Happenings in the (Not So) Great White North

By David Dittman • May 25, 2012 • Canadian Edge Weekly

If you haven’t already established positions in high-yielding, high-quality Canadian dividend-payers, now is the time to act.

Because just about everybody can agree that the first step to building wealth over the long term is “buy low.”

The S&P/Toronto Stock Exchange Composite Index (SPTSX) has lagged major equity benchmarks badly year to date, generating a negative total return in US dollar terms of 3.2 percent versus gains of 5.7 percent for the S&P 500 Index and 1.8 percent for the MSCI World Index. Its performance in many ways mirrors that of the S&P/Australian Securities Exchange 200 Index, which was off by 2.6 percent through May 23.

Backing out the impact of currency fluctuations, however, we see that the main Canadian benchmark is 2.3 percent to the negative, while Australia’s most-watched index is 2.9 percent to the positive in local terms. The Canadian dollar opened the year at USD0.9789, spiked to as high as USD1.0199 on Apr. 27 and is now trading near its 2012 low, USD09.733, as of May 24.

The Australian dollar, meanwhile, opened 2012 at USD1.0209 and rallied to USD1.0809 by Feb. 7, as the relative strengths of the underlying economy as well as the “interest rate” differential–the Reserve Bank of Australia’s official target rate remains well above that of any other developed nation’s central bank’s, even after a 50 basis point cut in early May–caught global investors’ fancy. Fears of a European contagion and its impact on China have sent the aussie spiraling to USD0.9734 as of May 24, around its low for the year as well.

Both the loonie and the aussie are widely regarded as “commodity currencies,” rising and falling with the resources that undergird both economies. The generic front-month West Texas Intermediate crude oil contract traded on the New York Mercantile Exchange dipped below USD90 this week, closing on May 24 at USD90.69, down from a 2012 high of USD109.77 established Feb. 24. Oil is ticking higher this morning, May 25, reaching USD91.01 shortly before noon.

The Thomson Reuters/Jefferies CRB Commodity Index, which is based on price movements for 19 commodities, is also plumbing its lows for the year after falling from an intra-2012 high of 325.91 to a close of 281.92 on Feb. 23. As of this morning the index is at 281.88.

Both the Canadian and the Australian currency have drawn considerable international attention of late because of the broader fundamentals that set them apart from other currencies such as the US dollar. Primarily, neither the Canadian nor the Australian federal government is saddled with a debilitating future debt burden. Employment rates in both countries are relatively low and stable, job creation continues and their respective citizens enjoy generally rising incomes. Though housing markets in the Great White North and Down Under have drawn scrutiny because of elevated prices, there are few if any signs of a coming disaster along the lines of what felled the US market.

Although the primary basis of Canada’s and Australia’s relative strength is each country’s resource wealth and the responsible way government has shepherded same for the broader good, there are now many more factors that make them attractive to international investors as “safe havens.” Down the road the loonie and the aussie will be prominent when what seems an inevitable transition from the present condition where the US dollar is the sole global reserve currency.

Recent fear-driven action in global equities markets has certainly created opportunities to buy and hold solid businesses whose stocks have sold off for no fundamental reason.

Take Winnipeg, Manitoba, Canada-based Ag Growth International Inc (TSX: AFN, OTC: AGGZF). The stock has bounced around in 2012, hitting a low of CAD33.76 on Mar. 8 after posting solid but unspectacular 2011 results.

But it soared to CAD41.95 on the Toronto Stock Exchange (TSX) by Mar. 27 after its name was mentioned in rumors about potentially acquisitive designs by global agribusiness giants in search of bargains in advance of what’s expected to be a long-term bull market for farm-and-food related companies.

Rule No. 1 when playing the mergers-and-acquisitions game from an individual investor’s point of view is to never buy a company–target or hunter–you wouldn’t want to own if no deal were ever made. Rule No. 2 is “Refer to Rule No. 1.”

Ag Growth is a company you want to own, and it closed at CAD37.01 on Thursday, May 24, 11.8 percent below its 2012 high and 31.2 percent below its Feb. 18, 2011, all-time high of CAD53.77.

At these levels this stock is yielding 6.5 percent. And that’s a reliable 6.5 percent.

Ag Growth has never cut its dividend– not during the Great Financial Crisis that got rolling in earnest in September 2008, not when it converted from an income trust to a corporation in June 2009. It still pays on a monthly basis–CAD0.20 per share, CAD2.40 per share on an annualized basis–though it declares three months’ worth of payouts when it reports quarterly results.

For example, when management posted first-quarter results on May 11, 2012, it also declared that it will pay a CAD0.20 per share dividends on Jul. 30, Aug. 30 and Sept. 28. So there’s visibility, too.

The only question now is when we’ll see growth in the dividend rate. The last increase came Nov. 10, 2010, when management raised the monthly rate from CAD0.17 to CAD0.20. This bump followed an Aug. 13, 2008, adjustment from CAD0.14.

First-quarter revenue for the manufacturer/marketer of portable grain handling equipment was up 9.5 percent, while adjusted cash flow grew by 3 percent. Net profit per share increased 10.5 percent, as Ag Growth posted numbers “roughly in line” with management expectations.

Not only has the company done well through the first half of the year. But its underlying business stands to benefit from what’s forecast to be the highest corn planting in the US since 1937. And world corn production will jump 5.4 percent in the 2012-13 crop year, more than predicted a month ago, based largely on this “huge” US harvest, according to the International Grains Council (IGC).

The IGC, in a May 24 report, predicted that 913 million metric tons of corn will be harvested around the world in the year to Jun. 30, 2013, up from 866.1 million tons for the year ending Jun. 30, 2012. This represents an increase of 12.7 million tons from the IGC’s Apr. 26 outlook.

Corn stocks are expected to climb to a three-year high, IGC data show, and it all has to be stored somewhere.

According to the IGC world corn stocks at the end of June 2013 may increase by 12 million tons year over year to 141 million tons. US production is forecast to climb 13 percent to 355 million tons, based on a “significant rise” in harvested area and yields matching the 10-year trend.

Based on solid first-quarter results reported May 12 Ag Growth seems to have solved supply and production problems that marred 2011 results. US first-quarter revenue was up 15 percent from last year’s record levels and accounted for 61.7 percent of overall sales. Demand in Western Canada is also shaping up much more favorably than last year, when planting was severely affected by flooding. Canadian revenue rose 22 percent in the quarter and accounted for 26.9 percent of overall sales.

The company has added capacity, at the same time addressing cost issues at its key Twister facility in North America. The company’s sales and supply network now extends from Russian and Eastern Europe to Latin America, Southeast Asia, the Middle East and Africa. And global sales backlog is “significantly” higher now than a year ago, with Finland-based Mepu also getting its costs under control.

Based on the company’s pattern of raising its dividend every two years as well as its solid first quarter–during what is typically a seasonally weak period–the probability we’ll see another boost in 2012 is high.

Ag Growth is one solid way to lock in an attractive, sustainable and growing yield amid a mixed-up market. US investors will also enjoy what will likely be a significant contribution from the loonie’s appreciation from here against the greenback once sanity returns and the market realizes that long-term fundamentals haven’t changed much during this latest spring of discontent.

There is blood in the water, as the saying goes, which means it’s time to buy.

The Roundup

Canada’s Big Six banks are rightly held up as an example for the rest of world about how traditional financial intermediaries should operate. Historically risk-averse and focused on collecting deposits from domestic customers, these pillars have been recognized multiple times by different agencies who undertake such things for their responsibility and safety relative to their global peers.

It’s second-quarter reporting season for the Big Six, whose fiscal year begins Nov. 1 and ends Oct. 31. First up this week were Royal Bank of Canada (TSX: RY, NYSE: RY), Toronto-Dominion Bank (TSX: TD, NYSE: TD) and Bank of Montreal (TSX: BMO, NYSE: BMO), which all posted bottom-line growth for the three months ended Apr. 30, 2012, but also sounded notes of caution with numbers as well as management commentary.

RBC, Canada’s biggest bank based on total assets, reported that adjusted profit from continuing operations grew by 5 percent to CAD1.77 billion (CAD1.15 per share). The major adjustment this quarter was an exclusion of the loss related to RBC’s purchase of custodian RBC Dexia Investor Services Ltd.

Net income from continuing operations was CAD1.56 billion (CAD1.01 per share), compared with CAD1.68 billion (CAD1.10 per share) during the prior corresponding period. Revenue for the quarter was CAD6.9 billion, up from CAD6.8 billion in the three months to Apr. 30, 2011.

The 7 percent decline in net income was due to a loss from its acquisition of the remaining half of RBC Dexia, an international pension fund advisory firm that RBC had set up with a European banking partner. RBC CEO Gord Nixon said during a conference call to discuss these results that the loss it recorded on its own RBC Dexia holdings reflects the lower price paid for Dexia’s share.

“I remind people,” said Mr. Nixon, “that the lower the price that we paid for the other half of Dexia, the larger the accounting loss. Or the reverse: If we had paid a premium, we would have reported a gain.”

Provisions for credit losses were CAD348 million, up from CAD273 million in the second quarter of fiscal 2011 due to increased set-asides for bad loans in its Caribbean operations, where the tourism-based economy is still lagging. Overall credit quality remains sound, and impaired loans were down CAD40 million compared with the previous quarter, according to RBC’s Chief Risk Officer Morten Friis added.

Mr. Nixon noted that, aside from the Dexia situation, RBC posted “solid” numbers in Canadian banking, capital markets, insurance and wealth management.

Income from Canadian banking rose 5 percent to CAD937 million due to stronger loan and deposit volumes, while capital markets income climbed 11 percent to CAD449 million, spurred by higher trading and investment banking revenue. RBC’s insurance business contributed CAD151 million of profit, up CAD28 million from a year ago, while RBC Capital Markets provided CAD449 million of net income, up CAD42 million from the second quarter of 2011.

RBC’s international banking division took a CAD196 million loss due to the acquisition of the 50 percent of its joint venture with Franco-Belgian lender Dexia that it did not already own.

The CEO also said that RBC is making plans for the possibility that the euro will break up. His primary concern, however, is not for the direct impact on RBC’s operations but for the “fallout on markets like the US and global economic growth,” which he described as “much less predictable at this point in time.”

RBC’s exposure to Europe in its capital markets and wealth management units stands at nearly CAD39.5 billion, down by CAD1.7 billion or 4 percent from the prior quarter, according to Mr. Friis.

Toronto-Dominion’s second-quarter profit rose 20.7 percent, driven by strong Canadian consumer banking, wealth management and insurance results. TD, Canada’s second-largest bank, earned CAD1.69 billion (CAD1.78 per share), up from CAD1.40 billion (CAD1.50 per share) during the three months ended Apr. 30, 2011. Excluding items the bank earned CAD1.82 per share.

Income from TD’s Canadian banking unit rose 10.2 percent to CAD808 million, while its US retail banking unit earned CAD356 million, up 20 percent. The wealth and insurance business, which includes the bank’s 45 percent stake in TD Ameritrade, climbed 15.5 percent to CAD365 million. Wholesale banking income, which includes trading and investment banking, rose 4.8 percent to CAD197 million.

TD’s loan-loss provisions rose 11 percent to CAD388 million, mainly from its MBNA credit card purchase. TD warned that slowing loan growth, low interest rates that erode margins and regulatory headwinds leading to re-pricing and tighter risk controls are the bank’s three major headwinds.

Bank of Montreal, No. 4 among the Big Six, reported a profit of CAD1.03 billion (CAD1.51 per share), up 27 percent from the prior corresponding period’s CAD813 million (CAD1.32). Adjusted net income was CAD982 million (CAD1.44 per share), up 28 percent compared the three months ended Apr. 30, 2011. Revenue increased by 19 percent to CAD3.96 billion.

Lower income taxes and larger-than-expected recoveries on Marshall & Ilsley loans that BMO had marked as impaired boosted earnings accounted for much of the impressive gain, and these items aren’t likely to recur.

Year-over-year growth was driven by BMO’s Canadian and US personal and commercial banking segments. In Canada revenue climbed 8 percent to CAD446 million on increased volumes across most products and higher fee revenue, partially offset by lower net interest margins.

Loan-loss provisions fell to CAD195 million from CAD297 million. Milwaukee, Wisconsin-based Marshall & Ilsley contributed CAD171 million to net income, more than double BMO’s year-earlier US profit.

Canadian retail banking income was up 8 percent to CAD449 million on lower provisions and higher mortgage volumes, which offset declining net interest margins. Profit at the BMO Private Client Group wealth management unit climbed 62 percent due to acquisitions and higher spread and fee-based revenue. Capital markets profit fell 1 percent to CAD226 million from a year earlier but was up 14 percent sequentially, as investment banking activity offset lower trading revenues.

We’ll Roundup Bank of Nova Scotia (TSX: BNS, NYSE: BNS), which reports May 29, as well as Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) and National Bank of Canada (TSX: NA, OTC: NTIOF), which both report May 31, in next week’s Maple Leaf Memo.

Here’s where to find analysis recent earnings numbers posted by Canadian Edge Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

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