Cheap Despite the Challenges
Editor’s Note: What follows is the executive summary of the December issue of Canadian Edge. Thanks for reading. — RSC
“Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up in 2013.”
Those are the words of Bank of Canada Governor Mark Carney this week. Mr. Carney continues to pilot a moderate course in his country’s monetary policy. He now plans to leave his post in June to become Bank of England Governor, an honor that reflects widely held appreciation of his effectiveness.
Canada’s economy grew at a pace of just 0.6 percent in the third quarter, so Mr. Carney’s prognosis is welcome news indeed. But the he also cautions that growth probably won’t accelerate enough to justify raising interest rates before he leaves office next year.
Further, he forecast the recovery would be led by business investment and consumption rather than the export growth that’s led the way in recent years.
If Mr. Carney’s right, there are major implications for investors in 2013. It will still be possible to make big money in Canada’s energy patch, for example, but only by focusing on growing output rather than price. Energy services companies will have to capitalize on niches and foreign expansion, as producers pull back to their most profitable properties.
Canada’s immense resource wealth will continue to develop. But the going will be a lot slower if capital flow from Asia and the US is restricted.
And Canadian regulators may be on the verge of doing just that, should they reject the resubmitted takeover bid by Petroliam Nasional Berhad, Malaysia’s state-owned oil and gas company better known as Petronas, for Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF) later this month.
Ottawa is also studying the much larger bid for Nexen Inc (TSX: NXY, NYSE: NXY) by China’s CNOOC Ltd (Hong Kong: 883, NYSE: CEO).
And the standard of providing a net benefit for Canada is proving a tough nut to crack even for Canadian companies with close government ties.
Telecom giant BCE Inc (TSX: BCE, NYSE: BCE), for example, was forced to submit a revised application to take over Quebec broadcaster Astral Media Inc (TSX: ACM/A, OTC: AIAAF) when its initial request for government approval was rejected.
The past few years’ rise in the Canadian dollar has provided capital gains and rising dividends for US investors. The dark side is that it’s made it increasingly difficult for the country’s industrial and technology companies to manufacture at home and sell abroad profitably.
And their dilemma could actually worsen in coming years as global growth returns and increases the appeal of the Canadian dollar.
If there is good news here it’s that all of these challenges are more than reflected in prices of Canadian stocks. And despite some wild gyrations in share prices the past few months, conservative financial and operating policies remain the rule, not the exception.
Despite the relative lack of dividend cuts this year, a large number of dividend-paying stocks are pricing in dividend cuts. And most of the affected companies are perfectly capable of maintaining current payout rates, unless North America swings into recession.
We’ve been here before, at the market bottoms in March 2009, spring 2010, fall 2011 and summer 2012. Each time numerous high-yielding stocks sold at washed-out prices that reflected expectations of dividend cuts and worse.
A few companies did actually falter. Most didn’t, and their share prices recovered sharply in the following months.
This time around resolution may take longer. For one thing a major point of uncertainty is political, mainly US federal budget negotiations that aren’t likely to conclude until late December at the earliest.
But history is clear stocks will recover, so long as the underlying businesses don’t buckle–and even in 2008-09 most did not.Roger Conrad
Editor, Canadian Edge
Portfolio Update
December is usually housecleaning month for the Canadian Edge Portfolio, when I swap the year’s underperformers for more promising fare.
This year, however, worries about a fiscal cliff, dividend taxes and sliding energy prices have exaggerated the demise of losers. It’s a bad time to sell anything.
Consequently, I’m only unloading one stock from the Aggressive Holdings, Pengrowth Energy Corp (TSX: PGF, NYSE: PGH). I’m still convinced this company has the financial power, reserves and ability to ramp up light oil production the next few years. And despite some late-year weakness, I’m bullish on oil prices for the long term. But for now this is a candidate for a tax loss.
IBI Group Inc (TSX: IBI, OTC: IBIBF) has also posted a significant loss this year, as has, of course, the year’s biggest loser Poseidon Concepts Corp (TSX: PSN, OTC: POOSF).
Note I’m moving IBI and Just Energy Group Inc (TSX: JE, NYSE: JE) to the Aggressive Holdings due to the greater exposure of their respective revenue streams to economic ups and downs.
I also highlight a strategy for what to do with the year’s biggest winners, including Acadian Timber Corp (TSX: ADN, OTC: ACAZF), Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) and TransForce Inc (TSX: TFI, OTC: TFIFF).
I also detail how Portfolio recommendations stack up on the CE Safety Rating System in a data-packed table.
Portfolio Update examines Pengrowth’s prospects in more detail as well as those of other fallen favorites I’m keeping at least for now.
Best Buys
Dividend growth is the surest sign of a healthy company and a safe payout. And both of our picks lifted their dividends in the past month.
For Conservative Holding Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) it was the second boost in as many quarters.
For Aggressive Holding Vermilion Energy Inc (TSX: VET, OTC: VEMTF) the increase was a very positive surprise. Management had previously guided toward a return to regular boosts in 2015, when the Corrib project off the Irish coast is slated to come on stream.
Both picks earned an increase in buy targets, Canadian Apartment to USD24 and Vermilion to USD52. They’re strong buys for anyone who doesn’t already own them.
Vermilion also plans to list on the New York Stock Exchange under the symbol VET by early 2013.In Focus
Despite a bullish January, investors’ desire for safety rose throughout 2012. And, despite few actual dividend cuts in the Canadian Edge universe, hints of risk were greeted with selling that in several cases turned into full-fledged routs, without any change to dividends.
As the year comes to a close risk aversion is stronger than ever. But so are the odds of a reversal of fortune, with the downtrodden leading the way.
This month’s In Focus rounds up prospects for How They Rate sectors along with my picks for best and worst performers in 2013.Dividend Watch List
Data Group Inc (TSX: DGI, OTC: DGPIF) was the only company in the Canadian Edge coverage universe to cut its dividend last month.
Management stated the 53.9 percent reduction was needed to free up cash to cut debt. It also reported third-quarter results that appeared decent on the surface, including a 2.8 percent boost in revenue, a 2.2 percent increase in gross profit and progress cutting costs.
Despite already pricing in a dividend cut, however, the stock slid by another third following the announcement as it only raised questions about long-term viability.
For more on Data Group and other companies whose payouts are at risk, see Dividend Watch List.Canadian Currents
Despite emerging headwinds, Canada’s banking system continues to prove itself among the strongest, soundest in the world. Here’s the story on how the Big Six fared during the fourth quarter of fiscal 2012.
Bay Street Beat–Two of the last group of Canadian Edge Portfolio Holdings to report third-quarter earnings suffered waves of downgrades in the aftermath of their respective announcements. Here are the details, along with a summary of the current standing of the entire Portfolio in the analyst community.
How They Rate Update
Coverage Changes
There are no How They Rate coverage changes this month.
HOMEQ Corp (TSX: HEQ, OTC: HEITF) was acquired by private capital firm Birch Hill Equity Partners for CAD9.50 per share in cash on Dec. 5. Investors should by now have received cash for their shares.
HOMEQ is delisted from the Toronto Stock Exchange, and we’ll drop it from How They Rate coverage next month.
Advice Changes
Bonterra Oil and Gas Corp (TSX: BNE, OTC: BNEFF)–To Buy @ 45 from Hold. The oil-focused energy producer reported solid third-quarter earnings and ramped up capital spending 71.6 percent, pointing to a brighter 2013.
CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–To Hold from Buy @ 10. Third-quarter results declined steeply on reduced medical reimbursements in Ontario.
Data Group Inc (TSX: DGI, OTC: DGPIF)–To SELL from Hold. The stock tumbled after announcing a dividend cut that raised questions about long-term viability.
Enerplus Corp (TSX: ERF, NYSE: ERF)–To Hold from SELL. The stock has fallen sharply since reporting third-quarter results that were actually decent. Management also reaffirmed the dividend.
Extendicare Inc (TSX: EXE, OTC: EXETF)–To Hold from Buy @ 9. The company has coped with lower Medicare reimbursements and held its dividend steady. How it will respond to a future round of cuts is less certain.
IBI Group Inc (TSX: IBG, OTC: IBIBF)–To Hold from Buy @ 15. Third-quarter results indicate cost-cutting plans are proceeding more slowly than projected.
Medical Facilities Corp (TSX: DR, OTC: MFCSF)–To Buy @ 14 from Hold. Solid third-quarter results and a recent acquisition point to strengths not reflected in a stock yielding more than 8 percent.
Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–To Hold from Buy @ 13. Dividend growth doesn’t appear likely until the company has a new supply contract. In the meantime, it’s a good candidate for taking partial profits.
Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–To SELL from Buy @ 7. There’s no immediate danger to the dividend, and production plans for 2013 appear to be on track. But the stock has been a very poor performer and is a great candidate for taking a tax loss. We can always get back in later.
Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)–To SELL from Buy @ 15. The stock’s late 2012 drop is well out of proportion to what were disappointing but hardly catastrophic third-quarter operating numbers. But it’s a great candidate for taking a tax loss.
Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–To Hold from Buy @ 20. The stock overcame an early swoon to emerge a big winner this year and has a bright future. At this point, however, anyone with a huge gain should consider taking a partial profit.
PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–To Hold from SELL. The company’s third-quarter results show it’s still expanding market share despite tougher market conditions.
Poseidon Concepts Corp (TSX: PSN, OTC: POOSF)–To Hold from Buy @ 10. Though disappointing, the third-quarter shortfall doesn’t justify the free-fall in the stock. So long as the company isn’t a total sham, we should see a sizeable recovery next year. But no one should ever add to positions when a stock falls this far this fast.
Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF)–To Hold from SELL. The stock trades at nearly a 10 percent discount to the CAD22 per share all-cash takeover offer from Petroliam Nasional Berhad, Malaysia’s state-owned oil and gas company better known as Petronas, and the deal is likely to be approved this month. US investors should sell when that happens.
Westshore Terminals Corp (TSX: WTE, OTC: WTSHF)–To Hold from Buy @ 24. Third-quarter numbers were super, and the company also signed on new business. But the stock’s recent rise reflects that and more.
Ratings Changes
Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–To 3 from 4. This year’s tribulations are due entirely to the temporary impact of the US drought. But Ag Growth now longer merits a point under the CE Safety Rating System for a low payout ratio.
Bonterra Oil and Gas Corp (TSX: BNE, OTC: BNEFF)–To 3 from 2. The third-quarter payout ratio fell to 71 percent, as production rose 13.2 percent.
Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–To 4 from 3. The third-quarter payout ratio declined to 74 percent after a 20 percent boost in funds from operations per unit.
Data Group Inc (TSX: DGI, OTC: DGPIF)–To 2 from 3. The dividend cut obscures the picture for future earnings.
Dundee REIT (TSX: D-U, OTC: DRETF)–To 5 from 4. The office property REIT misses a perfect “6” on the Rating System only because of its sector’s historical volatility.
Equal Energy Ltd (TSX: EQU, NYSE: EQU)–To 1 from 0. The company has reinstated a dividend as part of its strategic review, earning it a point on the payout ratio criterion.
IBI Group Inc (TSX: IBG, OTC: IBIBF)–To 3 from 4. The increase in the third-quarter payout ratio to 95 percent takes away a point under the Rating System.
Just Energy Group Inc (TSX: JE, NYSE: JE)–To 4 from 5. Management now expects a payout ratio over 100 percent until fiscal 2015, as it expenses expansion costs before cash starts flowing. It’s still affirming the current payout level but no longer gets the Rating System point.
Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–To 4 from 3. The company’s cost-management plans continue to exceed projections, and its payout ratio in the third quarter fell to just 38 percent.
Poseidon Concepts Corp (TSX: PSN, OTC: POOSF)–To 1 from 2. The third-quarter payout ratio rose to 90 percent, taking away a Rating System point from the hard-hit services company.
Royal Bank of Canada (TSX: RY, NYSE: RY)–To 4 from 5. The bank must refinance debt of more than CAD30 billion–or 35.5 percent of market capitalization–before the end of 2014.
Telus Corp (TSX: T, NYSE: TU)–To 5 from 4. Continued strong results and dividend growth provide added visibility to future earnings.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.
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