A Tale of One Continent

By David Dittman • January 10, 2014 • In Brief

Editor’s Note: What follows is the executive summary of the January 2014 issue of Canadian Edge. Thanks for reading.

Here’s the thing about recoveries from financial-driven– as opposed to usual business-cycle recessions–economic calamities: They take a long time.

Here’s another thing, addressing specifically the report from the US Bureau of Labor Statistics non-farm payroll data for December 2013: It reflects a lot of statistical noise and will be revised in coming weeks. We know from each month’s revisions that the initial read is off, often by a substantial amount.

That being said, this particular report is a strange collection of data with very weak headline payroll gains combined with another sharp drop in the unemployment rate.

Total payroll gains were estimated at just 74,000, well below a consensus of 197,000 and substantially below the ADP estimate of 238,000.

Note, however, that over the last three years there have been six separate instances of initial payroll reports below 100,000 (March 2013, May, June and August 2012, August and October 2011). On five of those occasions large revisions were made to the data over the next two months averaging over 80,000 from the initial print.

Such a weak number could give the Fed pause to consider its new “tapering” venture, though surely the pace of monetary stimulus withdrawal won’t be quickened from here. The 10-year Treasury yield saw its biggest one-day decline since October.

The unemployment rate fell to 6.7 percent, the lowest since October 2008, from 7.0 percent in November. But this was largely a function of the labor force continuing to shrink. A broader measure of unemployment would place the rate at a depressing 13.1 percent.

At the same time, November job gains were revised higher to 241,000 from 203,000. And payroll growth was stronger than originally expected in August, September, October,

So it’s way too early to say the positive employment trend in the US has been broken.

Looking northward, there is cause for concern.

A much-worse-than-expected report on Canada’s balance of trade for the month of November 2013 has traders upping their bets on a rate cut by the Bank of Canada.

Speculation that monetary policy will shift dovish north of the border at the same time the US Federal Reserve is unwinding its extraordinary easing policies has the Canadian dollar in free-fall versus the US dollar.

The loonie hit a fresh four-year low against the US dollar Friday, Jan. 10, 2014, and is down 2.7 percent versus the greenback this week alone. Indeed, for investors long the Canadian dollar–and if you own Canadian stocks this means you–it’s been an ugly week.

A seemingly perfect storm has descended on the loonie. Recent comments from Finance Minister Jim Flaherty about the benefits of a weaker currency, along with falling commodity prices, are largely responsible for dragging down the Canadian dollar.

And Statistics Canada reported that Canada’s economy shed 45,900 net jobs in December 2013, while the unemployment rate ticked higher. Inflation continues to hover near the lower end of the Bank of Canada’s policy range.

Meanwhile, optimism about the US economy persists, with many observers expecting 2014 to be the best year since the Great Financial Crisis/Great Recession.

Of course this is a low threshold.

Thanks to rising exports, the US trade deficit fell to a four-year low. And freight rail traffic is at an all-time high. The housing market is also doing well, and construction spending is the highest it’s been since March 2009.

The GDP report for the third quarter had the second-best growth rate in the last 30 quarters. And Wall Street firms are revising upward their estimates for fourth-quarter GDP growth.

There are still lots of weak spots in the economy, and the jobs market remains a concern. Quite simply, more jobs mean more consumers, and that drives earnings and growth.

So what’s the case for Canada in this context? Very simply, a broadly diversified equities portfolio will include a significant allocation to foreign stocks. And Canada is still home to some of the highest-yielding stocks in the world. Individual companies, as we detail in this month’s In Focus feature, can also thrive despite the travails of the broader local market and economy.

Note too that the Canadian dollar has likely reached a status where its new lows versus the US dollar will be much higher than those of the past. The loonie enjoys a new, higher profile among global central banks, which continue to accumulate assets denominated in the currency.

And Canada’s resource base, coupled with a mature, reliable institutional framework, makes it an attractive destination for foreign capital.

It may not take the shape of growth phases of the past, but eventually Canada will begin to pick up steam based on its close relationship with the world’s largest economy. And efforts to diversify its trade relationships to include greater engagement with emerging Asia, specifically China and India, will pay off in the long run.

Caution is certainly warranted in the aftermath of such a steep slide for the Canadian dollar. But the foundations of the Great White North remain solid.

And dividend-focused investors can still benefit from exposure to its high-quality businesses with US and global revenue streams.

David Dittman
Chief Investment Strategist, Canadian Edge

Portfolio Update

From Dec. 31, 2012, through Dec. 31, 2013, Canadian Edge Portfolio Holdings posted an average total return in US dollar terms of 2.4 percent.

That figure includes all stocks held during the year. We’ve based our calculations on the total return in US dollar terms for each Holding during the timeframe it was held in the Portfolio in 2013. For most this is the whole 12-month period.

Conservative Holdings posted an average total return of 8.3 percent, while Aggressive Holdings were down an average of 3.5 percent.

The S&P/TSX Composite Index was up 5.8 percent in US dollar terms for 2013. The iShares MSCI Canada Index Fund (NYSE: EWC) exchange-traded fund (ETF) posted a gain of 5.3 percent.

In local currency terms the S&P/TSX Composite posted a 13 percent gain, trailing most developed-world indexes, including the S&P 500 Index’ 32.4 percent surge and the MSCI World Index’ 27.5 percent rise, for the year.

The Canadian dollar, which began the year at USD1.0079, ended it at USD0.9414, a 6.6 percent decline. The CurrencyShares Canadian Dollar Trust (NYSE: FXC) ETF was off 6.3 percent.

Portfolio Update has more on 2013 as well as significant developments from seven Holdings, including a buy-under target increase for Pembina Pipeline Corp (TSX: PPL, NYSE: PBA).

Best Buys

The steep climb for the world’s key benchmark interest rate triggered significant selloffs for traditional high-yield stocks such as real estate investment trusts (REIT), utilities and telecoms.

But high-yielding Canadian energy stocks, including Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), have largely been spared.

Crescent Point, the highest-yielding among our top five picks at 6.9 percent, has demonstrated its ability to grow output, with its key advantage technical advances that have allowed to boost recoveries using its waterflood techniques.

Its performance on the TSX during the period of rising rates has been solid. From its April 17, 2013, 12-month closing low of CAD35.01 through Jan. 9, 2014, Crescent Point has produced a total return of 13.7 percent in US dollar terms and 20.1 percent in Canadian dollar terms, outperforming the S&P/TSX Composite and the S&P/TSX Energy Index.

Through Dec. 31, 2013, the stock was up more than 20 percent in US dollar terms, in line with the S&P 500 for the given time period. The shares have pulled back in the New Year after a solid run to end 2013.

Crescent Point is a buy under USD48.

In 2010 Bird Construction Inc (TSX: BDT, OTC: BIRDF) posted a total return in US dollar terms of 20.6 percent, at the tail end of the recently concluded era of outperformance for Canadian stocks versus US and global counterparts and helped by a strengthening Canadian dollar versus the buck.

It followed up in 2011 with a loss, including dividends, of 3.7 percent. Two-thousand twelve proved to be a big bounce-back year for Bird, as it posted a total return of 24 percent. Though Canadian stocks generally had begun to lag, the Canadian economy’s recovery in the aftermath of the Great Financial Crisis/Great Recession remained on track, as did the government and industrial building activity that drives Bird’s business.

In 2013 Bird posted a loss of 2.3 percent, sliding from a closing high of CAD15.08 on the TSX on Jan. 21 to as low as CAD11.20 on Aug. 29.

If the pattern holds–and, of course, past performance is no guarantee of future results–Bird is on track for a nice gain in 2014.

Bird Construction is a buy under USD14.50.

Best Buys has more on the Portfolio Holdings that represent our top ideas for new money in January.

In Focus

In a break from history, Canada’s export economy is not gaining steam along with a resurgent US. But high-quality Canada-based businesses with significant US exposure may be exceptions to lukewarm 2014 norms in the Great White North.

Canada’s bilateral trade surplus with the US is a shadow of its former past. This is partly due to the slow speed of the US economic recovery, but it also reflects deterioration in Canadian business competitiveness.

And energy prices in Canada, complicated by a glut of oil and natural gas production in the US, continue to remain volatile and will hamper business investment this year.

Meanwhile, the US trade deficit is at a four-year low. The traditional “consumer of last resort” is not acting so, at least at this stage of the recovery from the Great Recession.

Other indicators suggest weakness in the Great White North.

Although old patterns are not prevailing during this North American recovery, and Canada is not enjoying knock-on benefits of increased US economic activity, there are companies operating in specific areas that nevertheless should do well.

In Focus identifies three Canada-based industrial companies well-positioned to benefit from accelerating US economic growth and four energy-focused names whose fortunes will be impacted by an impending US executive branch decision on a key piece of North American infrastructure.

Dividend Watch List

There were no dividend cuts in the How They Rate coverage universe last month.

One company that recently graduated from the Dividend Watch List, Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF), followed through, at least partially, on a statement made by its CEO several months ago and raised its payout following the successful resolution of its arbitration dispute with Air Canada (TSX; AC/B, OTC: AIDIF).

And the share price of a Watch List holdover, Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF), has risen from the depths it plumbed in the immediate aftermath of a recent dividend cut, showing signs that it will indeed attract a bid based on its solid collection of light-oil assets.

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

Canadian Currents

Employment data are notoriously volatile from month to month, but we’re still disappointed by the US and Canada’s dismal December jobs reports, notes CE Associate Editor Ari Charney in this month’s Canadian Currents.

Bay Street Beat–We’re in something of a shoulder season, as third-quarter reporting season is over and fourth-quarter and full-year 2013 reporting season is still several weeks off. But analysts have been updating their models and their ratings.

Here’s how Bay Street sees the CE Portfolio early in 2014.

How They Rate Update

Coverage Changes

Please note that Enervest Energy & Oil Sands Total Return Trust has been merged into Canoe Energy Income Class, an open-ended mutual fund managed by Canoe Financial LP.

Enervest Energy & Oil Sands unitholders resident in Canada should have received 0.76 Series A shares Canoe Energy Income Class in exchange for each unit held.

Non-resident unitholders may have received cash in lieu of shares of the successor fund, as “unitholder accounts which are deemed to be non-resident of Canada may not be allowed to hold shares” of Canoe Energy Income “where the holding of such shares could be detrimental to” it. Enervest Energy & Oil Sands has been de-listed from the Toronto Stock Exchange and has been removed from How They Rate.

We’re in the process of evaluating members of the coverage universe based on a combination of low market capitalization, low daily trading volume on the Toronto Stock Exchange and in the US and, most importantly, for those that aren’t paying a dividend at present, whether there’s a reasonable likelihood of ever doing so in the near future.

This is part of an effort to streamline our focus on companies with a realistic opportunity to build wealth for investors for the long term, keeping in mind too that part of the rationale for building a coverage universe is to provide context and comparison.

With all this in mind, barring any objections from readers, which you can express via our “Stock Talk” feature at www.CanadianEdge.com, we will begin paring the ranks next month.

In the November 2013 issue we removed Tuckamore Capital Management Inc (TSX: TX, OTC: NWPIF), Lanesborough REIT (TSX: LRT-U, OTC: LRTEF) and Tree Island Steel Ltd (TSX: TSL, OTC: TWIRF) from the coverage universe.

We’re still considering our coverage of Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF), which pays no dividend and has a market capitalization of CAD36.3 million, and Imvescor Restaurant Group Inc (TSX: IRG, OTC: IRGIF), which discontinued its dividend in March 2011 and has a market capitalization of CAD90.8 million.

We’re also reviewing our coverage of Royal Host Inc (TSX: RYL, OTC: ROYHF), which hasn’t paid a dividend since December 2010 and is currently valued at just CAD20.5 million, and Data Group Inc (TSX: DGI, OTC: DGPIF), which last month suspended its dividend and now has a market cap of just CAD11.7 million.

Advice Changes

Fortis Inc (TSX: FTS, OTC: FRTSF)–From Hold to Buy < 31. The Canada-based gas and electric distribution company continues to expand its presence south of the border, as it announced an agreement to buy Arizona-based UNS Energy Corp (NYSE: UNS) for USD2.5 billion, or USD60.25 per share.

Management also boosted the quarterly dividend rate by 3.2 percent to CAD0.32 per share, or CAD1.28 annualized, as a solid record of yearly dividend increases continues.

New Flyer Industries Inc (TSX: NFI, OTC: NFYIF)–From Hold to Buy < 10. The largest designer and manufacturer of heavy-duty transit buses in North America holds a dominant position in bus manufacturing and the aftermarket segment. New Flyer is well positioned for a cyclical rebound in North America. Strong revenue and earnings growth over the next couple years will be driven by acquisitions as well as higher production rates.

A robust order pipeline, improving fundamentals and strong growth opportunities should result in further share price appreciation, on top of an attractive 5.6 percent yield.

Progressive Waste Solutions Inc (TSX: BIN, NYSE: BIN)–From Hold to Buy < 26. With nearly 60 percent of revenue coming from the US, this solid waste management company is poised for earnings growth based on rising volumes amid an accelerating US economy. Management has also announced two dividend increases over the past 24 months, with another likely to come in 2014.

Russel Metals Inc (TSX: RUS, OTC: RUSMF)–From Hold to Buy < 30. Another Canadian industrial leveraged to rising economic activity south of the border, Russel survived the Great Financial Crisis with a disciplined approach and is set to reap the benefits of oil and gas drilling activity in North America drives demand. Nearly a third of its 2012 revenue was generated in the US.

Rating Changes

There are not Safety Rating changes this month. Activity on this front will pick up once companies start reporting fourth-quarter and full-year 2013 results.

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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