Drivers of dividend growth

In their growth discipline, MacKay and his team apply both quantitative and qualitative analysis to stock selection. Quantitative screening of Canadian companies focuses on key characteristics such as earnings growth, earnings revisions by financial analysts and earnings surprises. Valuation does come into the picture, because the team assesses what the growth is worth.

Then there is a qualitative review of each targeted company to assess the drivers of its earnings growth and the potential for dividend/distribution increases. Hartford Canadian Dividend Growth, with $362 million in assets, is a concentrated portfolio of 25 names.

The stocks are introduced into the portfolio at a 4% weighting and are generally maintained at a 3% to 5% weighting. "We adjust the holding if it moves outside of this band," MacKay says. Turnover in the portfolio is low at 20% to 25% annually.

The objective, says MacKay, is to construct a portfolio with an income yield that is high relative to that of the S&P/TSX Composite Index. The current income yield is 4.25% versus the Composite's 2.7%. In addition to income yield, there is the expectation that the stock will produce a capital gain through a full cycle. When it comes to risk, the portfolio must have a lower volatility than that of the index.

Donald MacKay

Finally, the companies targeted must be "good quality," which means that they have "reasonable" dividend payout ratios and "modest" leverage on their balance sheets. The threshold market capitalization for inclusion in the portfolio is $1 billion.

An economically sensitive stock that the team added to the dividend-growth portfolio is the auto-parts giant Magna International Inc. MG. This company eliminated its dual-class share structure at the end of August. "We bought it after this change," says MacKay.

Magna is an outsourcing story and the company is benefitting from the recovery in the auto production, he says. "It is producing strong earnings-per-share growth, its payout ratio is modest, and there is the potential for a dividend increase." The current dividend yield is 1.5%."

Another play on the economic recovery that the team has invested in is Russel Metals Inc. RUS, which is one of the largest metals distribution and processing companies in North America. "The activity level of its business is increasing and the stock has a dividend yield of more than 5%."

Goldcorp Inc. G is the gold addition to the portfolio. "While the current dividend yield on the stock is low relative to the portfolio, the company is growing production," MacKay says. "It can grow cash flow by 20% to 30% over the next two to three years and the payout ratio is low." There is also the potential for capital gains on the stock, he adds.

In the telecommunications sector, representing about 9% of the portfolio, MacKay and his team hold Rogers Communications Inc. RCI.B. Rogers "has both predictability and growth in its earnings plus a good dividend yield, which is currently 3.5%." The company's wireless division has, says MacKay, produced better-than-expected results and analysts have boosted their 2010 and 2011 estimates for the company.

The rival BCE Inc. BCE is another Greystone holding in this sector. The stock has a higher dividend yield than Rogers at 5.5%, which means it has good dividend support, MacKay says. "In addition, the company is capable of exceeding the Street's low expectation of earnings growth." Finally, the valuation is low in the context of the telecommunications sector, he says.

		BCE Inc.	Rogers Communications B
	Sept.21 close	$33.50	$38.81
	52-week high/low	$25.07-$33.76	$27.40-$39.22
	Market cap	$25.3 billion	$22.3 billion
	Total % return 1Y*	33.7	34.4
	Total % return 3Y*	-2.3	-2.5
	Total % return 5Y*	5.5	12.5
	*As of Sept. 21,2010 Source: Morningstar

Financial-services stocks constitute 39% of the portfolio in 10 holdings. Here, MacKay favours the banks. He is cautious about those life-insurance companies that are significantly exposed to the volatility in the equity market and are suffering from the low- interest-rate environment.

The major banks are core holdings for MacKay. They are quality businesses with earnings that are "predictable and repeatable." Currently, the dividend yield on bank stocks is 3% to 5% and they are also producing solid earnings per share growth, "so that they are a good fit."

The financial-services sector includes real-estate stocks. The portfolio holds two real estate investment trusts "that have sustainable cash flows that can grow through the economic cycle, and distribution yields that compare favourably with the collapsed Treasury bill rate."

Boardwalk Real Estate Investment Trust BEI.UN, which is one of the largest portfolios of apartment buildings in Canada, has a distribution yield of 4.2%. "The vacancy rate in the portfolio is low."

A commercial REIT in the portfolio is RioCan Real Estate Investment Trust REI.UN, which has a distribution yield of 6.5%. "It has high-quality shopping centres across Canada which enjoy high occupancy rates."

MacKay and his team have taken profits in the consumer-staples stock Metro Inc. MRU.A, a leader in food and pharmaceutical retailing in Quebec and Ontario. "The stock has done well; as it has risen, the dividend yield has declined."

The team eliminated its holding in Ritchie Bros. Auctioneers Inc. RBA because "it showed up on our radar screen as having decelerating earnings per share growth."' Revenue from the company's auction business has been more modest than expected, MacKay says.