Mar 7, 2018

Douglas Kee's Top Picks: March 7, 2018

BNN Bloomberg

Kee , BNN

Douglas Kee, chief investment officer at Leon Frazer & Associates
Focus: Canadian dividend-paying stocks

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MARKET OUTLOOK

The global economic prospects remain constructive, with growth forecast in the 3.0 per cent to 3.5 per cent range in 2018. Strength will continue in Asia, with India and China near the 6 per cent level.

Growth in china is moderating due to slower infrastructure and consumer spending reflecting restrictive monetary policies. Europe and Japan will grow in the 2.5 per cent area — the best profile for this business cycle — reflecting still accommodative monetary policy.

Growth in North America will continue strong in the first half, but should moderate later in the year due to the effect of rising interest rates on consumer spending. Inflation in Canada and the U.S. is finally showing signs of increasing to near the 2 per cent level, given rising employment and increasing wage pressures. But excess capacity, technological change and demographics will keep inflation manageable.

The recent equity market correction was long overdue and has reduced the speculative fever that was evident over the last number of months. Market valuation has come down somewhat and earnings expectations have improved, especially in the U.S. thanks to tax reform. Our valuation range for the S&P/TSX Composite remains 14,600 to 17,500, while we remain close to fully invested, we’re accumulating income cash and looking to reduce the economic sensitivity of the portfolio. We’re committed to companies that provide current income and have the potential to increase their dividends over time.

TOP PICKS

TD BANK (TD.TO) — $74.00

TD recently reported first-quarter 2018 earnings of $1.56 per share, well ahead of street estimates and reflecting strength in both domestic retail earnings (up 10 per cent year-over-year) and U.S. retail earnings (up 30 per cent). TD increased their annual dividend by 12 per cent and yields 3.6 per cent.

We’re at our maximum allowable weight in Canadian banks. While the banks may be challenged by slower mortgage growth in Canada, rising interest rates will benefit interest rate margins. Banks have been able to return value to shareholders through dividend increases and share buybacks.

CN RAIL (CNR.TO) — $97.00

Shares of CN Rail are down about 10 per cent from recent highs, reflecting challenging network capacity and fluidity problems experienced over the last couple of quarters. We believe that the problems will be solved by the second half, given management’s action to increase the availability of locomotives and crews, higher capital investments and improving weather. Management has maintained guidance and recently increased the dividend by 10 per cent, which brings the five-year dividend growth to 20 per cent per annum.

FORTIS (FTS.TO) — $42.25

Fortis shares are off by about 14 per cent from 2017 highs primarily due to rising interest rates/multiple contraction and, more recently, the negative impact of U.S. tax reform. The company’s utility business is well-diversified from both a regulatory and geographical point of view.

Rate base growth is forecast to be more than 5 per cent to 2022 with upside if any of the proposed infrastructure projects come to fruition. While there may be further downside in the share price due to higher rates, the company will recoup higher interest costs over time. The current yield is 4 per cent, which management has guided to grow 5% per year. Fortis is a core holding.