Sep 17, 2018

Douglas Kee's Top Picks: Sep. 17, 2018

BNN Bloomberg

Douglas Kee , BNN Bloomberg

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

MARKET OUTLOOK

While global economic growth is forecast in the 3 to 3.5 per cent range, there are signs of slowing growth in Europe and China. The U.S. on the other hand recorded above 4 per cent growth in Q2 and we would expect strong growth for the remainder of the year. Employment growth in the U.S. remains robust, which bodes well for consumer spending. A friendlier regulatory landscape and recent tax cuts will continue to boost corporate spending. In Canada the economy is slowing, given more modest job growth, slower housing activity and investment and trade concerns for business.

Inflation in both Canada and the U.S. is moving up due to employment growth and increasing wage pressure. Also recently imposed tariffs are negatively affecting input costs on manufactured goods. Excess capacity, technological change and demographics should keep inflationary pressures manageable. We expect that the U.S. Federal Reserve and the Bank of Canada will continue to raise administered interest rates into 2019, but in a measured fashion.

Since the beginning of the year market valuations (price-to-earnings) have actually moderated somewhat, with earnings rising faster than expected. We would expect that earnings growth momentum is peaking and that earnings growth will moderate in 2019 back towards long-term trend line growth of about 6 per cent. Our valuation range for the S&P/TSX Composite remains 14,600 to 17,500. We have been accumulating cash through dividends received and by trimming positions. We remain committed to companies that provide current income and superior dividend growth prospects.

TOP PICKS

SCOTIABANK (BNS.TO)
Last purchased at $75.

Shares of Scotiabank are down approximately 8 per cent year-to-date, underperforming the market and its peers. The market has a number of concerns: the bank spending about $7 billion on acquisitions this year, the NAFTA negotiations and their effect on the Mexican economy, and the volatility of emerging market economies where Scotiabank has a higher exposure. We believe these concerns are short-term in nature and provide an attractive entry point. Q3 earnings were solid, with strength in Canadian and international retail banking. The stock provides a 4.5 per cent yield, raised its dividend by 7.5 per cent this year and has guided towards 7 per cent earnings growth in the medium term.

FORTIS (FTS.TO)
Last purchased at $42.

Utility stocks have been under pressure this year, with Fortis down approximately 9 per cent. Rising short-term interest rates have hurt valuations and may pressure the stock price further in the short term. Fortis shares are a solid, defensive investment with 97 per cent of assets regulated and have diversified utility operations in Canada, the U.S. and the Caribbean. Rate base growth is forecast to be 5.5 per cent yearly for the next five years. The shares currently yield 4 per cent; the company will likely raise its dividend 6 per cent this year and has guided for 6 per cent dividend growth annually until 2022.

SUN LIFE FINANCIAL (SLF.TO)
Last purchased at $50.

Sun Life’s core life insurance businesses in Canada and the U.S. provide steadily growing cash flow to reinvest in faster growing businesses such as insurance in Asia and wealth management. While recent earnings were in line with expectations, Sun Life remains challenged by asset outflows at U.S. mutual fund provider MFS. MFS is streamlining its offerings and rationalizing operations. Management has indicated that even with flat earnings from MFS the company can achieve 8 per cent to 10 per cent earnings growth over the medium term. Sun Life has about $2.4 billion in excess capital at the holdco level and generates approximately $750 million of cash per year. This cash can be utilized for further acquisitions, share buybacks and further (4 to 5 per cent) dividend increases.