Canadian equities roundtable: Part 3

A dividend bubble? Not for the banks.

Sonita Horvitch 8 February, 2013 | 7:00PM
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Editor's note: This week's coverage of our exclusive Morningstar manager roundtable on Canadian equities concludes today with picks in financial services and other non-resource sectors. Moderating the discussion was Morningstar columnist Sonita Horvitch. She spoke with three value managers:

 Daniel Bubis, president and chief investment officer and founder of Winnipeg-based Tetrem Capital Management Ltd., which manages money for institutional and high-net-worth clients. Bubis manages a range of mutual funds for CI Investments Inc., including CI Canadian Investment and CI Canadian Investment Corporate Class.

 Mark Thomson, managing director and head of research at Beutel, Goodman & Co. Ltd. Thomson and his team manage a range of mandates including Beutel Goodman Canadian EquityBeutel Goodman Canadian Dividendand Beutel Goodman Balanced.

 Ian Hardacre, vice-president and head of Canadian equities at Invesco Canada Ltd. His mandates include the lead manager role for Trimark Canadian and Trimark Select Balanced.

Q: Time to take a closer look at the Canadian banks. All three of you have Toronto-Dominion Bank TD, as your biggest bank weighting.

Bubis: It's an exceptionally well run bank. It should trade at a premium to the group and it hasn't. If you're worried about the strength of the Canadian housing market, TD also has exposure to the U.S. housing market, which is improving.

Thomson: TD trades at 10.5 times forward earnings-per-share estimates. The bank has outperformed consistently, but it still has among the lowest valuations. Historically, Royal Bank of Canada RY has traded at a premium to the group, even though it more recently lost a lot of money in the United States. By contrast, some people point to the 7% or 8% return on capital of TD's U.S. banking acquisitions. The equity market slots the major Canadian banks in a certain valuation range relative to Royal and Bank of Nova Scotia BNS.

Hardacre: There is concern that [TD Bank] might make another large acquisition in the United States. There have been rumours that TD could buy Royal Bank of Scotland's Citizens Bank.

Thomson: An acquisition of Citizens Bank would run contrary to what TD has done historically. It has always bought when things are out of favour. U.S. banks are not out of favour right now. Over time, if TD's valuation goes to a premium, that would be nice. But the bank's prospects are good, outside of that. TD has the lowest dividend yield and the lowest payout ratio of the group.

Bubis: The low dividend yield could be a factor in the valuation. As we've said, there is an investor preference for dividend yield.

Hardacre: You could argue that the two highest-yielding bank stocks -- Bank of Montreal BMO and Canadian Imperial Bank of Commerce CM -- are getting more than their fair share of investor attention given their relative growth prospects and quality.

Bubis: We own Commerce.

Thomson: So do we. Management understands the value of returning capital to shareholders, probably better than any of the banks.

Bubis: Generally, the bank stocks have had a good run. We're not adding to them.

Thomson: We already have a big weighting at some 27% of the portfolio.

Bubis: In summary, the financial-services stocks are an area where you have good dividend-yield support and good dividend-yield growth. They're not part of that dividend-stock bubble that we've discussed.

Q: Canadian telecommunications-services companies?

Hardacre: We don't own any, because we find better opportunities elsewhere. We were big holders of TELUS Corp. T for a long time, but we find the stock to be fairly valued. Its management has done a great job.

Bubis: We also find better opportunities elsewhere. Valuations on the stocks have gone up and the companies have growth challenges. Wire-line is in secular decline and wireless is hitting a ceiling on growth.

We own Shaw Communications Inc. SJR.B, which is in the consumer-discretionary sector. We bought it on weakness in 2012. Back to that theme of capital discipline and growing the dividend, Shaw's capital expenditure is rolling off and its cash flow is set to grow.

Thomson: We have more than 10% in telecoms. Some of the stocks are getting to be fairly to fully valued. TELUS is fairly valued. It's our largest position.

Bubis: Mark, you have done well with TELUS.

Thomson: In general, the telecom companies' managements have understood that they should not over-invest in the business and should return a lot more money to shareholders. We've been the beneficiaries of that. We don't own BCE Inc. BCE. We want to stay away from wire-line, which is shrinking. BCE has two-thirds of its business in wire-line and a 70% dividend-payout ratio. TELUS has a much greater exposure to wireless than wire-line. The payout ratio is around 60%. We're constructive on the prospects for wireless.

We also own Rogers Communications Inc. RCI.B, which has about 70% wireless and 30% cable. The valuation is still attractive. The payout ratio is 50%. Finally, we have a large position in Quebecor Inc. QBR.B, which is in the consumer-discretionary sector. It has 90% in cable. The Quebec market is one of the best in Canada.

Q: The Canadian consumer discretionary sector also includes some retailers.

Bubis: Did any of you buy into the November IPO (initial public offering) of the Hudson's Bay Co. HBC? I didn't.

Hardacre: I didn't either.

Thomson: Neither did we. We didn't look that closely at it.

Bubis: There were too many question marks. The IPO was not at a great valuation either.

Thomson: We continue to own Canadian Tire Corp. Ltd. CTC.A. We like it a lot. This retailer has dealt successfully with its competition over the years, whereas The Bay has been the walking wounded. Its competitive positioning is not nearly as strong as that of Canadian Tire. Tire has good free-cash-flow generating capabilities and its dividend has grown very rapidly. It's a good business and it's good at capital allocation.

Daniel Bubis, Ian Hardacre and Mark Thomson

Hardacre: We've owned RONA Inc. RON for six years and are the second biggest shareholder in the company. It's been a disappointing investment. In the last number of months, we've been highly involved in changing its board. Going forward, I'm optimistic that the new board will focus on the profitable parts of its business. The company is looking for a new CEO. The new executive chairman has a lot of experience in the business.

Q: Information technology?

Hardacre: MacDonald, Dettweiler and Associates Ltd. MDA is one of our largest positions in the portfolio. We have owned it for more than a decade. Its management team is excellent. MDA has been good at buying and selling assets. It recently acquired Space Systems/Loral Inc., which makes communications satellites. This was accretive to MDA on all measures. This purchase has opened up a lot of opportunities for MDA. It reduces its dependence on the Canadian government for business and gets it into the commercial satellite-manufacturing business. It also provides it with U.S. government clearance.

We own a tiny position in Research In Motion Ltd. BB, (which operates as Blackberry and will change its legal name later this year). The real issue with the BlackBerry maker is what is its long-term prospect? It's a pretty opaque picture, even if it is successful with its recent product launch.

Bubis: We own CGI Group Inc. GIB.A. It's an outsourcing firm running data centres. It's a stable, utility-type business. It has done some acquisitions and it's good at this. It recently acquired UK-based Logica PLC. They got Logica very inexpensively. CGI is growing and winning new business.

Another holding is Open Text Corp. OTC, which is an inexpensive software and services company. It's a pretty strong cash-flow generator. The concern has been about the growth of its core business.

CGI Group Inc. Open Text Corp.
Feb. 5 close $26.87 $57.75
52-week high/low $27.02-$20.00 $62.66-$44.76
Market cap $8.3 billion $3.4 billion
Total % return 1Y* 30.5 -4.3
Total % return 3Y* 22.7 5.7
Total % return 5Y* 21.5 12.6
*As of Feb. 5, 2012
Source: Morningstar

Thomson: We recently bought the stock.

Bubis: It's interesting that the Canadian technology sector is being increasingly dominated by software and services companies rather than by hardware companies. The software and services companies don't have the same obsolescence risk. They are stable, strong free-cash-flow-generating businesses.


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Sonita Horvitch

Sonita Horvitch  

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