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Tetrem's Daniel Bubis cautions against chasing yield

Value manager favours financial services over defensive dividend-payers.

Sonita Horvitch 26 February, 2014 | 7:00PM
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 Daniel Bubis, president and CEO at Winnipeg-based Tetrem Capital Management Ltd., says that defensive dividend-paying stocks remain expensive, while offering lacklustre earnings growth, against the backdrop of a strengthening global economy.

In this defensive-dividend category, he includes pipelines, utilities, telecommunications services and consumer staples. Investors have been chasing these stocks for their dividend yields, as well as for their safe-haven characteristics, says Bubis, who is a value manager.

Rising interest rates represent a headwind for these "bond proxies." These companies have "little economic sensitivity or exposure outside of Canada."

Of the interest-rate environment, Bubis says that the 31-year decline in interest rates ended in 2012. "While I don't see interest rates shooting up, the trend is for them to go higher."

In contrast to these defensive dividend-payers, the Canadian banks and insurers were not accorded the "bond-proxy status by investors and rightly so," says Bubis.

These financial companies have a number of lines of business, including their growing wealth-management divisions. "They benefit from rising interest rates, stronger equity markets and, in the case of those with substantial international operations, a weaker Canadian dollar."

Bubis says he has "selectively and opportunistically" added to his major holdings in Canadian banks and in one insurer.

In the shorter term, the insurers are likely to be bigger beneficiaries of the stronger equity markets and rising interest rates than the banks, he says. Also, the Canadian banks' consumer and mortgage-loan growth is being stunted by the slowdown in the Canadian housing market and the highly leveraged Canadian consumer. "But the banks remain steady-as-she-goes dividend payers and a core component of a Canadian equity portfolio."

At the end of January, Tetrem had $5.4 billion in assets under management, with CI Investments a major client. Heading the list of its CI mandates are CI Canadian Investment and CI Canadian Investment Corporate Class. These funds had assets under management of $2.3 billion and $994 million respectively.

Both funds have foreign content. At the end of January, they had 65% in Canada, 21.9% in the United States and the remaining 13.1% in Europe, Japan and elsewhere.

"We had increased the foreign content in our Canadian portfolios prior to 2013," says Bubis. This weighting rose to 38% during 2013, with the strong outperformance of the foreign-content holdings versus the Canadian holdings. Bubis emphasizes: "All our country sleeves did well, with the Canadian holdings handily beating the benchmark S&P/TSX Composite Index."

At the end of September, the Tetrem team started to move money out of the portfolio's international holdings and into Canadian stocks across the board. "This was a portfolio-allocation decision, which brought the foreign content down to 35%." This strategy will likely continue, he says, "so as to get back to our historic 30% in foreign content." The team has also used tactical changes to its hedging strategy for the portfolio's U.S.-dollar exposure to take advantage of the strength in the U.S. dollar.

Bubis and his team target securities that trade below Tetrem's estimated fair value. "We are, at times, contrarian and certainly opportunistic."

Daniel Bubis

Financials constituted 28.4% of the portfolio at the end of January. Top-10 holdings include Toronto-Dominion Bank TD, the largest overall weighting in the portfolio, Royal Bank of Canada RY and Canadian Imperial Bank of Commerce CM. Another major financial holding is Manulife Financial Corp. MFC.

Of TD, Bubis says the stock is "trading at a valuation premium and the team did not add to it, but it did to Royal on an opportunistic basis during 2013."

The Tetrem team also used weakness in CIBC's stock to add to its holding in this bank. CIBC's stock trades at a discount to its peers, yet the bank has a higher-than-average return on equity, says Bubis.

Earlier last year, the stock came under pressure due to uncertainty surrounding the future of CIBC's Aeroplan loyalty credit cards in the wake of TD's move into this business. "Later in 2013, a satisfactory compromise was reached on this matter, with both CIBC and TD issuing these loyalty credit cards."

Recent renewed concern about the health of the emerging markets put pressure on Scotiabank's stock, says Bubis. The bank has been building its South American operations and is the most exposed of its peers to these markets. "As contrarians, we used the weakness to add to our holding in Scotiabank; the stock was mispriced."

On average, Bubis says the major Canadian banks trade at 10 to 12 times earnings-per-share estimates for the next 12 months, and the stocks have dividend yields of 3.5% to 4.5%.

As for Manulife, Bubis says that the worst of its problems, which surfaced during the global financial crisis, are behind the company and the financial climate is favourable to insurers. "We upped our weighting in this stock."

Canadian Imperial Bank of Commerce Manulife Financial Corp. Royal Bank
of Canada
Toronto-Dominion Bank
Feb. 24 close $90.09 $21.20 $72.49 $49.44
52-week high/low $91.90-$73.89 $22.22-$13.79 $73.35-$58.55 $50.28-$39.80
Market cap $36.0 billion $39.1 billion $104.8 billion $45.5 billion
Total % return 1Y* 11.5 42.5 16.9 21.2
Total % return 3Y* 7.1 7.4 12.0 10.8
Total % return 5Y* 21.1 12.0 24.0 26.2
*As of Feb. 24, 2014
Source: Morningstar

At the end of January, energy constituted 17.8% of the portfolio and was the second largest sector weighting. The two biggest energy holdings are Suncor Energy Inc. SU and Canadian Natural Resources Ltd. CNQ.

The latter, says Bubis, is buying the Canadian conventional assets of U.S.-based Devon Energy Corp. DVN. "These predominantly natural-gas assets are close to CNQ's existing properties and infrastructure."

CNQ's management is a "great steward of capital." In the last few years, the company has been bearish on natural gas, he says. "This acquisition is a positive signal for the outlook for natural gas, which has seen its price rise in the wake of a tough winter and low inventories."

Also in this sector, the portfolio has a number of leading energy-services companies, "which should benefit from the expected pick-up in drilling in Canada, the United States and internationally."

They include Precision Drilling Corp. PD and Trican Well Service Ltd. TCW. Precision is gaining market share, says Bubis, and is enjoying pricing strength. "Trican USA has had challenges, but it is in the midst of a turnaround and the company has appointed a new president, a seasoned veteran in the field, to head this division."

The portfolio has a holding in one of the largest global energy-services companies, Schlumberger Ltd. SLB. "This high-quality company has a substantial research and development budget that far exceeds that of other oilfield services companies," says Bubis. "This keeps Schlumberger ahead of the curve when it comes to new technology."

In keeping with his view that "bond proxies are expensive," Bubis has sold the remainder of his holding in the Canadian pipeline company, Enbridge Inc. ENB, which is also part of the energy sector.

In consumer staples, the team sold a "small position" in Maple Leaf Foods Inc. MFI. Maple Leaf recently announced a deal to sell its 90% stake in Canada Bread Co. Ltd. CBY to Mexico's Grupo Bimbo. "This was the catalyst we were looking for in Maple Leaf Foods," says Bubis. "The story has played out."

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Sonita Horvitch

Sonita Horvitch  

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