Canadian Dividends: Better than Ever

By Roger Conrad • January 4, 2013 • In Brief

Editor’s Note: What follows is the executive summary of the January 2013 issue of Canadian Edge. Thanks for reading. — RSC

Parity with capital gains, no change in rates for up to USD450,000 in income and a top rate of 20 percent: That’s now US law on dividend taxes.

The upshot is even the highest-bracket Canadian Edge readers won’t see much change in levies on dividends paid by Canadian companies. In fact, most will pay the same in 2013 as they did in 2012.

Tax withholding imposed by US and Canadian tax authorities on one another’s citizens will also remain the same. That’s 15 percent for taxable accounts and zero for retirement accounts such as US IRAs and Canadian RRSPs.

As David Dittman explains in Canadian Currents, it is essential that US residents holding Canadian stocks–as well as Canadians that own US stocks–be certain their brokers have entered their ownership properly.

But so long as that “T” is crossed, there will be no changes in withholding rates either in 2013.

The result: The appeal of Canadian stocks’ dividends is as great in 2013 as it was in 2012.

The world’s highest payouts are arguably even more attractive now that sudden US austerity and a major recession are off the table.

The budget deal reached in Washington this week has other goodies as well.

These include a surprise extension of wind power tax credits that could aid development plans of several CE Portfolio Holdings, including AltaGas Ltd (TSX: ALA, OTC: ATGFF), Atlantic Power Corp (TSX: ATP, NYSE: AT) and Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF).

Of course the compromise didn’t raise the US federal debt ceiling, likely setting up another battle in roughly two months’ time. It left questions about government spending and tax deductions unanswered. And the 2 percentage point increase in Social Security taxes, as well as a higher top rate, will take money out of the economy starting now.

The latter provisions will no doubt have at least some negative impact on US growth. The big question is the multiplier effect, i.e. how many dollars are lost in the private sector when $1 is cut from the public sector. Conservatives argue little or nothing. But most economists believe the impact of even toned-down tax increases and spending cuts could be significant, at least in the first half of the year.

As an investor I’m hoping for as little multiplier as possible. There is precedent for belt-tightening actually spurring growth. President Clinton’s 1993 Budget Act, for example, raised taxes but it set the country on track for fiscal balance, and a major economic expansion followed.

In the early 1990s, as now, the Federal Reserve had been printing money for several years to overcome deflationary pressures. Then, as now, American consumers had slashed debt, and businesses were sitting on a mountain of cash.

Mr. Clinton’s budget was controversial, passing without a single Republican vote in Congress. But it did increase confidence needed to spur business investment–and good times for the US economy and stock market.

The Canadian Edge Portfolio was positive by roughly 7 percent in 2012. That steady-looking headline number, however, masked a sharp divergence between recommendations, with energy and high-yield companies standing out for poor performance.

If, as in 1993, 2013 turns out to be a turning point the energy and high-yield groups will produce the biggest winners. But if contractionary fiscal policies lead to a deeper slump they’ll almost surely lag. And individual companies that do crack as businesses will bring big losses.

Should that happen it’s important to remember the CE Portfolio built wealth for a fourth consecutive year despite steep losses in IBI Group Inc (TSX: IBG, OTC: IBIBF), Pengrowth Energy Corp (TSX: PGF, NYSE: PGH) and Poseidon Concepts Corp (TSX: PSN, OTC: POOSF). The key was having winners that in the aggregate more than offset the losers.

I’m an optimist for 2013. My strategy, however, is to be prepared for another year of 2012-type headwinds.

Accordingly, I’ve dumped Pengrowth and Poseidon. But the rest of the Portfolio is comprised of sound underlying businesses. All have what it takes to generate big capital gains this year if they continue to perform, as well as to continue paying generous dividends.

And if I’m wrong on any of them, diversification and portfolio balance will keep me whole and ready to fight another day, just as it did last year.

Roger Conrad
Editor, Canadian Edge

Portfolio Update

In a Dec. 27, 2012, Flash Alert I advised selling Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) on Jan. 2, 2013.

The reasons for waiting were, one, the likelihood of higher capital gains tax rates in 2013 to take the loss against and, two, the possibility a deal in Washington, DC, to avert the fiscal cliff would lift the market and provide a good opportunity to unload shares.

Both have happened, and I now consider us out of the position.

There are three other advice changes on current Holdings. Peyto Exploration & Development Corp’s (TSX: PEY, OTC: PEYUF) shares have dropped again and represent good value again. Peyto is a buy up to USD22 for those who don’t already own it.

Fellow Aggressive Holding Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) also goes from hold to buy, thanks to a hugely accretive acquisition of marketing assets. Despite being one of my biggest winners in 2012, Parkland is a bargain for new investors up to USD18.

Finally, Extendicare Inc (TSX: EXE, OTC: EXETF) is again a buy. Washington’s fiscal cliff deal doesn’t end the threat of lower Medicare reimbursement rates down the road.

But it did prevent a sudden hit to revenue in the first quarter and raises the hope of improved predictability in funding and regulation going forward. Extendicare is a buy up to USD8 for those who don’t own it.

For more on the Portfolio and how we did in 2012–and how we’re set for 2013–see Portfolio Update.

Best Buys

Best Buys features the two top candidates for purchase in January.

Both of this month’s picks boast hefty yields, primarily due to disappointing share-price performance in 2012: Aggressive Holding Ag Growth International Inc (TSX: AFN, OTC: AGGZF) and Conservative Holding Atlantic Power Corp (TSX: ATP, NYSE: AT).

Ag Growth’s weakness was due to generalized concerns about the impact on sales from drought conditions in North America. Atlantic Power’s came from low wholesale electricity prices in the US, resulting in a USD50 million fourth-quarter impairment of its investment in the Lake Cogen project in Florida.

Although both stocks arguably are pricing in dividend cuts now, neither is likely to reduce its payout in 2013. And both are investing for future dividend growth.

If they succeed–as I expect–both stocks will reward us with hefty capital gains in coming months, in addition to their generous monthly dividends.

In Focus

Buying and holding individual stocks has been our preferred way to invest since Canadian Edge’s first issue in July 2004.

However, we’ve also done well recommending closed-end mutual funds that hold Canadian stocks, and particularly the trio of Mutual Fund Alternatives currently in the Portfolio: Blue Ribbon Income Fund (TSX: RBN-U, OTC: BLUBF), EnerVest Diversified Income Fund (TSX: EIT-U, OTC: ENDTF) and First Asset Pipes & Power Income Fund (TSX: EWP-U, OTC: FAPPF).

In this issue’s In Focus feature I examine these funds in detail and forecast what to expect from them in 2013, and I also sort the good from the bad and ugly of the rest of the closed-end funds and exchange-traded funds under How They Rate coverage.

Dividend Watch List

Three How They Rate companies announced dividend cuts last month.

As I detailed in a Dec. 13, 2012, Flash Alert, IBI Group Inc (TSX: IBG, OTC: IBIBF) is cutting its distribution in half and going to a quarterly payment model. The cash will go to reduce debt and deal with a tough operating environment. IBI Group rates a hold.

Westshore Terminals Income Corp (TSX: WTE, OTC: WTSHF) reduced its quarterly dividend payable Jan. 15, 2013, to CAD0.275 from the previous quarter’s CAD0.33. A ship crashed into a trestle leading to one of the berths at the company’s facility, temporarily reducing capacity by about 830,000 metric tons of metallurgical coal a month. Westshore Terminals also rates a hold.

By contrast, Poseidon Concepts Corp’s (TSX: PSN, OTC: POOSF) indefinite cancellation of its dividend is just the latest in a series of unfortunate events that call into question its viability. Sell Poseidon if you didn’t already per my advice in a Dec. 27, 2012, Flash Alert.

Canadian Currents

A requirement that Canadian dividend payers certify eligibility of their payees for tax-treaty benefits was delayed for a year. It’s likely you haven’t been impacted in any significant way. Here’s what to do if you have been.

Canadian Employment–Statistics Canada reported Friday morning that employment increased by almost 40,000 in December 2012, pushing the jobless rate down 0.1 percentage points to 7.1 percent, the lowest level since December 2008, when the rate was 6.8 percent.

The December 2012 increase, the fourth month of growth in the last five, was all in full-time work.

Bay Street Beat–Action on Bay Street was limited over the past four weeks, as analysts enjoyed a holiday season and prepared for the next round of corporate reporting, which will get underway with Alcoa Inc’s (NYSE: A) traditional kickoff next Tuesday, Jan. 8, 2013.

Shaw Communications Inc (TSX: SJR/B, NYSE: SJR) will lead off for CE Portfolio Holdings when it posts fiscal 2013 first-quarter results on Wednesday, Jan. 9.

Here’s how the CE Portfolio stacks up on Bay Street heading into the reporting period.

How They Rate Update

Coverage Changes

Private capital firm Birch Hill Equity Partner completed its takeover of HOMEQ Corp for CAD9.50 per share in cash on Dec. 5, 2012. Investors should by now have received cash for their shares. HOMEQ is no longer traded on the Toronto Stock Exchange or covered in How They Rate.

Progress Energy Resources Corp is now part of Malaysian national oil company Petronas. Shareholders should by now have received CAD22 per share in cash. The acquisition of PRT Growing Services Ltd by a private capital firm has also been consummated, with PRT holders receiving CAD4.45 per share in cash.

Both Progress Energy and PRT Growing Services will be de-listed from How They Rate next month.

New to coverage this month is engineering and design firm Genivar Inc (TSX: GNV, OTC: GNVUF). The former income trust converted to a corporation in January 2011 without cutting its dividend. Genivar is listed under Business Trusts.

Advice Changes

Boyd Group Income Fund (TSX: BYD-U, OTC: BFGIF)–To Buy @ 16 from Hold. The company continues to cheaply fund rapid expansion and appears headed for another robust distribution increase in 2013.

Data Group Inc (TSX: DGI, OTC: DGPIF)–To Hold from SELL. A new product offering is a hopeful sign that the announced 54 percent dividend cut for this year will be the last.

Dundee Industrial REIT (TSX: DIR-U, OTC: None)–To Buy @ 11 from Hold. The owner of industrial properties is successfully adding scale to its operation while maintaining a strong balance sheet. The monthly distribution is CAD0.05625 per unit.

Extendicare Inc (TSX: EXE, OTC: EXETF)–To Buy @ 8 from Hold. Cuts in Medicare reimbursement are still a threat. But the US fiscal cliff deal limits immediate risk to the dividend, while a cut is already priced in.

Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–To Buy @ 18 from Hold. The purchase of Elbow River limits uncertainty from the pending expiration of a major fuel supply contract and is strongly accretive to distributable cash flow.

Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–To Buy @ 22 from Hold. The share price has backed off and is again at a value level.

PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–To Buy @ 9 from Hold. The financially strong, geographically diversified and technologically advanced rig operator is the best bet in a sector that continues to face severe headwinds.

Poseidon Concepts Corp (TSX: PSN, OTC: POOSF)–To SELL from Hold. The elimination of the dividend, sacking of key executives and planned writedown of previously booked revenue are plenty of reason to doubt the company’s ability to continue as a going concern.

Primaris Retail REIT (TSX: PMZ-U, OTC: PMZFF)–To Hold from Buy @ 20. The retail REIT’s units have surged due to an unsolicited takeover offer of CAD26 per unit from a private capital firm. Management is resisting the offer and may get a higher bid, but the REIT’s unit price will probably dip if the suitor walks away.

Progress Energy Resources Corp—To Acquired from SELL. The merger with Petronas is complete, and shareholders should by now have received CAD22 per share in cash.

PRT Growing Services Ltd—To Acquired from SELL. Investors should have received CD4.45 per share in cash by this time.

WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF)–To Hold from Buy @ 16. The stock has surged well past our buy target, but high-flying airline shares have a way of plummeting to earth on the slightest disappointment.

Ratings Changes

Algonquin Power & Utilities Corp (TSX: AQN, OTC: AQUNF)–To 5 from 4. Recent acquisitions of operating utilities and successful permanent financing have added visibility to long-term earnings growth.

AvenEx Energy Corp (TSX: AVF, OTC: AVNDF)–To 0 from 1. The surprising sale of the Elbow River marketing unit radically changes the revenue mix. The company plans a special meeting for shareholders on Feb. 19, 2013.

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–To 4 from 3. The coupon rate on debt maturing the next two years averages 2 percentage points more than the yield-to-maturity on the company’s five-year debt. Refinancing will cut interest costs.

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–To 2 from 3. Management has affirmed its intention to maintain the current dividend but volatile natural gas liquids prices limit predictability of future profits.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–To 3 from 4. The political situation in Ontario appears increasingly unsteady, as are the province’s finances. The potential impact of possible rate cuts on future earnings reduces dividend safety.

Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–To 4 from 5. Capital spending plans are on track, but volatile oil prices limit profit visibility for 2013.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–To 2 from 3. A spike in 2013 capital spending will likely reduce cash available for distribution. Deterioration in the zinc market could pressure the dividend.

Poseidon Concepts Corp (TSX: PSN, OTC: POOSF)–To 0 from 1. As if this company doesn’t have enough troubles, there’s CAD55.54 million drawn on its CAD100 million credit line that matures June 30, 2014. After the stock’s recent waterfall drop, that’s an amount nearly equal to half of the company’s current market capitalization.

Safety Ratings

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

Payout Ratio–A ratio below our proprietary industry baseline.
Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
Dividend History–No dividend cuts over the preceding five years.

Resources

The following Resources may be found in the top navigation menu at www.CanadianEdge.com:

Ask the Editor–We will reply to your queries via email or in an upcoming article.
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Cross-Border Tax Guide–What you need to know about taxes and Canadian investments.
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CE Safety Rating System–In-depth explanation of the proprietary ratings system and how to use it effectively.
Special Reports–The most recent reports for new subscribers. The most current advice is always in your regular issue.
Tips on DRIPs–Details for any dividend reinvestment plan offered by Canadian Edge Portfolio Holdings.