Douglas Kee's Top Picks: March 13, 2019

Douglas Kee, chief investment officer at Leon Frazer & Associates

Focus: Canadian dividend stocks

MARKET OUTLOOK

• From the market peak in Q1/18 to the trough in December last year, the S&P 500 index was down nearly 20 per cent. With the combination of rising interest rates, slowing economic growth outside the U.S., slowing earnings momentum, year-end liquidity constraints and ongoing trade war fears all pressured the market. Since the beginning of the year, the market has rebounded by approximately 11 per cent and is essentially flat year-over-year.
• The tone of the market has improved aided primarily by lower U.S. interest rates and a more cautious federal reserve. Q4 corporates earnings came through as expected and forward guidance was positive. The year’s earnings growth is forecast to be in the five per cent to seven per cent range. Challenges remain with the global economy continuing to slow, U.S. economic growth is forecasted to trend down, the high U.S. dollar hindering exports and corporate earnings. While the China-U.S. trade negotiations seem to be on a positive footing and a short-term agreement may happen, major structural changes will require more time.
• We remain cautious on the market outlook but view it as fairly valued based on current interest rates, inflation expectations and earnings growth. We are in the process of gradually reducing our cash holdings that were built up over last year. We have added defensive positions in energy and consumer discretionary, while also continuing to favour backbone sectors such as banks, utilities, pipelines and telecom services. Our portfolio provides attractive current income and superior dividend growth prospects.

TOP PICKS

FORTIS (FTS.TO)

Last purchased at $48.50.

• FTS is a core holding, would prefer to buy in the $44.00 to $46.00 range. The stock has run up recently on lower bond yields and hot money buying defensive stocks.
• Current yield is 3.7 per cent, one year dividend growth of six per cent and five year growth of eight per cent annualized. Expect six per cent dividend growth in 2019.
• Geographical and regulatory diversification in Canada, U.S. and Caribbean. Strength in electric distribution, transmission and natural gas distribution.
• Five year capex program of $17 billion primarily funded through cash flow, regulated debt, asset sales anddividend reinvestment plan (DRIP).
• Six per cent to seven per cent rate base growth back stops earnings and dividend growth

SCOTIABANK (BNS.TO)

Last purchased at $72.50.

• BNS share price has lagged against its peers on a year-to-date level and has declined about five per cent since Q1 earnings were released. While international property and casualty (P&C) earnings were strong, contributions from Canada P&C and capital markets were light versus forecasts.
• The bank closed $7.0 billion worth of acquisitions in 2018 which will add scale and be accretive to earnings over the next few years. As well, BNS is rationalizing international investments to concentrate on growth markets.
• Stock currently yields 4.8 per cent, one year dividend growth 7.5 per cent and five year with 6.5 per cent annualized. Semi-annual dividend increase in Q1 of 2.4 per cent.

CANADIAN TIRE (CTCa.TO)

Last purchased at $145.50.

• CTC has a long successful track record in retail, real estate and financial services. In the past the company has made retail acquisitions (Mark’s, FGL Sports) which have added scale, differentiated offerings and have been accretive to earnings.
• Last July, CTC acquired Helly Hansen for $1.1 billion, a global brand in sportswear and workwear. The market didn’t like the purchase due to the nature of the business and the price paid. We believe that CTC has a proven acquisition record, will benefit from global sales growth exposure and the considerable margin leverage as an integrated brand owner.
• Stock currently yields 2.8 per cent, one year dividend growth 38.5 per cent and five year growth of 26.4 per cent annualized.

PAST PICKS: March 7, 2018

TD BANK (TD.TO)

• Then: $75.83
• Now: $75.16
• Return: -1%
• Total return: 3%

CN RAIL (CNR.TO)

• Then: $94.09
• Now: $117.40
• Return: 25%
• Total return: 27%

FORTIS (FTS.TO)

• Then: $42.42
• Now: $48.81
• Return: 15%
• Total return: 20%

Total return average: 17%