic experience is not lost on us. The difference is Atlantic management has laid out a credible strategy based on the facts of the company’s business as they are now and holding onto the stock is the best way to recover something of what’s been lost.

We have faith in their numbers and believe in their hard assets.

David Dittman
Chief Investment Strategist, Canadian Edge

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Portfolio Update

 

As we preview above, in this issue’s Portfolio Update we take another long look at Atlantic Power Corp (TSX: ATP, NYSE: AT) in the aftermath of its second-quarter earnings report and management conference call.

In addition, we have second-quarter earnings reviews for the following Conservative Holdings:

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)
• Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)
• Keyera Corp (TSX: KEY, OTC: KEYUF)
• RioCan REIT (TSX: REI, OTC: RIOCF)
• TransForce Inc’s (TSX: TFI, OTC: TFIFF)

We also have second-quarter earnings reviews for the following Aggressive Holdings:

• Acadian Timber Corp (TSX: ADN OTC: ACAZF)
• Newalta Corp (TSX: NAL, OTC: NWLTF)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)

Please note that second-quarter results for ARC Resources Ltd (TSX: ARX, OTC: AETUF), Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF) and Vermilion Energy Inc (TSX: VET, NYSE: VET) are discussed in this month’s In Focus feature.

Highlights include dividend increases for AltaGas and Keyera.

Portfolio Update has the latest on Atlantic Power as well as those Portfolio Holdings that reported second-quarter earnings since the July issue of CE.

 

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Best Buys

A story oriented around banks and farmers would seem a great foundation for a mid-20th century Frank Capra-filmed morality tale, the evil and the good easily separated.

In this space this month, where we discuss our two best ideas for new money right now, we find the element of positive international exposure shared in common by two Canada-based companies that have proven themselves leaders in their particular industries.

New Conservative Holding Bank of Nova Scotia (TSX: BNS, NYSE: BNS) is No. 3 among Canada’s Big Five banks but No. 1 in terms of expanding its operations beyond its solid domestic franchise.

Ag Growth International Inc (TSX: AFN, OTC: AGGZF) is an agribusiness specialist focused on the development, manufacture and marketing of augers, conveyors, storage bins and conditioning (aeration, dryers) equipment for grain handling.

Both companies’ earnings profiles are diversified in terms of business lines and products as well as geography.

Best Buys has more on the Portfolio Holdings–including new addition Scotiabank–that represent our top ideas for new money in August.

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In Focus

As a recent report from the Woodrow Wilson International Center for Scholars notes, “We cannot snap our fingers and be off hydrocarbons tomorrow, nor can we snap our fingers and move instantly to renewable sources of energy.”

Reasonable minds that have trained on the problem are in basic agreement that we’ll need oil for the next half-century. Accepting this as fact does not obviate the twin needs to diversify our energy sources and to make production and transportation of existing fuels more efficient in terms of greenhouse-gas emissions.

The key to unlocking North America’s–and Canada’s–energy potential is infrastructure.

This month’s In Focus feature also explores our top picks for long-term value creation in the Canadian energy space as well as a couple names worthy of aggressive speculators’ risk capital.

In Focus provides an overview of recent pipeline developments, earnings news from favored oil and gas producers and ideas for potential takeover targets.

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Dividend Watch List

There were two cuts in the How They Rate coverage universe last month, by Barrick Gold Corp (TSX: ABX, NYSE: ABX) and former Portfolio Holding Colabor Group Inc (TSX: GCL, OTC: COLFF).

Dividend Watch List has the details on members of the How They Rate coverage universe whose current dividend rates are in jeopardy.

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Canadian Currents

 

As Canada’s economy regroups in 2013, the next two years promise a return to stronger growth, with the US economy leading the way, writes CE Associate Editor Charney.

Canadian Currents has more Canada’s still-deep economic relationship with its neighbor down south.

Bay Street Beat–We’re now in the heat of reporting season, and Bay Street analysts are asking questions on conference calls, adjusting their models and updating their buy/hold/sell advice. Here’s how Bay Street has responded to the first major wave of Canadian Edge Portfolio Holdings’ second-quarter earnings reports.

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How They Rate Update

 

Coverage Changes

Poseidon Concepts Corp, which completed the sale of its water storage and containment system assets to Rockwater Energy Solutions in June and is no longer listed on the Toronto Stock Exchange, is no longer covered in How They Rate.

There are a number of shareholder suits ongoing against the company, which is now under bankruptcy protection in Canada and the US. 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.

Advice Changes

Essential Energy Services Ltd (TSX: ESN, OTC: EEYUF)–From Hold to Buy < 2.65. Essential has carved out key niches in the drilling services market, with a geographically dispersed service rig fleet and ownership of the largest coil tubing well service fleet in Canada insulating it from ups and downs in drilling activity. That’s not to mention the fact that Bay Street is uniformly bullish on the stock, with all 12 analysts that cover it rating it a “buy.”

Manitoba Telecom Services Inc (TSX: MBT, OTC: MOBAF)–From SELL to Hold. Second-quarter wireless results were solid, and the company reported improving wireline subscriber trends. Cost-cutting efforts have been effective, and the company isn’t exposed to potential competition from a Verizon Communications Inc (NYSE: VZ) entry into Canada.

The Allstream sale was well-timed, as it provided a significant infusion of cash and streamlined operations. Dividend coverage is solid as well.

Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)–From Hold to Buy < 13. Penn West, which recently slashed its dividend, announced sweeping management changes and embarked on an all-encompassing strategic review, earns an upgrade based on the potential that a buyer might find it compellingly attractive priced at such a steep discount to the value of its assets. It’s for the aggressive only.

Precision Drilling Corp (TSX: PD, NYSE: PDS)–From Hold to Buy < 11. Precision has won more than 50 percent of the Canadian newbuild rig contracts over the last several years, and it should be in good position to win more in coming years.

Second-quarter funds from operations dove by 46 percent to CAD33.8 million, as revenue slipped 1 percent to CAD378.9 million. But management is optimistic about Canadian activity in the second half of 2013 and hinted at new opportunities tied to LNG projects.

Talisman Energy Inc (TSX: TLM, NYSE: TLM)–From Hold to Buy < 12. Talisman is now a perpetual target for takeover speculation. The advice upgrade applies to investors with risk capital who appreciate the fact that there’s no guarantee, or even a better than 50-50 likelihood, of a deal.

Ten Peaks Coffee Company Inc (TSX: TPK, OTC: SWSSF)–From SELL to Hold. Management reported solid numbers for the first half of 2013, with gross profit, net income and EBITDA all up over the same period last year. Cash from operations rose by 26 percent, allowing it to reduce debt and strengthen its balance sheet.

Ten Peaks continued to benefit from declining coffee commodity prices, which led to a drop in revenue but an even larger decrease in cost of sales.Ten Peaks is adding market share on solid performance in the US, where volumes have grown 35 percent over the past three years. Coffee is a tough, volatile business, and it’s a hard model on which to base a dividend-paying business. But recent results earn it an upgrade.

Trinidad Drilling Ltd (TSX: TDG, OTC: TDGCF)–From Hold to Buy < 9.50. Second-quarter funds from operations were off 24 percent to CAD39.1 million, as revenue dipped 5.1 percent to CAD165.4 million on slower US activity.

Management noted stable land-drilling day-rates despite weaker demand and strong competition. Its deepwater focus is a key advantage. Bay Street is also uniformly bullish, with 18 “buys” versus zero “hold” and zero “sells.”

Rating Changes

Essential Energy Services Ltd (TSX: ESN, OTC: EEYUF)–From 1 to 3. The company’s payout ratio is exceptionally low relative to other Energy Services firms. Its operating niches and conservative approach following the discontinuation of its dividend from November 2009 through March 2012 ensure a sustainable current rate over the next 18 to 24 months. It scores another point for low overall debt relative to assets.

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.