Michele Robitaille, managing director and equity-income specialist at Guardian Capital LP, says that there is still a need for a conservative, cautious approach to equities, given the global macroeconomic uncertainties and the elusiveness of corporate earnings momentum.
"Our approach today is to be neutral between our weightings in defensive and economically sensitive stocks in the dividend-oriented portfolios that we manage," says Robitaille.
Of the global macro picture, Robitaille says that Europe "will remain an ongoing source of concern and there will be flare-ups from time to time." By contrast, she says, the United States is "showing signs of modest strength and China has the tools to engineer a soft landing." In all, she says, the global economic recovery "remains muted and longer-term growth will be dampened by fiscal austerity and deleveraging in most regions of the world."
Corporate earnings are, she says, "unlikely to be a positive catalyst for the market in the near term." Management's guidance is "cautious" and projected earnings growth is "modest."
Despite the current global macroeconomic uncertainties, there has been some good news, of late, for Canadian energy producers, says Robitaille.
The price of natural gas is up some 20% in the year to date, she notes. The prolonged cold winter in Canada and the eastern United States, and the increase in industrial demand have been a plus for the commodity, she says. Also, natural-gas producers have been disciplined on the supply side. "In response to the commodity-price hike, there has been a huge run-up in natural-gas stocks and we have taken some money off the table here."
There has also been a positive development in the price for Canadian heavy oil, says Robitaille. The heavy-oil differential versus the West Texas Intermediate crude-oil price has narrowed "significantly." These stocks have not yet reacted, she says. The uncertainty surrounding the approval of the Keystone XL pipeline project is putting a damper on the stocks. "Washington's crucial decision on this has been pushed back yet again." Robitaille says the equity-income team has been adding to select long-standing holdings of Canadian oil producers.
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Guardian Capital, with assets under management of $17.3 billion at the end of last year, is a sub-adviser to the BMO family of funds. The equity-income team is responsible for managing assets of $5.1 billion. Its mandates include BMO Growth & Income, which had assets at the end of March of $479 million, and the $1.2-billion BMO Monthly High Income II. (Before being renamed effective April 1, the funds were offered under the BMO Guardian brand name, which has been discontinued.)
The Guardian equity-income team targets businesses with a sustainable competitive advantage that can generate high levels of free cash flow to support stable and growing dividends or distributions over time. The valuation on the stock or trust must be reasonable. To qualify for the portfolio, the company or trust must have a strong balance sheet and a payout ratio "that is appropriate for the type of the business," says Robitaille. Also key, she says, is the quality of management.
At the end of March, BMO Monthly High Income, with 42 names, had 39.7% of the portfolio in financials, with banks at 14.1% of the fund, real estate investment trusts at 17.8% and other financials at 7.8%. The second largest sector weighting in the fund was energy at 30.2%, represented by 17.8% in energy producers and 12.4% in energy infrastructure companies.
There has been a "modest increase" in the energy weighting, says Robitaille. The Guardian equity-income team has been adding to its core holdings in Canadian oil producers: Cenovus Energy Inc. CVE, Baytex Energy Corp. BTE and Crescent Point Energy Corp. CPG. But it lightened up on its holding in natural-gas producer Peyto Exploration & Development Corp. PEY, as the stock had a strong run.
Energy infrastructure companies remain a cornerstone of the portfolio, says Robitaille. "There are high barriers to entry in this business and there are good low-risk growth prospects."
The equity-income team recently trimmed its holding in Keyera Corp. KEY, a midstream, company that provides a range of services to energy producers in Western Canada. "The company produced good results and the stock ran up sharply," says Robitaille. "The stock is a long-standing holding and remains a core position."
The team deployed the proceeds of this trimming into another infrastructure holding, Pembina Pipeline Corp. PPL, a pipeline and natural-gas-processing company. "The stock's valuation was more attractive given Pembina's growth prospects," says Robitaille.
In March, Pembina came to market with a bought deal worth approximately $300 million and "we participated in it." The proceeds, she says, will help the company to finance its proposed $1 billion in capital expenditures.
Both Keyera and Pembina offer midstream services, says Robitaille, including gas fractionation, "which removes valuable liquids such as propane and butane, from the gas." These companies also store, transport and market these liquids. "Industry dynamics favour midstream companies, as there is a shortage of their services and the facilities are hard to replicate," Robitaille says.
BMO Monthly High Income also has a holding in TransCanada Corp. TRP. The company is the sponsor of the Keystone XL Pipeline project. "The company has done a good job in diversifying its project mix, in case this project is not approved," says Robitaille. For example, TransCanada is looking to convert natural-gas pipeline capacity in its existing Canadian Mainline to crude-oil service so as to transport crude from Western Canada to eastern Canadian markets.
| Keyera Corp. | Pembina Pipeline Corp. | TransCanada Corp. | ||
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| April 15 close | $58.47 | $31.39 | $47.94 | |
| 52-week high/low | $59.24-$37.50 | $32.13-$24.86 | $50.08-$41.47 | |
| Market cap | $4.6 billion | $9.6 billion | $33.8 billion | |
| Total % return 1Y* | 55.3 | 12.0 | 17.0 | |
| Total % return 3Y* | 35.1 | 26.9 | 12.1 | |
| Total % return 5Y* | 27.1 | 18.6 | 8.4 | |
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| *As of April 15, 2013 Source: Morningstar |
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In the financial sector, Robitaille reports that the Guardian equity-income team has been selectively adding to its REIT holdings. This is after two years of steadily reducing its weighting in this area for reasons of valuation. "In the first quarter of 2013, a number of REITs offered a decent buy opportunity," says Robitaille. The team has added to Boardwalk REIT BEI.UN/TSX and Cominar REIT CUF.UN/TSX.
Canadian Real Estate Investment Trust REF.UN/TSX continues to be the portfolio's largest REIT holding. "It has a high-quality, diversified real-estate portfolio and a conservative management team."
Overall, says Robitaille, Canadian REITs are "fundamentally healthy." They are growing operating earnings in the 4% to 6% range and their distribution yield is 4% to 6%, she notes. "They are capable of producing total returns to investors of 10% a year," she says.
Investors, she says, can look to similar or slightly better returns from the major Canadian chartered banks. "This is despite the headwinds on the domestic retail-banking front." BMO Monthly High Income has significant holdings in Toronto-Dominion Bank TD, Bank of Nova Scotia BNS and Royal Bank of Canada RY.
