Michele Robitaille, managing director and equity-income specialist at Guardian Capital LP, says the pullback in key dividend-paying areas of the Canadian equity market has created opportunities for investors with a longer-term horizon.
"Looking past their near-term headwinds, the major Canadian chartered banks, which have experienced a modest weakness in their stocks year-to-date, look most attractive," she says. "Looking further ahead, the stocks of dividend-paying Canadian energy producers, which have been hard hit, should rebound once the oil price recovers."
By contrast, Real Estate Investment Trusts have fared well for the year to date, she says, "but there are still select opportunities." Also, the telecommunication services stocks have put up a good showing. "Investors have become more comfortable with the regulatory backdrop to this sector."
Of late, the index representing Canadian dividend-paying stocks has been underperforming the overall Canadian index, says Robitaille. In the first six months of this year, the S&P/TSX Composite High Dividend Index had a total return of minus 2.7% versus a total return of plus 0.9% for the S&P/TSX Composite Index. For the 12 months to June-end, the High Dividend Index produced a negative total return of 8.7% versus a negative 1.2% for the Composite.
Canadian REITs "have solidly outperformed" both the High Dividend Index and the Composite, says Robitaille. The S&P/TSX Capped REIT Index, the benchmark for Canadian REITs, had a total return in the first-half of this year of 2.6% and a 3% total return for the 12-months to June-end.
Guardian Capital, which has $24.2 billion in assets under management, is a sub-adviser to the BMO family of funds. The firm's equity-income team, which is responsible for $3.8 billion in assets, manages a number of BMO funds including BMO Growth & Income and BMO Monthly High Income ll.
The Guardian equity-income team targets businesses that have sustainable competitive advantages and can generate high levels of free cash flow to support stable and growing dividends or distributions over time. "Quality of management is a big factor in our decision-making," says Robitaille.
The $2-billion BMO Monthly High Income contains some 40 names and has its own benchmark: 85% of the S&P/TSX High Dividend Index and 15% of the S&P/TSX Capped REIT Index. At the end June, the two biggest sector weights in the fund -- financial and energy -- were close to the portfolio's benchmark weights. The financial sector (which includes REITs) was at 40.2% versus 40.4% in this benchmark. Energy, which includes both producers and infrastructure companies, was 25.7% of versus 25.1% of its benchmark. The largest sector underweight in the fund at June-end was telecommunication services at 5.9% versus 10% in its benchmark.
In the financial services sector, BMO Monthly High Income currently has an underweight in REITs at 16% of the portfolio versus 21% of the benchmark. "REITs have been looking attractive and we have made modest additions to them on a selective basis," says Robitaille. There is, she notes, likely to be an initial sell-off in these securities when the U.S. Federal Reserve Board raises its policy rate. "At that point, we would consider adding to REITs more aggressively."
A new REIT name in the portfolio is Allied Properties Real Estate Investment Trust (AP.UN). This is an office REIT with a portfolio of buildings that are "brick-and-beam" or older buildings that are retrofitted with modern office amenities. "The valuation on this REIT is not cheap," she says, "but its portfolio is high quality."
The Guardian equity-income team has also added "a little" to a number of the portfolio's existing REIT holdings. For example, additions have been made to RioCan Real Estate Investment Trust (REI.UN) and H&R Real Estate Investment Trust (HR.UN).
A top-10 holding in the portfolio, RioCan specializes in retail real estate, with its focus on owning and managing shopping centres. H&R has a diversified portfolio of office, industrial and retail properties.
| Allied Properties REIT | RioCan REIT | H&R REIT | |
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| July 27 close | $35.54 | $25.91 | $21.80 |
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| 52-week high/low | $41.37-$33.63 | $30.25-$25.11 | $25.27-$20.73 |
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| Market cap | $2.76 billion | $8.25 billion | $6.04 billion |
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| Total % return 1Y* | 5.4 | -1.4 | -1.3 |
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| Total % return 3Y* | 9.7 | 3.8 | 0.4 |
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| Total % return 5Y* | 14.9 | 4.0 | 8.8 |
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| *As of July 27, 2015 Source: Morningstar |
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The equity-income team has also added to two other REIT holdings that "came under selling pressure because of their exposure to Western Canada": Canadian Real Estate Investment Trust (REF.UN) and Boardwalk REIT (BEI.UN).
A top-10 holding, CREIT is "one of Canada's oldest and largest REITs," says Robitaille. "It holds a diversified portfolio of retail, office and industrial properties and has a proven management team." Boardwalk is a residential REIT and one of Canada's largest owners and managers of multi-family rental communities.
Turning to the financial services industry, BMO Monthly High Income has a 15% weighting in the major Canadian chartered banks. Three banks -- 
Toronto-Dominion Bank (TD), Royal Bank of Canada (RY) and Bank of Nova Scotia (BNS) -- are in the fund's top-10 holdings. "We are enthusiastic about bank stocks and our strategy is to pick away at them selectively," says Robitaille.
The short interest (the number of shorted shares divided by the number of shares outstanding) is high in bank stocks, says Robitaille. "This is mainly the action of U.S. investors, who are predicting an imminent collapse in the Canadian housing market." Robitaille considers this to be unlikely. Furthermore, she says, the major Canadian chartered banks can "successfully manage their loan losses, including a potential uptick in problems in Alberta."
In summary, she says, the investment case for the major banks remains strong. "The valuations on the stocks are reasonable, the dividend yield on bank stocks is more than 4% and the banks are capable of growing their earnings per share at 4% to 6% per annum."
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| Michele Robitaille | |
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BMO Monthly High Income has an underweight in the stocks of energy producers relative to the fund's benchmark. Robitaille notes that dividend-paying Canadian energy producers have also seen a significant uptick in the level of short interest positions in their stocks. "Some investors are concerned that the companies will be forced to cut or eliminate their dividends in the face of the recent pullback in the oil price."
It will, she says, be undoubtedly challenging for Canada's energy producers if the current US$50-per-barrel oil price persists or goes lower. "Near-term, there will likely be continued volatility and potential weakness in these stocks." But, once the oil price looks as if it is capable of a sustained recovery, "we would consider overweighting Canadian dividend-paying energy producers in the portfolio."
Robitaille says she is more optimistic about the outlook for oil producers and their stocks than the prospects for natural gas producers. "The global demand/supply conditions for oil should improve in the second half of 2015 and into 2016, but the oversupply of North American natural gas will continue to be a problem."
The Guardian equity-income team has sold the fund's long-standing holding in Bonavista Energy Corp. (BNP). "It has a natural gas focus, and Bonavista's debt levels are higher than we like to see."
Robitaille says she has become more optimistic about the outlook for the telecommunication services sector. "The CRTC has dealt with the roaming decision and much of the regulatory uncertainty has been cleared up." Contrary to earlier concerns, she says, Industry Canada has adopted a "balanced approach" to supporting the incumbents, while encouraging a fourth entrant into the business.
BMO Monthly High Income currently has two holdings in this sector: Telus Corp. (T), which is in the fund's top-10, and Manitoba Telecom Services Inc. (MBT). "We would consider adding to our telecom holdings, if valuations become more attractive."
