When Richard Liley, Canadian equity analyst and portfolio manager at Vancouver-based Leith Wheeler Investment Counsel Ltd. says his investment time horizon is long-term, he means it.
Annual turnover in bronze-medallist Leith Wheeler Canadian Dividend has been in the range of 15% for the past few years, and it’s not unusual for a stock to stay in the fund for 10 years.
“We don’t spend a lot of time trying to predict things like inflation or economic growth rates, which are pretty unknowable,” says Liley. “We seek resilient companies that can thrive through various economic cycles and we don’t make big changes in the portfolio.”
No Siloed Strategies
Liley is part of a team that oversees the fund, including fellow portfolio managers David Jiles, Nick Szucs and Marco Tang. Each manager is responsible for covering a diverse group of industries and businesses, providing perspective on quality and valuations. With no team member focused on a single industry, the team has well-informed debates and can challenge each other’s biases and conclusions.
The goal is to find solid, dividend-paying companies with stable earnings, healthy growth prospects and capable management teams experienced in navigating fluctuating economic conditions.
Liley, who covers various companies in the financial, technology, consumer discretionary and industrial sectors, has covered some for more than 20 years and has access to corporate executives who take his calls and answer his questions.
Looking for Leaders
“Good corporate managers are receptive to long-term, committed investors and that helps us better understand what we own,” says Liley. “Some things are not immediately obvious in the financial statistics.”
He says the team steers clear of investment fads and has avoided fickle trends like cryptocurrencies and meme stocks that gain short-lived popularity through social media hype. They will, however, sometimes invest in young companies if they see long-term potential.
For example, the firm first invested in Constellation Software Inc. (STZ) when it went public in 2006, originally holding it in another portfolio. It remains an important holding in Leith Wheeler Canadian Dividend.
“The management strategy made sense and the valuation was attractive,” Liley says of the original decision to invest in Constellation. “A company doesn’t necessarily need a long public track record, we use our experience and judgment.”
While the team doesn’t attempt to make economic forecasts, its members do ponder how the current environment could affect the companies in the portfolio, which currently stand at 38.
For example, inflation is at multi-decade highs, and it’s important that holdings can manage rising expenses and have pricing power to pass on cost increases.
Earnings Risk in Banks Ahead?
Interest rates are also rising, and this has been a reason to take a hard look at the effects on certain holdings such as banks. The portfolio contains Canadian Western Bank (CBWBF) as well as all five of the big Canadian chartered banks, of which three are in the top 10 holdings – Royal Bank of Canada (RY), Toronto-Dominion Bank (TD) and Bank of Montreal (BMO).
The Royal Bank is the fund’s largest holding, and financials are the dominant sector with a 37% weight.
The market perceives some risk to the downside in bank earnings, which is why banks are trading at lower price/earnings multiples than usual, Liley says. Recently, P/Es for banks were around 9.5 - 10 on average relative to a more normal 11.5 - 12. He says the market is pricing in about a 20% probability of economic recession and an 80% probability of slower growth.
Housing Market’s Still Healthy
“The slowdown in the housing market could affect mortgage growth and there is some concern about credit issues,” Liley says. “But we’ve done some stress-testing and there isn’t any evidence of serious problems. Property values have risen a lot in the past few years, loan-to-value ratios are still healthy and consumers still have strong balance sheets.”
While interest costs have risen and loan creation may now grow less quickly, there are growth opportunities outside of banking’s “bread and butter areas,” such as wealth management and international expansion, Liley says.
Other financial holdings in the fund include insurance companies Manulife Financial Corp. (MFC) and Great-West Lifeco Inc (GWO).
The portfolio is also overweight relative to the S&P/TSX Dividend Composite Index in industrials, but there is a lot of diversity in the sector. Holdings include heavy equipment dealer Toromont Industries Ltd. (TIH), Canadian National Railway Co. (CNR) and waste management firm Waste Connections of Canada (WCN).
In addition, the technology sector is overweight relative to the index and includes mostly software companies such as Constellation Software (CNSWF), OpenText Corp. (OTEX) and Enghouse Systems Ltd (ENGH).
“These software firms have strong cash flow characteristics and are steady businesses where the revenue tends to be sticky,” Liley says. “It’s hard for clients to switch software providers, so there is high retention, and the companies have pricing power.”
Underweight Energy and Materials
The fund is underweight in cyclical sectors such as materials and energy and tends to avoid gold stocks. These industries are vulnerable to fluctuating commodity prices, and their earnings are less stable, says Liley.
Nevertheless, he has some favourites in the energy group, including Canadian Natural Resources Ltd. (CNQ) and Tourmaline Oil Corp. (TOU), both senior producers with healthy dividends.
He says the better companies in the energy business are disciplined around reinvesting in growing reserves and are spending less of their cash in exploration and development while paying more out in dividends to shareholders.
“Companies are employing more discipline and there is less of a race to put money back into the ground,” he says.
The fund holds no foreign content, but invests in Canadian companies of various sizes. Among its smaller holdings are A&W Revenue Royalties Income Fund (AW.UN), a royalty model based on franchise income from hamburger sales, and Stingray Group Inc., a distributor of audio and video music content.
The portfolio also holds mattress retailer Sleep Country Canada Holdings Inc. (ZZZ) and Winnipeg-based bus manufacturer, NFI Group Inc (NFI).
