Editor’s Note: What follows is the executive summary of the February 2014 issue of Canadian Edge. Thanks for reading.

From Dec. 31, 2013, through Feb. 7, 2014, the S&P/TSX Composite Index is actually in positive territory in local currency terms, including dividends, with a total return this young trading year of 1.5 percent.

The S&P 500 Index, meanwhile, is off by 2.6 percent, including dividends. The MSCI World Index, through Feb. 6, is down 4 percent. Adjusting the S&P/TSX to US dollar terms makes for a 2.2 percent loss.

The Canadian dollar has rebounded a bit in recent days, rising from a nearly five-year low of USD0.8952 on Jan. 29, 2014, to USD0.9065 on Feb. 7.

With the prevailing mood around global equity indexes colored by the weak start to the 2014 trading year, wonder whether this will prove the long-awaited correction for the post-March 2009 rally and concern about emerging-market “contagion” spreading around the world, the question becomes, Is this a dip you want to buy?

For us the key metric–or metrics–to follow are the recommended buy-under targets for specific stocks.

We remain confident that our diversified mix of dividend-paying stocks in the CE Portfolio is set up well to generate wealth for the long term, despite the steep decline in the value of the loonie versus the buck since mid-2011.

The State of Keystone

As other pipeline projects enter service or get closer to development and alternative means of transporting Canadian crude emerge, the importance of TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone XL project recedes.

That’s not to say completion of the northern leg of the system–the part that will cross the US-Canada border, therefore requiring a review by the US State Dept as a prerequisite to the granting of a Presidential Permit–isn’t a significant part of the North American energy infrastructure equation.

But producers have become less reliant on Keystone XL, as new rail terminals increase their ability to ship oil on trains.

And support is growing for other pipeline proposals, including a separate TransCanada project that would carry crude from Alberta to Canada’s Atlantic Coast. Enbridge Inc’s (TSX: ENB, NYSE: ENB) proposed Northern Gateway conduit would connect the oil sands with Pacific Rim markets.

There are curious and curiouser aspects to this Keystone XL quandary, a saga now stretching into its six year.

For one, oil is already flowing through the southern leg of the project, which connects storage terminals at Cushing, Oklahoma, to refineries on the Gulf Coast near Nederland, Texas.

For another, the delay in getting the northern leg of Keystone XL approved and in service has led to a dramatic uptick in the use of railcars to ship crude. And this, in turn, has led to an uptick in oil train accidents.

It’s become a game of environmental whack-a-mole.

Residents along railroad lines increasingly concerned about the impact of potential spills due to derailments on their neighborhoods, not to mention the threat to their very lives (a fatal oil train explosion in Quebec last summer killed 47 people and flattened a downtown).

But a vocal, star-studded opposition to Keystone XL gets louder, turning up the volume to 11 in the aftermath of the Jan. 31, 2014, release by the US State Dept of its final environmental impact statement.

That report concluded that Keystone XL would be unlikely to alter global greenhouse gas emissions and presents no additional threat to the environment.

It also estimates the pipeline’s construction would result in 3,900 jobs over two years. The additional spending on construction material would push the job gains up to about 42,000 counting jobs building the pipeline, selling materials for the pipeline and those supported by the spending of people in the first two categories.

The real goal of activists opposed to Keystone XL, as it’s been since 2008, is to prevent production of the Canadian oil sands. But Canadian companies have been actively developing projects over the past five-plus years and oil is being produced from Alberta’s bitumen.

And a lot of this output is being shipped by rail. And a lot of it has been spilled recently.

If the northern leg isn’t built, output from the oil sands will move by rail to refineries in the US, and it will move west for shipment to China.

The State Dept concluded that oil sands will continue to be a viable energy source with or without Keystone XL. The impact of the pipeline on climate change due to emissions from using these fossil fuels is therefore negligible.

Better, in fact, that shipment to the US, where there are robust laws and regulations to protect the environment and limit the increase of GHG, be facilitated than to China, where there is no such framework.

I understand and appreciate the passion of those who’ve nurtured Keystone XL into a cause célèbre. But you should be careful what you wish for, as it will result in more crude-by-rail, more shipment of oil sands output to China and more GHG.

As we’ve note, TransCanada has a diversified portfolio of energy infrastructure assets in operation and/or in development that makes Keystone XL an increasingly minor part of its growth equation.

And Canadian producers are finding ways to get oil sands output to market.

The political calculus involves charismatic figures on the “pro-environment” side, and it involves as well one of the US’ most important trading and geopolitical partners on the practical side.

It may take a little more time, but there really is only one decision to be made, particularly in light of the US State Dept’s findings.

David Dittman
Chief Investment Strategist, Canadian Edge

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Portfolio Update

 

Two Canadian Edge Portfolio Conservative Holdings, Brookfield Renewable Energy Partners LP (TSX: BEP-U, NYSE: BEP) and Shaw Communications Inc (TSX: SJR/B, NYSE: SJR), and one Aggressive Holding, ARC Resources Ltd (TSX: ARX, OTC: AETUF), reported financial and operating results since the January 2014 issue of CE was published.

Brookfield Renewable, reporting fourth-quarter and full-year 2013 numbers, and Shaw, reporting fiscal 2014 first-quarter numbers, also boosted their respective payouts, the latter by 6.9 percent, the former by 7.8 percent.

ARC Resources, reporting fourth-quarter and full-year 2013 numbers, posted company-record production and guided to output growth in 2014 that justifies an increase in our recommended buy-under target.

Brookfield Renewable and ARC Resources were absolutely on point with financial, operating and development updates.

Shaw Communications’ dividend increase is certainly a welcome development, a sign of management’s confidence in the core cable TV operation as well as an indication of strong belief in its Internet and WiFi growth initiatives.

But the western Canada-focused company continues to lose subscribers.

Portfolio Update has more on financial and operating results from Brookfield Renewable, Shaw Communications and ARC Resources and updates on several other Holdings.

 

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Best Buys

It’s time to be a little greedy where others are fearful.

A couple solid names–one a new Aggressive Holding, the other the lone representative from Canada’s Big Five banks among our Conservative Holdings–have been heavily discounted here in early 2014.

That’s despite good track records of dividend growth, entrenched positions in key markets and realistic prospects for new opportunities to expand business operations.

Energy services outfit ShawCor Ltd (TSX: SCL, OTC: SAWLF), a new addition to the CE Portfolio this month, is down 4 percent on the Toronto Stock Exchange (TSX) since Dec. 31, 2013. Some of that is a function of a flight from risk that’s characterized equity markets thus far in the still-new year.

But ShawCor has underperformed the S&P/TSX Composite Index, which is 1 percent to the positive in local currency terms for the comparable period, because of an overreaction to an operations update provided by management in early January.

Bank of Nova Scotia (TSX: BNS, NYSE: BNS), meanwhile, a Conservative Holding since August 2013, is lagging its Big Five banking peers in Canada because a large portion of its earnings are derived overseas. And “emerging markets” has been a definite pejorative thus far in the 2014 investing vocabulary.

Scotiabank is down by 5.8 percent, including dividend, thus far in 2014. That compares to an average loss for Bank of Montreal (TSX: BMO, NYSE: BMO), Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM), Royal Bank of Canada (TSX: RY, NYSE: RY) and Toronto-Dominion Bank (TSX: TD, NYSE: TD) of just 2 percent.

As the Canadian dollar weakens Scotiabank’s global presence should provide uplift to earnings. And growth should be supported for the long term by positive demographic trends in its Latin American and Southeast Asian markets.

Best Buys has more on the Portfolio Holdings that represent our top ideas for new money in February.

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In Focus

The Canadian dollar, going the way the Bank of Canada (BoC) would like these days, posted its worst January since at least 1972.

But longer-term factors, such as the fiscal health of the Canadian federal government, the potential for Canada’s trading relationships with emerging Asian nations that are still hungry for resources and its everlasting ties with what remains the world’s largest economy, suggest that softness in the loonie represents a buying opportunity.

And going long dividend-paying Canadian equities is a great way to enjoy the eventual rebound in multiple ways, through the impact of an appreciating currency on regular payouts as well as for the effect on capital-appreciation.

For now, however, there are also ways to profit from weakness.

In Focus examines the downturn for the Canadian dollar, addresses the silver linings and identifies opportunities amid the clouds.

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Dividend Watch List

Our regular review of How They Rate revealed that, for the second straight month, there were no dividend cuts in the Canadian Edge coverage universe.

We are adding one company to the Watch List this month. And we’re removing two others.

It’s highly likely that Capstone Infrastructure Corp’s (TSX: CSE, OTC: MCQPF) negotiations with the Ontario Power Authority (OPA) will ultimately result in a new power purchase agreement (PPA) for its Cardinal natural gas cogeneration facility. But it’s likely that Cardinal’s output will be deemed “dispatchable,” and such plants usually operate at capacity factors between 30 percent and 70 percent. In 2012 and 2013 Cardinal ran at a capacity factor equal to over 90 percent. New capacity payments would go some way to making up for the lost revenue when Cardinal no longer operates as a baseload facility. But at this stage it seems highly likely that management will have to cut the dividend.

We added Exchange Income Corp (TSX: EIF, OTC: EIFZF) to the Dividend Watch List out of an abundance of caution in November 2013 after management warned on third-quarter earnings.

We’re now removing it from the Watch List after management met guidance and reported impressive revenue growth. And Exchange Income has maintained its CAD0.14 monthly dividend rate for payments due Dec. 15, 2013, Jan. 15, 2014, and Feb. 14, 2014.

We’re also removing New Flyer Industries Inc (TSX: NFI, OTC: NFYED) from the Watch List following management’s report of stronger-than-anticipated deliveries in the fourth quarter of 2013 compared to the previous year.

Dividend Watch List has the details on members of the How They Rate coverage universe whose current dividend rates are in jeopardy.

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Canadian Currents

 

Canada’s economic growth still hinges upon a strong rebound in the US, notes CE Associate Editor Ari Charney in this month’s Canadian Currents.

Bay Street Beat–Reporting season for fourth-quarter and full-year operating and financial results is just under way for Canadian companies.

Here’s how Bay Street has reacted to early reporters and how it sees the CE Portfolio early in 2014.

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How They Rate Update

 

Coverage Changes

Please note that we’ve moved new Aggressive Portfolio Holding ShawCor Ltd (TSX: SCL, OTC: SAWLF) to the Energy Services segment of How They Rate from Business Trusts to better reflect the nature of its operations.

After this issue we’ll remove from How They Rate coverage Royal Host Inc (TSX: RYL, OTC: ROYHF), which hasn’t paid a dividend since December 2010 and is currently valued at just CAD20 million, barring any objection from subscribers.

We continue to evaluate members of the coverage universe based on a combination of low market capitalization, low daily trading volume on the Toronto Stock Exchange and in the US and, most importantly, for those that aren’t paying a dividend at present, whether there’s a reasonable likelihood of ever doing so in the near future.

This is part of an effort to streamline our focus on companies with a realistic opportunity to build wealth for investors for the long term, keeping in mind too that part of the rationale for building a coverage universe is to provide context and comparison.

We’re still considering our coverage of Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF), which pays no dividend and has a market capitalization of CAD44.5 million, and Imvescor Restaurant Group Inc (TSX: IRG, OTC: IRGIF), which discontinued its dividend in March 2011 and has a market capitalization of CAD80.1 million.

Due to the fact that a CE reader expressed an interest in continuing to hear from us regarding Data Group Inc (TSX: DGI, OTC: DGPIF), we will continue to cover the company in How They Rate.

Advice Changes

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–From Buy < 28 to Hold. The yield is certainly attractive at greater than 7 percent, and the company continues to generate a lot of cash. But revenue growth has been non-existent for more than five years. In fact the company just posted its best year-over-year revenue performance since 2008, as 2013 revenue declined by just 0.1 percent compared to 2012.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–From Hold to Buy < 11. Management reported solid fourth-quarter results, with net income up to CAD14.2 million, or CAD0.20 per share, from CAD5.4 million, or CAD0.08 per share a year ago, while full-year earnings rose to CAD41.8 million, or CAD0.59 per share, from CAD13.4 million, or CAD0.14 per share, in 2012.

Norbord Inc (TSX: NBD, OTC: NBDFF)–From Hold to Buy < 30. Earnings before interest, taxation, depreciation and amortization (EBITDA) for 2013 were up 52.6 percent to CAD287 million. Lower oriented strandboard prices in the fourth quarter resulted in a year-over-year quarterly EBITDA decline, but the positive impact of recovering housing markets in North America and Europe is real.

Secure Energy Services Inc (TSX: SES, OTC: SECYF)–From Hold to Buy < 15. Prospects for the company are bright, as increasingly complex environmental regulations require specialization. At present 49 percent of oil and gas fluid and waste handling needs are management by producers themselves. This is likely to come down considerably as the trend toward outsourcing to experts in the field gains steam.

Tim Hortons Inc (TSX: THI, NYSE: THI)–From Hold to Buy < 54. The iconic Canada-based coffee-and-donuts retailer has sold off by nearly 9 percent in Canadian dollar terms and 13 percent in US dollar terms thus far in 2014, and it looks like a solid value at these levels.

WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF)–From Buy < 22 to Hold. The International Air Transport Association (IATA) has forecast strong airline profits in 2014. But the loonie’s steep decline could have a negative impact on earnings, as fuel, which is priced in US dollars, accounts for the largest share of airlines’ expenses. Costs will rise and likely be passed on to passengers. And that could crimp demand.

Rating Changes

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–From 4 to 3. The full-year payout ratio for 2013 came in at 93 percent, outside the safe range for Telecommunications companies. And management’s guidance for 2014 suggests it won’t come down much from there in the foreseeable future. The company earns two points for its debt situation, with manageable maturities before Jan. 1, 2016, and low overall debt relative to total assets, and it gets another for operating in a relatively stable industry.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–From 2 to 3. The company posted a full-year payout ratio of 33.8 percent for 2013, a very safe level for a Natural Resources company. There are no maturities coming due before Jan. 1, 2016, and overall debt as a percentage of total assets is just 14.4 percent.

Norbord Inc (TSX: NBD, OTC: NBDFF)–From 1 to 2. The building supply manufacturer posted a full-year payout ratio–based on 2013 earnings per share of CAD3.06 and an annualized dividend rate of CAD2.40–of 78.4 percent. There are no debt maturities coming due before Jan. 1, 2016, and overall debt is a modest 34.3 percent of total assets.

Secure Energy Services Inc (TSX: SES, OTC: SECYF)–From 3 to 4. The payout ratio for the trailing 12 months is well within the “very safe” range for Energy Services companies and is likely to remain within that range for next 18 to 24 months. There are no maturities before Jan. 1, 2016, and overall debt relative to total assets is also in the “very safe” range for its industry.

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

• Payout Ratio–A ratio below our proprietary industry baseline.
• Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
• Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
• Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
• Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
• Dividend History–No dividend cuts over the preceding five years.

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Resources

 

The following Resources may be found in the top navigation menu at www.CanadianEdge.com:

• Ask the Editor–We will reply to your queries via email or in an upcoming article.
• Broker Guide–Comparison of brokers for purchasing Canadian investments.
• Getting Started–Tour of the Canadian Edge website and service.
• Cross-Border Tax Guide–What you need to know about taxes and Canadian investments.
• Other Websites–Links to other websites to help you get the most out of your Canadian stocks.
• Promo Stocks–Guide to the mystery stocks we tease in our promotional messages.
• CE Safety Rating System–In-depth explanation of the proprietary ratings system and how to use it effectively.
• Special Reports–The most recent reports for new subscribers. The most current advice is always in your regular issue.
• Tips on DRIPs–Details for any dividend reinvestment plan offered by Canadian Edge Portfolio Holdings.