I've been saying for a couple weeks now that, based on the fact that interest rates rode a decades-long downtrend into an historically low range, it's likely that there's only room to go up from here.
And yet the yield on the 10-year US Treasury note, a widely followed benchmark, continues to make new 2014 lows.
The timing and magnitude of the increase are still open questions. But we still seem to be stuck in a low-growth environment. And that augurs continued subdued inflation.
Slower growth relative to historical norms also suggests that when the Fed does get around to raising its benchmark fed funds rate increases will be slow and not as aggressive compared to past tightening cycles.
The Australian dollar and the Canadian dollar have shown some stability in recent weeks, though the Land Down Under remains vulnerable to a sharp slowdown of Chinese growth and US GDP data are not positive for the Great White North.
Against this backdrop I sat for my monthly chat on April 30, 2014, with subscribers to Utility Forecaster, Canadian Edge and Australian Edge.
What follows is an edited transcript of the session.
Question: How do you feel about Southern Company's (NYSE: SO) quarter? Do you think they have turned the corner?
Answer: I was encouraged by Southern Company's revenue and earnings, with solid sales numbers across its four-state territory.
I was a little troubled by the new cost overruns and the delay of in-service date until 2015 at the Kemper IGCC plant in Mississippi. The 3.4 percent dividend increase was good news, and the Vogtle nuclear project is on track. I rate the stock a buy under 46.
Question: Do you consider Canadian stocks overvalued?
Answer: I usually don’t use such generalizations. I focus on buy-under targets for individual companies. The S&P/TSX Composite Index has indeed enjoyed a solid run since mid-2012. Bu! t, again, focus on individual companies and their ability to sustain and grow dividends.
Question: What do you think of AT&T Inc (NYSE: T) and Verizon Communications Inc (NYSE: VZ)? Both stocks have been in a downtrend lately.
Answer: AT&T had a great quarter in terms of postpaid wireless subscriber additions, beating Verizon for the first time in a while. And Verizon posted another quarter of double-digit earnings growth.
I would look at this weakness as an opportunity to pick up a couple solid long-term holdings that still occupy dominant positions in the US wireless market.
Question: Should we consider selling some utilities because of [the April 29, 2014] Supreme Court ruling upholding the EPA on interstate air emissions?
Answer: I posted a Utility & Income commentary on the Supreme Court’s decision on May 1, 2014.
There will be some negative impact for generators with a heavy tilt toward coal in their overall mix. But the big decision will come June, when the Supremes rule on emissions from existing coal-fired plants.
Coal, however, is not going away. It’s still the cheapest fuel to burn. This will raise the costs, but it won’t kill it as a source of producing electric power in the US–at least not yet.
Question: Please comment on the potential for a dividend cut or other major changes at Liquor Stores NA (TSX: LIQ, OTC: LIQSF) due to recent management/director changes.
Answer: Management recently announced a $16 million plan to upgrade stores and its technology platform as a means of improving performance.
More importantly, the payout ratio for 2013 was a very manageable 50 percent. The company is struggling in Kentucky and with the prevalence of state-owned liquor stores in the US in general, which limits opportunities for expansion.
But I think the board changes don’t signal an imminent dividend cut.
Question: I still don’t know what to do about the dividends issued by Dun! dee REIT ! (TSX: D-U, OTC: DRETF), Artis REIT (TSX: AX-U, OTC: ARESF) and Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), which were reported as non-qualified and therefore taxed at the owners regular tax rate.
But I heard from an accountant that some brokerages are reporting them as qualified. Your answer to me last month was that there is a treaty between the US and Canada that all dividends were to be treated at qualified.
Can you get me a copy of that treaty–the part that states "all dividends will be classified as 'qualified.'" There is a problem if one company is reporting them as qualified and another non-qualified.
Answer: Here’s the long answer: The vast majority of Canadian income trusts converted into corporations in 2011, as a result of the Canadian government's decision to close the loophole that eliminated taxation at the corporate level.
With the notable exception of REITs, most other entities that opted to maintain an income trust structure would be classified as Specified Investment Flow-Through entities (SIFT) and would be taxed at the corporate level.
Distributions from a SIFT held in an IRA aren't subject to the 15 percent withholding tax by the Canadian government. That's because SIFTs essentially have tax parity with corporations, and therefore their distributions are considered dividends under Canadian tax law.
Distributions from REITs, by contrast, will be withheld at the 15 percent rate when US investors hold them in their IRAs or other tax-advantaged accounts.
Unfortunately, the exemption from Canada's withholding tax of 15 percent on dividends/distributions from holdings in US investors' tax-advantaged accounts, such as IRAs and Roth IRAs, only applies to corporations, not REITs.
Furthermore, unlike when Canadian REITs are held within a US investor's taxable account, the amount withheld by the Canadian government from a REIT in an IRA cannot be recaptured via tax credits from the IR! S.
! Question: You have TECO Energy Inc (NYSE: TE) as a buy under 18, but it's also on the Utility Forecaster Dividend Watch List. What do you really recommend?
Answer: TECO Energy is on the DWL because its payout ratio, at more than 90 percent, is a little too high for comfort. At the same time, the company operates in a solid local economy, the Tampa area, with relatively favorable regulation. And more than 80 percent of revenue comes from regulated operations. Its inclusion on the Watch List is a function of its 93.6 percent payout ratio, a cautious measure.
It’s important to note that some companies rated “8″ under the UF Safety Rating System can be rated “hold” on valuation concerns, while others rated “3″, as is TECO, could offer solid value.
Question: I note that National Fuel Gas Co (NYSE: NFG) is usually only rated a “hold.” Yet it's been very consistent with paying dividends–including during the '29 crash and depression that followed.
Why is it only a “hold"?
Answer: The primary concern I have right now about National Fuel Gas is its ongoing shift away from regulated gas utility operations toward unregulated exploration and production activity, which would make for a more volatile revenue and earnings profile.
It’s also trading at steep 22.2 price-to-earnings and 2.73 price-to-book ratios.
Question: Pembina Pipeline Corp (TSX: PPL, NYSE: PBA) is up more than 15 percent over the last three months. Is it still your top pick for new investments now?
And any update on Duke Energy Corp (NYSE: DUK)? If it’s a hold, would one not be better off exchanging it for a solid utility or master limited partnership (MLP) that's rated "buy"?
Answer: Pembina Pipeline has surged well beyond our recommended buy-under target, but it remains one of my favorite invest-to-grow stories.
My favorite MLPs for new money include recent distribution-raisers Kinder Morgan ! Energy Pa! rtners LP (NYSE: KMP) and Plains All American Pipeline LP (NYSE: PAA).
Duke Energy still faces serious questions about the Dan River coal ash spill. But I think it will be able to absorb cleanup costs, appease local, state and federal regulators and continue to grow its dividend.
The stock is trading well above our recommended buy-under target of 62, an indication that the market doesn’t see any debilitating Dan River problems. So it is effectively a hold at these levels.
If you have money to invest, focus on Northeast Utilities (NSYE: NU), Kinder Morgan Energy Partners and/or TransCanada Corp (TSX: TRP, NYSE: TRP).
Question: What’s happening with Dundee REIT and Canadian Apartment Properties?
Answer: I think the market continues to punish the Canadian REITs due to perceived vulnerability in a rising rate environment.
But financial and operating numbers for both REITs have been solid, and distributions are well covered and sustainable.
Question: You do a great job in Utility Forecaster covering many foreign utilities. One you have never mentioned is PT Telekomunikasa Indonesia (TLK). Is it a buy?
Answer: Thanks, I appreciate that. I don’t currently cover PT Telekomunikasi Indonesia (Indonesia: TLKM, OTC: TLKMF), so I wouldn’t want to offer an opinion. I will consider it for future addition to the UF How They Rate Foreign Communications group.
Question: I've been surprised by the rapid price increase in National Grid Plc (London: NG/, NYSE: NGG) this year. Is the stock overvalued? Would you suggest an alternative?
And your long-term your thoughts on Verizon?
Answer: Financial and operating numbers for National Grid have been solid, but the share price has shot up since early February. I rate it a buy under 64.
I’m a big fan of Verizon, the April Growth Spotlight/Best Buy in Utility Forecaster, for the long term. Still has the greatest capacity to reinvest in its network, still growing earnings ! at a doub! le-digit rate, still well positioned for the continuing explosion of data-driven wireless services demand. Consolidation of Verizon Wireless ownership was a solid move.
Question: I have two holdings that have caused me much angst, Just Energy Group Inc (TSX: JE, NYSE: JE) and Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF). What are your current views on each? Thanks.
Answer: I abandoned Just Energy last year after a very unflattering article about its business practices appeared in the Toronto Globe & Mail’s business magazine.
That piece was the final straw, as the company had taken on considerable debt to expand beyond its core business operation. Recent financial results have been solid, but it’s not a company I consider “high quality.”
As for Lightstream Resources, average daily production for 2013 was up 9 percent versus 2012 to 46,438 barrels of oil equivalent per day (boe/d), though fourth-quarter production was flat sequentially and down 4 percent year over year. Annual operating netback was up 4 percent, and funds from operations were up 12 percent.
The key for Lightstream remains maintaining production and cash flow as it sells assets to reduce debt. The recent dividend cut will help with financial flexibility. And first-quarter 2014 numbers (detailed in the May 2014 Canadian Edge Best Buys feature) suggest the turnaround program is showing progress.
The market has certainly looked fondly upon these efforts, as the stock price is up to CAD6.51 as of this writing from CAD5.15 in mid-December, or just after the dividend cut. (Lightstream was trading at CAD7.14 as of midday May 15.)
Question: I see NextEra Energy Inc (NYSE: NEE) had a good quarter. Would you still buy or wait until they do a YieldCo and buy it instead?
Answer: I would stick with NextEra, but wait for a pullback to the 94 range. The first quarter was a good one, with expectations-beating top- and bottom-line numbers, not to mention the 9.8 percent div! idend inc! rease.
Question: If you were limited to owning five to six stocks for the next five years what would they be?
Answer: Verizon, NextEra, Enterprise Products Partners LP (NYSE: EPD), Pembina Pipeline, Apple Inc (NSDQ: AAPL) and APA Group (ASX: APA, OTC: APAJF).
Question: I recently purchased Chevron (NYSE: CVX) at $113 and it has run to $126. Is it prudent to take some profits?
Answer: If Chevron has come to represent an outsized portion of your portfolio, yes. If you’re diversified by sector and company, I’d say let this winner run.
Question: CEMIG (NYSE: CIG) is still way off multi-year highs due to some pretty serious government interference in Brazil. Nevertheless, it’s up dramatically the last couple of months.
Would you be taking profits now, or is it “smooth sailing,” with more price appreciation ahead?
Answer: Analysts are becoming more bullish on Brazilian economic growth, and Brazil’s banks have stepped up to provide “emergency” loans to cover cash flow shortages until tariff adjustments are finalized, and the country’s development bank is also pitching in.
CEMIG was recently was granted a 14.76 percent rate increase versus a request of 29.74 percent. I wouldn’t say “smooth sailing,” but things are definitely improving, at a macro and company level.
Question: Is Exelon Corp (NYSE: EXC) a buy now?
Answer: Richard Stavros, Ari Charney and I had a long conversation about Exelon in the aftermath of the announcement of its proposed acquisition of Pepco Holdings (NYSE: POM).
We’re taking a wait-and-see approach. It’s still an open question whether the recent improvement in the wholesale power market has legs.
And Exelon’s asset mix–heavy on nuclear–still seems like more of a burden than a boon right now. I do like the fact that’s its potentially adding regulated revenue and that Pepco’s utilities are geographically clo! se to Exe! lon’s east coast utilities.
But there are a lot of regulatory hurdles left to surmount, not to mention the integration issues. There are many management layers and a lot of cumbersome logistics to work out. It would be tough for the companies to announce a lot of job cuts right now, though, as they still need to court regulators who will likely be loath to agree to measures that harm local economies.
Question: What percentage of a portfolio should MLPs be?
Answer: Generally speaking I would limit exposure to MLPs to about 15 percent to 20 percent.
Question: Several of the REITs have been coming back, but Dundee seems to slowly drift lower. It would take over three years of dividends to make up my losses, and those losses may not stop.
Wouldn’t it be better to sell and purchase something that has more opportunity for growth? Having been had losses from other items held too long in Canadian Edge or Personal Finance it seems prudent to cut the loss now.
Answer: I completely appreciate what you’re saying. The difference with Dundee REIT is that its assets continue to generate solid cash flow. We did, as you allude to, hold onto several companies past the point where underlying business fundamentals justified doing so.
At the end of the day, it’s most important that you are comfortable with your portfolio allocations when you go to sleep at night. One of the keys to long-term investing success is to know yourself, your risk tolerance, your goals, and how you’ll react to downturns and upturns.
I’ll stick with Dundee because the distribution is sustainable and the operating picture will improve with strong North American economic growth.
But I understand your view. And I would not question you selling Dundee in favor of another holding with, for example, better prospects for payout growth versus simple sustainability.
Question: I recently sold Duke Energy due to the company’s recent coal ash spill and the! large am! ount of money it will take to clean up this spill and also new requirements for their other coal ash sites.
Will this affect Duke’s Safety Rating and regulatory relationships?
Answer: Duke estimates that remediation of the ash issues post-Dan River will cost $2 to $2.5 billion, though government demands could push the total to $7 to $10 billion. A company of Duke’s size will be able to absorb these costs, perhaps dumping them into a “bad quarter.”
I don’t anticipate that we’ll see costs of $10 billion. Management has been aggressive in its approach to the problem, accepting responsibility and offering a reasonable, prudent solution that has resulted in the Dan River producing safe water-test results and will allow it to continue to serve its customers in North Carolina for the long term.
Question: Would you prefer KMR over KMP, as it is trading at discount and has a better tax picture?
Answer: If you don’t want to deal with K-1s at tax time, Kinder Morgan Inc (NYSE: KMI) is a suitable alternative, as is Kinder Morgan Management (NYSE: KMR), which pays its distribution in the form of Kinder Morgan Energy Partners units.
Question: What are your thoughts on TransForce Inc (TSX: TFI, OTC: TFIFF)?
Answer: TransForce has had an up-and-down 2014 after a strong rally at the end of 2013. It remains a strong consolidator in the still-fragmented North American truckload and less-than-truckload markets. The Vitran deal is a positive.
As for the first quarter, the severe winter had a negative impact on results. Earnings per share were CAD0.20, down from CAD0.26. And revenue missed analysts’ estimates.
But other smaller, weaker players dealt with the same weather. TransForce has proven its ability to build its business during tough times, as weaker competitors struggled to survive. Better North American economic growth would certainly help. But I like TransForce for the long term.
This 2014 pullback has actuall! y brought! it below my recommended buy-under target of USD23.
Question: What do you think of the methanol industry and do you have a favorite stock pick in that group?
Answer: We recently added Methanex Corp (TSX: MX, NSDQ: MEOH) to the Canadian Edge How They Rate coverage universe. I currently rate the stock a hold, as it’s been on a very strong run since late 2012. The pullback since mid-March could provide a good entry point. (I upgraded Methanex to "buy under USD65" in the May 2014 CE.)
It’s the global leader in production of a feedstock for key chemicals and fuel additives. Global economic growth will drive future results.
Question: I purchased Vermilion Energy Inc (TSX: VET, NYSE: VET) and Pembina Pipeline in 2004. I'm looking to buy more Vermilion on dips. Your buy number is 56. That represents an 18 percent difference. Do you intend to raise the buy target in the near future?
Answer: I did boost the buy-under target for Vermilion Energy to USD56 in February, but the stock spiked higher beginning in mid-March. My predilection is to not chase stocks. Increases in buy-under targets are driven by dividend growth and asset/production growth.
(I raised my buy-under target for Vermilion to USD64 in the May 2014 CE based on its strong production growth profile.)
Question: You say REITs are being punished because of a rising rate environment, but the Canadian dollar is being hammered because rates are so low. Can you explain?
Answer: Traditional fixed-income investors rotated into REITs en masse in search of better-but-still-relatively-safe yields. The perception that higher yields will soon be on offer from risk-free assets is a contributing factor to the REIT selloff.
Operating and financial results have actually been solid. The one thing REITs haven’t done, probably in anticipation of higher rates and higher costs of capital, is raise distributions.
The Canadian dollar’s weakness is, as you note, a function of a potent! ially exp! anding rate differential–comparing the Bank of Canada’s target rate and “dovish” stance to the fed funds rate and the Fed’s more “hawkish” tone of late, including the rollback of QE–as well as softer Canadian economic growth.
Question: Please comment on Dominion Resources Inc's (NYSE: D) earnings and your buy-under target.
Answer: Operating earnings per share growth was impressive at $1.04 versus $0.83 a year ago, and they beat guidance of $0.85 to $1.00.
Weather helped performance at its regulated utilities, but management also noted significant improvement for its merchant generation business. Lower costs also contributed to the expectations-beat.
I have Dominion rated a buy under 60, which is well below the current price of $72.55. There’s a big “MLP premium” built into the share price in anticipation of the spinoff of its LNG assets, presumably later this year but subject, as management recently noted, to final regulatory approval of its Cove Point LNG export project.
Question: Hello, David, and thank you for taking the time to host these sessions. IBI Group Inc (TSX: IBG, OTC: IBIBF) seems to be clawing its way out of the hole; any hope for them? And the same applies to a long-term holding of mine, Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE). Do you think they will ever get their act together?
Answer: BI Group’s operating cash flow improved significantly during the second half of 2013, a sign that management’s efforts to turn the business around are having positive affect. Higher-cost debt is also being refinanced on more favorable terms. We’ll look for more progress with first-quarter numbers, which will come out on or about May 9. (IBI released its first-quarter numbers on May 14.)
As for Penn West, the stock has bounced off its all-time low of Jan. 23, but I think investors are growing weary of a company that’s been in perpetual turnaround for a couple ye! ars now. ! Asset sales continue.
2013 gross revenue was down 14 percent to CAD2.84 billion, as funds flow per share declined by 17 percent to CAD2.17. Average daily production was down 16 percent to 135,093 boe/d.
First-quarter gross revenue declined by 5 percent to CAD668 million, though FFO per share was up 4 percent to CAD0.57. Total production was down 22 percent to 110,795 boe/d, though netback was up 32 percent to CAD36.67 per boe.
I think the current dividend rate is sustainable, but it’s a fine line to sell assets while maintaining production at a level sufficient to support cash flow and the payout.
Question: Are any of the Big Five Canadian banks attractively priced for new money?
Answer: My favorite Canadian bank is Bank of Nova Scotia (TSX: BNS, NYSE: BNS), which I recommend under USD62 and is trading at USD60.87 right now. (Scotiabank rallied to USD62.02 on the New York Stock Exchange by May 15.)
Question: What do you recommend doing with Linn Energy LLC (NSDQ: LINE)?
Answer: I rate Linn Energy a hold. We sold it from the UF Portfolio last year due to long-term concerns about its production profile and in the aftermath of a series of articles in Barron’s questioning its accounting practices.
The Berry Petroleum deal is now complete. But JPMorgan and Citigroup recently issued downgrades, and short interest surged on suspicion rising debt, equity needs and weak production threaten the current payout.
Question: Is now a good time to add to BCE Inc (TSX: BCE, NYSE: BCE) or Rogers Communications Inc (TSX: RCI/B, NYSE: RCI)? Are there other telecoms or communications/TV stocks that you prefer over them?
Answer: I rate BCE a buy under USD45, Rogers Communications a buy under 44.
Rogers is a value play right now, as it’s perceived to be the most vulnerable to the Canadian government’s effort to stimulate the creation of a fourth national wireless carrier.
BCE’s revenue base is more well-rounded.
Ques! tion: Do ! you follow Norbord Inc (TSX: NBD, OTC: NBRXF)? Have an opinion?
Answer: I rate Norbord a buy under USD30. Management expects the North American housing recovery to run for “several years,” with cash generation helping to deleverage the balance sheet.
Question: As a new investor, which Canadian stock would you recommend for new money?
Answer: My two Best Buys for April were Artis REIT (TSX: AX-U, OTC: ARESF), up to USD16, and ARC Resources Ltd (TSX: ARX, OTC: AETUF), under USD28.
Question: How is Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) doing? Any concerns?
Answer: ANZ is pushing to new highs on the Australian Securities Exchange (ASX). It’s my top pick among Australia’s for biggest banks. I’m still concerned about its Asia exposure for the short term. But it’s a solid dividend grower for the long term.
Question: Would you buy Apple here or wait until after the split? Since the announcement it has gone up quite a bit.
Answer: Yeah, that was a quick rise for Apple. With the 7.9 percent dividend increase my new buy-under target is 520, but it’s obviously gone well beyond that.
Question: What do you think is the likelihood that SK Telecom Co Ltd (Korea: 017670, NYSE: SKM) will cut its dividend in 2014?
Answer: SK Telecom has been a consistent dividend payer, with conservative financial policies in support. Operating numbers have been solid. I don’t see a cut on the horizon.
Question: Any comments on Entergy Corp (NYSE: ETR)?
Answer: Management boosted its first-quarter operating EPS guidance to $2.28, up from $0.94 on colder weather and pipeline constraints, and actually reported $2.29. Electricity sales were up 15 percent. Full-year guidance was lifted to $5.55 to $6.75.
I like it up to 75.
Question: What are your top two or three holdings for a Canadian investor looking for pure growth?
Answer: Well, the CE How They Rate coverage univ! erse is b! uilt around dividend-paying companies. But Magna International Inc (TSX: MG, NYSE: MGA), ARC Resources and Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) all offer solid growth prospects with decent payouts attached.
Question: If you had to choose to buy either EnerCare Inc (TSX: ECI, OTC: CSUWF) or Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF), which would it be and why?
Answer: would take EnerCare over Brookfield Real Estate Services because of greater potential for dividend growth.
EnerCare’s submetering business has 166,000 units contracted, 136,000 units installed and 82,000 units being billed, implying a doubling of baked-in revenue over the next five years.
Brookfield Real Estate’s upside is limited by the nature of its agreements with Canadian realtors. But the dividend is sustainable, with modest growth prospects.
Question: Thoughts on MarkWest Energy Partners LP (NYSE: MWE)? I live in Western Pennsylvania, and MarkWest hass been laying pipeline everywhere.
Answer: The pullback since mid-March offers a good opportunity to buy MarkWest Energy under 66. Management recently boosted the quarterly distribution rate by 1.2 percent and increased the MLP’s revolving credit facility to $1.3 billion and extended its maturity by 18 months to March 2019.
Question: Student Transportation Inc (TSX: STB, NSDQ: STB) continues to pay a steady dividend, but the price shows no increase over a long period. It seems to bounce up and down in a narrow range. Is there a reasonable chance for long-term growth?
Answer: I think Student Transportation would see upside should the current tenor of state and local officials on spending on education change. I also think it would benefit should the wider investing community begin to appreciate the fact that despite challenges represented by constrained public budgets the company continues to grow its business.
Question: Windstream Holdings Inc (NYSE: WIN) has moved up significantly since your! "sell�! �� recommendation. What is the reason? Short covering? The company continues to support the dividend. What is your expectation?
Answer: My "sell" recommendation on Windstream was based primarily on the slow growth of its “strategic” business services and broadband units. Had I a crystal ball I would have waited to sell into this strength.
But dividend growth certainly is nil. And sustainability is a question until they finally show the ability to grow the strategic businesses at a faster clip than the negative 1 percent to positive 3 percent pace management expects for 2014.
Question: What is your opinion of Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)?
Answer: Davis + Henderson has executed a fantastic growth strategy and is now a top player in the global financial information services space. Dividend growth is steady.
Management reported a 55.1 percent surge in first-quarter revenue to CAD266.3 million, as the acquisition of Harland Financial has in fact proved a step-change for the business.
US operations accounted for 46 percent of total revenue, up from 13 percent a year ago. Organic growth in Canada was also solid, as adjusted EBITDA grew by 74.4 percent. The payout ratio for the three months ended March 31, 2014, was 66.7 percent. Davis + Henderson–based on the Harland acquisition and corresponding asset growth–is now a buy under USD28.
Please note that the next Utility Forecaster/Canadian Edge/Australian Edge web chat will take place Wednesday, May 28, at 2 pm.
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