In praise of dividend-rich stocks

GCIC's Jason Gibbs challenges notion of price bubble.

Sonita Horvitch 29 May, 2013 | 6:00PM

Jason Gibbs, vice-president and portfolio manager at GCIC Ltd., says that Canadian and U.S. real-estate companies, telecommunications-services providers, pipelines and railways all continue to represent ideal holdings in an equity portfolio seeking to generate both a high level of dividend income and preserve capital.

Gibbs challenges those who contend that some of the more defensive dividend-paying stocks have risen to bubble levels. For a start, he says, most of these stocks have dividend yields comfortably above the risk-free [government] rate of interest both in Canada and the United States.

Then, he says, there is "not an avalanche of new issues, which typifies the last stages of a bubble, as was evidenced in the tech fever of the late '90s." In the final stages of these bubbles, "lesser quality companies jump on the bandwagon." Also, North American demographics are such that "there is a growing investor preference for dividend-paying stocks."

There are, Gibbs acknowledges, instances where dividend-paying stocks are expensive. In general, the multiples on the stocks "have expanded substantially," he says. "This is unlikely to continue indefinitely." Here the key, he says, "is to emphasize companies with growing earnings and increasing cash flow that are raising their dividends."

Granted, a "significant rise in interest rates" would represent a substantial headwind for all dividend-paying stocks, he says. "But I do not see this happening any time soon."

GCIC Ltd., which is the long-time manager of the Dynamic family of funds, is the investment-management division of DundeeWealth Inc., which was bought by Bank of Nova Scotia BNS in early 2011. Gibbs is a senior member of GCIC's equity-income team, which has a wide range of mandates including Scotia Canadian DividendScotia Diversified Monthly Income and Scotia Income Advantage.

 
Jason Gibbs

Toward the end of 2011, Gibbs became the lead manager of Scotia Canadian Dividend. The fund, which was launched in October 1992, currently has 53 names, with no single name constituting more than 5% of the portfolio.

In stock selection, the GCIC equity-income team's well-honed discipline is to focus on "best-in-class" businesses that are strong cash-flow generators and have solid balance sheets. The target must have a dominant market position in an industry where there are significant barriers to entry.

Gibbs reports that he has continued to add to his U.S. holdings in Scotia Canadian Dividend, which now has about 30% in foreign content, the maximum permitted. "The bulk of this represents U.S. stocks, both as a means of diversification and as a play on the U.S. economic recovery."

Scotia Canadian Dividend has about 11% in real-estate stocks. "I have not recently added to this sector," says Gibbs. "But it continues to fit my criteria. There is a limited supply of prime commercial real estate in leading markets around the globe and the properties generate solid cash flow." The valuations on the fund's real-estate holdings are "fair," he says. The stocks trade at a "slight premium" to the net asset value of the underlying real-estate portfolios.

The largest holding in the fund is Brookfield Asset Management Inc. BAM.A. The company has built "a comprehensive and commanding global portfolio" of real estate, renewable energy and infrastructure assets and has also developed its private-equity offerings. The company's real-estate assets include a 50% holding in Brookfield Office Properties Inc. BPO. It also owns ports, utilities and toll roads and other assets that generate "sustainable and growing cash flows," he says.

Telecommunications-services stocks represent about 7% of the fund. Here, Gibbs's three holdings are Telus Corp. T, which is in the fund's top 10 holdings, BCE Inc. BCE and Rogers Communications Inc. RCI.B. Gibbs reports that he recently added to Rogers on weakness. "In Canada, telecom services are an oligopoly and the companies have pricing power; it has been tough for new entrants to break through."

Of Telus, Gibbs says that the company has good visibility when it comes to both earnings and cash-flow growth. The company, he says, has been steadily growing its dividends. This May, Telus announced that it was extending its semi-annual dividend-growth program to 2016 and was "looking for the increase to continue to be in the 10% range per annum."

Turning to energy, Gibbs says that infrastructure companies, such as pipeline and midstream energy companies, provide an "excellent marriage between income and growth." These companies represent some 13% of Scotia Canadian Dividend.

One of Gibbs's long-standing favourites is the Canadian pipeline giant Enbridge Inc. ENB, which "has visible and significant cash-flow growth, for which the market is prepared to pay a premium."

The North American map of energy infrastructure is being redrawn, says Gibbs. New pipeline systems are under construction and existing pipelines are being repurposed "to deliver the range of new energy products -- heavy oil, light oil and shale gas -- to their markets."

Brookfield Asset
Management Inc.
Enbridge Inc. Telus Corp.
May 27 close $37.87 $47.80 $37.28
52-week high/low $39.37-$30.41 $49.17-$37.74 $37.94-$28.26
Market cap $23.3 billion $39.0 billion $24.4 billion
Total % return 1Y* 21.4 20.6 35.3
Total % return 3Y* 17.1 29.6 30.4
Total % return 5Y* 3.4 19.2 14.1
*As of May 27, 2013
Source: Morningstar

Besides Enbridge, which is a top-10 holding, the fund also has stakes in TransCanada Corp. TRP, also in the top 10, Pembina Pipeline Corp. PPL and the midstream energy-services company Gibson Energy Inc. GEI.

Of industrials, Gibbs notes that he has been adding to his holdings south of the border, with his focus on those companies best placed to benefit from the U.S. economic recovery.

He cites the example of his holding in a major U.S. rail company, Union Pacific Corp. UNP. "This western-based railroad company has a diverse source of revenue, as it transports a wide range of products." This makes it less dependent on coal freight than its rivals, he says. "The demand for metallurgical coal has weakened with China's slowdown."

In the consumer-discretionary sector, Gibbs likes Home Depot Inc. HD, as a play on the U.S. housing-market recovery. "The company generates significant free cash flow and is increasing its dividend," he says. "It also has an ongoing share-repurchase program."

Gibbs reports that he has reduced his holding in the Canadian consumer-staples company Alimentation Couche-Tard Inc. ATD.B. The valuation on this convenience-store operator became stretched, he says, with the stock's dividend yield now below the risk-free rate of interest. "You need a lot of growth at Couche-Tard to justify this."

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Sonita Horvitch

Sonita Horvitch