In This Issue

TARGET: 2015

By Gordon Pape

Get ready for 2-1/2 more years of slog – and that’s the optimistic view. That’s the message we’re getting in increasingly definitive tones from central bankers, politicians, and economists. It won’t be until 2015 – if then – that the world emerges from the long slump that was triggered by the credit crunch of 2008-09 and exacerbated by the sovereign debt crisis.

The U.S. Federal Reserve Board acknowledged that reality several months ago when it announced that it would maintain its target rate at an all-time low of zero to 0.25% until the end of 2014. The Fed reinforced its stance last week by reducing its estimate for U.S. growth this year to a maximum of 2.4%, down half a point from its April prediction. In response to the deteriorating outlook, Chairman Ben Bernanke announced an extensive of “Operation Twist” until year-end. It’s a financial manoeuvre that involves selling billions of dollars worth of short-term bonds and buying longer-term issues in an effort to keep interest rates low.

Moreover, there are indications the Fed might reluctantly consider a third round of quantitative easing (QE) if conditions worsen, although that may not happen until late in the year. QE is a euphemism for turning on the printing presses and flooding the economy with more cash. The aim is to prime the lending pump and encourage consumer spending but the longer-term results include higher inflation and a debasement of the U.S. dollar. In other words, short-term gain (maybe) for long-term pain (certainly).

The U.S. is not the only country to resort to QE to try to stimulate growth. The Bank of Japan tried it in the early years of this century as a means of fighting off deflation. It didn’t work. The European Central Bank has used it twice in the past few years, although they have avoided referring to it as QE – they call it long-term refinancing operations (LTRO). As far as anyone can tell, the positive effects have been negligible.

Britain has a £325 billion QE program in place and Bank of England Governor Mervyn King wanted to pump in an additional £50 billion to try to right the faltering economy. However, that move was defeated earlier this month by the Bank’s monetary policy committee in a tight 5-4 vote.

Does it work? The International Monetary Fund (IMF) says QE helped to ease the credit freeze that seized up financial markets after the collapse of Lehman Brothers in September 2008. The IMF also credits QE with boosting the stock market recovery that began in March 2009. However, many members of the U.S. Congress on both sides of the floor strongly oppose the strategy.

“I think it’s a bad idea,” said Ohio Republican Congressman Steve Chabot last year. “Just printing more money and throwing it out there is devaluing the money we already have. Over the long term it’s inflationary. It sends the wrong message.”

On the other hand, investors love the idea because QE theoretically stimulates lending and encourages people to buy homes, expand businesses, and hit the malls. All of that is good for stock markets. That explains why the expectation of another round of QE sparked a short-lived rally from June 11 to 19, during which the Dow rose 426 points. Then the Fed spoiled the party by rejecting QE3 in favour of more Twist. Stocks promptly sold off.

Gold was also hammered after the Fed statement was released. Bullion had been on the rise because it is priced in U.S. dollars so any devaluation in the currency would increase the value of the metal in world markets. When QE3 didn’t happen, gold (and silver) sold off.

Clearly, the Fed is reluctant to implement another round of QE, especially in an election year given the opposition on Capitol Hill. So any decisive action to revive sagging U.S. growth is likely on hold until after the first week of November, unless the economy falls off a cliff in the meantime.

This means we should prepare ourselves for more of the same, both short and long term. Europe’s crisis will not be solved any time soon, the Americans are almost powerless to deal decisively with their situation until after the election, and we’re caught in the middle. Stay defensive with your portfolio, focus your stock selections on top-quality companies that can do well in a weak economy, and don’t abandon bonds. That may be my core advice for the next two years.

 

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BUY WALMART

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In keeping with my advice to buy stocks in companies that can continue to generate profits in a weak economy, I am adding Walmart (NYSE: WMT) to our Recommended List.

The company hardly needs an introduction. I would be surprised if there is a single person reading this column who has not been in a Walmart store at one time or another. We all know the experience: endless aisles of merchandise ranging from baby food to large-screen TVs, with hardly any staff available to help or advise. Apart from the friendly greeter at the door, it’s an unmemorable shopping experience.

So why do people flock there? Because it’s cheap, of course. Walmart consistently manages to undersell everyone else, in part because of the hard-line deals it drives with suppliers and in part because of its controversial success in keeping trade unions at bay. When times are tough, cheap is what people want – just look at the rapid rise in the shares of Dollarama for evidence.

But you can’t buy TVs or groceries or gardening supplies at Dollarama. Walmart has it all. It has dominated the discount market for many years and will continue to do so for the foreseeable future.

Recently, the company celebrated its 50th year in business at its annual meeting in Fayetteville, Arkansas (the company is based in nearby Bentonville, reflecting its deep Middle America roots). During the meeting, CEO Mike Duke pledged that Walmart will continue to thrive for the next 50 years, based on its five “enduring values”: integrity, opportunity, family and community, purpose, and responsibility.

“I’ve said this before, and I’ll say it again, Walmart is the best-positioned global retailer in the world today,” he said.

It may sound boastful, but he’s right. No one else is in the same league.

Walmart may represent the values of Middle America but it has become an international retailer with 10,130 stores under 69 different banners in 27 countries. The company employs more than two million “associates” world-wide and claims to serve more than 200 million customers a week.

In mid-May, the company reported results for its 2013 fiscal first quarter (to April 30). Earnings from continuing operations came in at $1.09 per share (figures in U.S. dollars). That was up from $0.96 the year before and ahead of the company guidance of between $1.01 and $1.06 per share. U.S. comparable stores sales increased by 2.6% while sales at its Sam’s Club stores were up 5.3%, not including fuel. Those are healthy increases for a well-established company in a weak economy.

Consolidated net sales were $112.3 billion, an increase of 8.6% from last year. Walmart ended the first quarter with free cash flow of $3.1 billion and had cash in the bank of $8.1 billion. Return on investment (ROI) for the trailing 12-month period was an impressive 18.1%. From a financial perspective, this is a very sound company.

The share price has moved higher in recent months, bucking the trend in the U.S. market. However, at about 14 times anticipated fiscal 2013 earnings, it does not appear to be out of line.

In March, the company announced a 9% dividend increase, bringing the annualized payout to $1.59 a share. Based on Friday’s closing price of $67.30, the yield is 2.4%.

Action now: Walmart is a Buy for defensive investors. – G.P.

 

RYAN IRVINE ON BEATING THE MARKET

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Contributing editor Ryan Irvine is back this week with some practical advice on how to construct a diversified portfolio that is designed to outperform the broad indexes. Ryan is the CEO of KeyStone Financial (www.keystocks.com) which specializes in identifying high-quality small-cap stocks. Over to him.

Ryan Irvine writes:

Most financial advisors recommend that you diversify for your own protection. What they fail to tell you is that it is also for their protection. For someone starting out, or with a relatively small portfolio, a broad based ETF or combination of ETFs may be a good idea. Indeed, a personal stock portfolio must be diversified to some degree. No one should put all their eggs in one basket and expose themselves to the inherent risk of holding only one stock.

But if you want to beat the market, you cannot be the market.

The problem we see often today is that many funds and other investment products hold between 50 and 300 stocks. According to the modern portfolio theory, you come very close to achieving optimal diversity after adding about the 20th stock to your portfolio.

So why do fund and investment managers over-diversify and create below-average returns for your portfolios over time? We think the following quote from the world’s greatest investor, Warren Buffett, sums it up: “Wide diversification is only required when investors do not understand what they are doing.”

To give you an idea of how little Mr. Buffet himself believes in over-diversification, recently a study of his portfolio over the last 25 years was completed. Within his multi-billion dollar portfolio he averaged only 33 stocks per year. Perhaps more astonishingly, his top five holdings, on average, comprised 73% of his portfolio. So much for diversification!

To quote Mr. Buffett again: “Why not invest your assets in the companies you really like? As Mae West said, ‘Too much of a good thing can be wonderful.’ “

While we do not advocate under-diversification, to beat the market long-term we recommend a strategy of “focused diversification” within the growth segment of your portfolio. When building your Small-Cap Growth Stock Portfolio, we suggest you follow the following simple steps.

1, Purchase between 10 and 12 small-cap stocks and equally weight each selection initially. For example, a $10,000 portfolio with 10 stocks would allocate $1,000 per stock.

2. Construct your portfolio over at least a one-year period thus ensuring you do not buy at a market peak within a year or cycle.

3. Buy companies from a diverse set of industries within our Recommended List to achieve appropriate diversification.

4. Review and pay careful attention to our updates and use our continuing research to guide your decisions to Buy, Hold, or Sell given your time horizon and tolerance for risk.

If one stock performs very poorly, three average, two above average, two very well, and two excellent, it has been our experience that the overall return of a Small-Cap Growth Stock Portfolio constructed in this manner can significantly outperform the market over time. We do our research and focus our Buy recommendations on the companies that rank highest within our growth and value criteria. By investing with conviction and with a realistic time horizon, this strategy allows our winning recommendations to truly affect the value of your portfolio over time.

Following are updates to a couple of relatively recent Buy recommendations that may make solid additions to, or starting points for, your Small-Cap Growth Stock Portfolio.

 

RYAN IRVINE’S UPDATES

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Enghouse Systems Ltd. (TSX: ESL, OTC: EGHSF)

Originally recommended on May 7/11 (IWB #21109) at C$9.10. Closed Friday at C$13.75, US$12.78 (June 18).

Enghouse Systems was introduced to the IWB in our February 2011 installment when the stock traded at $9.10. Our most recent update was in March of this year with the stock closing at $14.19.

At that time we shifted our near-term rating to Hold and maintained our long-term rating (one year+) at Buy. While we continue to like the business long-term, the near-term rating change was a result of the stock jumping 70% in the last year and our assessment that Enghouse had reached fair value in the near term. With the stock closing Friday at $13.75, we look more closely at the company’s latest financial results and our current rating.

Enghouse develops enterprise software solutions for a variety of vertical markets. The company is organized around two business segments: the Interaction Management Group (IMG), which accounted for 88% of second-quarter revenue, and the Asset Management Group (AMG) which contributed 12%.

IMG serves the customer service market segment through the provision of interactive voice response (IVR) systems and speech/voice recognition solutions, as well as an advanced contact centre platform that manages multichannel customer interactions. Its customers include insurance companies, banks, utilities, as well as high technology, health care, and hospitality companies.

AMG provides visual-based software solutions for the design and management of complex network infrastructures to telecommunications, utilities, public and private transportation, and oil and gas companies.

On June 6, Enghouse announced that its second-quarter 2012 revenue rose 4% to $31.5 million from $30.3 million in the prior year. Hosted services and maintenance revenue was $16 million compared to $13.9 million, an increase of 16%. This includes maintenance revenue of $14.5 million compared to $13.1 million in the prior year and reflects incremental maintenance revenue on license sales in the past fiscal year as well as contributions from acquired operations. Hosted revenue was up 76% in the quarter to $1.5 million as a result of hosted revenue contributions from CustomCall subsequent to an acquisition on March 1, 2012. Recurring revenue is important to the company as it increases the predictability of future cash flows and is consistent with the company’s strategy of growing its hosted revenue base.

Net income jumped to $4.2 million ($0.16 per share fully diluted) compared to $2.1 million ($0.08 per share) in the second quarter of fiscal 2011, primarily as a result of increased hosted and maintenance services revenue. On a year-to-date basis, net income was $8.2 million ($0.32 per share) compared to $5.1 million ($0.20 per share) in the prior year.

Enghouse’s strategic focus is to continue to build its business into a larger and more diverse software and services company, with a mandate of further growth both organically (low single digit) and through acquisitions within and outside its current vertical markets. Pro forma, the company currently holds $70 million ($2.73 per share) in cash. The company continues to have no long-term debt and has sufficient cash resources to fund both its current and future financial operating commitments as well as its dividend strategy.

With a cash war chest of over $70 million (after spending approximately $37 million year-to-date in 2012), Enghouse has the means to make accretive acquisitions to grow cash flow. To this end, on June 1 Enghouse acquired Zeacom Group Ltd., a leading provider of multi-channel contact centre communications solutions for a cash purchase price of approximately US$30.6 million.

Headquartered in Auckland, New Zealand, with offices in Australia, the U.K., and the U.S., Zeacom’s leading-edge contact centre software and business process automation solutions have been installed in over 3,500 customer sites worldwide. Zeacom is currently profitable with annual revenue in the range of $29 million.

The deal gives Enghouse critical mass in the growing Asia Pacific area, gives a product offering for smaller (10-100 people) contact centres, and also provides a hedge against Microsoft’s Lync software, which is making inroads in the private branch exchange (PBX) space. While there will likely be some initial integration cost, we expect Zeacom to begin contributing to cash flow by the fourth quarter of this year and, as such, the acquisition appears to be a good use of cash – time will ultimately tell us how good.

The general economic climate continues to present challenges to the company’s business overall. As such, management is not scaling up investments for internal or organic growth in 2012. We do not expect material organic growth in the near term (we estimate organic growth to be just over 2% year-to-date). Having said this, top and bottom line growth in upcoming quarters will continue from acquisitions including CosmoCom and Zeacom, as well as slight margin improvements from further integration progress.

Enghouse’s enviable balance sheet not only buffers the company in the event of downturn, but allows it to be aggressive on the acquisition front, likely at attractive prices under this scenario. If a tepid “recovery” continues, the acquisition environment remains relatively favourable, so Enghouse should also be able to make accretive acquisitions at a reasonable pace. The company is also in the process of consolidating its operation under a singular brand which should provide for operational efficiencies going forward.

At first glance, with a trailing p/e of 17.5, Enghouse may not appear cheap. Indeed, with the price up more than 50% since our original recommendation just over one year ago, the stock is not as cheap as it was at that time. In fact, in the near term, we believe the company reached close to fair value when it hit a recent high in the $14.50-$15.25 range.

However, when we dig a little deeper we find that the company’s consensus earnings per share (EPS) 2012 estimate is in the range of $0.68. If we strip out the pro forma $2.73 per share in cash and just look at the base business, the forward-looking p/e is a more reasonable 16.2. Moreover, if we look out to 2013, where current earnings estimates are in the range of $0.95 per share (as acquisition growth kicks in) and strip out the cash, the stock is trading at around 11.6 times earnings. On a cash flow basis, the company remains at a discount to its peers.

In the near term, we believe organic growth will be challenging but recent acquisitions will provide decent overall growth, following initial integration which may impact the next quarter. Therefore, in the near term (six months) we do not see the stock moving much higher than the upper end of its recent range.

Based on this, we maintain our near-term rating at Hold and our long-term rating at Buy. We expect management to continue to execute its acquisition strategy, driving revenues beyond $200 million over the next two years. In the near term, we will be patient, expect volatility due to the relatively low amount to shares available at present, and collect our 2% dividend as the company grows and eventually attracts the attention of the broader market.

Action now: Hold for the near term, Buy for the long term.

Athabasca Minerals Inc. (TSX-V: ABM)

Originally recommended on Jan. 30/12 (IWB #21204) at $0.485. Closed Friday at $0.64.

Our second update comes from the micro-cap arena, which is not for the faint of heart. Athabasca Minerals is a management and exploration company. Its activities include developing and exploring industrial minerals in Alberta and providing aggregate management for the construction, oil sands, and infrastructure industries of the province. The company has one of the largest aggregate operations in Canada and holds a significant land position in the Athabasca region of Alberta. The stock was recommended at $0.485 in January of this year.

Historically, all of the company’s revenue has been derived from management contracts but this is changing. The company is advancing its wholly-owned aggregate projects including its Kearl, Logan, Pelican Hill, and House River operations. We expect three to be operational and generating higher margin income in 2012.

Sand and gravel aggregates are the most common construction materials used in the world. Since the invention of cement, aggregates in the form of concrete have become the building blocks of civilization. They are not as sexy as gold or silver but they are basic, boring materials that are in high demand in Alberta’s vast and ever-expanding oil sands. Perhaps most importantly, they provide strong cash flow for Athabasca, which is well positioned to service this market for the next several decades.

The ability to remove gravel from pits in Northern Alberta can be hampered by cold and wet weather conditions. As a result, winter and spring are traditionally the slowest time for the company. However, during the first quarter of this year Athabasca reported record high sales volume, with unusually increased demand for aggregates. As various oil sands companies have announced plans to increase their production, strong continuing demand for aggregate is anticipated by management.

For the quarter, Athabasca said that total tonnage sales of aggregate increased by 123.6%, with almost two million tonnes sold compared with just under 900,000 tonnes in the same period last year. Aggregate sales on which management fee revenue is earned (Susan Lake) rose 101% on sales of close to 1.8 million tonnes.

Revenues jumped to $4.45 million. This compared to 2011 first-quarter revenue of $1.35 million. Overall, total revenue increased by 230% and aggregate management fee revenue increased by 111%. Net income jumped to $784,408 ($0.029 per share) from a small net loss of $1,890 last year. Due to a solid outlook and the fact that fiscal 2012 sales have begun at a strong rate, management now anticipates that aggregates sales for this fiscal year will surpass the almost 7.8 million tonnes sold in fiscal 2011.

Despite its solid rise since our recommendation earlier in the year, the stock continues to appear cheap long term on a valuation basis. On a trailing basis (over the past 12 months), the company has now posted earnings per share of $0.131 giving it a p/e ratio of under five. With an improving balance sheet, better liquidity, strong cash flow, the potential for further wholly-owned pit sales this year, and strong near- to long-term demand forecasted for its managed operations, the stock remains attractive.

Action now: Buy.

A final thought: these are just two ideas to look over, see if they fit with your strategy, and potentially use to begin the construction of your Small-Cap Growth Stock Portfolio. While we continue to like each company, they are part of an overall “Focused Diversification” portfolio strategy. As such, if you are planning to utilize this strategy, we urge you to follow the complete process and not just take the proverbial “flyer” on two individual stocks – this creates too much company-specific risk.

– end Ryan Irvine

 

GORDON PAPE’S UPDATES

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Silver Wheaton (TSX: NYSE: SLW)

Originally recommended on Sept. 20/10 (IWB #20133) at C$25.75, US$25.02. Closed Friday at C$26.84, US$26.20.

When gold took a big dive earlier this year, silver followed suit, dragging the price of this stock as low as C$23.11, US$22.94 on May 16. Precious metals have recovered somewhat since and so have the fortunes of Silver Wheaton but we’re still well below the all-time highs of almost $50 a share reached in the spring of 2011.

In mid-May the company reported impressive first-quarter results. Revenues increased 26% compared with the same period in 2011, to a record $199.6 million (the company reports in U.S. currency). Sales hit record levels of 6.1 million silver equivalent ounces (5.9 million ounces of silver and 3,900 ounces of gold). Net earnings were up 20% to $147.2 million ($0.42 per share) while operating cash flows increased 29% to $163.8 million ($0.46 per share). Average cash costs were $4.08 per silver equivalent ounce, relatively unchanged from last year.

The Vancouver-based company also announced it has attributable proven and probable silver reserves of 798 million ounces. That is nearly twice the reserves of any other silver company in the world. Silver Wheaton had cash on hand of $997 million as of the end of March.

CEO Randy Smallwood said the company is “on target to attaining our annual production guidance of 27 million silver equivalent ounces” in 2012. He added: “With continued positive progress at our world-class cornerstone assets, including the Peñasquito and Pascua-Lama mines, Silver Wheaton retains one of the strongest growth profiles in the sector.”

The company declared a quarterly dividend of $0.09 per share, which was paid on June 6.

This stock is a play on precious metals prices as well as on the widely-held belief that silver is undervalued compared to gold. If you believe the metals will move higher from here, this is a good time to take a position.

Action now: The stock is a Buy for aggressive investors.

Lundin Mining (TSX: LUN, OTC: LUNMF)

Originally recommended by Yola Edwards on May 14/07 (IWB #2719) at C$14.18. Closed Friday at C$4.13, US$4.00.

After a flurry of merger talks and takeover rumours last year, Lundin’s stock has pulled back to below $5 and has been languishing in that range all year. Recently the company reported first-quarter net income of $58.3 million ($0.10 per share) compared to $71.2 million ($0.12 per share) for the first quarter of 2011 and $36.1 million ($0.06 per share) for the fourth quarter of last year (results in U.S. currency). Sales were flat year-over-year, coming in at $212.8 million.

Lundin is a base metals producer (copper, zinc, nickel, and lead) with operations in Spain, Portugal, Sweden, and Ireland. Its potentially most important asset is its equity stake in the huge Tenke Fungurume copper/cobalt mine in the Democratic Republic of Congo. The company had cash available of $274 million as of the end of March and is using about $75 million of that to acquire an 80% stake in the Touro copper project in Spain.

This stock needs a catalyst to get it moving again, otherwise it is likely to continue to trade around the current level for the next several months.

Action now: Hold.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (IWB #21114) at C$10, US$10.44. Closed Friday at C$5.34, US$5.25.

What’s wrong with this picture? Trinidad Drilling’s stock has lost almost half its value since I recommended it a little more than a year ago and yet the company continues to post impressive results.

First-quarter figures released last month are the latest example. Revenue increased by almost 14% year-over-year to just under $256 million while net earnings more than doubled to $34.5 million ($0.29 a share) from just under $16 million ($0.13 a share) in the first quarter of 2011. After stripping out non-recurring revenue and expenses, adjusted earnings were $42.7 million ($0.35 a share), up from $21.8 million ($0.18 a share) in 2011. Looking at the balance sheet, net debt was reduced by 5.7% to $421 million.

Moreover, the company says it expects more of the same for the rest of 2012 despite the weakness in natural gas prices. “Trinidad has demonstrated an ability to switch its focus away from dry natural gas development towards oil and liquids-rich plays,” the company said in a statement accompanying the results. “As rigs have been moved from dry natural gas projects they have largely been absorbed by ongoing demand in oil or liquids-rich plays. The strength in crude oil prices and the high level of demand for equipment has to date maintained dayrates at relatively strong levels, particularly for high performance equipment.” As a result, the company described the outlook for the rest of the year as “positive”.

At the current price, the shares look undervalued. Analysts estimate earnings this year of $0.82 a share, increasing to $0.92 in 2013. This means the stock is trading at a p/e of only 6.5 based on projected 2012 profits. The shares pay a quarterly dividend of $0.05, to yield 3.7% at the current price.

Action now: Trinidad is a Buy for aggressive investors.

 

YOUR QUESTIONS

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Payout ratios

Q – After reading a report on several oil and gas companies and comparisons of their payout ratio, I’m finding it hard to understand how they can sustain their company’s business.

Included with the report was a table which suggests that the sum of their capital expenditures and dividend payout exceeds their incoming cash flow. Is that possible? As well they are borrowing considerable amounts from their credit facilities to pay for both the cap ex and dividend payout. Am I understanding this correctly? Is the gamble being taken based on the expectation that commodity prices for oil and gas are going to rise again? If you could clarify this for my wife and me it would be greatly appreciated. – Adolfo E., Toronto

A – The table our reader included in his e-mail was not in a format that can be reproduced here, however it showed 16 energy producers with a projected average payout ratio for 2012 of 151%, including dividends and capital expenditures. I asked Tom Slee, our resident expert on balance sheets to give us his thoughts. Here is his reply:

“I think that the short answer to our reader’s question is yes! The companies are living beyond their means.
 
There are four variables at play as far as oil gas payout ratios are concerned: estimated oil prices, estimated gas prices (both of which are constantly moving), dividends, and capital expenditure programs, which are always being revised. It’s a huge balancing act. To remain competitive a company wants to have an aggressive capital program. In fact, if management cuts back on this the stock moves off, which is what we recently saw at ARC Resources. So companies have programs that exceed their cash flow after dividends and finance this shortfall with bank loans.

As a rule of thumb, the Canadian industry operates at 120% total payout ratio. Remember, however, that drilling can be halted at short notice and of course dividends in this industry are not secure. The real problem arises when the oil and gas prices slump. Then the payout ratios soar. I notice that Pengrowth Energy was using a $101 price for oil in its figures for the recent NAL takeover. That is already looking far too optimistic.
 
Right now, with gas flat on its back, we are seeing some frightening payout ratios but these could change quickly if things improve. Certainly, the companies and the banks are not very worried. The major producers are very strong due to their accumulated earnings which have very little to do with cash flow. Dividends are the question mark.”

Hope this is of some help in understanding a complex business model. – G.P.

Manitoba rates

Q – Why are Manitoba credit union GIC rates much better than Ontario and are they safe – are we protected in Ontario by the Deposit Guarantee Corporation of Manitoba? Also is there someplace in Ontario where we can get the same rates as Manitoba? – David D., Toronto

A – It’s true that several Manitoba-based credit unions offer GIC rates that are among the highest in Canada, sometimes through a separate division such as Outlook Financial, Achieva Financial, MAXA Financial, and AcceleRate Financial. There is no obvious reason for this beyond the fact they have decided to be highly competitive in attracting new business, not just from within Manitoba but across the country.

Manitoba’s deposit insurance system protects all depositors, not just residents of the province. But it is worth noting that this is not a government agency nor is the coverage backed by any provincial government guarantee.

It is possible to find a matching rate in Ontario, in fact a slightly better one. According to Globeinvestor.com, ICICI Bank Canada, which is a subsidiary of one of India’s largest banks, is offering 3.3% on five-year non-redeemable GICs. This compares to 3.25% from the highest-paying Manitoba credit unions.

ICICI has seven branches in the Greater Toronto area as well as one each in Calgary and Surrey B.C. See their website for details at www.icicibank.ca. The site does not post current rates for non-redeemable GICs so call the bank to confirm the Globeinvestor rate is correct before you make a trip to a branch. – G.P.

 

That wraps things up for June. Enjoy the Canada Day holiday and we’ll see you again on Tuesday, July 3.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.

In This Issue

TARGET: 2015

By Gordon Pape

Get ready for 2-1/2 more years of slog – and that’s the optimistic view. That’s the message we’re getting in increasingly definitive tones from central bankers, politicians, and economists. It won’t be until 2015 – if then – that the world emerges from the long slump that was triggered by the credit crunch of 2008-09 and exacerbated by the sovereign debt crisis.

The U.S. Federal Reserve Board acknowledged that reality several months ago when it announced that it would maintain its target rate at an all-time low of zero to 0.25% until the end of 2014. The Fed reinforced its stance last week by reducing its estimate for U.S. growth this year to a maximum of 2.4%, down half a point from its April prediction. In response to the deteriorating outlook, Chairman Ben Bernanke announced an extensive of “Operation Twist” until year-end. It’s a financial manoeuvre that involves selling billions of dollars worth of short-term bonds and buying longer-term issues in an effort to keep interest rates low.

Moreover, there are indications the Fed might reluctantly consider a third round of quantitative easing (QE) if conditions worsen, although that may not happen until late in the year. QE is a euphemism for turning on the printing presses and flooding the economy with more cash. The aim is to prime the lending pump and encourage consumer spending but the longer-term results include higher inflation and a debasement of the U.S. dollar. In other words, short-term gain (maybe) for long-term pain (certainly).

The U.S. is not the only country to resort to QE to try to stimulate growth. The Bank of Japan tried it in the early years of this century as a means of fighting off deflation. It didn’t work. The European Central Bank has used it twice in the past few years, although they have avoided referring to it as QE – they call it long-term refinancing operations (LTRO). As far as anyone can tell, the positive effects have been negligible.

Britain has a £325 billion QE program in place and Bank of England Governor Mervyn King wanted to pump in an additional £50 billion to try to right the faltering economy. However, that move was defeated earlier this month by the Bank’s monetary policy committee in a tight 5-4 vote.

Does it work? The International Monetary Fund (IMF) says QE helped to ease the credit freeze that seized up financial markets after the collapse of Lehman Brothers in September 2008. The IMF also credits QE with boosting the stock market recovery that began in March 2009. However, many members of the U.S. Congress on both sides of the floor strongly oppose the strategy.

“I think it’s a bad idea,” said Ohio Republican Congressman Steve Chabot last year. “Just printing more money and throwing it out there is devaluing the money we already have. Over the long term it’s inflationary. It sends the wrong message.”

On the other hand, investors love the idea because QE theoretically stimulates lending and encourages people to buy homes, expand businesses, and hit the malls. All of that is good for stock markets. That explains why the expectation of another round of QE sparked a short-lived rally from June 11 to 19, during which the Dow rose 426 points. Then the Fed spoiled the party by rejecting QE3 in favour of more Twist. Stocks promptly sold off.

Gold was also hammered after the Fed statement was released. Bullion had been on the rise because it is priced in U.S. dollars so any devaluation in the currency would increase the value of the metal in world markets. When QE3 didn’t happen, gold (and silver) sold off.

Clearly, the Fed is reluctant to implement another round of QE, especially in an election year given the opposition on Capitol Hill. So any decisive action to revive sagging U.S. growth is likely on hold until after the first week of November, unless the economy falls off a cliff in the meantime.

This means we should prepare ourselves for more of the same, both short and long term. Europe’s crisis will not be solved any time soon, the Americans are almost powerless to deal decisively with their situation until after the election, and we’re caught in the middle. Stay defensive with your portfolio, focus your stock selections on top-quality companies that can do well in a weak economy, and don’t abandon bonds. That may be my core advice for the next two years.

 

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BUY WALMART

In keeping with my advice to buy stocks in companies that can continue to generate profits in a weak economy, I am adding Walmart (NYSE: WMT) to our Recommended List.

The company hardly needs an introduction. I would be surprised if there is a single person reading this column who has not been in a Walmart store at one time or another. We all know the experience: endless aisles of merchandise ranging from baby food to large-screen TVs, with hardly any staff available to help or advise. Apart from the friendly greeter at the door, it’s an unmemorable shopping experience.

So why do people flock there? Because it’s cheap, of course. Walmart consistently manages to undersell everyone else, in part because of the hard-line deals it drives with suppliers and in part because of its controversial success in keeping trade unions at bay. When times are tough, cheap is what people want – just look at the rapid rise in the shares of Dollarama for evidence.

But you can’t buy TVs or groceries or gardening supplies at Dollarama. Walmart has it all. It has dominated the discount market for many years and will continue to do so for the foreseeable future.

Recently, the company celebrated its 50th year in business at its annual meeting in Fayetteville, Arkansas (the company is based in nearby Bentonville, reflecting its deep Middle America roots). During the meeting, CEO Mike Duke pledged that Walmart will continue to thrive for the next 50 years, based on its five “enduring values”: integrity, opportunity, family and community, purpose, and responsibility.

“I’ve said this before, and I’ll say it again, Walmart is the best-positioned global retailer in the world today,” he said.

It may sound boastful, but he’s right. No one else is in the same league.

Walmart may represent the values of Middle America but it has become an international retailer with 10,130 stores under 69 different banners in 27 countries. The company employs more than two million “associates” world-wide and claims to serve more than 200 million customers a week.

In mid-May, the company reported results for its 2013 fiscal first quarter (to April 30). Earnings from continuing operations came in at $1.09 per share (figures in U.S. dollars). That was up from $0.96 the year before and ahead of the company guidance of between $1.01 and $1.06 per share. U.S. comparable stores sales increased by 2.6% while sales at its Sam’s Club stores were up 5.3%, not including fuel. Those are healthy increases for a well-established company in a weak economy.

Consolidated net sales were $112.3 billion, an increase of 8.6% from last year. Walmart ended the first quarter with free cash flow of $3.1 billion and had cash in the bank of $8.1 billion. Return on investment (ROI) for the trailing 12-month period was an impressive 18.1%. From a financial perspective, this is a very sound company.

The share price has moved higher in recent months, bucking the trend in the U.S. market. However, at about 14 times anticipated fiscal 2013 earnings, it does not appear to be out of line.

In March, the company announced a 9% dividend increase, bringing the annualized payout to $1.59 a share. Based on Friday’s closing price of $67.30, the yield is 2.4%.

Action now: Walmart is a Buy for defensive investors. – G.P.

 

RYAN IRVINE ON BEATING THE MARKET

Contributing editor Ryan Irvine is back this week with some practical advice on how to construct a diversified portfolio that is designed to outperform the broad indexes. Ryan is the CEO of KeyStone Financial (www.keystocks.com) which specializes in identifying high-quality small-cap stocks. Over to him.

Ryan Irvine writes:

Most financial advisors recommend that you diversify for your own protection. What they fail to tell you is that it is also for their protection. For someone starting out, or with a relatively small portfolio, a broad based ETF or combination of ETFs may be a good idea. Indeed, a personal stock portfolio must be diversified to some degree. No one should put all their eggs in one basket and expose themselves to the inherent risk of holding only one stock.

But if you want to beat the market, you cannot be the market.

The problem we see often today is that many funds and other investment products hold between 50 and 300 stocks. According to the modern portfolio theory, you come very close to achieving optimal diversity after adding about the 20th stock to your portfolio.

So why do fund and investment managers over-diversify and create below-average returns for your portfolios over time? We think the following quote from the world’s greatest investor, Warren Buffett, sums it up: “Wide diversification is only required when investors do not understand what they are doing.”

To give you an idea of how little Mr. Buffet himself believes in over-diversification, recently a study of his portfolio over the last 25 years was completed. Within his multi-billion dollar portfolio he averaged only 33 stocks per year. Perhaps more astonishingly, his top five holdings, on average, comprised 73% of his portfolio. So much for diversification!

To quote Mr. Buffett again: “Why not invest your assets in the companies you really like? As Mae West said, ‘Too much of a good thing can be wonderful.’ “

While we do not advocate under-diversification, to beat the market long-term we recommend a strategy of “focused diversification” within the growth segment of your portfolio. When building your Small-Cap Growth Stock Portfolio, we suggest you follow the following simple steps.

1, Purchase between 10 and 12 small-cap stocks and equally weight each selection initially. For example, a $10,000 portfolio with 10 stocks would allocate $1,000 per stock.

2. Construct your portfolio over at least a one-year period thus ensuring you do not buy at a market peak within a year or cycle.

3. Buy companies from a diverse set of industries within our Recommended List to achieve appropriate diversification.

4. Review and pay careful attention to our updates and use our continuing research to guide your decisions to Buy, Hold, or Sell given your time horizon and tolerance for risk.

If one stock performs very poorly, three average, two above average, two very well, and two excellent, it has been our experience that the overall return of a Small-Cap Growth Stock Portfolio constructed in this manner can significantly outperform the market over time. We do our research and focus our Buy recommendations on the companies that rank highest within our growth and value criteria. By investing with conviction and with a realistic time horizon, this strategy allows our winning recommendations to truly affect the value of your portfolio over time.

Following are updates to a couple of relatively recent Buy recommendations that may make solid additions to, or starting points for, your Small-Cap Growth Stock Portfolio.

 

RYAN IRVINE’S UPDATES

Enghouse Systems Ltd. (TSX: ESL, OTC: EGHSF)

Originally recommended on May 7/11 (IWB #21109) at C$9.10. Closed Friday at C$13.75, US$12.78 (June 18).

Enghouse Systems was introduced to the IWB in our February 2011 installment when the stock traded at $9.10. Our most recent update was in March of this year with the stock closing at $14.19.

At that time we shifted our near-term rating to Hold and maintained our long-term rating (one year+) at Buy. While we continue to like the business long-term, the near-term rating change was a result of the stock jumping 70% in the last year and our assessment that Enghouse had reached fair value in the near term. With the stock closing Friday at $13.75, we look more closely at the company’s latest financial results and our current rating.

Enghouse develops enterprise software solutions for a variety of vertical markets. The company is organized around two business segments: the Interaction Management Group (IMG), which accounted for 88% of second-quarter revenue, and the Asset Management Group (AMG) which contributed 12%.

IMG serves the customer service market segment through the provision of interactive voice response (IVR) systems and speech/voice recognition solutions, as well as an advanced contact centre platform that manages multichannel customer interactions. Its customers include insurance companies, banks, utilities, as well as high technology, health care, and hospitality companies.

AMG provides visual-based software solutions for the design and management of complex network infrastructures to telecommunications, utilities, public and private transportation, and oil and gas companies.

On June 6, Enghouse announced that its second-quarter 2012 revenue rose 4% to $31.5 million from $30.3 million in the prior year. Hosted services and maintenance revenue was $16 million compared to $13.9 million, an increase of 16%. This includes maintenance revenue of $14.5 million compared to $13.1 million in the prior year and reflects incremental maintenance revenue on license sales in the past fiscal year as well as contributions from acquired operations. Hosted revenue was up 76% in the quarter to $1.5 million as a result of hosted revenue contributions from CustomCall subsequent to an acquisition on March 1, 2012. Recurring revenue is important to the company as it increases the predictability of future cash flows and is consistent with the company’s strategy of growing its hosted revenue base.

Net income jumped to $4.2 million ($0.16 per share fully diluted) compared to $2.1 million ($0.08 per share) in the second quarter of fiscal 2011, primarily as a result of increased hosted and maintenance services revenue. On a year-to-date basis, net income was $8.2 million ($0.32 per share) compared to $5.1 million ($0.20 per share) in the prior year.

Enghouse’s strategic focus is to continue to build its business into a larger and more diverse software and services company, with a mandate of further growth both organically (low single digit) and through acquisitions within and outside its current vertical markets. Pro forma, the company currently holds $70 million ($2.73 per share) in cash. The company continues to have no long-term debt and has sufficient cash resources to fund both its current and future financial operating commitments as well as its dividend strategy.

With a cash war chest of over $70 million (after spending approximately $37 million year-to-date in 2012), Enghouse has the means to make accretive acquisitions to grow cash flow. To this end, on June 1 Enghouse acquired Zeacom Group Ltd., a leading provider of multi-channel contact centre communications solutions for a cash purchase price of approximately US$30.6 million.

Headquartered in Auckland, New Zealand, with offices in Australia, the U.K., and the U.S., Zeacom’s leading-edge contact centre software and business process automation solutions have been installed in over 3,500 customer sites worldwide. Zeacom is currently profitable with annual revenue in the range of $29 million.

The deal gives Enghouse critical mass in the growing Asia Pacific area, gives a product offering for smaller (10-100 people) contact centres, and also provides a hedge against Microsoft’s Lync software, which is making inroads in the private branch exchange (PBX) space. While there will likely be some initial integration cost, we expect Zeacom to begin contributing to cash flow by the fourth quarter of this year and, as such, the acquisition appears to be a good use of cash – time will ultimately tell us how good.

The general economic climate continues to present challenges to the company’s business overall. As such, management is not scaling up investments for internal or organic growth in 2012. We do not expect material organic growth in the near term (we estimate organic growth to be just over 2% year-to-date). Having said this, top and bottom line growth in upcoming quarters will continue from acquisitions including CosmoCom and Zeacom, as well as slight margin improvements from further integration progress.

Enghouse’s enviable balance sheet not only buffers the company in the event of downturn, but allows it to be aggressive on the acquisition front, likely at attractive prices under this scenario. If a tepid “recovery” continues, the acquisition environment remains relatively favourable, so Enghouse should also be able to make accretive acquisitions at a reasonable pace. The company is also in the process of consolidating its operation under a singular brand which should provide for operational efficiencies going forward.

At first glance, with a trailing p/e of 17.5, Enghouse may not appear cheap. Indeed, with the price up more than 50% since our original recommendation just over one year ago, the stock is not as cheap as it was at that time. In fact, in the near term, we believe the company reached close to fair value when it hit a recent high in the $14.50-$15.25 range.

However, when we dig a little deeper we find that the company’s consensus earnings per share (EPS) 2012 estimate is in the range of $0.68. If we strip out the pro forma $2.73 per share in cash and just look at the base business, the forward-looking p/e is a more reasonable 16.2. Moreover, if we look out to 2013, where current earnings estimates are in the range of $0.95 per share (as acquisition growth kicks in) and strip out the cash, the stock is trading at around 11.6 times earnings. On a cash flow basis, the company remains at a discount to its peers.

In the near term, we believe organic growth will be challenging but recent acquisitions will provide decent overall growth, following initial integration which may impact the next quarter. Therefore, in the near term (six months) we do not see the stock moving much higher than the upper end of its recent range.

Based on this, we maintain our near-term rating at Hold and our long-term rating at Buy. We expect management to continue to execute its acquisition strategy, driving revenues beyond $200 million over the next two years. In the near term, we will be patient, expect volatility due to the relatively low amount to shares available at present, and collect our 2% dividend as the company grows and eventually attracts the attention of the broader market.

Action now: Hold for the near term, Buy for the long term.

Athabasca Minerals Inc. (TSX-V: ABM)

Originally recommended on Jan. 30/12 (IWB #21204) at $0.485. Closed Friday at $0.64.

Our second update comes from the micro-cap arena, which is not for the faint of heart. Athabasca Minerals is a management and exploration company. Its activities include developing and exploring industrial minerals in Alberta and providing aggregate management for the construction, oil sands, and infrastructure industries of the province. The company has one of the largest aggregate operations in Canada and holds a significant land position in the Athabasca region of Alberta. The stock was recommended at $0.485 in January of this year.

Historically, all of the company’s revenue has been derived from management contracts but this is changing. The company is advancing its wholly-owned aggregate projects including its Kearl, Logan, Pelican Hill, and House River operations. We expect three to be operational and generating higher margin income in 2012.

Sand and gravel aggregates are the most common construction materials used in the world. Since the invention of cement, aggregates in the form of concrete have become the building blocks of civilization. They are not as sexy as gold or silver but they are basic, boring materials that are in high demand in Alberta’s vast and ever-expanding oil sands. Perhaps most importantly, they provide strong cash flow for Athabasca, which is well positioned to service this market for the next several decades.

The ability to remove gravel from pits in Northern Alberta can be hampered by cold and wet weather conditions. As a result, winter and spring are traditionally the slowest time for the company. However, during the first quarter of this year Athabasca reported record high sales volume, with unusually increased demand for aggregates. As various oil sands companies have announced plans to increase their production, strong continuing demand for aggregate is anticipated by management.

For the quarter, Athabasca said that total tonnage sales of aggregate increased by 123.6%, with almost two million tonnes sold compared with just under 900,000 tonnes in the same period last year. Aggregate sales on which management fee revenue is earned (Susan Lake) rose 101% on sales of close to 1.8 million tonnes.

Revenues jumped to $4.45 million. This compared to 2011 first-quarter revenue of $1.35 million. Overall, total revenue increased by 230% and aggregate management fee revenue increased by 111%. Net income jumped to $784,408 ($0.029 per share) from a small net loss of $1,890 last year. Due to a solid outlook and the fact that fiscal 2012 sales have begun at a strong rate, management now anticipates that aggregates sales for this fiscal year will surpass the almost 7.8 million tonnes sold in fiscal 2011.

Despite its solid rise since our recommendation earlier in the year, the stock continues to appear cheap long term on a valuation basis. On a trailing basis (over the past 12 months), the company has now posted earnings per share of $0.131 giving it a p/e ratio of under five. With an improving balance sheet, better liquidity, strong cash flow, the potential for further wholly-owned pit sales this year, and strong near- to long-term demand forecasted for its managed operations, the stock remains attractive.

Action now: Buy.

A final thought: these are just two ideas to look over, see if they fit with your strategy, and potentially use to begin the construction of your Small-Cap Growth Stock Portfolio. While we continue to like each company, they are part of an overall “Focused Diversification” portfolio strategy. As such, if you are planning to utilize this strategy, we urge you to follow the complete process and not just take the proverbial “flyer” on two individual stocks – this creates too much company-specific risk.

– end Ryan Irvine

 

GORDON PAPE’S UPDATES

Silver Wheaton (TSX: NYSE: SLW)

Originally recommended on Sept. 20/10 (IWB #20133) at C$25.75, US$25.02. Closed Friday at C$26.84, US$26.20.

When gold took a big dive earlier this year, silver followed suit, dragging the price of this stock as low as C$23.11, US$22.94 on May 16. Precious metals have recovered somewhat since and so have the fortunes of Silver Wheaton but we’re still well below the all-time highs of almost $50 a share reached in the spring of 2011.

In mid-May the company reported impressive first-quarter results. Revenues increased 26% compared with the same period in 2011, to a record $199.6 million (the company reports in U.S. currency). Sales hit record levels of 6.1 million silver equivalent ounces (5.9 million ounces of silver and 3,900 ounces of gold). Net earnings were up 20% to $147.2 million ($0.42 per share) while operating cash flows increased 29% to $163.8 million ($0.46 per share). Average cash costs were $4.08 per silver equivalent ounce, relatively unchanged from last year.

The Vancouver-based company also announced it has attributable proven and probable silver reserves of 798 million ounces. That is nearly twice the reserves of any other silver company in the world. Silver Wheaton had cash on hand of $997 million as of the end of March.

CEO Randy Smallwood said the company is “on target to attaining our annual production guidance of 27 million silver equivalent ounces” in 2012. He added: “With continued positive progress at our world-class cornerstone assets, including the Peñasquito and Pascua-Lama mines, Silver Wheaton retains one of the strongest growth profiles in the sector.”

The company declared a quarterly dividend of $0.09 per share, which was paid on June 6.

This stock is a play on precious metals prices as well as on the widely-held belief that silver is undervalued compared to gold. If you believe the metals will move higher from here, this is a good time to take a position.

Action now: The stock is a Buy for aggressive investors.

Lundin Mining (TSX: LUN, OTC: LUNMF)

Originally recommended by Yola Edwards on May 14/07 (IWB #2719) at C$14.18. Closed Friday at C$4.13, US$4.00.

After a flurry of merger talks and takeover rumours last year, Lundin’s stock has pulled back to below $5 and has been languishing in that range all year. Recently the company reported first-quarter net income of $58.3 million ($0.10 per share) compared to $71.2 million ($0.12 per share) for the first quarter of 2011 and $36.1 million ($0.06 per share) for the fourth quarter of last year (results in U.S. currency). Sales were flat year-over-year, coming in at $212.8 million.

Lundin is a base metals producer (copper, zinc, nickel, and lead) with operations in Spain, Portugal, Sweden, and Ireland. Its potentially most important asset is its equity stake in the huge Tenke Fungurume copper/cobalt mine in the Democratic Republic of Congo. The company had cash available of $274 million as of the end of March and is using about $75 million of that to acquire an 80% stake in the Touro copper project in Spain.

This stock needs a catalyst to get it moving again, otherwise it is likely to continue to trade around the current level for the next several months.

Action now: Hold.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (IWB #21114) at C$10, US$10.44. Closed Friday at C$5.34, US$5.25.

What’s wrong with this picture? Trinidad Drilling’s stock has lost almost half its value since I recommended it a little more than a year ago and yet the company continues to post impressive results.

First-quarter figures released last month are the latest example. Revenue increased by almost 14% year-over-year to just under $256 million while net earnings more than doubled to $34.5 million ($0.29 a share) from just under $16 million ($0.13 a share) in the first quarter of 2011. After stripping out non-recurring revenue and expenses, adjusted earnings were $42.7 million ($0.35 a share), up from $21.8 million ($0.18 a share) in 2011. Looking at the balance sheet, net debt was reduced by 5.7% to $421 million.

Moreover, the company says it expects more of the same for the rest of 2012 despite the weakness in natural gas prices. “Trinidad has demonstrated an ability to switch its focus away from dry natural gas development towards oil and liquids-rich plays,” the company said in a statement accompanying the results. “As rigs have been moved from dry natural gas projects they have largely been absorbed by ongoing demand in oil or liquids-rich plays. The strength in crude oil prices and the high level of demand for equipment has to date maintained dayrates at relatively strong levels, particularly for high performance equipment.” As a result, the company described the outlook for the rest of the year as “positive”.

At the current price, the shares look undervalued. Analysts estimate earnings this year of $0.82 a share, increasing to $0.92 in 2013. This means the stock is trading at a p/e of only 6.5 based on projected 2012 profits. The shares pay a quarterly dividend of $0.05, to yield 3.7% at the current price.

Action now: Trinidad is a Buy for aggressive investors.

 

YOUR QUESTIONS

Payout ratios

Q – After reading a report on several oil and gas companies and comparisons of their payout ratio, I’m finding it hard to understand how they can sustain their company’s business.

Included with the report was a table which suggests that the sum of their capital expenditures and dividend payout exceeds their incoming cash flow. Is that possible? As well they are borrowing considerable amounts from their credit facilities to pay for both the cap ex and dividend payout. Am I understanding this correctly? Is the gamble being taken based on the expectation that commodity prices for oil and gas are going to rise again? If you could clarify this for my wife and me it would be greatly appreciated. – Adolfo E., Toronto

A – The table our reader included in his e-mail was not in a format that can be reproduced here, however it showed 16 energy producers with a projected average payout ratio for 2012 of 151%, including dividends and capital expenditures. I asked Tom Slee, our resident expert on balance sheets to give us his thoughts. Here is his reply:

“I think that the short answer to our reader’s question is yes! The companies are living beyond their means.
 
There are four variables at play as far as oil gas payout ratios are concerned: estimated oil prices, estimated gas prices (both of which are constantly moving), dividends, and capital expenditure programs, which are always being revised. It’s a huge balancing act. To remain competitive a company wants to have an aggressive capital program. In fact, if management cuts back on this the stock moves off, which is what we recently saw at ARC Resources. So companies have programs that exceed their cash flow after dividends and finance this shortfall with bank loans.

As a rule of thumb, the Canadian industry operates at 120% total payout ratio. Remember, however, that drilling can be halted at short notice and of course dividends in this industry are not secure. The real problem arises when the oil and gas prices slump. Then the payout ratios soar. I notice that Pengrowth Energy was using a $101 price for oil in its figures for the recent NAL takeover. That is already looking far too optimistic.
 
Right now, with gas flat on its back, we are seeing some frightening payout ratios but these could change quickly if things improve. Certainly, the companies and the banks are not very worried. The major producers are very strong due to their accumulated earnings which have very little to do with cash flow. Dividends are the question mark.”

Hope this is of some help in understanding a complex business model. – G.P.

Manitoba rates

Q – Why are Manitoba credit union GIC rates much better than Ontario and are they safe – are we protected in Ontario by the Deposit Guarantee Corporation of Manitoba? Also is there someplace in Ontario where we can get the same rates as Manitoba? – David D., Toronto

A – It’s true that several Manitoba-based credit unions offer GIC rates that are among the highest in Canada, sometimes through a separate division such as Outlook Financial, Achieva Financial, MAXA Financial, and AcceleRate Financial. There is no obvious reason for this beyond the fact they have decided to be highly competitive in attracting new business, not just from within Manitoba but across the country.

Manitoba’s deposit insurance system protects all depositors, not just residents of the province. But it is worth noting that this is not a government agency nor is the coverage backed by any provincial government guarantee.

It is possible to find a matching rate in Ontario, in fact a slightly better one. According to Globeinvestor.com, ICICI Bank Canada, which is a subsidiary of one of India’s largest banks, is offering 3.3% on five-year non-redeemable GICs. This compares to 3.25% from the highest-paying Manitoba credit unions.

ICICI has seven branches in the Greater Toronto area as well as one each in Calgary and Surrey B.C. See their website for details at www.icicibank.ca. The site does not post current rates for non-redeemable GICs so call the bank to confirm the Globeinvestor rate is correct before you make a trip to a branch. – G.P.

 

That wraps things up for June. Enjoy the Canada Day holiday and we’ll see you again on Tuesday, July 3.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.