A Method out of Madness

By Roger Conrad • August 10, 2012 • In Brief

Editor’s Note: This month we’ve made several improvements to the structure of the CE issue. These changes are intended to make In Brief more concise and each article category more relevant. We welcome your feedback regarding these changes or suggestions for any further improvements you’d like to see via our Ask the Editor page. Thank you. — RSC

Meaningless but jarring volatility: That’s been the downside to generally up-trending global stock markets since the March 2009 bottom. And, judging by the action this summer, this won’t change anytime soon.

Some method, however, is starting to emerge from the madness. Take, for example, the succession of higher lows we’re seeing for the Canadian dollar-US dollar exchange rate whenever the global economy has a hiccup.

Since the 2008 crash the US dollar and specifically US Treasury bonds have been the safe haven of last resort for global capital. Each time panic has set in Treasuries and the dollar have rallied hard, while virtually every other investment around the world has sold off.

During the 2008-09 debacle, for example, the Canadian dollar fell from near parity in the summer to a low of less than USD0.78 in March 2009. By contrast, during the panic that set in this past May the loonie found a bottom around USD0.96. Now, a little over two months later, the currency has again hit and passed parity with the greenback.

Moreover, these gains have been realized even as oil has struggled to stay over USD90 a barrel. That’s a clear demonstration the world’s major financial institutions are turning to Canadian assets for something more than just a commodity play.

And with the Canadian banking system and fiscal health among the strongest in the world, we’re likely to see a lot more of that in the years ahead.

A stronger Canadian dollar provides a bonus to US investors, as it lifts the US dollar value of Canadian stocks and their dividends.

The result has been a welcome boost for all Canadian Edge Portfolio Holdings–along with the promise of more to come.

The other welcome pattern we’re seeing is earnings stability, especially for former income trusts still paying high dividends. Several favorites have faced intense analyst skepticism that they can sustain their generous payouts, let alone generate enough cash to grow. And the result has been their stocks have languished.

We’ve now seen results for 30 of 36 Portfolio recommendations, including new addition Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF). To a company, the numbers have supported management guidance, dividends and balance sheets. And this includes companies whose revenue was depressed this year by falling natural resource prices.

Unfortunately, not every How They Rate company can say the same. But the numbers are still more confirmation that the dividend-paying model is alive and well, and that our holdings’ payouts are secure.

So long as that’s the case any damage to share prices from a potential market slide will prove temporary.

Buying and selling momentum triggered by a shifting market mood is still many income investors’ greatest enemy. The first encourages paying too much for stocks considered “safe.” The second induces selling at abysmal prices due to fear of worse damage. Both are emotional responses and the very antithesis of value investing.

Momentum does, however, bring opportunity for those not afraid to bet against it. Three Aggressive Holdings and 10 Conservative Holdings currently trade above my buy-under targets, providing an opportunity to take some money off the table. Meanwhile, nine holdings yield more than 8 percent, making them ripe for buying with the proceeds.

It can be hard to remember in a volatile market. But business growth is ultimately what drives shareholder wealth building. Keep your eye on that and you’ll do just fine, even if the broad market falters. The rest is just background noise.

Roger Conrad
Editor, Canadian Edge

Portfolio Update

I’m adding Best Buy Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF) to the Conservative Holdings as a buy up to USD14.

The franchiser of Canadian residential real estate brokers is backed by Brookfield Asset Management Inc (TSX: BAM/A, NYSE: BAM) and currently yields a bit over 9 percent.

Portfolio Update also highlights the following companies’ earnings. Look for updates on the rest in upcoming Flash Alerts as well as the September issue. Vermilion Energy Inc (TSX: VET, OTC: VEMTF) is the other Best Buy of the month and is highlighted in that section.

Conservative Holdings

AltaGas Ltd (TSX: ALA, OTC: ATGFF)
Artis REIT (TSX: AX-U, OTC: ARESF)
Atlantic Power Corp (TSX: ATP, NYSE: AT)
Bird Construction Inc (TSX: BDT, OTC: BIRDF)
Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)
Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)
Cineplex Inc (TSX: CGX, OTC: CPXGF)
Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)
Dundee REIT (TSX: D, OTC: DRETF)
IBI Group Inc (TSX: IBG, OTC: IBIBF)
Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)
Just Energy Group Inc (TSX: JE, NYSE: JE)
Keyera Corp (TSX: KEY, OTC: KEYUF)
Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)
Shaw Communications Inc (TSX: SJR/B, NYSE: SJR)
TransForce Inc (TSX: TFI, OTC: TFIFF)

Aggressive Holdings

Acadian Timber Corp (TSX: ADN, OTC: ACAZF)
ARC Resources Ltd (TSX: ARX, OTC: AETUF)
Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)
Colabor Group Inc (TSX: GCL, OTC: COLFF)
Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)
Extendicare Inc (TSX: EXE, OTC: EXETF)
Newalta Corp (TSX: NAL, OTC: NWLTF)
Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)
Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)
PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)
Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)
PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)

Best Buys

Best Buys features the two best buys for the current month. If you’re starting a portfolio, buying these two selections each month is one good strategy, provided the picks meet your own risk/reward preferences.

This month’s choices are new Conservative Holding Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF) and longtime Aggressive Holding Vermilion Energy Inc (TSX: VET, OTC: VEMTF).

Brookfield Real Estate draws 68 percent of revenue from fixed fees. Vermilion is a long-term holding with big production gains on tap and unmatched insulation from energy price volatility while we wait.

In Focus

Energy prices are as volatile as global economic fears. But investment in Canada’s energy patch continues to accelerate, with beneficiaries from pipelines and drillers to real estate owners and construction companies.

Here’s how we’re taking advantage.

Dividend Watch List

Two Canadian Edge How They Rate companies cut dividends last month: Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF) and Talisman Energy Inc (TSX: TLM, NYSE: TLM), both largely due to falling prices for the commodities they produce. I rate both stocks holds, as prices have reflected the potential for cuts for some time and both companies are still generally solid.

For more endangered payouts, see Dividend Watch List.

Canadian Currents

We’re introducing three companies to How They Rate coverage this month, 0il and gas drilling fluids solutions provider Poseidon Concepts Corp (TSX: PSN, OTC: POOSF), pipeline coatings specialist ShawCor Ltd (TSX: SCL/A, OTC: SAWLF) and coffee, doughnut and muffin kingpin Tim Hortons Inc (TSX: THI, NYSE: THI). Here’s how those companies fared during the second quarter.

Bay Street Beat–Most CE Portfolio Holdings have reported earnings this season. A handful of Bay Street analysts made substantive changes on their views on three Holdings. We also provide a summary of analyst opinion on those that have turned in numbers. Here’s how Bay Street sees it.

How They Rate Update

Coverage Changes

Cinram International Income Fund (TSX: none, OTC: none) is being dropped from coverage. The stock was delisted from the Toronto Stock Exchange after selling all its assets.

ShawCor Ltd (TSX: SCL/A, OTC: SAWLF) is being added to coverage under Business Trusts. Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) is now tracked under Energy Services. Tim Hortons Inc (TSX: THI, NYSE: THI) is now covered under Food and Hospitality.

Advice Changes

Talisman Energy Inc (TSX: TLM, NYSE: TLM)–To Hold from Buy @ 15. The stock has surged since cutting its dividend in half.

Zargon Oil & Gas Ltd (TSX: ZAR, OTC: ZARFF)–To Hold from SELL. The stock has fallen to reflect dividend cut risk and insiders have been buying.

Ratings Changes

Cameco Corp (TSX: CCP, NYSE: CCJ)–To 3 from 4. The second-quarter payout ratio ballooned out to 11 percent on lower prices and higher production costs.

Talisman Energy Inc (TSX: TLM, NYSE: TLM)–To 3 from 4. The gas-weighted producer no longer meets the criteria for no dividend cuts the past five years.

Safety Ratings

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.

Here’s an in-depth explanation of the proprietary CE Safety Ratings System.

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.
How to Build a Portfolio–Guidance on how best to structure your holdings.
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.