In This Issue

TAX FILING BLUES

By Gordon Pape

Now that the tax deadline has passed, I’d like to know whether many people had the same problems I encountered in trying to use Netfile. It’s been a long time since I had such a frustrating day (two of them, actually).

It’s an important issue because the Canada Revenue Agency is aggressively encouraging all of us to file electronically. They don’t even send paper returns any more. If you want to file the old-fashioned way you have to download a return from the CRA site or trek to the nearest post office to pick up a form.

When you go to 2012 Tax Package page on the CRA website, right at the top is an inducement to submit your return electronically. “Filing online is easy and we can help you,” the site proclaims. “Let us walk you through it step by step.”

Good luck with that. I tried filing my return by Netfile several times. On each occasion, my TurboTax Home and Business software told me I had no errors and was eligible for Netfile. Each time, the CRA returned a message stating: “Your tax return has not been accepted. It contains errors that need to be corrected.” That was followed by an attempt to identify the error that made no sense. There was a number – 180003 – followed by a line that read: “The first digit of the message number on the left identifies one of your financial statements.” Really? Which one? The rest of the message was unable to clarify that.

When I called the CRA helpline for the promised step-by-step walkthrough, I was told that the problem was with the TurboTax software and I needed to contact their technical support line. “It’s a known flaw in TurboTax,” the CRA rep said after consulting with her supervisor. She couldn’t help.

There were three problems with the CRA’s advice. First, the error message originated from them, not from TurboTax. Second, the TurboTax technical support centre is in India – I know because I asked. In all, I spoke to three people there. All were male, all had heavy accents, and all spoke extremely quickly. To make matters worse, there was an echo on the line, presumably because of the distance involved. The result was that the advice I received was virtually incomprehensible.

The third problem, which was identified after a lot of shouting into the phone at both ends and repeated pleas from me to speak more slowly, was that TurboTax technical support knew nothing about the “known flaw” described by the CRA. I was asked to submit a page grab of the error message and a file containing my return for analysis. I would get a reply in one to three days. The filing deadline was less than 48 hours away.

I gave up and filed a paper return. I know that’s not what the CRA wants but it was that or more days of frustration. At that point, I had lost all faith that either the CRA or TurboTax could resolve the issue.

If Ottawa wants us all to file electronically, it’s time for the CRA to step up and offer a free, glitch-free software program that anyone can use. As things stand right now, there are 12 approved Windows-based programs listed on the CRA website, 14 online programs, three Mac packages, and two programs for mobile devices. The CRA promotes the fact that some of the programs are free but these are usually for people with low income or very basic returns.

TurboTax by Intuit is the top-selling package in Canada but as my experience shows it has problems even though it is CRA-approved. I did not try any of the other packages (I will next year, believe me!) but I cannot believe they are all error-free.

If you have a Netfile story to tell, I’d like to hear it. Now that the CRA has decided that it wants all Canadians to go this route, the government needs to know if there are major bugs in the current system.

Perhaps mine was an isolated case. But somehow, I suspect it wasn’t.

 

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CANADA LAGS THE WORLD

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Contributing editor Gavin Graham joins us this week with a look at what’s happening in world markets and some thoughts about the sharp drop in the price of gold. Gavin is an expert in global investing and is president of Graham Investment Strategy. Here is his report.

Gavin Graham writes:

The boom in world stock markets continues unabated, with only temporary pauses for breath. As of the end of April, the MSCI World Index was up 13.2%, the S&P 500 had gained 11.8%, and the MSCI EAFE (Europe, Australasia & the Far East) Index was up 8.8%. The latter was held back by the relative weakness in European markets, with Germany only up 6%. Japan has been the outperformer here, as Gordon noted in last week’s issue, up a remarkable 33% in yen terms, although the attendant weakness in the currency has reduced returns for Canadian investors to a still very respectable 19%.

Of course, this is what happens when the new Prime Minister, Shinzo Abe, makes it clear to the Bank of Japan that he wants the country’s two decade long experience of deflation to be addressed. The Bank of Japan has raised its GDP growth forecast for the 2013-14 fiscal year from 2.3% and forecasts that inflation will hit 1.9% by 2015.

Some investors are concerned that the domestic holders of 10-year Japanese government bonds (JGBs) yielding 0.6% will start to sell their enormous positions once they realize that they are guaranteed to lose money on their holdings in real terms if the Bank of Japan is successful. However, skepticism remains that this attempt to kick-start the moribund Japanese economy will be any more successful than previous efforts. That should be enough to prevent any immediate panic.

In the meantime, equity holders are enjoying a 61% increase in the Nikkei 225 Index since mid-November in yen terms. Analysts are upgrading company earnings forecasts after the 22% fall in the yen from Y77.5=US$1 in September to Y94.5 today, which will boost the earnings of Japanese exporters next year.

Amid all of this excitement, Toronto remains the odd man out. As of the end of April, the S&P/TSX Composite Index was almost flat. This is mainly due to its high weighting in resource stocks, which comprise almost 40% of the index by market capitalization.

The problem has two separate parts. The first is the economically sensitive energy and base metals companies, which are reflecting investors’ concerns over slower Chinese and Indian GDP growth this year. India’s GDP in the fiscal year just ended came in at 5%, well down from the 8% it has averaged for most of the last few years. China’s new leadership is forecasting GDP growth of 7.5%, the slowest for five years.

In response, oil, copper, and metallic coal are all down from their highs of the last 12 months. A barrel of West Texas Intermediate (WTI) crude was selling for US$94.50 at the time of writing, down from US$106.50 a year ago. It actually dipped below US$90 a barrel a couple of weeks ago. North Sea Brent crude has fallen from over US$120 to US$102 a barrel.

Copper tells the same story. Some people call it Dr. Copper, the metal with a PhD in economics, due to its extensive use in many industries and its track record of predicting economic booms and slowdowns. It touched US$3.80 a pound three times in the last year (in May and October 2012 and February this year) but is now off 20%, selling at US$3.25 at present.

It’s therefore unsurprising that the shares of many Canadian energy producers are off this year. These range from Husky Energy (-1.4%) and Canadian Oil Sands (-4%) through to Imperial Oil (-6.3%), Suncor (-9.4%), and Penn West (-4.2%).

Meanwhile, base metal producers First Quantum and Teck Resources are off 21% and 27% respectively. These declines at least have the merits of being logical, assuming that slower growth in China and India is likely to continue for the remainder of 2013.

The carnage in the gold mining sector, however, is difficult to justify, given how badly the mining companies had underperformed the metal itself over the last two years. In my review of my gold mining recommendations a few weeks ago, I noted that the gold miners were now as cheap compared to gold itself as at any time since the beginning of the gold bull market in 1999. This valuation has become even cheaper despite gold’s US$200 plunge from US$1,565 per oz. to US$1,335 per oz. between Friday April 11 and Tuesday April 15. The sudden drop was seemingly triggered by worries over Cyprus being forced to sell its US$400 million in gold reserves as part of its rescue package.

While the SPDR gold bullion ETF (NYSE: GLD) is down -12.2% year-to-date, the iShares Gold Mining ETF (TSX: XGD) is off -34.2%. The BMO Junior Gold Mining ETF (TSX: ZJG) is down a whopping -40.2% for the year as junior miners struggle to raise financing to keep going and develop their properties.

Over the last 12 months gold itself is only off 11.8%, with all the decline occurring this year. Despite this, it is still up 7.6% per year over the last three years. That compares to a return of -0.6% per year over the same period for the S&P/TSX 60 Index. XGD is off 17.6% per year and ZJG has lost 19.8% per year over the same three-year period.

Some of this reflects justified disappointment at delayed mines, overpaying for developments, expropriations by unfriendly regimes, and the rising costs of personnel, fuel, infrastructure, and other inputs which have squeezed miners’ profits. However, my recommendations of Franco-Nevada (TSX, NYSE: FNV), Goldcorp (TSX: G, NYSE: GG), and Agnico-Eagle (TSX, NYSE: AEM) remain Buys.

One reason for this is that their production is increasing. Agnico-Eagle’s output is expect to rise 20% while Goldcorp should be up 70% over the next couple of years, regardless of the level of the gold price.

As for royalty company Franco-Nevada, four new developments are coming on stream. The company is insulated from rising costs through its business model, which sees it receive between 0.5% and 5% of the value of everything produced from mines with which it has royalty agreements. If investors want a lower risk way to play precious metals, then Franco-Nevada is the best way to do so. The stock is down a mere 3.5% over the last year and up 17.5% per year, compounded, over the last three years. Along the way, it has not only outperformed the other mining stocks but even beaten gold itself.

I can’t tell you exactly when the gold mining stocks will turn around. But I’m confident it is going to happen, perhaps sooner rather than later.

 

GAVIN GRAHAM LIKES HONDA

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Last week, Gordon recommended the currency neutral iShares Japanese Fundamental Index Fund (TSX: CJP) as a means of playing the recovery in that country. I would also suggest looking at some of the Japanese automakers with American Depository Receipts (ADRs) that trade in New York. I especially like Honda Motor (NYSE: HMC).

Honda is a great way to benefit from the 20% decline in the Japanese yen since new Prime Minister Shinzo Abe demanded the introduction of an accelerated form of quantitative easing (QE) at the Bank of Japan. As the eighth largest auto producer in the world and the largest motorcycle manufacturer, Honda is well placed to benefit from a cheaper yen.

At Y100=US$1, Morgan Stanley calculates Japanese automakers’ top lines will receive a boost of US$2,000 for each car they sell in the States (the exchange rate last week was Y97.24=US$1.

Although Honda makes more than 90% of the cars it sells in North America in the U.S, and Canada, compared to two-thirds for Toyota and Nissan, it still receives the benefit of reporting U.S. and Canadian sales in a weaker yen. Plus, the weakness of the Japanese currency helps its sales in other markets such as China and India, against its Korean, U.S., and European rivals.

Like the other Japanese carmakers, Honda has moved much of its production offshore over the last 6-7 years, from 2006 when the yen was trading at Y115=US$1. With its joint ventures in China (Guangzhou Honda and Dongfeng Honda), India (Hero Honda Motorcycles and Siel Honda), Pakistan (Honda Atlas), and Malaysia (Boon Siew Honda), Honda has established lower cost manufacturing bases in addition to its operations in North America and the U.K.

While Honda’s sales in China have been affected by the anti-Japanese sentiment due to the ongoing dispute between China and Japan over the Senkaku islands in the East China Sea, sales are continuing to grow in other emerging markets. Honda’s focus on innovative front-wheel drive cars, based on its experience with motorcycle technology, makes it well equipped to provide suitable vehicles for the emerging market middle classes.

Five of the top ten models for fuel economy over the last quarter-century in the U.S. have been made by Honda, according to the U.S. Environmental Protection Agency. Honda has also been innovative in brand introductions, being the first Japanese manufacturer to launch a separate luxury brand with the Acura in 1986 and the first mid-engine all aluminum sports car, the Honda NSX, in 1991, which employed variable valve timing technology, known as VTEC.

While Honda and other Japanese automakers have had to recall several million cars in North America this year due to a defective component in their airbags, this is a general problem not specific to Honda alone. The supplier of the component has agreed to reimburse the auto companies for the expense of the recall.

In the fiscal year ended March 31, Honda earned $3.9 billion ($2.17 per share, figures in U.S. dollars), up 52% from $2.8 billion ($1.43 per share) the year before. Sales were $105 billion, up 5% from $100 billion for the previous year. The company saw sales recover from the after-effects of the Fukushima earthquake in March 2011 and the flooding in Thailand later that year, where many Japanese automakers produce parts.

For the fourth quarter of the 2013 fiscal year, automobile revenues were up 16% to $22.7 billion with operating income up 71% to $822 million. Motorcycle revenues increased 5% to $3.99 billion but net income was down 23% to $276 million. Financial services revenues were up 17% to $1.6 billion with operating income up 14% to $435 million. Honda’s smallest division, power products, which produces lawnmowers, marine engines, chainsaws etc., saw revenue gain 12% to $863 million but its loss increased from $22 million to $79 million.

For the fiscal 2013-14 year, Honda is forecasting revenues up 23% to $128 billion, based on an exchange rate of Y95=US$1. The company expects operating income to increase 43% to $8.2 billion and net income to be up 58% to $6.1 billion ($3.38 per share).

The company will be raising its dividend 5% from Y76 to Y80. This would put Honda at a forecast price/earnings ratio of 11.5 times and a dividend yield of 2.1%, compared to Toyota which has a forecast p/e ratio of 15.6 times and a 1.3% yield.

Toyota stock has risen by 44% in US$ terms over the last year, while GM is up 38% and Ford 19%. Meanwhile, Honda has trailed with an advance of only 11%. So Honda is both cheaper and has underperformed despite benefiting almost as much from the recovery in Japanese auto production and sales and the weakness of the currency.

The industry has upward momentum right now. Auto sales in April were at their highest level for the month since 2008 with Honda Canada among the companies posting the biggest gains. Cyclical industries such as automakers and my other auto sector recommendation, parts maker Linamar (TSX: LNR) are stocks that should be bought and sold rather than held for the long term. This is the correct stage in the auto cycle to own these companies.

Action now: Honda is a Buy. The shares closed on Friday at US$40.24.

– end Gavin Graham

 

GORDON PAPE’S UPDATES

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Metro Inc. (TSX: MRU, OTC: MTRAF)

Originally recommended on Aug. 27/12 (#21230) at C$57.93, US$58.37. Closed Friday at C$69.24, US$65.93 (April 29).

Metro continues to perform to expectations with the shares showing a gain of 9.7% since our last update in mid-March when they were trading at $63.14 on the TSX.

On April 24 the company released results for the second quarter of fiscal 2013 (to March 16). They showed a year-over-year drop in revenue of 2.6% to $2.51 billion which the company said was caused by a shift in the reporting of pre-Christmas week results into the first quarter, the closure of some unprofitable stores in Ontario, and “temporary efficiency difficulties” in the pharmaceutical division following the implementation of a new warehouse management system.

On the plus side, adjusted net earnings from continuing operations were up 4.4% to $100.5 million ($1.02 per share) from $96.3 million ($0.94 a share) in the comparable period of fiscal 2012. Net earnings increased 282% to $366.8 million ($3.77 a share) however that included an after-tax profit of $266.4 million from the sale of about half Metro’s stake in Alimentation Couche-Tard.

Metro continues to actively repurchase its shares. The current normal course issuer bid allows it to buy up to six million shares in the year ending Sept. 13. Thus far, the company has bought back just over 2.3 million shares at an average price of $60.29 for a total cost of $140.1 million. Metro also said that it has private agreements with an arm’s-length third party seller to buy back up to one million shares at a price to be negotiated.

The stock pays a quarterly dividend of $0.25 a share ($1 a year), which was increased by 16% effective with the February payment. The next dividend is due on May 21. At the current price, the stock yields 1.4%.

Action now: Metro continues to be a Buy for conservative investors seeking modest income and long-term growth.

Suncor Energy (TSX, NYSE: SU)

Originally recommended on June 12/06 (#2622) at C$41.63, US$37.57 (split-adjusted). Closed Friday at C$31.09, US$30.86.

Almost everyone expected Suncor to announce a dividend increase when it released its first-quarter results. But few people predicted it would be by so much. The 54% hike, to $0.20 a share quarterly, combined with a share buy-back program of up to $2 billion, was welcome news for investors who pushed up the price of the stock by almost 6% on Tuesday.

The company was sitting on a horde of cash, much of which had been earmarked for the now-cancelled Voyageur upgrader program. As well, Suncor announced in mid-April that it has reached an agreement to sell a significant portion of its natural gas business in Western Canada for $1 billion. With future development ramping down, the company decided to do something to reward patient shareholders who have been holding a stock that has gone nowhere in recent years.

“Suncor’s unique integrated business model is driving strong and consistent financial results, allowing us to make a step change in the dividends we pay our shareholders while continuing to invest in profitable growth,” said CEO Steve Williams. “We have the resources, the assets, the balance sheet and the strategy to continue to grow shareholder returns.”

First-quarter operating earnings came in at $1.367 billion ($0.90 per share), compared to $1.318 billion ($0.84 per share) for the same period of 2012. However, net earnings dropped to $1.094 billion ($0.72 per share) from $1.446 billion ($0.93 per share) last year due to a $127 million charge for the cancellation of Voyageur and a $146 million after-tax foreign exchange loss on the revaluation of U.S. dollar denominated long-term debt.

Cash operating costs per barrel for Oil Sands operations decreased in the quarter, averaging $34.80 per barrel compared to $38.10 per barrel in the first quarter of 2012 due to higher production volumes.

The increased dividend will be paid on June 25 to shareholders of record as of June 4. Based on a $0.80 per share annual payout, the stock yields 2.6% at the current price.  

Although the news of the dividend hike and share buy-back program are welcome, what we really need to see from Suncor is increasing profits and production. Until there is some evidence of that, the stock remains a Hold.

Action now: Hold.

CGI Group (TSX: GIB.A, NYSE: GIB)

Originally recommended on Aug. 20/12 (#21229) at C$24.42, US$24.66. Closed Friday at C$31.31, US$31.08.

We got another good news story last week, this one from CGI Group. The company reported strong results for its second quarter of fiscal 2013. Revenue was up 137% to $2.53 billion, bookings were up 180% to $2.2 billion, and the $18 billion backlog was up 37%.

Those are heady numbers but the bottom line wasn’t quite so bright. CGI posted a profit of $114.2 million. That was up from $105.7 million a year ago, but down on a per share basis from $0.40 to $0.36. The reason for the decline in earnings per share was the on-going cost of integrating U.K.-based Logica, which was acquired last year, into CGI’s corporate fabric.

In a statement, the company said it has expanded its integration goals, increasing the annualized savings target from $300 million to $375 million by the end of fiscal 2014 and completing the program a year earlier than originally planned. “To realize these additional benefits and incremental EPS accretion, the company will increase its investment from $400 million to $525 million over the integration period,” the statement said.

In a research report published after the results came out, RBC Capital Management said this was the first quarter since the acquisition when Logica’s margins beat expectations. Analyst Paul Treiber wrote that the first phase of the integration “delivered faster than expected accretion” and raised his target price to $38, from $33.

Investors were enthusiastic enough to push the price higher by $4.87 in Toronto or 18%. That’s a huge one-day move for any stock. The shares finished the week at C$31.31, US$31.08.

Action now: I’m putting the stock on Hold because big price jumps are often followed by a pull-back and consolidation. Buy if the shares fall below $30.

 

AFTER DPS, WHAT?

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I received an e-mail last week from a reader who followed my advice about Diversified Preferred Share Trust (TSX: DPS.UN). She wrote: “We sold our entire position of Diversified Preferred Shares today. We made a nice capital gain since we purchased more during the 2008 crash and also have received a nice dividend. Can you please suggest some alternatives now? This was in a RRIF where we need the maximum cash flow possible without too much risk.” – Jane S.

Good question. The closest thing to DPS is the iShares S&P/TSX Canadian Diversified Preferred Share Index Fund (TSX: CPD). As the name suggests, this ETF tracks the performance of the S&P/TSX Preferred Share Index, less fees and expenses. It holds a total of 180 positions, almost all of which are preferreds issued by blue-chip companies such as banks, telecoms, utilities, and insurance firms. Almost 70% of the holdings are rated Pfd-1 or Pfd-2, the two highest levels given by the rating agencies.

Over the year ending March 31, the fund posted a total return of 6.03% compared to an advance of 6.71% for the index. That’s a differential of 68 basis points (bp), which is higher than the MER of 50 bp (0.5%). This means the fund underperformed by 18 bp in relation to its mandate. We see the same pattern with the three-year numbers with the fund showing an average annual compound rate of return of 6.82% compared to 7.5% for the benchmark.

Distributions are paid monthly. The most recent payouts have been $0.061 per unit however you should not assume they will continue at that rate as the distributions have been gradually declining over the past year. (At this time in 2012 they were $0.069 per unit). If the present payout were to be maintained, investors would receive $0.732 per unit over the next year for a yield of 4.23% based on Friday’s closing price of $17.31.

The ETF was launched in April 2007 so we have enough of a track record to make an assessment. The only year in which it lost money was in 2008 when it dropped 17.2% Assets under management are almost $1.6 billion.

Another option is the BMO S&P/TSX Laddered Preferred Share Index Fund (TSX: ZPR). This takes a more focused approach, creating a five-year laddered structure using reset preferreds. This is done by dividing the holdings into five annual “buckets” which are equal weighted. Within each bucket, the securities are weighted according to market capitalization. One bucket matures each year and the assets are rolled over into a new five-year bucket. If all that sounds complex, think of it in terms as a simple GIC ladder. The concept is the same except in this case several securities are rolled over annually rather than a single GIC.

Does it work any better than the iShares entry? It’s too soon to say because this ETF has been around for less than six months – it was launched on Dec. 14, 2012. So far this year (to the end of April) the BMO fund has been the better performer with a gain of 1.98% versus 1.23% for the iShares ETF. But that’s too short a time frame to allow for any definitive conclusions.

The current monthly distribution is $0.054 per unit, which projects to $0.648 a year if it is maintained. At Friday’s closing price of $15.17 that would translate into a yield of 4.27%. So there is not a lot of difference between the two in yield terms.

This fund has assets of about $734 million and a maximum management fee of 0.45%. Since it has not been in existence for a year, we do not have an MER at this stage but it will probably be close to that of the iShares fund.

At this point, my choice would be CPD but only because it has a longer track record that enables us to gauge its consistency. The concept of the BMO fund is intriguing and it could end up being a better performer over time but much depends on what happens to the yields on the preferreds it holds when they are reset over the next few years. – G.P.

 

YOUR QUESTIONS

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U.S. dividends

Q – I understand there are tax considerations when investing in U.S. dividend stocks. However, if the shares are held in a TFSA are those implications no longer a concern? – Bill H.

A – The tax consideration to which you refer is the 15% withholding on dividends paid to Canadians from U.S. companies. This is covered by the Canada-U.S. Tax Treaty and it’s a two-way street – Americans have 15% withheld by the Canadian government when they receive dividends from this country.

The problem goes away if the dividends are paid into a retirement plan such as an RRSP or RRIF. But TFSAs do not benefit because they are not considered to be “retirement plans” and in fact did not even exist when the Treaty was last updated. So any U.S. dividends paid into a TFSA will be dinged for the 15% withholding. To make matters worse, you can’t claim a foreign tax credit for it because the money was paid to a tax-sheltered account. It’s gone, end of story.

If there is a bright side to this, that 15% is the only tax you’ll ever pay on the money. In the case of a RRIF or RRSP, while you avoid the withholding tax at the outset, by the time the money comes out it will more than likely be taxed at a much higher rate. – G.P.

Converting RRSPs

Q – I will be 67 this December and was wondering when would be the best time to start to convert my RRSPs to a RRIF.  I don’t want to be paying taxes all at once. – Theresa S.

A – I suggest you move just enough money into a RRIF now to take advantage of the pension income tax credit. It covers the first $2,000 of pension income and that includes RRIF payments for anyone 65 or older. If you have no other pension income (CPP and OAS don’t count), this will provide a tax break for you.

You can leave the rest of the money in the RRSPs until Dec. 31 of the year you turn 71. There is no reason to convert sooner; you’d just be putting yourself in a position of having to take forced RRIF withdrawals and paying the appropriate tax. – G.P.

 

MEMBERS’ CORNER

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Reporting foreign assets

Member comment: Re your warning about form T1135, paragraph 2 says we must report foreign assets if the value exceeds $100,000. This should read if the cost exceeds $100,000. There is a big difference between cost and value. Using the term value instead of cost is misleading. Please correct. – Myra A.
 
Response: Our reader is correct. I apologize for the error. – G.P.

 

That’s it for another week. We will see you again on May 13.

Best regards,

Gordon Pape

In This Issue

TAX FILING BLUES

By Gordon Pape

Now that the tax deadline has passed, I’d like to know whether many people had the same problems I encountered in trying to use Netfile. It’s been a long time since I had such a frustrating day (two of them, actually).

It’s an important issue because the Canada Revenue Agency is aggressively encouraging all of us to file electronically. They don’t even send paper returns any more. If you want to file the old-fashioned way you have to download a return from the CRA site or trek to the nearest post office to pick up a form.

When you go to 2012 Tax Package page on the CRA website, right at the top is an inducement to submit your return electronically. “Filing online is easy and we can help you,” the site proclaims. “Let us walk you through it step by step.”

Good luck with that. I tried filing my return by Netfile several times. On each occasion, my TurboTax Home and Business software told me I had no errors and was eligible for Netfile. Each time, the CRA returned a message stating: “Your tax return has not been accepted. It contains errors that need to be corrected.” That was followed by an attempt to identify the error that made no sense. There was a number – 180003 – followed by a line that read: “The first digit of the message number on the left identifies one of your financial statements.” Really? Which one? The rest of the message was unable to clarify that.

When I called the CRA helpline for the promised step-by-step walkthrough, I was told that the problem was with the TurboTax software and I needed to contact their technical support line. “It’s a known flaw in TurboTax,” the CRA rep said after consulting with her supervisor. She couldn’t help.

There were three problems with the CRA’s advice. First, the error message originated from them, not from TurboTax. Second, the TurboTax technical support centre is in India – I know because I asked. In all, I spoke to three people there. All were male, all had heavy accents, and all spoke extremely quickly. To make matters worse, there was an echo on the line, presumably because of the distance involved. The result was that the advice I received was virtually incomprehensible.

The third problem, which was identified after a lot of shouting into the phone at both ends and repeated pleas from me to speak more slowly, was that TurboTax technical support knew nothing about the “known flaw” described by the CRA. I was asked to submit a page grab of the error message and a file containing my return for analysis. I would get a reply in one to three days. The filing deadline was less than 48 hours away.

I gave up and filed a paper return. I know that’s not what the CRA wants but it was that or more days of frustration. At that point, I had lost all faith that either the CRA or TurboTax could resolve the issue.

If Ottawa wants us all to file electronically, it’s time for the CRA to step up and offer a free, glitch-free software program that anyone can use. As things stand right now, there are 12 approved Windows-based programs listed on the CRA website, 14 online programs, three Mac packages, and two programs for mobile devices. The CRA promotes the fact that some of the programs are free but these are usually for people with low income or very basic returns.

TurboTax by Intuit is the top-selling package in Canada but as my experience shows it has problems even though it is CRA-approved. I did not try any of the other packages (I will next year, believe me!) but I cannot believe they are all error-free.

If you have a Netfile story to tell, I’d like to hear it. Now that the CRA has decided that it wants all Canadians to go this route, the government needs to know if there are major bugs in the current system.

Perhaps mine was an isolated case. But somehow, I suspect it wasn’t.

 

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CANADA LAGS THE WORLD

Contributing editor Gavin Graham joins us this week with a look at what’s happening in world markets and some thoughts about the sharp drop in the price of gold. Gavin is an expert in global investing and is president of Graham Investment Strategy. Here is his report.

Gavin Graham writes:

The boom in world stock markets continues unabated, with only temporary pauses for breath. As of the end of April, the MSCI World Index was up 13.2%, the S&P 500 had gained 11.8%, and the MSCI EAFE (Europe, Australasia & the Far East) Index was up 8.8%. The latter was held back by the relative weakness in European markets, with Germany only up 6%. Japan has been the outperformer here, as Gordon noted in last week’s issue, up a remarkable 33% in yen terms, although the attendant weakness in the currency has reduced returns for Canadian investors to a still very respectable 19%.

Of course, this is what happens when the new Prime Minister, Shinzo Abe, makes it clear to the Bank of Japan that he wants the country’s two decade long experience of deflation to be addressed. The Bank of Japan has raised its GDP growth forecast for the 2013-14 fiscal year from 2.3% and forecasts that inflation will hit 1.9% by 2015.

Some investors are concerned that the domestic holders of 10-year Japanese government bonds (JGBs) yielding 0.6% will start to sell their enormous positions once they realize that they are guaranteed to lose money on their holdings in real terms if the Bank of Japan is successful. However, skepticism remains that this attempt to kick-start the moribund Japanese economy will be any more successful than previous efforts. That should be enough to prevent any immediate panic.

In the meantime, equity holders are enjoying a 61% increase in the Nikkei 225 Index since mid-November in yen terms. Analysts are upgrading company earnings forecasts after the 22% fall in the yen from Y77.5=US$1 in September to Y94.5 today, which will boost the earnings of Japanese exporters next year.

Amid all of this excitement, Toronto remains the odd man out. As of the end of April, the S&P/TSX Composite Index was almost flat. This is mainly due to its high weighting in resource stocks, which comprise almost 40% of the index by market capitalization.

The problem has two separate parts. The first is the economically sensitive energy and base metals companies, which are reflecting investors’ concerns over slower Chinese and Indian GDP growth this year. India’s GDP in the fiscal year just ended came in at 5%, well down from the 8% it has averaged for most of the last few years. China’s new leadership is forecasting GDP growth of 7.5%, the slowest for five years.

In response, oil, copper, and metallic coal are all down from their highs of the last 12 months. A barrel of West Texas Intermediate (WTI) crude was selling for US$94.50 at the time of writing, down from US$106.50 a year ago. It actually dipped below US$90 a barrel a couple of weeks ago. North Sea Brent crude has fallen from over US$120 to US$102 a barrel.

Copper tells the same story. Some people call it Dr. Copper, the metal with a PhD in economics, due to its extensive use in many industries and its track record of predicting economic booms and slowdowns. It touched US$3.80 a pound three times in the last year (in May and October 2012 and February this year) but is now off 20%, selling at US$3.25 at present.

It’s therefore unsurprising that the shares of many Canadian energy producers are off this year. These range from Husky Energy (-1.4%) and Canadian Oil Sands (-4%) through to Imperial Oil (-6.3%), Suncor (-9.4%), and Penn West (-4.2%).

Meanwhile, base metal producers First Quantum and Teck Resources are off 21% and 27% respectively. These declines at least have the merits of being logical, assuming that slower growth in China and India is likely to continue for the remainder of 2013.

The carnage in the gold mining sector, however, is difficult to justify, given how badly the mining companies had underperformed the metal itself over the last two years. In my review of my gold mining recommendations a few weeks ago, I noted that the gold miners were now as cheap compared to gold itself as at any time since the beginning of the gold bull market in 1999. This valuation has become even cheaper despite gold’s US$200 plunge from US$1,565 per oz. to US$1,335 per oz. between Friday April 11 and Tuesday April 15. The sudden drop was seemingly triggered by worries over Cyprus being forced to sell its US$400 million in gold reserves as part of its rescue package.

While the SPDR gold bullion ETF (NYSE: GLD) is down -12.2% year-to-date, the iShares Gold Mining ETF (TSX: XGD) is off -34.2%. The BMO Junior Gold Mining ETF (TSX: ZJG) is down a whopping -40.2% for the year as junior miners struggle to raise financing to keep going and develop their properties.

Over the last 12 months gold itself is only off 11.8%, with all the decline occurring this year. Despite this, it is still up 7.6% per year over the last three years. That compares to a return of -0.6% per year over the same period for the S&P/TSX 60 Index. XGD is off 17.6% per year and ZJG has lost 19.8% per year over the same three-year period.

Some of this reflects justified disappointment at delayed mines, overpaying for developments, expropriations by unfriendly regimes, and the rising costs of personnel, fuel, infrastructure, and other inputs which have squeezed miners’ profits. However, my recommendations of Franco-Nevada (TSX, NYSE: FNV), Goldcorp (TSX: G, NYSE: GG), and Agnico-Eagle (TSX, NYSE: AEM) remain Buys.

One reason for this is that their production is increasing. Agnico-Eagle’s output is expect to rise 20% while Goldcorp should be up 70% over the next couple of years, regardless of the level of the gold price.

As for royalty company Franco-Nevada, four new developments are coming on stream. The company is insulated from rising costs through its business model, which sees it receive between 0.5% and 5% of the value of everything produced from mines with which it has royalty agreements. If investors want a lower risk way to play precious metals, then Franco-Nevada is the best way to do so. The stock is down a mere 3.5% over the last year and up 17.5% per year, compounded, over the last three years. Along the way, it has not only outperformed the other mining stocks but even beaten gold itself.

I can’t tell you exactly when the gold mining stocks will turn around. But I’m confident it is going to happen, perhaps sooner rather than later.

 

GAVIN GRAHAM LIKES HONDA

Last week, Gordon recommended the currency neutral iShares Japanese Fundamental Index Fund (TSX: CJP) as a means of playing the recovery in that country. I would also suggest looking at some of the Japanese automakers with American Depository Receipts (ADRs) that trade in New York. I especially like Honda Motor (NYSE: HMC).

Honda is a great way to benefit from the 20% decline in the Japanese yen since new Prime Minister Shinzo Abe demanded the introduction of an accelerated form of quantitative easing (QE) at the Bank of Japan. As the eighth largest auto producer in the world and the largest motorcycle manufacturer, Honda is well placed to benefit from a cheaper yen.

At Y100=US$1, Morgan Stanley calculates Japanese automakers’ top lines will receive a boost of US$2,000 for each car they sell in the States (the exchange rate last week was Y97.24=US$1.

Although Honda makes more than 90% of the cars it sells in North America in the U.S, and Canada, compared to two-thirds for Toyota and Nissan, it still receives the benefit of reporting U.S. and Canadian sales in a weaker yen. Plus, the weakness of the Japanese currency helps its sales in other markets such as China and India, against its Korean, U.S., and European rivals.

Like the other Japanese carmakers, Honda has moved much of its production offshore over the last 6-7 years, from 2006 when the yen was trading at Y115=US$1. With its joint ventures in China (Guangzhou Honda and Dongfeng Honda), India (Hero Honda Motorcycles and Siel Honda), Pakistan (Honda Atlas), and Malaysia (Boon Siew Honda), Honda has established lower cost manufacturing bases in addition to its operations in North America and the U.K.

While Honda’s sales in China have been affected by the anti-Japanese sentiment due to the ongoing dispute between China and Japan over the Senkaku islands in the East China Sea, sales are continuing to grow in other emerging markets. Honda’s focus on innovative front-wheel drive cars, based on its experience with motorcycle technology, makes it well equipped to provide suitable vehicles for the emerging market middle classes.

Five of the top ten models for fuel economy over the last quarter-century in the U.S. have been made by Honda, according to the U.S. Environmental Protection Agency. Honda has also been innovative in brand introductions, being the first Japanese manufacturer to launch a separate luxury brand with the Acura in 1986 and the first mid-engine all aluminum sports car, the Honda NSX, in 1991, which employed variable valve timing technology, known as VTEC.

While Honda and other Japanese automakers have had to recall several million cars in North America this year due to a defective component in their airbags, this is a general problem not specific to Honda alone. The supplier of the component has agreed to reimburse the auto companies for the expense of the recall.

In the fiscal year ended March 31, Honda earned $3.9 billion ($2.17 per share, figures in U.S. dollars), up 52% from $2.8 billion ($1.43 per share) the year before. Sales were $105 billion, up 5% from $100 billion for the previous year. The company saw sales recover from the after-effects of the Fukushima earthquake in March 2011 and the flooding in Thailand later that year, where many Japanese automakers produce parts.

For the fourth quarter of the 2013 fiscal year, automobile revenues were up 16% to $22.7 billion with operating income up 71% to $822 million. Motorcycle revenues increased 5% to $3.99 billion but net income was down 23% to $276 million. Financial services revenues were up 17% to $1.6 billion with operating income up 14% to $435 million. Honda’s smallest division, power products, which produces lawnmowers, marine engines, chainsaws etc., saw revenue gain 12% to $863 million but its loss increased from $22 million to $79 million.

For the fiscal 2013-14 year, Honda is forecasting revenues up 23% to $128 billion, based on an exchange rate of Y95=US$1. The company expects operating income to increase 43% to $8.2 billion and net income to be up 58% to $6.1 billion ($3.38 per share).

The company will be raising its dividend 5% from Y76 to Y80. This would put Honda at a forecast price/earnings ratio of 11.5 times and a dividend yield of 2.1%, compared to Toyota which has a forecast p/e ratio of 15.6 times and a 1.3% yield.

Toyota stock has risen by 44% in US$ terms over the last year, while GM is up 38% and Ford 19%. Meanwhile, Honda has trailed with an advance of only 11%. So Honda is both cheaper and has underperformed despite benefiting almost as much from the recovery in Japanese auto production and sales and the weakness of the currency.

The industry has upward momentum right now. Auto sales in April were at their highest level for the month since 2008 with Honda Canada among the companies posting the biggest gains. Cyclical industries such as automakers and my other auto sector recommendation, parts maker Linamar (TSX: LNR) are stocks that should be bought and sold rather than held for the long term. This is the correct stage in the auto cycle to own these companies.

Action now: Honda is a Buy. The shares closed on Friday at US$40.24.

– end Gavin Graham

 

GORDON PAPE’S UPDATES

Metro Inc. (TSX: MRU, OTC: MTRAF)

Originally recommended on Aug. 27/12 (#21230) at C$57.93, US$58.37. Closed Friday at C$69.24, US$65.93 (April 29).

Metro continues to perform to expectations with the shares showing a gain of 9.7% since our last update in mid-March when they were trading at $63.14 on the TSX.

On April 24 the company released results for the second quarter of fiscal 2013 (to March 16). They showed a year-over-year drop in revenue of 2.6% to $2.51 billion which the company said was caused by a shift in the reporting of pre-Christmas week results into the first quarter, the closure of some unprofitable stores in Ontario, and “temporary efficiency difficulties” in the pharmaceutical division following the implementation of a new warehouse management system.

On the plus side, adjusted net earnings from continuing operations were up 4.4% to $100.5 million ($1.02 per share) from $96.3 million ($0.94 a share) in the comparable period of fiscal 2012. Net earnings increased 282% to $366.8 million ($3.77 a share) however that included an after-tax profit of $266.4 million from the sale of about half Metro’s stake in Alimentation Couche-Tard.

Metro continues to actively repurchase its shares. The current normal course issuer bid allows it to buy up to six million shares in the year ending Sept. 13. Thus far, the company has bought back just over 2.3 million shares at an average price of $60.29 for a total cost of $140.1 million. Metro also said that it has private agreements with an arm’s-length third party seller to buy back up to one million shares at a price to be negotiated.

The stock pays a quarterly dividend of $0.25 a share ($1 a year), which was increased by 16% effective with the February payment. The next dividend is due on May 21. At the current price, the stock yields 1.4%.

Action now: Metro continues to be a Buy for conservative investors seeking modest income and long-term growth.

Suncor Energy (TSX, NYSE: SU)

Originally recommended on June 12/06 (#2622) at C$41.63, US$37.57 (split-adjusted). Closed Friday at C$31.09, US$30.86.

Almost everyone expected Suncor to announce a dividend increase when it released its first-quarter results. But few people predicted it would be by so much. The 54% hike, to $0.20 a share quarterly, combined with a share buy-back program of up to $2 billion, was welcome news for investors who pushed up the price of the stock by almost 6% on Tuesday.

The company was sitting on a horde of cash, much of which had been earmarked for the now-cancelled Voyageur upgrader program. As well, Suncor announced in mid-April that it has reached an agreement to sell a significant portion of its natural gas business in Western Canada for $1 billion. With future development ramping down, the company decided to do something to reward patient shareholders who have been holding a stock that has gone nowhere in recent years.

“Suncor’s unique integrated business model is driving strong and consistent financial results, allowing us to make a step change in the dividends we pay our shareholders while continuing to invest in profitable growth,” said CEO Steve Williams. “We have the resources, the assets, the balance sheet and the strategy to continue to grow shareholder returns.”

First-quarter operating earnings came in at $1.367 billion ($0.90 per share), compared to $1.318 billion ($0.84 per share) for the same period of 2012. However, net earnings dropped to $1.094 billion ($0.72 per share) from $1.446 billion ($0.93 per share) last year due to a $127 million charge for the cancellation of Voyageur and a $146 million after-tax foreign exchange loss on the revaluation of U.S. dollar denominated long-term debt.

Cash operating costs per barrel for Oil Sands operations decreased in the quarter, averaging $34.80 per barrel compared to $38.10 per barrel in the first quarter of 2012 due to higher production volumes.

The increased dividend will be paid on June 25 to shareholders of record as of June 4. Based on a $0.80 per share annual payout, the stock yields 2.6% at the current price.  

Although the news of the dividend hike and share buy-back program are welcome, what we really need to see from Suncor is increasing profits and production. Until there is some evidence of that, the stock remains a Hold.

Action now: Hold.

CGI Group (TSX: GIB.A, NYSE: GIB)

Originally recommended on Aug. 20/12 (#21229) at C$24.42, US$24.66. Closed Friday at C$31.31, US$31.08.

We got another good news story last week, this one from CGI Group. The company reported strong results for its second quarter of fiscal 2013. Revenue was up 137% to $2.53 billion, bookings were up 180% to $2.2 billion, and the $18 billion backlog was up 37%.

Those are heady numbers but the bottom line wasn’t quite so bright. CGI posted a profit of $114.2 million. That was up from $105.7 million a year ago, but down on a per share basis from $0.40 to $0.36. The reason for the decline in earnings per share was the on-going cost of integrating U.K.-based Logica, which was acquired last year, into CGI’s corporate fabric.

In a statement, the company said it has expanded its integration goals, increasing the annualized savings target from $300 million to $375 million by the end of fiscal 2014 and completing the program a year earlier than originally planned. “To realize these additional benefits and incremental EPS accretion, the company will increase its investment from $400 million to $525 million over the integration period,” the statement said.

In a research report published after the results came out, RBC Capital Management said this was the first quarter since the acquisition when Logica’s margins beat expectations. Analyst Paul Treiber wrote that the first phase of the integration “delivered faster than expected accretion” and raised his target price to $38, from $33.

Investors were enthusiastic enough to push the price higher by $4.87 in Toronto or 18%. That’s a huge one-day move for any stock. The shares finished the week at C$31.31, US$31.08.

Action now: I’m putting the stock on Hold because big price jumps are often followed by a pull-back and consolidation. Buy if the shares fall below $30.

 

AFTER DPS, WHAT?

I received an e-mail last week from a reader who followed my advice about Diversified Preferred Share Trust (TSX: DPS.UN). She wrote: “We sold our entire position of Diversified Preferred Shares today. We made a nice capital gain since we purchased more during the 2008 crash and also have received a nice dividend. Can you please suggest some alternatives now? This was in a RRIF where we need the maximum cash flow possible without too much risk.” – Jane S.

Good question. The closest thing to DPS is the iShares S&P/TSX Canadian Diversified Preferred Share Index Fund (TSX: CPD). As the name suggests, this ETF tracks the performance of the S&P/TSX Preferred Share Index, less fees and expenses. It holds a total of 180 positions, almost all of which are preferreds issued by blue-chip companies such as banks, telecoms, utilities, and insurance firms. Almost 70% of the holdings are rated Pfd-1 or Pfd-2, the two highest levels given by the rating agencies.

Over the year ending March 31, the fund posted a total return of 6.03% compared to an advance of 6.71% for the index. That’s a differential of 68 basis points (bp), which is higher than the MER of 50 bp (0.5%). This means the fund underperformed by 18 bp in relation to its mandate. We see the same pattern with the three-year numbers with the fund showing an average annual compound rate of return of 6.82% compared to 7.5% for the benchmark.

Distributions are paid monthly. The most recent payouts have been $0.061 per unit however you should not assume they will continue at that rate as the distributions have been gradually declining over the past year. (At this time in 2012 they were $0.069 per unit). If the present payout were to be maintained, investors would receive $0.732 per unit over the next year for a yield of 4.23% based on Friday’s closing price of $17.31.

The ETF was launched in April 2007 so we have enough of a track record to make an assessment. The only year in which it lost money was in 2008 when it dropped 17.2% Assets under management are almost $1.6 billion.

Another option is the BMO S&P/TSX Laddered Preferred Share Index Fund (TSX: ZPR). This takes a more focused approach, creating a five-year laddered structure using reset preferreds. This is done by dividing the holdings into five annual “buckets” which are equal weighted. Within each bucket, the securities are weighted according to market capitalization. One bucket matures each year and the assets are rolled over into a new five-year bucket. If all that sounds complex, think of it in terms as a simple GIC ladder. The concept is the same except in this case several securities are rolled over annually rather than a single GIC.

Does it work any better than the iShares entry? It’s too soon to say because this ETF has been around for less than six months – it was launched on Dec. 14, 2012. So far this year (to the end of April) the BMO fund has been the better performer with a gain of 1.98% versus 1.23% for the iShares ETF. But that’s too short a time frame to allow for any definitive conclusions.

The current monthly distribution is $0.054 per unit, which projects to $0.648 a year if it is maintained. At Friday’s closing price of $15.17 that would translate into a yield of 4.27%. So there is not a lot of difference between the two in yield terms.

This fund has assets of about $734 million and a maximum management fee of 0.45%. Since it has not been in existence for a year, we do not have an MER at this stage but it will probably be close to that of the iShares fund.

At this point, my choice would be CPD but only because it has a longer track record that enables us to gauge its consistency. The concept of the BMO fund is intriguing and it could end up being a better performer over time but much depends on what happens to the yields on the preferreds it holds when they are reset over the next few years. – G.P.

 

YOUR QUESTIONS

U.S. dividends

Q – I understand there are tax considerations when investing in U.S. dividend stocks. However, if the shares are held in a TFSA are those implications no longer a concern? – Bill H.

A – The tax consideration to which you refer is the 15% withholding on dividends paid to Canadians from U.S. companies. This is covered by the Canada-U.S. Tax Treaty and it’s a two-way street – Americans have 15% withheld by the Canadian government when they receive dividends from this country.

The problem goes away if the dividends are paid into a retirement plan such as an RRSP or RRIF. But TFSAs do not benefit because they are not considered to be “retirement plans” and in fact did not even exist when the Treaty was last updated. So any U.S. dividends paid into a TFSA will be dinged for the 15% withholding. To make matters worse, you can’t claim a foreign tax credit for it because the money was paid to a tax-sheltered account. It’s gone, end of story.

If there is a bright side to this, that 15% is the only tax you’ll ever pay on the money. In the case of a RRIF or RRSP, while you avoid the withholding tax at the outset, by the time the money comes out it will more than likely be taxed at a much higher rate. – G.P.

Converting RRSPs

Q – I will be 67 this December and was wondering when would be the best time to start to convert my RRSPs to a RRIF.  I don’t want to be paying taxes all at once. – Theresa S.

A – I suggest you move just enough money into a RRIF now to take advantage of the pension income tax credit. It covers the first $2,000 of pension income and that includes RRIF payments for anyone 65 or older. If you have no other pension income (CPP and OAS don’t count), this will provide a tax break for you.

You can leave the rest of the money in the RRSPs until Dec. 31 of the year you turn 71. There is no reason to convert sooner; you’d just be putting yourself in a position of having to take forced RRIF withdrawals and paying the appropriate tax. – G.P.

 

MEMBERS’ CORNER

Reporting foreign assets

Member comment: Re your warning about form T1135, paragraph 2 says we must report foreign assets if the value exceeds $100,000. This should read if the cost exceeds $100,000. There is a big difference between cost and value. Using the term value instead of cost is misleading. Please correct. – Myra A.
 
Response: Our reader is correct. I apologize for the error. – G.P.

 

That’s it for another week. We will see you again on May 13.

Best regards,

Gordon Pape