The Next 10 Years

By David Dittman • July 12, 2014 • In Brief

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

Canadian Edge is fundamentally a buy-and-hold service.

When we add stocks to the Aggressive Holdings or the Conservative Holdings we do so with the intention of keeping it so long as the underlying business holds up, that it continues to generate revenue, earnings and cash flow growth that support dividends.

We think of ourselves much like a small business owner conceives of his or her enterprise, with a commitment for the duration.

We’re on issue No. 121 now, the beginning of the second decade of publication. And if you take a look at the 10 stocks that comprised the original CE Portfolio back in July 2014 you’ll see that six of these companies are current Portfolio Holdings.

In fact five of them we’ve held ever since that first issue: ARC Energy Trust, now known as ARC Resources Ltd (TSX: ARX, OTC: AETUF), Great Lakes Hydro Income Fund, now Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF), Pembina Pipeline Income Fund, now Pembina Pipeline Corp (TSX: PPL, NYSE: PBA), RioCan REIT (TSX: REI-U, OTC: RIOCF) and Vermilion Energy Trust, now Vermilion Energy Inc (TSX: VET, OTC: VEMTF).

We sold Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) within a couple months of putting together what was then the Top 10 Portfolio, largely because it had seemed to run into regulatory problems. Those suspicions never materialized but the company nonetheless had a comeuppance a few years later, eliminating dividends at the end of 2009.

We re-entered the stock in December 2011. Noranda is the only original member of the Top 10 that hasn’t converted from an income fund to a corporation.

The first five stocks have generated an average total return of 530.6 percent since July 2004. We see further growth ahead, as all continue to add assets that will drive dividends and share prices higher for the long term.

As for the rest of the group, Boralex Power Income Fund was bought out by its parent at a price that basically resulted in us breaking even including accumulated dividends. Calpine Power Income Fund was also acquired, though at a much better price.

We took losses on Superior Plus Income Fund, now Superior Plus Corp (TSX: SPB, OTC: SUUIF) and Yellow Pages Income Fund, now Yellow Media Inc (TSX: YLO, OTC: YLWPF), as their businesses came up against challenges and dividends were cut.

Unfortunately we gave up on Superior a bit early–its stock has revived–and bailed out of Yellow Media only after losing nearly 90 percent of principal. The only saving grace was accumulated dividends, which softened our losses.

Despite these setbacks the 10 original CE Portfolio Holdings have returned more than 300 percent since July 2004. That’s against a 117.8 percent increase in the S&P 500 Index and it also tops the S&P/Toronto Stock Exchange Composite Index’ 186.4 percent.

This month’s Portfolio Update details recent performance, including the fact that the 39 stocks and funds that currently comprise the Portfolio posted an average total return in US dollar terms from Dec. 31, 2013, through June 30, 2014, of 14.9 percent.

The S&P/TSX Composite generated a total return of 12.5 percent, the S&P 500 Index was up 7.1 percent and the MSCI World Index was up 6.6 percent.

We of course have made plenty of mistakes over 120 issues, including most notably Poseidon Concepts Corp, which went under within months of us adding it to our Aggressive Holdings. We also held onto Atlantic Power Corp (TSX: ATP, NYSE: AT) for too long. Colabor Group Inc (TSX: GCL, OTC: COLFF) was another losing proposition, as was Just Energy Group Inc (TSX: JE, NYSE: JE).

We sold Atlantic, Colabor and Just Energy shortly after I became chief strategist in May 2013. I did hold onto Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF) through its November 2013 dividend cut, and the stock price has responded to management’s efforts to sell non-core assets to generate cash to pay down debt. It remains highly sensitive to oil price swings, so we’ll see.

REITs have been soft since Ben Bernanke introduced “tapering” to the market lexicon last May. But I think over time the five we currently residing in our Conservative Holdings–Artis REIT (TSX: AX-U, OTC: ARESF), Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Dream Office REIT (TSX: D-U, OTC: DRETF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and, of course, RioCan REIT–will provide steady, reliable income for investors looking for alternatives with bond yields so low.

We do have concerns about Dream Office, which we detail in this month’s In Focus feature.

We’ve made four additions to the Portfolio since May 2013.

Since August 2013 Conservative Holding Bank of Nova Scotia (TSX: BNS, NYSE: BNS) has generated a total return of 23.6 percent in US dollar terms versus 18.9 percent for the S&P/TSX Composite and 18.6 percent for the S&P 500.

Automotive parts and components supplier Magna International Inc (TSX: MG, NYSE: MGA) is 37.8 percent to the positive from Dec. 6, 2013, through July 11, 2014. The S&P/TSX Composite is up 15.2 percent, the S&P 500 10.3 percent.

We’ve seen explosive returns from global pipecoating specialist ShawCor Ltd (TSX: SCL, OTC: SAWLF), which is up 39 percent over its first five months as an Aggressive Holding. During this time the S&P/TSX Composite is up 14.3 percent, the S&P 500 10.5 percent.

And last month we added PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) back to the Aggressive Holdings. We had sold it in favor of Poseidon Concepts in October 2012. PHX has underperformed the S&P/TSX Composite, 2.4 percent versus 4.3 percent, but has beaten the S&P 500’s 1.1 percent return during its first month-plus back in the Portfolio.

Over the long haul our approach has proven successful.

And we look forward to the next decade of building wealth via the Great White North.

David Dittman
Chief Investment Strategist, Canadian Edge

Portfolio Update

The first six months of 2014 have been good for the Canadian Edge Portfolio.

The 39 stocks and funds that currently comprise the Portfolio posted an average total return in US dollar terms from Dec. 31, 2013, through June 30, 2014, of 14.9 percent.

The Canadian dollar ended 2013 at USD0.9414. As of June 30, 2014, the loonie was valued at USD0.9373, a decline of 0.4 percent. This currency fluctuation was basically neutral as far as US investors long dividend-paying Canadian equities are concerned.

Let’s establish the baselines.

The S&P/Toronto Stock Exchange Composite Index, the main Canadian benchmark, generated a total return–capital gain or loss plus dividends paid–in US dollar terms of 12.5 percent for the first half of the year. The S&P 500 Index was up 7.1 percent, the MSCI World Index 6.6 percent.

The breakdown by Portfolio segment is as follows.

The 17 Aggressive Holdings posted an average first-half total return of 19.8 percent. The 19 Conservative Holdings posted an average total return of 10.7 percent. The three Mutual Fund Alternatives were up an average of 13.2 percent.

Note that we’ve adjusted for holding period.

Performance data for ShawCor Ltd (TSX: SCL, OTC: SAWLF) and PHX Energy Services Inc (TSX: PHX, OTC: PHXHF) have been calculated from the dates the stocks were added to the Aggressive Holdings, Feb. 7, 2014, for ShawCor, June 6 for PHX. We’ve sold no stocks from the Aggressive Holdings yet in 2014.

The 19 Conservative Holdings have been static all year, as has the lineup of funds, with no additions or subtractions.

Portfolio Update takes a look at Portfolio performance for the first half of the year, including leaders and laggards, and has the first earnings report of the new season.

Best Buys

Oil and gas exploration and production stocks have led the CE Portfolio to an outstanding, benchmark-beating performance over the first half of 2014. Energy, for better and worse, is a huge part of the Canadian economy.

We’re in the midst of an energy production and infrastructure super-spending cycle, and there’s a long ways to go, with fundamentals in place for robust growth through the end of the decade.

According to the Canadian Association of Petroleum Producers, Canadian crude output is expected to rise to 4.9 million barrels per day by 2020 from 3.2 million barrels per day in 2012.

Oil sands and liquids-rich natural gas are driving growth in the Western Canadian Sedimentary Basin. Going forward further development of the Montney, increasing development of the Duvernay and drilling in anticipation of liquefied natural gas (LNG) export projects in British Columbia will be major catalysts.

More than a dozen of LNG projects have been proposed for the province as Canadian natural gas producers seek new export markets in Asia.

AltaGas Ltd (TSX: ALA, OTC: ATGFF) recently signed a letter of intent with the British Columbia government regarding regional LNG development. Its portfolio of energy export projects in British Columbia alone could total CAD2 billion to CAD5 billion of net capital investment. Opportunities span multiple jurisdictions and all business segments, including midstream and power projects. The diversity of projects is notable and reduces risk to its growth profile.

Newalta Corp (TSX: NAL, OTC: NWLTF), with a network of more than 85 facilities across North America, is one of the established leaders in the niche market of providing waste processing and management services to the oil and gas sector in Western Canada and increasingly in the US.

Demand for such services has increased and is likely to continue so as a result of increasingly stringent environmental regulations relating to the production and drilling activities in the sector.

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

In Focus

At the financial and operational levels the five Canadian REITs we hold in the Canadian Edge Portfolio continue to maintain solid interest coverage ratios, due to generally steady operating income growth and interest expense savings on debt refinancing.

Their continued health is supported by the relatively sound state of the Canadian economy and the currently reasonable balance between demand and supply of commercial real estate (with the exception of the Canadian office market, which is experiencing sluggish demand and an increase in sublet space, and has new supply coming online in 2014-2015). Residential apartment REITs stand to benefit from the fact that it’s becoming harder for a family to buy a home in much of Canada.

The bottom line is Canadian REITs will continue to benefit from a low interest rate environment for the foreseeable future.

And their steady, relatively high yields will continue to benefit income-focused investors.

In Focus reflects on a tough year for Canadian REITs, as financial and operating metrics are generally solid, distributions are well-protected and yields are relatively high.

Dividend Watch List

It was an encouraging month for the Canadian Edge How They Rate coverage universe as far as dividend announcements are concerned.

There were no dividend cuts announced.

Five companies, including one oil and gas producer, three of Canada’s big banks and a conglomerate with food distribution interests, did announce dividend increases.

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

Canadian Currents

Canada’s economy has failed to sustain the momentum from its surprisingly strong first quarter, notes CE Associate Editor Ari Charney in this month’s Canadian Currents.

Second-quarter reporting season is just underway for the Canadian Edge Portfolio.

Analyst reaction to Shaw Communications Inc’s (TSX: SJR/B, NYSE: SJR) fiscal 2014 third-quarter earnings report and views on Portfolio Holdings as we enter the second half of 2014 are summarized in Bay Street Beat.

How They Rate Update

Coverage Changes

We have no additions to or subtractions from the How They Rate coverage universe this month.

Our evaluation of the coverage universe is ongoing, as we streamline our focus to companies with realistic opportunities 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.

Advice Changes

Barrick Gold Corp (TSX: ABX, NYSE: ABX)–From SELL to Hold. The company has made solid progress with its asset-sale program, while gold had a decent second quarter. Sentiment on the metal has reached rock bottom, perhaps reflecting overly negative attitudes. The share price has also recovered much of what’s been lost. We’ll look for continuing signs of cost cuts in management second-quarter report.

BlackBerry Ltd (TSX: BB, NSDQ: BBRY)–From SELL to Hold. CEO John Chen’s strategic shift away from devices toward business customers, software and mobile services such as the BBM messaging service is showing signs of progress, as the company reported a narrower-than-expected fiscal 2015 first-quarter loss of USD0.11 per share on solid, forecast-beating sales of USD966 million.

WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF)–From Hold to Buy < 27. The Canadian dollar has strengthened, and competitive threats have receded. Management is now aiming at Air Canada (TSX: AC/B, OTC: AIDEF) with the planned acquisition of wide-body jets that will allow it to expand its service to overseas markets.

June traffic was up 5 percent, while capacity grew by 4.3 percent.

Rating Changes

We have no Safety Rating change this month. We will, however, evaluate the How They Rate coverage universe based on second-quarter earnings in coming weeks, reviewing payout ratios and debt levels.

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.
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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.
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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.