Editor’s Note: Please see our analysis of the latest quarterly earnings for nine of our Dividend Champions in the Portfolio Update following the article below

Another month, another big jump for Canadian house prices.

According to just-released figures from the Canadian Real Estate Association, average resale prices rose 8.3% in October from a year earlier, to nearly CAD454,976. As always, Vancouver and Toronto led the way, with gains of 15.3% and 10.3%, respectively.

However, two new reports suggest the market’s hot streak may be headed for a cool-down, at least in the country’s two priciest cities.

The first came from the Organization for Economic Cooperation and Development (OECD), which had pointed words concerning house prices in the country’s biggest city on Nov. 9, when it released a report stating that “newly completed but unoccupied housing units have soared in Toronto, increasing the risk of a sharp market correction.”

However, the organization did note that in Toronto, “economic activity has been relatively buoyant and demand by foreigners has been boosted by the low Canadian dollar.”

Overvaluation, Foreign Buyers Heighten Concerns

A few days before the OECD weighed in, the Canada Mortgage and Housing Corp. released its quarterly survey, saying it had detected moderate signs of overvaluation in 11 of 15 major markets, with strong signs in three: Toronto, Montreal and Ottawa.

But in all, the CMHC said just four markets showed strong evidence of “problematic conditions”: Toronto, Saskatoon, Regina and Winnipeg. (The agency bases this judgment on not only overvaluation but also factors like overbuilding and price acceleration.)

Hanging over Canada’s real estate concerns is the participation of buyers from outside the country. That can be a plus, as the OECD pointed out, but how these investors would respond to a slowdown is an open question.

“While both domestic and foreign investment activity can be speculative, foreign investment may be more mobile and subject to capital flight,” CMHC president Evan Siddall said in a Nov. 12 CBC article. “This would increase volatility in domestic housing markets.”

What’s more, the size of the foreign contingent is anyone’s guess: the government doesn’t keep track, though Prime Minister Justin Trudeau promised to look into eroding affordability during the recently completed election campaign: “If there are issues of speculation, then yes, the federal government has the tools to step in,” he said in a Sept. 9 CBC article.

A Market Divided

As we said in the June issue of Canadian Edge, it’s important to keep in mind that just because a market is overvalued doesn’t necessarily mean a quick correction is in the cards, as overvaluation can continue for a long time and isn’t always enough on its own to trigger a price drop.

Another thing to note is that the Canadian real estate market is more than a tale of two cities: if you strip Vancouver and Toronto out of the October sales figures, Canadian house prices rose a much more moderate 2.5%, to CAD339,059.

And despite its overvaluation concerns, the CMHC’s latest forecast points to a soft landing, with the average price of an existing home rising 7.2% this year but the pace of gains slowing to 1.3% next year and 1.4% in 2017.

That largely jibes with the view of Bank of Canada (BoC) senior deputy governor Carolyn Wilkins. “Our base case, and one that we outlined in the [October monetary policy report], is that the housing market and household debt are going to evolve in a constructive way,” she told The Globe and Mail on Nov. 13. “We don’t see the risk as part of our base case at all.”

“We see strengthening growth in Canada that’s coming from the US, from past monetary policy easing and also from the lower dollar,” she added.

Something else that’s absent from the Canadian real estate story: large numbers of subprime borrowers. Despite the ongoing rise in home prices, just 0.27% of Canadian mortgages are currently in arrears, according to the Canadian Bankers’ Association.

Market Will Be Tested: Economist

Of course, none of this is to say the risk of a Canadian housing correction should be dismissed. Even though there are few signs of a bubble outside Toronto and Vancouver, those two markets are home to about a quarter of Canada’s population, so a sharp correction in one or both would have a knock-on effect for the broader economy.

But you have to go beyond the headline numbers, says CIBC deputy chief economist Benjamin Tal.

“The OECD and others are looking at the headline numbers, and they jump to conclusions,” he said in a Nov. 9 BNN interview. “If you look at population growth in Canada, Canada is not overbuilding. At 190,000 units a year, that’s more or less in line with population growth.”

Tal thinks rising interest rates will be the real test for Canadian housing, particularly following the extended period of low rates the country has experienced. Higher rates could also pose a challenge for consumer spending in the years ahead as Canadians pay more to service their mortgages.

The BoC, for its part, isn’t expected to make any upward moves anytime soon, regardless of what the Federal Reserve does (or doesn’t do) in December. “This test will be maybe a 2017 story,” said Tal. “If interest rates don’t rise very quickly, it will be more of a gentle slowdown as opposed to a crash.”

The Dividend Champions: Portfolio Update

By Deon Vernooy

K-Bro Linen Inc. (TSX: KBL, OTC: KBRLF) announced earnings per share for the third quarter 7.5% below last year. Net income increased by 2.7% but the company issued additional shares during the year which increased the share count by 12.4% causing the drag at the per share level. The dividend per share remained unchanged with a pay-out ratio of 38% of free cash flow.

The additional shares were issued to finance the completion of a new $36 million laundry processing plant in Regina which will provide health care linen services to the entire Saskatchewan province until 2025. The plant came into operation at the end of the third quarter and is expected to add annually around $10 million (7%) to total revenue.

The balance sheet remains in good shape and cash flow is strong. In 2016, with the Regina plant in full operation, results should be much improved with prospects for solid dividend growth in years ahead.

We estimate the fair value of the stock at C$51/US$39 and with a forward dividend yield of 2.6%, we remain comfortable holders of the company in the Dividend Champions portfolio.  

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Crombie REIT (TSX: CRR-U, OTC: CROMF) reported unchanged funds from operations per unit for the third quarter and also kept the dividend the same as before.

The REIT owns a high quality, geographically diversified portfolio of retail and mixed use Canadian properties. The main tenant is grocery retailer Sobeys who is responsible for more than 50% of the rent.

The occupancy in the portfolio was reported at 93.2% slightly higher than the previous quarter but lower than last year as the now defunct Target Canada vacancies continue to remain empty.

The REIT trades at an attractive and secure dividend yield of 7%. With numerous development opportunities in the pipeline which could result in faster profit growth, the rating may also improve over time. We are comfortable holders of the units in the Dividend Champions portfolio.

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Power Corporation of Canada (TSX: POW, OTC: PWCDF), is a diversified holding company with interests in companies in the financial services, communications and other business sectors in North America, Europe and Asia. The main asset is the 66% interest in Power Financial which in turn holds controlling interests in Great-West Lifeco and IGM Financial.

Power Corp. reported third quarter operating earnings per share 37% ahead of the same quarter last year. Apart from reasonable results from Power Financial, the major boost to profits came from income from investments including private equity and hedge fund gains. The declared dividend was 7.3% higher than last year.

With a dividend yield of 4% and a substantial discount to the value of the underlying portfolio assets, we are comfortable holders of the company in the Dividend Champions portfolio.

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The reorganisation and restructuring of the hotel portfolio of InnVest REIT (TSX: INN-U, OTC: IVR.F) is continuing with good results already evident.

Funds from operations (which is a standard measure to assess the performance of REITs) increased by 24% during the third quarter compared to last year. As a result of a 21% increase in the number of units, the per unit profit was unchanged from last year. The dividend per unit was also unchanged.

Very positive developments during the quarter was the jump in hotel occupancy rates from 74.2% to 76.7% and an 8% increase in the average daily room rate. Gross operating profit increased by 17% during the quarter. These improvements were the result of improving market conditions as well as renovations and other enhancements to the overall portfolio.

The balance sheet and liquidity position of InnVest is also improving with the debt to gross asset value ratio down to 58.1% from 65.8% a year ago while the interest cover ratio improved to 2.5 times. The debt term and weighted average interest rate on the debt has also improved considerably during the past year.

The dividend yield on the units is now 7.6% and the pay-out ratio is 76%. While we see no increase in the dividend while the portfolio is repositioned and the debt reduced, we remain comfortable holders of InnVest units in the Dividend Champions portfolio.

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ManuLife Financial Corp. (TSX:MFC, NYSE: MFC) reported third quarter earnings per share of C$0.43, 9% better than last year. The dividend per share was increased by 10%.

The valuation on the stock remains attractive with a forward price to earnings ratio of 12.6 times and a dividend yield of 3.2%. We remain holders of the company in the Dividend Champions portfolio with a fair value of C$23/US$17.

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The largest Caterpillar distributor in the world, Finning International Inc. (TSX:FTT, OTC:FINGF) reported third quarter adjusted earnings per share down by 28% compared to last year. The dividend was increased by 3%.

Revenue for the 3 month period was 10% lower than the previous year with new equipment sales taking the brunt of weaker conditions in mining and energy markets. Product support, which normally acts somewhat countercyclical generated a slightly higher revenue for the period but not enough to compensate for the 30% decline in new product sales.

The company intends to cut costs further in response to the weak market conditions. Another 8% of the workforce will be terminated and more sales and service facilities will be closed.

The cash generation of the business remains strong with C$350 million of free cash flow generated over the past 12 months compared to a dividend payment of C$124 million. The balance sheet is also in reasonable shape with a debt/capital ratio of 39% which is appropriate for a cyclical business such as Finning.

Times are undoubtedly tough for the company. The dividend yield is now 3.8% but the dividend is relatively safe in our view. We plan to continue holding the stock in the Dividend Champion portfolio although it may be a long wait for an improved performance.

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Potash Corp. (TSX:POT, NYSE: POT) declared a dividend for the last quarter of 2015 of US$0.38 which is 9% ahead of the same quarter last year. Profits for the third quarter, 9% below the same quarter last year, was declared earlier.

In our opinion, the company remain considerably undervalued compared to our fair value estimate of C$35/US$26.

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Suncor Energy (TSX:SU, NYSE:SU) declared a dividend of C$0.29 for the fourth quarter 4% higher than the same quarter last year. The company also announced a slight reduction in expected oil production for 2016 as a result of maintenance work at major facilities.

Despite difficult market conditions, we believe that the strength of the diversified nature of the Suncor business model, ample cash flow and solid balance sheet will ensure a steady dividend until energy prices recover. Meanwhile, the company is in an excellent position to acquire assets at bargain prices in a depressed environment and investors get paid a dividend yield of 3.0% while waiting for the economic environment to improve.

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Although the third quarter results reported by loyalty card operator, Aimia Inc. (TSX:AIM, GAPFF) were not very different from the general market expectation, the share price took a heavy beating in the days after the announcement.

Key reasons for the 22% decline in adjusted earnings per share were declines in gross billings caused by lower loyalty partner activity, higher cost of rewards and higher marketing expenses. The dividend per share was increased by 6% compared to the previous year.

Cash flow generation remains solid and free cash flow covers the dividends adequately. The balance sheet is sound with a debt/capital ratio of 11%.

The outlook provided by management was weaker than previously indicated. This seemingly was the main reason for aggressive selling of the stock after the results announcement. Nevertheless, 2016 may be a much better year for the company and with a cheap valuation and with a dividend yield now over 8% we intend to hold our shares in the Dividend Champions portfolio.