Equity-income roundtable: Part 2

Managers find attractive values in pipeline stocks.

Sonita Horvitch 25 January, 2017 | 6:00PM

Editor's note: In today's part two of our equity-income roundtable series, the managers discuss where they're finding attractive valuations. Among their favoured holdings are infrastructure stocks such as pipelines, which are energy-related but less vulnerable to swings in commodity prices.

The panellists:

Michele Robitaille, managing director and equity-income specialist at Guardian Capital L.P., a sub-advisor to the BMO family of funds. The Guardian equity team's mandates include BMO Monthly High Income ll.

Jason Gibbs, vice-president and portfolio manager at 1832 Asset Management L.P. Gibbs is a senior member of the firm's equity-income team, which has a wide range of mandates, including Scotia Canadian Dividend.

Peter Frost, senior vice-president and portfolio manager at AGF Investments Inc. His responsibilities include two income-oriented balanced funds: AGF Monthly High Income and AGF Traditional Income.

This week's coverage of the manager roundtable, which was convened and moderated by Morningstar columnist Sonita Horvitch, began on Monday and concludes on Friday.


Q: Different sectors in the Canadian equity market react differently to a rising interest-rate environment. We have discussed utilities. Can we discuss some of the other key sectors?

Gibbs: The financial stocks have done extraordinarily well since the Trump election, mostly because interest rates have gone up. The Canadian banks are in a good shape. Interest margins are starting to go up, their capital is going up and they have cut costs.

Michele Robitaille
Michele Robitaille

Robitaille: Their dividend growth is solid. The banks will continue to find ways to grow their earnings. This growth is likely to continue to be in the 4% to 6% or even 7% range year in year out, and dividend growth is going to follow on that. It will probably be at least 3%, or even higher. Bank stocks already have healthy dividend yields. These stocks are attractive for investors looking for a stable income stream with a nice growth trajectory.

Frost: Canadian bank stocks are not expensive.

Robitaille: Valuations are in line with long-term averages. There's probably a little room for a multiple expansion, if the Canadian economy strengthens.

Q: What about the insurers? They also do well in a rising interest-rate environment.

Frost: These stocks have already had a pretty good run. But there is still probably some upside. They're still trading at decent dividend yields. Their dividends will grow, but it's going to be modest growth.

Robitaille: As long as interest rates continue to move higher, you will see positive momentum in both the insurers and in bank stocks.

Q: Canadian telecommunications stocks?

Gibbs: Telecom stocks are interest-sensitive in the sense that when rates go up, the stocks tend to come under pressure. From a longer-term perspective, the major Canadian telecom companies have pricing power. It's an oligopoly. These companies offer an essential service that people will pay higher prices for. This provides the dividend growth. But the telecom stocks are not that cheap any more.

Robitaille: There are pressures on telecom companies' earnings growth. Also, investors have treated these telecom stocks as a safety trade.

Q: Finally, real estate investment trusts?

Robitaille: They're currently at fair value. They're trading at a 2% to 4% discount to net asset value. REITs are considered to be interest-sensitive, and they tend to be lower growth. But the high-quality REITs are still good long-term value and provide ballast in the portfolio.

Peter Frost
Peter Frost

Frost: REITs are an area that we're looking at hard right now, as there are some decent opportunities.

Gibbs: You have to be selective. I have trouble with office REITs longer-term, as increasingly people are working out of office. It's similar to the impact of Internet shopping on physical retail stores. We focus on the grocery-anchored retail REITs and also like those addressing seniors. We also like apartment REITs.

Frost: Industrial REITs are also attractive.

Q: Time to discuss your portfolios.

Frost: I have essentially equal weights in the equity portion of the two balanced funds that we're discussing. In AGF Traditional Income, dividend growth is the main focus and the focus in AGF Monthly High Income is on high-dividend-paying companies, which tend to be slower growth and have higher payout ratios. We currently have about 67 names in each fund. There are a number of holdings that qualify for both funds. We've been finding great opportunities.

Gibbs: I have about 50 names in Scotia Canadian Dividend. We invest in high-quality companies and do not overpay for them.

Robitaille: We focus on investing in stocks offering yields at a reasonable price in BMO Monthly High Income II. We look for sustainability of the cash flow and dividend and the ability of companies to grow those cash flows over time. There are 37 names in the portfolio.

Q: Can we discuss your main holdings in key Canadian sectors? Let us start with energy, which Michele and Peter identified as offering opportunities.

Robitaille: We have about one-third of our energy weight in the producers and about two-thirds in energy infrastructure companies. The federal government seems to be fairly friendly to pipeline development with its support of both the Trans Mountain Expansion Project and for Line 3, the Pipeline Replacement Project of  Enbridge Inc. (ENB). The question is: Will these projects stand up to environmentalist opposition? Also, the U.S. regulatory environment is likely to improve under a Trump administration. This is positive for Enbridge and  TransCanada Corp. (TRP), which have both made sizeable acquisitions there. These acquisitions were transformational for both companies. Both these stocks are in BMO Monthly High Income II. I also own smaller midstream companies such as Altagas Ltd. (ALA) and  Pembina Pipelines Corp. (PPL).

Jason Gibbs
Jason Gibbs

Gibbs: I own both Enbridge and TransCanada in Scotia Canadian Dividend. We still like these two stocks. We have reduced our weight in Enbridge over the past few years. We have a higher weighting in TransCanada. I like its diversification, it has Mexican assets and power assets and there is upside if its Keystone XL pipeline project is approved by Trump. It's now hard to build new pipeline assets. In the past, these companies were able to build pipelines at a fairly cheap cost. Now the companies are acquiring pipelines and that's more expensive. But I do like these U.S. acquisitions that both Enbridge and TransCanada have made. It does diversify their businesses. The stocks will be good investments near-term. The question mark longer-term will be where will these companies' growth be? The valuations on pipeline stocks are fair.

Robitaille: We still see these stocks as being quite attractive.

Frost: In AGF Traditional Income, I have more service companies than energy producers. In AGF Monthly High Income, energy producers dominate. In both funds, I own Canadian Energy Services & Technology Corp. (CEU). It produces chemicals for oilfield services. It has grown by acquisition over the past 15 years. Management has a big stake in the company. Pricing power for the services companies should start to come back this year. Among the energy producers, I own Vermilion Energy Inc. (VET),  ARC Resources Ltd. (ARX) and Bonterra Energy Corp. (BNE) in AGF Monthly High Income.

Robitaille: I own Vermilion and ARC. I also own  Peyto Exploration & Development Corp. (PEY).

Frost: When it comes to pipeline stocks, I own Inter Pipeline Ltd. (IPL) in both funds. It recently bought the Canadian midstream business from  The Williams Cos. Inc. (WMB). I sold Enbridge and TransCanada. I'm favouring the midstream companies that have more exposure to the commodities. The one with the most exposure to the commodity prices that I own in both funds is Gibson Energy Inc. (GEI).

Enbridge Inc. Inter Pipeline Ltd. TransCanada Corp.
Jan. 23 close $56.63 $28.54 $62.54
52-week high/low $59.19-$41.01 $30.07-$20.10 $64.48-$45.70
Market cap $53.2 billion $10.5 billion $55.3 billion
Total % return 1Y* 23.9 39.6 38.2
Total % return 3Y* 9.5 7.5 12.0
Total % return 5Y* 11.8 14.4 11.4
*As of Jan. 23, 2017
Source: Morningstar

Gibbs: We are substantially underweight the energy sector in Scotia Canadian Dividend. The only two energy producers that I own are  Canadian Natural Resources Ltd. (CNQ) and  Suncor Energy Inc. (SU). These are core holdings. The companies will be the survivors among the Canadian energy producers. They have great management teams. They generate strong free cash flow, which is hard to find in a lot of these companies. I find it hard to predict the oil price. That is one of the reasons why I am underweight the sector. I have a much better idea of where key prices are headed for in the case of other businesses.

Photos: Paul Lawrence Photography

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
AltaGas Ltd18.44 CAD-1.23
ARC Resources Ltd5.66 CAD-5.03
Bonterra Energy Corp4.03 CAD-4.28
Canadian Natural Resources Ltd30.19 CAD-3.61
CES Energy Solutions Corp2.00 CAD-2.91
Enbridge Inc43.35 CAD-2.45
Gibson Energy Inc22.81 CAD-1.98
Inter Pipeline Ltd24.25 CAD-0.86
Pembina Pipeline Corp47.48 CAD-2.28
Peyto Exploration & Development Corp3.21 CAD-4.46
Suncor Energy Inc37.04 CAD-1.91
TC Energy Corp64.37 CAD-0.65
Vermilion Energy Inc18.76 CAD-4.87
Williams Companies Inc22.88 USD-3.05

About Author

Sonita Horvitch

Sonita Horvitch