Teal Linde, manager, Linde Equity Fund

FOCUS: North American mid and large-cap stocks

MARKET OUTLOOK:

Compelling dividends add to the attractiveness of the Canadian market.  

The U.S. stock market looks like it will deliver a double-digit percentage gain in the first half of 2023, driven almost entirely by Apple, Microsoft, Amazon, Alphabet, Nvidia, Tesla and Meta (dubbed the Magnificent Seven by some). The Canadian market has only delivered low single-digit percentage returns, with IT giants Shopify and Constellation Software accounting for about two-thirds of the gains for the entire TSX Composite so far in 2023.

The financials and energy sectors, which together make up almost half of the TSX Composite’s market capitalization, have both had mediocre returns year-to-date, with financials essentially flat and energy down in the high single digits percentage-wise. Financials have suffered from concerns stemming from bank failures in the U.S. and Switzerland while energy has fallen on weaker oil and gas prices. 

This had led to some compelling dividend yields among Canada’s largest stocks. In the last 12 months, all six major Canadian banks, three major life insurers (Manulife, Sun Life and Great-West Life) and the four biggest players in the Canadian energy sector (Enbridge, Canadian Natural Resources, TC Energy and Suncor) have all increased quarterly dividends and all yield more than four per cent at current prices. Canadian high dividend payers are generally financially strong and now offer an interesting combination of good dividend payouts and potential growth going forward.

Strong and rising dividends are often an indication that companies believe in their ability to deliver results in the future because no company wants to cut its dividend, for what it says about its prospects. The strong yields among Canada’s largest stocks can provide income while waiting for growth to return for these companies and provide yield support should the broader market fall. Current attractive dividends support longer-term prospects for the Canadian markets. 

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TOP PICKS:

TD BANK (TD TSX)

Last purchased on April 19, 2023, at $83.03

Rarely do we ever see TD Bank trading at under 10 times earnings and its dividend yield near five per cent. Yet, today TD is trading at 9.6x this year’s expected EPS and yielding 4.7 per cent. TD Bank historically trades closer to the same valuation as Royal Bank, and the two banks usually hold the top two positions for the highest P/Es. Today TD Bank ranks third behind Royal Bank and National Bank, and is a full 1.5 multiple points below Royal Bank which is trading at 11.1x this year’s expected EPS. Royal Bank isn’t overpriced, TD Bank appears underpriced. TD Bank is also the most capitalized bank of the Big Six with an estimated $16 billion of excess capital. It recently announced a plan to use some of that capital to buy back 30 million shares, or 1.6 per cent of shares outstanding before the end of the summer at a cost of about $2.6 billion – still a small portion of its $16 billion available. The combination of its annual dividend yield of 4.7 per cent, and buying back 1.6 per cent of its shares for a combined 6.3 per cent yield of returned capital, and historically low valuation, all point to capital appreciation upside.

TC ENERGY (TRP TSX)

Last purchased on April 13, 2023, at $56.39

TC Energy is one of the highest dividend yielders on the TSX with a dividend yield of 6.7 per cent. It is able to achieve this high dividend yield while keeping its payout ratio, based on earnings, at less than 100 per cent. There has been a tendency over the last couple of decades for more companies to pay out annual dividends that exceed annual earnings, and instead base the payout ratio on distributable cash flow, which gives them more leeway. This is acceptable, but payout ratios based on cash flow are not as conservative as payout ratios based on earnings, with depreciation expense being the major difference. TC Energy also trades at 13 times the expected EPS of $4.25 for this year and is the subject of considerable insider buying. Over the last year, insiders have purchased nearly $4 million worth of stock and sold only $2,000 worth. TC Energy’s stock is also trading near the bottom end of its 10-year trading range.   

ARITZIA (ATZ TSX)

Last purchased on May 3, 2023, at $33.35

Aritzia’s stocks took a major hit last month after announcing strong quarterly results. It disclosed increased investment spending to support its industry-leading growth that is expected to contribute to a decline in adjusted EBITDA margins from 16 per cent to 12 per cent for the current fiscal year. Management, however, expects EBITDA margins to return to 16 per cent the following year as transitory distribution center pre-opening costs, inflationary pressures, and inventory storage costs subside. The company is now trading at 25 times the current fiscal year’s expected earnings. But upon normalized earnings expected next year, it is trading at a forward P/E of ~15.  Given the company’s track record and ability to grow double digits in the years ahead in terms of retail square footage, revenues and EPS, Aritzia is unlikely to trade at such a low P/E by this time next year and therefore should be trading higher. 

PAST PICKS: June 20, 2022

NATIONAL BANK OF CANADA (NA TSX)

• Then: $88.47
• Now: $98.82
• Return: 12%
• Total Return: 17%

AIR CANADA (AC TSX)

• Then: $17.83
• Now: $23.18
• Return: 30%
• Total Return: 30%

ENSIGN ENERGY SERVICES (ESI TSX)

• Then: $3.66
• Now: $2.07
• Return: -43%
• Total Return: -43%

Total Return Average: 1%