Michele Robitaille, managing director and equity-income specialist at Guardian Capital LP, says that she and her colleagues have become less defensive over the past several months in their high-income portfolios.
"We have shifted to a more neutral stance, given the unexpected resilience of the U.S. economy and a global economy that is doing better than many anticipated," she says. "But given the ongoing macroeconomic headwinds, we are not in the pro-cyclical camp."
The medium-term risks to U.S. and global growth remain, says Robitaille. South of the border, the political gridlock in the run-up to the fall election will mean that important government decisions like the continuation of payroll tax cuts, the rollback of the Bush-era tax cuts, cuts to health care and the debt-ceiling debate will be held back until 2013. "This delay could create a potential drag of as much as 3.5% on U.S. GDP."
Europe is in recession, says Robitaille. "While there has been significant progress in addressing the Euro-zone's debt issues, there are still many rounds to go on this." Emerging economies are the bright spot, she says. "Despite recent soft data, we consider that China is likely to engineer a soft economic landing and emerging economies will continue to drive global growth." This prospect is encouraging and helped to shape "our generally less defensive stance," says Robitaille.
Guardian Capital (managed assets $14.4 billion) is a sub-adviser to the BMO Guardian family of funds. The equity-income team's responsibilities include BMO Guardian Growth & Income (which has assets of $408 million) and BMO Guardian Monthly High Income II, with assets of $866 million.
The equity-income team seeks to invest in businesses with a dominant market position that can generate high levels of free cash flow to support stable and growing dividends over time. A targeted company must have a strong balance sheet, a low dividend/distribution payout ratio and management aligned with investors' interests. It must also trade at a reasonable valuation.
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| Michele Robitaille | |
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At the end of March, BMO Guardian Monthly Income had 37% in the financial-services sector (which includes real estate investment trusts), with REITs at 19.4% of the portfolio and banks at 14.2%. The second biggest weighting in the portfolio was energy at 31.1%, represented by energy producers at 18.1% and energy-infrastructure companies and other energy-related stocks at 12.9%.
Robitaille reports that within the financial sector, the equity-income team has been gradually reducing its weighting in REITs, by taking its holdings down across the board. "REITs have had such a good run over the past three years and are close to fully valued." But she notes that REITs, at almost 20% of BMO Guardian Monthly Income, continue to be a core holding. "They are solid cash-flow generators and their operating fundamentals are strong."
The two largest REIT holdings in the portfolio are RioCan Real Estate Investment Trust REI.UN and Canadian Real Estate Investment Trust REF.UN. "They are high-quality, defensive holdings."
The Guardian equity-income team has been boosting its exposure to the banks. "The major Canadian banks represented good value at the beginning of 2012," says Robitaille. In January, the team added Bank of Nova Scotia BNS to the portfolio's long-standing holdings in Toronto Dominion Bank TD and Royal Bank of Canada RY. These three banks are in the fund's top 10 holdings, with TD the largest weighting.
"Our thesis on banks at the beginning of the year was that while growth in their Canadian retail business was slowing, there was room for an expansion of the price/earnings multiple on the stocks." This began in the first quarter of 2012, "and we expect this multiple expansion to continue."
The equity-income team continues to be unenthusiastic about Canadian insurers, says Robitaille. "Although these stocks had a big run in the first quarter, reflecting both short-covering and the back-up in long bond yields, we consider that their core earnings power remains challenged."
The insurers, she notes, are sensitive to the low-interest-rate environment and to stock- market volatility. "Interest rates would have to move up sharply, which we do not anticipate, for the insurers to become interesting."
Turning to energy, Robitaille notes that Canadian producers have been under pressure for the past couple of months, "because of the structural oversupply of natural gas in North America and the bottlenecks in the transportation of oil from Western Canada to the refineries in the Gulf Coast."
With the natural gas price at less than break-even levels for many producers, there could be production shut-ins this summer, says Robitaille. From an investor perspective, "the concern is about cutbacks in capital spending which will limit production growth and the sustainability of dividends."
Robitaille points out that a top 10 holding in the fund, natural-gas producer Bonavista Energy Corp. BNP has seen its stock come under significant pressure of late, due to restrictions in its bank covenants on its dividend payout. "Yet, the company is a low-cost producer with a relatively high liquids content and is in relatively better shape than many of its peers."
The supply/demand equation for oil is healthier than for natural gas, says Robitaille. But, she cautions that there is currently a glut of oil in Cushing Oklahoma, the world largest oil-storage facility, "because of the lack of pipelines to transport the oil to the Gulf refineries."
This glut is affecting Canadian producers. The Canadian oil price is at a "significant discount" to the U.S. benchmark West Texas Intermediate, which is in turn at a "substantial discount" to North Sea Brent, the European benchmark.
From an investor perspective, "the price of oil realized by Canadian producers in the first quarter could be significantly lower than market expectations," says Robitaille. The good news, she says, it that there are already moves afoot to add the necessary pipelines. "This will help to alleviate the problem."
The equity-income team's strategy has been to buy select oil producers on dips. For example, the team added to Baytex Energy Corp. BTE and to Crescent Point Energy Corp. CPG "Both companies are heavily weighted to oil production, have low debt levels and are using hedging programs to protect them against fluctuations in the oil price."
| Baytex Energy Corp. | Crescent Point Energy Corp. |
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| April 10 close | $48.20 | $40.78 | |
| 52-week high/low | $59.40-$39.18 | $47.30-$35.51 | |
| Market cap | $5.7 billion | $12.9 billion | |
| Total % return 1Y* | -13.8% | -6.9% | |
| Total % return 3Y* | 49.8% | 21.2% | |
| Total % return 5Y* | 23.3% | 24.6% | |
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| *As of April 10,2012 Source: Morningstar |
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