Leith Wheeler focuses on total returns, not just dividends

Sustainable business models, profits, returns on invested capital, free cash flow yields, and strong balance sheets, are some of the things manager Patrick Reddy seeks

Diana Cawfield 21 February, 2019 | 6:00PM

When it comes to dividend investing, Patrick Reddy, manager of the Gold-rated Leith Wheeler Canadian Dividend Series F, says the investment team seeks sustainable, resilient companies, not dividend yields.

Reddy, a Canadian equity analyst at Vancouver-based Leith Wheeler Investment Counsel says, “Our view is that what’s key for dividend investing is to focus on the total return of a business, not just a dividend. We believe it’s a mix of capital appreciation and the dividend that’s important. As a firm, we’re value managers, and our mantra since inception is to buy businesses that we understand, trading at discounts to intrinsic value.”

According to Reddy, the mandate has traditionally had a yield greater than the TSX, but on average, it’s been anywhere between 3% and 4%. “When investors screen dividend funds to pick the ones with the highest yield, ours would not score well,” says Reddy.

The five members of the of the Canadian equity team work together to make decisions on the high-conviction fund. All five are sector specialists. “We’re rather unique here,” says Reddy, who specializes in energy and utilities. “The analysts’ roles are like portfolio managers and there is no one decision-maker for the portfolio.”

The portfolio has between 20 to 40 names, and Reddy believes the select stock-picking process adds to risk management.

Along with sustainable business models, the bottom-up stock selection strategy looks for highly-profitable companies, high returns on invested capital, high free cash flow yields, and a strong balance sheet. Also key are management strength and alignment with shareholders, including ESG – environmental, social and governance – initiatives.

As a result of the investment approach, the approximately 40% weighting in the financial sector is characteristic of the fund. According to Reddy, there always seems to be clouds over the Canadian financials, whether post the financial crisis, past recessions, the housing bubble, consumer debt, or other concerns. “We think the clouds continue to present an opportunity to buy businesses that look attractive.”

An environment of rising interest rates is not a concern. From a portfolio perspective, the team considers an improvement in the economy leading to higher rates should be positive. “We have a large exposure to financials and industrials (a 15% weighting),” says Reddy, “two business lines that improve when the economy improves.”

The Canadian banks meet the stock criteria of strong business models and four of the big banks are included in the top 10 holdings.

The Toronto-Dominion Bank (TD) is among the top five names in the portfolio. “Over the last five years, it’s grown earnings by 10% per annum, and they’ve grown the dividend by 10% per annum. You’ve got quite a resilient business and attractive growth profile,” Reddy says, adding that it’s trading at quite a healthy discount, so he thinks it looks attractive.”

Montreal-based Canadian National Railway Co (CNR) has been held since the fund’s inception eight years ago, and was added to recently. “It’s one of the stocks that you wouldn’t normally see in a dividend fund because the yield is about 1.7%. Though the yield isn’t high, we believe the total return in this business can deliver double-digits per annum over time,” Reddy says, adding that CN Rail, with a strong balance sheet, has a long, steady track record of delivering value to shareholders and has been able to reinvest in their business over time to increase pricing on its services.

Another name that was added to recently is Saputo Inc (SAP), a global dairy and cheese producer, based in Montreal. “The yield is 1.7%,” says Reddy, “so again, it’s quite below that of the TSX, but it’s a very profitable business and the insiders are quite aligned with shareholders.” The stock is favoured for its ability to grow its business over time through acquisitions, its high level of profitability, as well as being able to grow its earnings by double digits over the last three years.

In positioning the fund this year, despite investor concerns over global trade tensions, tightening monetary conditions and other market worries, “we think equities will do quite well,” says Reddy. “Valuations in Canada continue to get cheaper relative to the U.S. Right now, bottom-up expectations for Canadian earnings growth is about mid-to-high single digits with dividends growing about 3% to 5% a year.”

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Canadian National Railway Co119.45 CAD-2.31
Saputo Inc38.92 CAD-1.96
The Toronto-Dominion Bank71.58 CAD-1.46

About Author

Diana Cawfield

Diana Cawfield  Diana Cawfield is an award-winning writer who has been a regular Morningstar contributor since 2000. Her numerous publication credits include the Toronto StarAdvisor's Edge and Chatelaine, as well as the Canadian Securities Institute's online educational services.