The big picture looks brighter for 2013

Rate outlook is good news for equity income, says Guardian Capital's Michele Robitaille.

Sonita Horvitch 28 November, 2012 | 7:00PM
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Michele Robitaille, managing director and equity-income specialist at Guardian Capital LP, says that there is reason for caution about the equity market until year-end, but the outlook for 2013 is more favourable.

"The market is currently being driven by daily headlines and macroeconomic news, resulting in substantial volatility," says Robitaille. "This could persist through year-end."

Investor focus, she says, has shifted from Europe's economic and financial challenges to the U.S. fiscal cliff. This, she says, refers to a number of budget laws that come into effect on Jan. 1, 2013, which if unchanged could result in tax increases and government spending cuts. "This would have a significant negative impact on U.S. economic growth."

Budget decisions in the U.S. were deferred until after the November election, causing considerable uncertainty in the business community. "We expect the politicians to reach some form of compromise," says Robitaille. The good news, she notes, is that "U.S economic data is more positive with signs of stabilization in the housing and employment markets."

Europe, she says, "has made solid advances toward a fiscal union, and the risk of a disorderly exit from the eurozone or a major credit upset has diminished." The challenge to global growth is that Europe, which accounts for some 15% of global GDP, is in recession, says Robitaille.

An offset, she says, is that the U.S. economy is expected to improve further in 2013. Also China, which has experienced a slowdown after years of exceptionally high GDP growth, "should successfully engineer a soft landing, and its economic growth should start to re-accelerate."

 
Michele Robitaille

On the outlook for interest rates, "the expectation is that they will remain low for some time, likely into 2015." While this is good news for dividend-paying stocks, says Robitaille, "research shows that these stocks can still outperform in a rising interest rate environment, despite the perception to the contrary."

Guardian Capital, with assets under management of $16.6 billion at the end of September, is a sub-adviser to the BMO Guardian family of funds. The equity-income team is responsible for managing assets of $3 billion. Its mandates include BMO Guardian Growth & Income (which had assets at the end of September of $470 million) and BMO Guardian Monthly Income II ($1 billion).

The Guardian equity-income team seeks to invest in businesses that have dominant market positions and can generate high levels of free cash flow to support stable and growing dividends over time. A targeted company or trust must have a strong balance sheet and a low dividend/distribution payout ratio. It must also trade at a reasonable valuation.

At the end of October, BMO Guardian Monthly Income had 38% in the financial-services sector. This includes real estate investment trusts at 17% of the portfolio. The second biggest sector weight was energy at 30%, represented by 18% in energy producers and 12% in energy infrastructure companies.

When it comes to investing in the Canadian banks, the emphasis, says Robitaille, is on those that are "well placed to counter the slowdown in domestic retail loan growth."

For example, the team has been buying Bank of Nova Scotia BNS. "Its significant international operations should help compensate for the domestic slowdown." Scotiabank is in the fund's top 10 holdings.

Toronto-Dominion Bank TD has been the largest holding in the fund for some time. Another top 10 holding is Royal Bank of Canada RY. TD is a "low-cost operator with a leading customer-service model and a growing U.S. footprint," says Robitaille. "Royal has a commanding position in the domestic banking market and a strong and growing international capital-markets operation."

The Guardian equity-income team, says Robitaille, has turned more positive on Canadian life insurers and built a position in Manulife Financial Corp. MFC through the summer. "Our view is that the risk/reward profile on the stock has substantially improved."

Manulife, says Robitaille, has reduced its exposure to the capital markets and interest rates. It has also repositioned its product line, "eliminating those products that were not profitable, she says." As a result, it should begin to grow core earnings." Finally, Manulife has a good platform in Asia, "which it can grow even without making acquisitions."

Manulife stock trades at just under book value per share, she notes. The company halved its dividend in August of 2009. The result, she says, is that it can comfortably sustain its dividend.

The newest addition to the fund, says Robitaille, is Intact Financial Corp. IFC. This property and casualty company is the largest player in Canada with "significant advantages of scale." This allows it to focus on profitable business segments and to manage claims costs, she says.

Intact is "a strong earnings grower and has consistently raised its dividend every year since its initial public offering at the end of 2004." Though the stock has had a good run in recent weeks, "the long-term prospects are positive."

In energy infrastructure, the Guardian equity income team added to AltaGas Ltd. ALA earlier this year, says Robitaille. "We participated in the company's bought deal in February at $29 a share," she says. AltaGas used this share issue to help finance its acquisition of SEMCO Holding Corp., "a privately held regulated public utility based in Michigan."

SEMCO has substantial infrastructure assets in Michigan and Alaska, says Robitaille. "SEMCO's Alaskan operations have particularly good growth prospects for a utility company." AltaGas is in the fund's top 10 holdings.

The equity-income team has also added to its holding in the oil-sands producer Cenovus Energy Inc. CVE. "We used pullbacks in the stock, which we consider to offer good value, to add to our position throughout the year."

AltaGas Ltd. Cenovus Energy Inc.
Nov. 27 close $34.08 $32.55
52-week high/low $34.29-$27.46 $39.64-$30.09
Market cap $3.6 billion $24.6 billion
Total % return 1Y* 18.0% 10.8%
Total % return 3Y*  28.0% n/a
Total % return 5Y*  11.2% n/a
*As of Nov. 27, 2012
Source: Morningstar

Cenovus is one of the "best operators in the oil sands with high-quality assets, considerable technical expertise and strong growth prospects," says Robitaille. Cenovus's dividend is lower than most of the fund's other oil and gas producers, she says. "But its dividend-growth prospects are superior given its strong cash-flow generation."

Earlier this fall, the Guardian team sold its holding in the medical diagnostic company, CML Healthcare Inc. CLC on concerns that its dividend might not be sustainable. The company, says Robitaille, has stated recently that it will be reviewing its dividend policy.

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Sonita Horvitch

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