In This Issue

BUY STOCKS, NOT STORIES

By Gordon Pape

Buy good stocks, not good stories.

That was the answer I gave to a writer for Investment Executive who asked me to sum up in a sentence what advice I would give to novice investors.

It was a lesson I learned the hard way. As a career journalist and author, I have always been a sucker for a great story. So during my early years of investing, I was often persuaded to put money into fledgling companies that were poised to make gazillions of dollars with innovative, usually off-beat concepts. Almost inevitably, they crashed and burned.

One example was a Quebec-based company that claimed to have developed a technique for making super-strong bullet-proof vests out of spider silk. At first I was sceptical (I should have remained so) but when I learned that they were receiving grants from the U.S. military to pursue their research I figured there had to be something to it and bought shares. That was before it became general knowledge that the U.S. military throws money at almost any project, no matter how weird, that it thinks may give it a technical advantage. In the end, the stock fell to zero and I lost my investment. Perhaps not surprisingly, the name of the company has been blotted from my memory.

Then there was the Lady Mary saga. It was an old tub that had been refitted to offer dinner cruises on Simpson Bay on the Dutch/French Caribbean island of St. Martaan. A marketing executive in Montreal heard that it was for sale and decided he wanted to get away from the rat race and move to Paradise. He persuaded some acquaintances to form a limited partnership to buy the boat, which he and his spouse would crew. I got sucked in through a friend of a friend.

Again, it was a great story. There was no competition and the popularity of the island resort would ensure a steady stream of business. Investors were welcome any time for a sail and a free dinner. Simpson Bay was beautiful, calm, safe, and sheltered. We were assured that hurricanes never hit the island and in the unlikely event one did, the boat was insured. The projected cash flow looked good and there were tax write-offs. I bought two shares.

The business limped along for a few years. The bonanza of passengers never materialized and a break-even season became a welcome event. Then one dark summer night, a hurricane passed directly over Simpson Bay and the Lady Mary went to the bottom along with dozens of other small craft. As for the insurance money, our charming “friend” absconded with it and has never been heard from again. He’s probably sailing around Tahiti these days under an assumed name. The investors lost everything.

This is not to say that good stories never translate into profits. Occasionally they do. Back in the 1990s while on a cruise to Alaska I was told to buy shares in a company called Dia Met Minerals, which was then trading as a penny stock on the old Vancouver Stock Exchange. The founder was an old diamond hand who was convinced there were thousands of the gems in the Canadian north. He was reputed to have discovered a big diamond pipe somewhere in the sub-Arctic that was being kept under wraps.

Diamonds? In the Arctic? Even my fertile brain couldn’t imagine that. With the super spiders still fresh in my mind, I passed. In 2001, BHP Billiton, the same company that is now trying to grab Potash Corp., took control of Dia Met, paying $21 a share for the company.

But stories like that are rare. Maybe one out of a hundred ends up that way. The other 99 times, investors lose their money.

So if you should avoid good stories, how do you find good stocks? It takes some homework or finding a great advisor. The best stocks are often the ones you never hear about in the news.

I cannot remember even reading a single article about Canadian Utilities (TSX: CU) but it is one of the core stocks in my portfolio and has been on the IWB Recommended List since May, 2000 when I picked it at $18.88. It’s one of the dullest companies you’ll find anywhere, with a website to match (www.canadian-utilities.com). The core business is supplying natural gas and electricity to residents of Alberta which it does in a low-key, efficient, and profitable manner. In a little over a decade, the stock has gone up by about $30 a share. The dividend has been increased nine times and we have received a total $9.16 in payments. That works out to an average annual compound rate of return of 11.3%. Now that’s a good stock!

There are lots of others that fall into that category: boring companies that quietly go about their business, making investors rich in the process. Examples include Fortis Inc. (TSX: FTS), Brookfield Asset Management (TSX: BAM.A, NYSE: BAM), Enbridge (TSX, NYSE: ENB), TransCanada (TSX, NYSE: TRP), CN Rail (TSX: CNR, NYSE: CNI), and most of the banks.

Here’s how to separate the good stocks from the good stories.

Look at the bottom line. If a company is not making a profit, pass. No matter how good the story is, there is no guarantee it will ever earn a dime for investors. Think about all the great high-tech start-ups of the late 1990s. They all looked like huge money-spinners, at least conceptually. Most ended up on the rubbish heap.

Check the earnings record. If the company is making money, do some digging and see whether earnings have been growing and if so at what rate. Double-digit profit growth over several consecutive years is a clear indication that management is doing something right.

Make sure it pays a dividend. These days, I rarely buy a stock that doesn’t pay a dividend. I’m not terribly concerned if the yield isn’t high but I want to see a history of steady dividend increases over the years. CN Rail only yields 1.6% but it has raised its dividend 11 times since 1996.

Choose industry leaders. Companies that dominate their sectors tend to stay on top for a long time – sometimes even longer than our life expectancy. General Electric was founded by Thomas Edison more than a century ago. It has had its ups and downs over the years but remains one of the giants of U.S. industry to this day.

Look for barriers to entry. When the Internet was ramping up, everyone wanted to get in on the act and it was cheap and easy to do so. All you needed was a few skilled programmers, a couple of computers, and an idea. The barriers to entry were minimal. Contrast that with the obstacles facing an entrepreneur who wants to launch a new cable TV system in Canada or build a new railroad. They’re overwhelming. That’s why companies like Rogers, Shaw, CN, and CP are going to be on top for the foreseeable future, maybe forever.

Those are the truly good stories. They may not be sexy but they’ll make money for you. In the end, that’s what counts.


Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

BANK STOCKS WILL LEAD TSX HIGHER IN 2011

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Contributing editor Tom Slee is back with us this week with a fresh look at the banking sector, which he follows closely. He likes what he sees, and so should you. Here is his report.

Tom Slee writes:

Make a note of Sept. 7. That was the day Canadian financial regulator Julie Dickson gave our banks the green light. The usually tight-lipped Superintendent of Financial Institutions announced that she was allowing banks to increase their dividends and start buying back shares. After two years of curbs and constraints, she was easing the leash. It was a clear signal that Canadian financial institutions were able to meet new capital requirements then being negotiated in Switzerland. We were turning the page.

A week later, the International Banking Governors unveiled their revised regulations (Basel III) and markets heaved a sigh of relief. The requirements were far less stringent than many people had feared. Obviously, an intensive lobbying campaign by the major banks had paid off. The Governors chose to water down a lot of the original proposals, so much so that Mary Monroe, vice president of the American Bankers Association, expressed satisfaction at the outcome.

Certainly banks will have to strengthen their balance sheets but not immediately. There is a 10-year phase-out period as certain securities are eliminated from the Tier 1 capital calculations. The new and extremely expensive liquidity coverage ratio that makes the system more resilient has been delayed until 2015. Some of its requirements are not going to be fully implemented until 2019. Canadian banks should have no trouble meeting the thresholds.

It’s all a big step in the right direction. My feeling, though, is that no amount of legislation is going to make the banking system totally safe. The recent worldwide financial collapse was not caused by banks being undercapitalized. It resulted from bad management or, to put it more bluntly, greed and incompetence. Bank officers became reckless, stopped doing their homework, reached for yield, and loaded up the balance sheets with toxic assets. Common sense alone should have told them that the subprime derivatives were garbage. It could happen again. Still, that having been said, the new regulations are welcome news for several reasons.

First and foremost, the rules lift a large cloud of uncertainty that has been hanging over bank stocks. It’s a big plus for the market, not only because the banking sector constitutes more than 20% of the entire S&P/TSX Composite Index but because these shares tend to set the tone. If banks perform well, there is going to be a positive ripple effect.

Equally important, the new capital requirements are a vote of confidence in the Canadian financial system. Unlike their European counterparts, our banks can take the proposed rules in their stride and start lending more aggressively. That should spur business activity and boost consumer as well as investor confidence.

Of course, I am not suggesting that it is plain sailing from now on. Our economy remains fragile. However, the Basel announcements have given us a shot in the arm, mainly because the new rules are not draconian. We are not going to face an international credit crunch while financial institutions hunker down and build reserves.

As to the dividend increases that Ms. Dickson referred to, I doubt whether they are going to be dramatic. Some people have suggested that we are going to see large catch-up payments but that’s very unlikely. According to the Bloomberg Dividend Forecast, which is compiled of seven factors and has a current 81% accuracy rate, the major Canadian banks will announce somewhat similar increases between now and the end of 2011. Bloomberg expects TD to raise its dividend 12c per annum and Royal, BMO, BNS, and National to each declare 8c increases. CIBC remains a bit of a question mark because CEO Gerald McCaughey seems to regard dividends as a low priority but a modest 8c hike seems to be in the cards. Of course, nothing is certain but that gives you some idea of what the Street is looking for.

The important thing is that the banks are once more free to conduct their own businesses. Not that the restraints have hampered them very much. Take their recent third-quarter results for example. Some of the analysts were disappointed but I suspect that was sour grapes. The numbers were fine. It was the forecasts that were wrong. Our five largest banks reported a combined profit of $4.8 billion, up 9% from the third quarter of 2009. That’s an encouraging performance by any standard, especially since Canadian consumer confidence slumped during the summer months to its lowest point since January 2009. Earnings from capital markets were less than expected, mainly because of troubles in Europe, but the corporate and retail banking operations came through in style. A lot of the subsequent bad press resulted from the fact that analysts had failed to factor the listless stock markets into their projections.

Royal Bank, the industry’s flagship, is a good case in point. The bank’s third-quarter earnings were 87c a share compared to a forecasted 96c, largely because trading profits were $350 million less than expected. All the other operating divisions performed well. Canadian banking profits were actually up 14% year-over-year, yet the Street was unhappy. It seems harsh. Royal is not my number one choice but it is on track to earn about $4 a share this year, a substantial increase over $3.40 in 2009.

National Bank had similar numbers. Third-quarter earnings of $1.56 a share were respectable but down from $1.78 the previous year. Personal and commercial banking profit was up 32% while income from financial markets dropped 42%. CIBC came in at $1.55 a share for the quarter versus $1.04 year-over-year, in line with consensus estimates. Here again, though, Canadian and Caribbean banking jumped an impressive 44% while trading revenues slumped $200 million.

You can see the pattern. The banks’ traditional core business delivered the goods in the third quarter. I think that this is important. I would have been alarmed if loan losses had soared but been offset by good trading results. The fact that the banks are building their base is encouraging. Of course, capital market income is important but we have to be realistic. These earnings are dependent on the unpredictable international markets and are going to remain volatile. It would help if some forecasters realized this.

 

TOM SLEE’S UPDATES

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Bank of Montreal (TSX, NYSE: BMO)

Originally recommended on July 27/09 (IWB #2928) at C$51.67, US$47.71. Closed Friday at C$59.12, US$58.08.

The Bank of Montreal reported earnings of $1.14 a share, up 16% from 98c the previous year but below the consensus forecast of $1.21. BMO’s Canadian banking operations racked up another strong quarter, booking higher loan volumes and better spreads to earn $428 million, a 17% improvement year-over-year. This more than offset a 58% drop in capital market profit.

U.S. personal and commercial banking remains a problem, mainly because it’s difficult to achieve economies of scale with only 300 American branches. Now that the fiscal restraints have been eased, BMO is expected to make a U.S. acquisition and double the size of this division. There are certainly plenty of American medium-sized banks that would welcome an injection of capital. As a matter of fact, there have already been reports of BMO being on the list of potential bidders for struggling Wisconsin-based Anchor Bank. Its US$4 billion of assets and 55 branches would be a step in the right direction.

I think that, overall, BMO is extremely well positioned going forward. Its Tier 1 capital ratio is 13.6%, well in excess of the guidelines, while return on equity (ROE) is a solid 14%. At the same time, the once exposed $2.80 dividend is now only 51% of the bank’s anticipated 2011 earnings of $5.50 a share. The stock, with an 11 times earnings multiple, remains excellent value.

Action now: BMO is a Buy for income and capital gains. I have set a $67 target and a $55 revisit level.

Toronto-Dominion Bank (TSX, NYSE: TD)

Originally recommended on Feb. 12/07 (IWB #2706) at C$69.85, US$59.59. Closed Friday at C$73.58, US$72.32.

TD Bank also had a good third quarter. The bank reported a profit of $1.245 billion, or $1.43 a share, up 23% from $1.16 the year before. Analysts had been looking for $1.45. Once again, TD booked impressive Canadian loan business. Volume increased 13% while spreads remained flat. Domestic retail banking was particularly strong and some forecasters believe that this division could be earning as much as $1 billion a quarter by the end of 2012.

U.S. loan growth was slower due to the still troubled American financial system but TD is capitalizing on the extensive mortgage refinancing now underway. Inevitably, however, as with the other banks, TD was hurt by lower trading revenues that fell 53% year-over-year to $300 million. The bank is now expected to earn about $6 a share this year and $6.75 or more in 2011.

Tier 1 capital is at a comfortable 12.5% and return on equity is 14.8%, up from 14.3%. Incidentally, BMO Nesbitt Burns feels that TD could increase its dividend of $2.44 by as much as 10% next year.

Action now: TD Bank is a Buy with a target of $85. I will revisit the stock if it dips to $65.

Thomson Reuters (TSX, NYSE: TRI)

Originally recommended on April 13/09 (IWB #2914) at C$33.78, US$27.59. Closed Friday at C$38.45, US$37.82.

Thomson Reuters continues to integrate its US$7 billion acquisition of Reuters and reported lacklustre second-quarter results. Adjusted earnings were 47c a share (TRI reports in U.S. funds), down 20% from 58c a year earlier, but in line with expectations. Management has confirmed its guidance of relatively flat revenue and profits this year.

All things considered, Thomson is on track and should start producing substantial cash flow and revenue growth in 2011. An array of new products such as Westlaw Reset, an upgraded legal platform, Eikon, a new desktop for financial services, and ONESOURCE, a global tax workstation, are coming on stream. So I was surprised when Standard & Poor’s issued a strong sell recommendation. Even after studying the agency’s report, which on balance is fairly positive, I am still puzzled. There is no smoking gun and the analyst’s only concern seems to be the difficulties of merging Thomson and Reuters, coupled with doubts about the publishing industry.

I see Thomson differently. For a start, it’s not in the traditional publishing business. The company is a global information and electronic solutions provider. A large portion of its revenues are generated from “must have” legal and accounting support where costs are fixed and any growth flows to the bottom line. In 2011 this business base is expected to pay off. At the same time, integration expenses should drop to $100 million from almost $500 million this year. As a result, we should see earnings of about $2.40 a share.

Action now: Thomson Reuters is a Buy with a target of C$43. I have set a $34 revisit level.

Enbridge (TSX, NYSE: ENB)

Originally recommended on Aug. 23/99 (IWB #9930) at C$16. Closed Friday at C$53.95, US$52.92.

Enbridge had an excellent second quarter. Adjusted earnings of 63c a share were up almost 19% from 53c a year earlier and well ahead of the 56c consensus forecast. Most encouraging was an increasing cash flow as two of the company’s major projects, Alberta Clipper and Southern Lights, came on stream. Management is upbeat and has raised 2010 earnings guidance to the $2.70 a share range.

All of the good operating results have, however, been overshadowed by a series of high-profile breaks in the company’s U.S. pipelines. First there was a 13,000 barrel oil spill into Michigan’s Kalamazoo River in July. More recently there has been a 6,100 barrel leak at Romeoville, Illinois and a minor spill, a trickle really, at Buffalo, New York. All oil leaks are unforgivable, of course, and Enbridge will pay a price. CEO Patrick Daniel has been forced to testify before Congress and the company’s impeccable image has been tarnished.

None of the leaks or ensuing pipeline shutdowns will hurt the company’s earnings, however. ENB carries insurance against this sort of incident. But the stock may suffer some short-term damage if the politicians and media draw attention to the dangers of aging pipelines. I personally would regard any weakness in the shares as a buying opportunity.

Action now: Enbridge, having traded through our $53 target, is a Buy with a new target of $57. I will monitor the stock closely and update you about possible lawsuits and penalties resulting from the leaks.

– end Tom Slee

 

THE “CURSE” OF THE OIL SANDS

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By Gordon Pape

And God gazed upon the vastness of the Canadian oil sands and pronounced them to be a curse.

Correction: an incipient curse – one that would materialize unless Alberta orders an immediate halt to development and cleans up its environmental act.

And no, it really wasn’t the Supreme Being in that helicopter over the blighted landscape near Fort McMurray. It was famed movie director James Cameron, the genius behind Titanic and Avatar. It was just the Canadian media that gave the impression that God had come down for a visit, dogging every step of his three-day tour and parsing every word he uttered.

Even before he arrived on the scene, Mr. Cameron had made clear his distaste for the oil sands and the havoc they wreak upon the environment. Anyone who has seen Avatar will recognize the parallels between its plotline and what critics say is happening in Alberta: a proud and noble indigenous people under attack by money-grubbing outsiders bent on pillaging their resources even if it means the destruction of their way of life.

In fact, it was an invitation from the first nations people of Fort Chipeywan that brought Mr. Cameron to Alberta in the first place. They have complained for years that pollution from oil sands projects was fouling their drinking water and making the Athabasca River unsafe for swimming and fishing. The director was outraged by that. “I can’t imagine being told by my mom that I can’t swim in the river,” he told reporters.

During his visit, Mr. Cameron met with oil industry officials, environmental groups, and senior politicians. He described himself as a “sponge”, soaking up all the available information before reaching conclusions. But in fact his mind was made up long before he arrived on the scene. It’s hard to believe the oil sands weren’t somewhere in the back of his head when he conceived Avatar. On his way out the door, he allowed during an interview with The Globe and Mail that he might make a documentary on the oil sands. You can guess what the message will be. Think of Al Gore’s An Inconvenient Truth set in Alberta.

At least Mr. Cameron has the bona fides to act as an oil sands critic, unlike anti-seal hunt crusaders from Brigette Bardot to Sir Paul McCartney. Mr. Cameron was born in Kapuskasing, Ontario in 1954 and received his elementary and high school education in Chippewa (a village near Niagara Falls) and later at Stamford Collegiate School in Niagara Falls. He left Canada at age 17 when his family moved to California. He is still a Canadian citizen, having withdrawn his application for U.S. citizenship in 2004 as a protest against the re-election of George W. Bush as U.S. president. So he has every right to speak his mind on the oil sands, or anything else Canadian, without being branded as an outsider.

That said, let’s consider the realities of the situation. While most people support the principles of environmental protection, few would want to go back to the 18th century, living without electricity, central heating, air travel, and automobiles, all of which rely primarily on hydrocarbons to function. Ideally, that will change in the future but no one suggests it will happen within the next decade or perhaps even within a generation. Weaning ourselves off oil will be a long, expensive, and sometimes painful process.

Although demand is growing in emerging economies like China and India, the United States is still the world’s number one oil consumer. Where is that oil going to come from in the years ahead? The U.S. Energy Information Administration (EIA) recently estimated that domestic production will increase by an average of 70,000 barrels a day (b/d) in 2010 while demand will grow by 200,000 b/d. The situation will become even worse in 2011 when the EIA predicts U.S. production will actually decline while demand rises by another 170,000 b/d. The result, says the Agency, will be an increase of 190,000 b/d in petroleum product imports.

Where will that new supply come from? According to the EIA’s latest statistics, Canada is the number one foreign source of U.S. oil, by a wide margin. Through the first seven months of 2010, American imports of Canadian crude oil and petroleum products averaged 2.55 million barrels a day, up by 91,000 b/d from last year. The other top five U.S. sources were:

Mexico. U.S. imports from Mexico are running at about half the level as those from Canada and there does not seem to be much likelihood of significant increases in the near future. Production from some of the country’s key oil fields is declining rapidly and is not being replaced quickly enough. Average daily exports to the U.S. are about flat compared to 2009.

Nigeria. Average daily imports from Nigeria are up almost 50% from 2009 but are still only 40% of Canada’s level. Moreover, Nigeria’s oil-producing region is politically unstable with frequent reports of pipeline sabotage and oil worker kidnappings.

Venezuela. U.S. imports from Chavezland are down from last year and no one wants to be dependant on the whims of the country’s mercurial leader. Come to think of it, much of the country’s reserves are heavy oil, similar in some ways to the Alberta oil sands. Why aren’t the environmentalists on their case? I’m sure President Chavez would be delighted to give Mr. Cameron a tour of the Orinoco Belt, which is said to contain as much as 513 billion barrels of recoverable oil. On second thought, maybe not.

Saudi Arabia. The one-time number one supplier of U.S. foreign oil has dropped to number five on the list with an average of about 1.1 million b/d. Not surprisingly, America wants to be less reliant on Middle East oil.

So back to the question: where will the extra 190,000 b/d come from in 2011 if not Canada? It’s an issue the environmentalists may wish to ponder before they go too far down the “boycott the tar sands” road.

This is not to say that Canada, Alberta, and the oil industry don’t need to clean up their act. They do. No one can look at that devastated northern Alberta landscape and not be repulsed. If Mr. Cameron’s visit adds to the political pressure to take action, it will be a positive result. But if all it does is inspire environmental zealots to ratchet up their anti-Canada rhetoric another notch, it would have been better if he had stayed in Hollywood.

 

GOOD WEEK, BAD WEEK

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Here are some winners and losers from the last seven days.

Good week

The Toronto Stock Exchange. The S&P/TSX Composite Index finally clawed its way back to the level of early October 2008 as it posted a gain of 3.8% in September and finished the week at 12,363.08 after a small loss on Friday. That’s still a long way short of the all-time high 15,073, reached in June 2008. But it’s a huge improvement from where we were about 18 months ago.

Gold, silver, and oil. One of the reasons for the recent rally on the TSX has been the performance of several key commodities. Bullion broke through the US$1,300 barrier last week and, after a mid-week pull-back, rebounded on Friday to gain US$8.20 and finish at US$1,317.80. The S&P/TSX Global Gold Index has gained 5.3% since Sept. 9 and our main gold stock selection, Agnico-Eagle (TSX, NYSE: AEM) is ahead about 9% over that period.

Silver has also been on a big run, hitting the US$22 an ounce level on Friday. Our recent pick, Silver Wheaton (TSX, NYSE: SLW) closed on Friday at C$27.13, US$26.67, up from C$25.75, US$25.02 when it was recommended on Sept. 20.

As for oil, it is back over US$80 a barrel, finishing on Friday at US$81.47. The S&P/TSX Capped Energy Index gained 4.6% in September, thanks to a very strong final week.

Bad week

BHP Billiton (NYSE: BHP). It’s becoming increasingly apparent that BHP Billiton’s US$130 a share takeover bid for Potash Corporation of Saskatchewan (TSX, NYSE: POT) is doomed to failure and it’s not even clear that a significant boost in the offering price would do the trick. The Government of Saskatchewan escalated its opposition another notch last week with Premier Brad Wall telling The Globe and Mail that it could potentially cost his government $100 million in lost revenue, an amount he described as “a big deal”.

On another front, BHP was shot down by a Chicago judge when it tried to stop Potash Corp. from getting access to documents relating to a lawsuit that claims the Australian company systematically tried to undermine POT’s share price prior to the takeover attempt.

Meanwhile, investors continue to await the emergence of a white knight to top the BHP bid. That too is looking problematic. Rumours of significant Chinese participation in a management-led consortium, even in a minority position, have already set off alarm bells in Ottawa and there are no guarantees the federal government would give its blessing to such a deal.

This is a story that could drag on for many months. Don’t be surprised if it ends in the same way as the abortive privatization of BCE. In the meantime, POT’s price continues to slide as investors grow increasingly nervous. The shares finished the week at C$145, US$142.64.

Alimentation Couche-Tard (TSX: ATD.B). The Quebec-based convenience store chain was finally forced to take its billions and go home after Casey’s General Stores (NDQ: CASY) successfully fought off its hostile takeover bid. The Canadian company, which already has a large U.S. network, had offered $38.50 per share for Casey’s in a deal valued at $2 billion, including debt assumption (figures in U.S. currency). But Casey’s board rejected every overture and the final blow came on Sept. 23 when all eight incumbent directors were re-elected at the annual meeting. Couche-Tard conceded defeat when it let its offer expire at 5 p.m. on Sept. 30. The shares dropped 54c on the TSX on Friday to finish the week at $22.47.

 

YOUR QUESTIONS

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Claymore closed-end fund

Q – I have a question about Big Bank Big Oil Split Corp. (TSX: BBO). This closed-end fund by Claymore is a collection of the top five banks and oil and gas companies. It is currently paying an 8.5% dividend, clearly more than if I held the individual companies (which, for the most part, I do own). This trend has been the case for several years now.

Am I missing something here? Is there more than just the normal closed-end fund trading below NAV phenomena?

I only have about $5,000 left for equity RRSP investment this year and was thinking this might be a better option then just choosing to buy more of one of the banks. – Rick Z., Calgary

A – Many split corporation funds have ended up promising more than they delivered and this one falls into that category. There are two parts to this fund: the capital shares to which you refer (BBO) and the preferred shares (TSX: BBO.PR.A).

BBO was launched on June 16, 2006 with an initial public offering price of $15 (the preferreds were priced at $10). It managed to climb to the $16 range in spring 2008 but has not been anywhere close to that level since although the shares have rebounded from the $5 range in late 2009. They closed on Friday at $11.30.

The capital shares currently pay a monthly distribution of 8c per unit. That would translate into a yield of 8.5% however the payments can vary significantly from one month to another. So far this year, for example, they have been as low as 5c a unit and as high as 9c. So it is not a good idea to assume that the payments being made now will remain consistent going forward.

The fund has a high MER of 1.75% and the units are very illiquid, rarely exceeding a daily volume of 3,000. This is not a security I would recommend. – G.P.

 

MEMBERS’ CORNER

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Gold talk

Member comment: I remember reading years ago that, when asked whether he had a favourite stock market pick, a sage said: “Just buy what everyone is talking about”. As silly as this statement might seem, there is a lot of wisdom there. Just think of the recent run-up in oil. It defied all sense and logic re: supply vs. demand yet it went up to almost $150 a barrel. Why? Because everyone was talking about it.
 
I think it is the same with gold today. Forget logic, common sense, U.S. dollar, etc. Everyone is taking about it. Therefore, it will probably continue higher. – W.W.

Response: While it’s true that demand often increases in response to positive publicity, the result can be a bubble which eventually bursts. It may happen with gold at some point, but not now. – G.P.

 

That’s all for this week. Please note that there will be no IWB over the Thanksgiving weekend to allow our staff to enjoy this family holiday (we publish 44 times a year). Look for your next issue on Oct. 18.

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

BUY STOCKS, NOT STORIES

By Gordon Pape

Buy good stocks, not good stories.

That was the answer I gave to a writer for Investment Executive who asked me to sum up in a sentence what advice I would give to novice investors.

It was a lesson I learned the hard way. As a career journalist and author, I have always been a sucker for a great story. So during my early years of investing, I was often persuaded to put money into fledgling companies that were poised to make gazillions of dollars with innovative, usually off-beat concepts. Almost inevitably, they crashed and burned.

One example was a Quebec-based company that claimed to have developed a technique for making super-strong bullet-proof vests out of spider silk. At first I was sceptical (I should have remained so) but when I learned that they were receiving grants from the U.S. military to pursue their research I figured there had to be something to it and bought shares. That was before it became general knowledge that the U.S. military throws money at almost any project, no matter how weird, that it thinks may give it a technical advantage. In the end, the stock fell to zero and I lost my investment. Perhaps not surprisingly, the name of the company has been blotted from my memory.

Then there was the Lady Mary saga. It was an old tub that had been refitted to offer dinner cruises on Simpson Bay on the Dutch/French Caribbean island of St. Martaan. A marketing executive in Montreal heard that it was for sale and decided he wanted to get away from the rat race and move to Paradise. He persuaded some acquaintances to form a limited partnership to buy the boat, which he and his spouse would crew. I got sucked in through a friend of a friend.

Again, it was a great story. There was no competition and the popularity of the island resort would ensure a steady stream of business. Investors were welcome any time for a sail and a free dinner. Simpson Bay was beautiful, calm, safe, and sheltered. We were assured that hurricanes never hit the island and in the unlikely event one did, the boat was insured. The projected cash flow looked good and there were tax write-offs. I bought two shares.

The business limped along for a few years. The bonanza of passengers never materialized and a break-even season became a welcome event. Then one dark summer night, a hurricane passed directly over Simpson Bay and the Lady Mary went to the bottom along with dozens of other small craft. As for the insurance money, our charming “friend” absconded with it and has never been heard from again. He’s probably sailing around Tahiti these days under an assumed name. The investors lost everything.

This is not to say that good stories never translate into profits. Occasionally they do. Back in the 1990s while on a cruise to Alaska I was told to buy shares in a company called Dia Met Minerals, which was then trading as a penny stock on the old Vancouver Stock Exchange. The founder was an old diamond hand who was convinced there were thousands of the gems in the Canadian north. He was reputed to have discovered a big diamond pipe somewhere in the sub-Arctic that was being kept under wraps.

Diamonds? In the Arctic? Even my fertile brain couldn’t imagine that. With the super spiders still fresh in my mind, I passed. In 2001, BHP Billiton, the same company that is now trying to grab Potash Corp., took control of Dia Met, paying $21 a share for the company.

But stories like that are rare. Maybe one out of a hundred ends up that way. The other 99 times, investors lose their money.

So if you should avoid good stories, how do you find good stocks? It takes some homework or finding a great advisor. The best stocks are often the ones you never hear about in the news.

I cannot remember even reading a single article about Canadian Utilities (TSX: CU) but it is one of the core stocks in my portfolio and has been on the IWB Recommended List since May, 2000 when I picked it at $18.88. It’s one of the dullest companies you’ll find anywhere, with a website to match (www.canadian-utilities.com). The core business is supplying natural gas and electricity to residents of Alberta which it does in a low-key, efficient, and profitable manner. In a little over a decade, the stock has gone up by about $30 a share. The dividend has been increased nine times and we have received a total $9.16 in payments. That works out to an average annual compound rate of return of 11.3%. Now that’s a good stock!

There are lots of others that fall into that category: boring companies that quietly go about their business, making investors rich in the process. Examples include Fortis Inc. (TSX: FTS), Brookfield Asset Management (TSX: BAM.A, NYSE: BAM), Enbridge (TSX, NYSE: ENB), TransCanada (TSX, NYSE: TRP), CN Rail (TSX: CNR, NYSE: CNI), and most of the banks.

Here’s how to separate the good stocks from the good stories.

Look at the bottom line. If a company is not making a profit, pass. No matter how good the story is, there is no guarantee it will ever earn a dime for investors. Think about all the great high-tech start-ups of the late 1990s. They all looked like huge money-spinners, at least conceptually. Most ended up on the rubbish heap.

Check the earnings record. If the company is making money, do some digging and see whether earnings have been growing and if so at what rate. Double-digit profit growth over several consecutive years is a clear indication that management is doing something right.

Make sure it pays a dividend. These days, I rarely buy a stock that doesn’t pay a dividend. I’m not terribly concerned if the yield isn’t high but I want to see a history of steady dividend increases over the years. CN Rail only yields 1.6% but it has raised its dividend 11 times since 1996.

Choose industry leaders. Companies that dominate their sectors tend to stay on top for a long time – sometimes even longer than our life expectancy. General Electric was founded by Thomas Edison more than a century ago. It has had its ups and downs over the years but remains one of the giants of U.S. industry to this day.

Look for barriers to entry. When the Internet was ramping up, everyone wanted to get in on the act and it was cheap and easy to do so. All you needed was a few skilled programmers, a couple of computers, and an idea. The barriers to entry were minimal. Contrast that with the obstacles facing an entrepreneur who wants to launch a new cable TV system in Canada or build a new railroad. They’re overwhelming. That’s why companies like Rogers, Shaw, CN, and CP are going to be on top for the foreseeable future, maybe forever.

Those are the truly good stories. They may not be sexy but they’ll make money for you. In the end, that’s what counts.


Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

BANK STOCKS WILL LEAD TSX HIGHER IN 2011

Contributing editor Tom Slee is back with us this week with a fresh look at the banking sector, which he follows closely. He likes what he sees, and so should you. Here is his report.

Tom Slee writes:

Make a note of Sept. 7. That was the day Canadian financial regulator Julie Dickson gave our banks the green light. The usually tight-lipped Superintendent of Financial Institutions announced that she was allowing banks to increase their dividends and start buying back shares. After two years of curbs and constraints, she was easing the leash. It was a clear signal that Canadian financial institutions were able to meet new capital requirements then being negotiated in Switzerland. We were turning the page.

A week later, the International Banking Governors unveiled their revised regulations (Basel III) and markets heaved a sigh of relief. The requirements were far less stringent than many people had feared. Obviously, an intensive lobbying campaign by the major banks had paid off. The Governors chose to water down a lot of the original proposals, so much so that Mary Monroe, vice president of the American Bankers Association, expressed satisfaction at the outcome.

Certainly banks will have to strengthen their balance sheets but not immediately. There is a 10-year phase-out period as certain securities are eliminated from the Tier 1 capital calculations. The new and extremely expensive liquidity coverage ratio that makes the system more resilient has been delayed until 2015. Some of its requirements are not going to be fully implemented until 2019. Canadian banks should have no trouble meeting the thresholds.

It’s all a big step in the right direction. My feeling, though, is that no amount of legislation is going to make the banking system totally safe. The recent worldwide financial collapse was not caused by banks being undercapitalized. It resulted from bad management or, to put it more bluntly, greed and incompetence. Bank officers became reckless, stopped doing their homework, reached for yield, and loaded up the balance sheets with toxic assets. Common sense alone should have told them that the subprime derivatives were garbage. It could happen again. Still, that having been said, the new regulations are welcome news for several reasons.

First and foremost, the rules lift a large cloud of uncertainty that has been hanging over bank stocks. It’s a big plus for the market, not only because the banking sector constitutes more than 20% of the entire S&P/TSX Composite Index but because these shares tend to set the tone. If banks perform well, there is going to be a positive ripple effect.

Equally important, the new capital requirements are a vote of confidence in the Canadian financial system. Unlike their European counterparts, our banks can take the proposed rules in their stride and start lending more aggressively. That should spur business activity and boost consumer as well as investor confidence.

Of course, I am not suggesting that it is plain sailing from now on. Our economy remains fragile. However, the Basel announcements have given us a shot in the arm, mainly because the new rules are not draconian. We are not going to face an international credit crunch while financial institutions hunker down and build reserves.

As to the dividend increases that Ms. Dickson referred to, I doubt whether they are going to be dramatic. Some people have suggested that we are going to see large catch-up payments but that’s very unlikely. According to the Bloomberg Dividend Forecast, which is compiled of seven factors and has a current 81% accuracy rate, the major Canadian banks will announce somewhat similar increases between now and the end of 2011. Bloomberg expects TD to raise its dividend 12c per annum and Royal, BMO, BNS, and National to each declare 8c increases. CIBC remains a bit of a question mark because CEO Gerald McCaughey seems to regard dividends as a low priority but a modest 8c hike seems to be in the cards. Of course, nothing is certain but that gives you some idea of what the Street is looking for.

The important thing is that the banks are once more free to conduct their own businesses. Not that the restraints have hampered them very much. Take their recent third-quarter results for example. Some of the analysts were disappointed but I suspect that was sour grapes. The numbers were fine. It was the forecasts that were wrong. Our five largest banks reported a combined profit of $4.8 billion, up 9% from the third quarter of 2009. That’s an encouraging performance by any standard, especially since Canadian consumer confidence slumped during the summer months to its lowest point since January 2009. Earnings from capital markets were less than expected, mainly because of troubles in Europe, but the corporate and retail banking operations came through in style. A lot of the subsequent bad press resulted from the fact that analysts had failed to factor the listless stock markets into their projections.

Royal Bank, the industry’s flagship, is a good case in point. The bank’s third-quarter earnings were 87c a share compared to a forecasted 96c, largely because trading profits were $350 million less than expected. All the other operating divisions performed well. Canadian banking profits were actually up 14% year-over-year, yet the Street was unhappy. It seems harsh. Royal is not my number one choice but it is on track to earn about $4 a share this year, a substantial increase over $3.40 in 2009.

National Bank had similar numbers. Third-quarter earnings of $1.56 a share were respectable but down from $1.78 the previous year. Personal and commercial banking profit was up 32% while income from financial markets dropped 42%. CIBC came in at $1.55 a share for the quarter versus $1.04 year-over-year, in line with consensus estimates. Here again, though, Canadian and Caribbean banking jumped an impressive 44% while trading revenues slumped $200 million.

You can see the pattern. The banks’ traditional core business delivered the goods in the third quarter. I think that this is important. I would have been alarmed if loan losses had soared but been offset by good trading results. The fact that the banks are building their base is encouraging. Of course, capital market income is important but we have to be realistic. These earnings are dependent on the unpredictable international markets and are going to remain volatile. It would help if some forecasters realized this.

 

TOM SLEE’S UPDATES

Bank of Montreal (TSX, NYSE: BMO)

Originally recommended on July 27/09 (IWB #2928) at C$51.67, US$47.71. Closed Friday at C$59.12, US$58.08.

The Bank of Montreal reported earnings of $1.14 a share, up 16% from 98c the previous year but below the consensus forecast of $1.21. BMO’s Canadian banking operations racked up another strong quarter, booking higher loan volumes and better spreads to earn $428 million, a 17% improvement year-over-year. This more than offset a 58% drop in capital market profit.

U.S. personal and commercial banking remains a problem, mainly because it’s difficult to achieve economies of scale with only 300 American branches. Now that the fiscal restraints have been eased, BMO is expected to make a U.S. acquisition and double the size of this division. There are certainly plenty of American medium-sized banks that would welcome an injection of capital. As a matter of fact, there have already been reports of BMO being on the list of potential bidders for struggling Wisconsin-based Anchor Bank. Its US$4 billion of assets and 55 branches would be a step in the right direction.

I think that, overall, BMO is extremely well positioned going forward. Its Tier 1 capital ratio is 13.6%, well in excess of the guidelines, while return on equity (ROE) is a solid 14%. At the same time, the once exposed $2.80 dividend is now only 51% of the bank’s anticipated 2011 earnings of $5.50 a share. The stock, with an 11 times earnings multiple, remains excellent value.

Action now: BMO is a Buy for income and capital gains. I have set a $67 target and a $55 revisit level.

Toronto-Dominion Bank (TSX, NYSE: TD)

Originally recommended on Feb. 12/07 (IWB #2706) at C$69.85, US$59.59. Closed Friday at C$73.58, US$72.32.

TD Bank also had a good third quarter. The bank reported a profit of $1.245 billion, or $1.43 a share, up 23% from $1.16 the year before. Analysts had been looking for $1.45. Once again, TD booked impressive Canadian loan business. Volume increased 13% while spreads remained flat. Domestic retail banking was particularly strong and some forecasters believe that this division could be earning as much as $1 billion a quarter by the end of 2012.

U.S. loan growth was slower due to the still troubled American financial system but TD is capitalizing on the extensive mortgage refinancing now underway. Inevitably, however, as with the other banks, TD was hurt by lower trading revenues that fell 53% year-over-year to $300 million. The bank is now expected to earn about $6 a share this year and $6.75 or more in 2011.

Tier 1 capital is at a comfortable 12.5% and return on equity is 14.8%, up from 14.3%. Incidentally, BMO Nesbitt Burns feels that TD could increase its dividend of $2.44 by as much as 10% next year.

Action now: TD Bank is a Buy with a target of $85. I will revisit the stock if it dips to $65.

Thomson Reuters (TSX, NYSE: TRI)

Originally recommended on April 13/09 (IWB #2914) at C$33.78, US$27.59. Closed Friday at C$38.45, US$37.82.

Thomson Reuters continues to integrate its US$7 billion acquisition of Reuters and reported lacklustre second-quarter results. Adjusted earnings were 47c a share (TRI reports in U.S. funds), down 20% from 58c a year earlier, but in line with expectations. Management has confirmed its guidance of relatively flat revenue and profits this year.

All things considered, Thomson is on track and should start producing substantial cash flow and revenue growth in 2011. An array of new products such as Westlaw Reset, an upgraded legal platform, Eikon, a new desktop for financial services, and ONESOURCE, a global tax workstation, are coming on stream. So I was surprised when Standard & Poor’s issued a strong sell recommendation. Even after studying the agency’s report, which on balance is fairly positive, I am still puzzled. There is no smoking gun and the analyst’s only concern seems to be the difficulties of merging Thomson and Reuters, coupled with doubts about the publishing industry.

I see Thomson differently. For a start, it’s not in the traditional publishing business. The company is a global information and electronic solutions provider. A large portion of its revenues are generated from “must have” legal and accounting support where costs are fixed and any growth flows to the bottom line. In 2011 this business base is expected to pay off. At the same time, integration expenses should drop to $100 million from almost $500 million this year. As a result, we should see earnings of about $2.40 a share.

Action now: Thomson Reuters is a Buy with a target of C$43. I have set a $34 revisit level.

Enbridge (TSX, NYSE: ENB)

Originally recommended on Aug. 23/99 (IWB #9930) at C$16. Closed Friday at C$53.95, US$52.92.

Enbridge had an excellent second quarter. Adjusted earnings of 63c a share were up almost 19% from 53c a year earlier and well ahead of the 56c consensus forecast. Most encouraging was an increasing cash flow as two of the company’s major projects, Alberta Clipper and Southern Lights, came on stream. Management is upbeat and has raised 2010 earnings guidance to the $2.70 a share range.

All of the good operating results have, however, been overshadowed by a series of high-profile breaks in the company’s U.S. pipelines. First there was a 13,000 barrel oil spill into Michigan’s Kalamazoo River in July. More recently there has been a 6,100 barrel leak at Romeoville, Illinois and a minor spill, a trickle really, at Buffalo, New York. All oil leaks are unforgivable, of course, and Enbridge will pay a price. CEO Patrick Daniel has been forced to testify before Congress and the company’s impeccable image has been tarnished.

None of the leaks or ensuing pipeline shutdowns will hurt the company’s earnings, however. ENB carries insurance against this sort of incident. But the stock may suffer some short-term damage if the politicians and media draw attention to the dangers of aging pipelines. I personally would regard any weakness in the shares as a buying opportunity.

Action now: Enbridge, having traded through our $53 target, is a Buy with a new target of $57. I will monitor the stock closely and update you about possible lawsuits and penalties resulting from the leaks.

– end Tom Slee

 

THE “CURSE” OF THE OIL SANDS

By Gordon Pape

And God gazed upon the vastness of the Canadian oil sands and pronounced them to be a curse.

Correction: an incipient curse – one that would materialize unless Alberta orders an immediate halt to development and cleans up its environmental act.

And no, it really wasn’t the Supreme Being in that helicopter over the blighted landscape near Fort McMurray. It was famed movie director James Cameron, the genius behind Titanic and Avatar. It was just the Canadian media that gave the impression that God had come down for a visit, dogging every step of his three-day tour and parsing every word he uttered.

Even before he arrived on the scene, Mr. Cameron had made clear his distaste for the oil sands and the havoc they wreak upon the environment. Anyone who has seen Avatar will recognize the parallels between its plotline and what critics say is happening in Alberta: a proud and noble indigenous people under attack by money-grubbing outsiders bent on pillaging their resources even if it means the destruction of their way of life.

In fact, it was an invitation from the first nations people of Fort Chipeywan that brought Mr. Cameron to Alberta in the first place. They have complained for years that pollution from oil sands projects was fouling their drinking water and making the Athabasca River unsafe for swimming and fishing. The director was outraged by that. “I can’t imagine being told by my mom that I can’t swim in the river,” he told reporters.

During his visit, Mr. Cameron met with oil industry officials, environmental groups, and senior politicians. He described himself as a “sponge”, soaking up all the available information before reaching conclusions. But in fact his mind was made up long before he arrived on the scene. It’s hard to believe the oil sands weren’t somewhere in the back of his head when he conceived Avatar. On his way out the door, he allowed during an interview with The Globe and Mail that he might make a documentary on the oil sands. You can guess what the message will be. Think of Al Gore’s An Inconvenient Truth set in Alberta.

At least Mr. Cameron has the bona fides to act as an oil sands critic, unlike anti-seal hunt crusaders from Brigette Bardot to Sir Paul McCartney. Mr. Cameron was born in Kapuskasing, Ontario in 1954 and received his elementary and high school education in Chippewa (a village near Niagara Falls) and later at Stamford Collegiate School in Niagara Falls. He left Canada at age 17 when his family moved to California. He is still a Canadian citizen, having withdrawn his application for U.S. citizenship in 2004 as a protest against the re-election of George W. Bush as U.S. president. So he has every right to speak his mind on the oil sands, or anything else Canadian, without being branded as an outsider.

That said, let’s consider the realities of the situation. While most people support the principles of environmental protection, few would want to go back to the 18th century, living without electricity, central heating, air travel, and automobiles, all of which rely primarily on hydrocarbons to function. Ideally, that will change in the future but no one suggests it will happen within the next decade or perhaps even within a generation. Weaning ourselves off oil will be a long, expensive, and sometimes painful process.

Although demand is growing in emerging economies like China and India, the United States is still the world’s number one oil consumer. Where is that oil going to come from in the years ahead? The U.S. Energy Information Administration (EIA) recently estimated that domestic production will increase by an average of 70,000 barrels a day (b/d) in 2010 while demand will grow by 200,000 b/d. The situation will become even worse in 2011 when the EIA predicts U.S. production will actually decline while demand rises by another 170,000 b/d. The result, says the Agency, will be an increase of 190,000 b/d in petroleum product imports.

Where will that new supply come from? According to the EIA’s latest statistics, Canada is the number one foreign source of U.S. oil, by a wide margin. Through the first seven months of 2010, American imports of Canadian crude oil and petroleum products averaged 2.55 million barrels a day, up by 91,000 b/d from last year. The other top five U.S. sources were:

Mexico. U.S. imports from Mexico are running at about half the level as those from Canada and there does not seem to be much likelihood of significant increases in the near future. Production from some of the country’s key oil fields is declining rapidly and is not being replaced quickly enough. Average daily exports to the U.S. are about flat compared to 2009.

Nigeria. Average daily imports from Nigeria are up almost 50% from 2009 but are still only 40% of Canada’s level. Moreover, Nigeria’s oil-producing region is politically unstable with frequent reports of pipeline sabotage and oil worker kidnappings.

Venezuela. U.S. imports from Chavezland are down from last year and no one wants to be dependant on the whims of the country’s mercurial leader. Come to think of it, much of the country’s reserves are heavy oil, similar in some ways to the Alberta oil sands. Why aren’t the environmentalists on their case? I’m sure President Chavez would be delighted to give Mr. Cameron a tour of the Orinoco Belt, which is said to contain as much as 513 billion barrels of recoverable oil. On second thought, maybe not.

Saudi Arabia. The one-time number one supplier of U.S. foreign oil has dropped to number five on the list with an average of about 1.1 million b/d. Not surprisingly, America wants to be less reliant on Middle East oil.

So back to the question: where will the extra 190,000 b/d come from in 2011 if not Canada? It’s an issue the environmentalists may wish to ponder before they go too far down the “boycott the tar sands” road.

This is not to say that Canada, Alberta, and the oil industry don’t need to clean up their act. They do. No one can look at that devastated northern Alberta landscape and not be repulsed. If Mr. Cameron’s visit adds to the political pressure to take action, it will be a positive result. But if all it does is inspire environmental zealots to ratchet up their anti-Canada rhetoric another notch, it would have been better if he had stayed in Hollywood.

 

GOOD WEEK, BAD WEEK

Here are some winners and losers from the last seven days.

Good week

The Toronto Stock Exchange. The S&P/TSX Composite Index finally clawed its way back to the level of early October 2008 as it posted a gain of 3.8% in September and finished the week at 12,363.08 after a small loss on Friday. That’s still a long way short of the all-time high 15,073, reached in June 2008. But it’s a huge improvement from where we were about 18 months ago.

Gold, silver, and oil. One of the reasons for the recent rally on the TSX has been the performance of several key commodities. Bullion broke through the US$1,300 barrier last week and, after a mid-week pull-back, rebounded on Friday to gain US$8.20 and finish at US$1,317.80. The S&P/TSX Global Gold Index has gained 5.3% since Sept. 9 and our main gold stock selection, Agnico-Eagle (TSX, NYSE: AEM) is ahead about 9% over that period.

Silver has also been on a big run, hitting the US$22 an ounce level on Friday. Our recent pick, Silver Wheaton (TSX, NYSE: SLW) closed on Friday at C$27.13, US$26.67, up from C$25.75, US$25.02 when it was recommended on Sept. 20.

As for oil, it is back over US$80 a barrel, finishing on Friday at US$81.47. The S&P/TSX Capped Energy Index gained 4.6% in September, thanks to a very strong final week.

Bad week

BHP Billiton (NYSE: BHP). It’s becoming increasingly apparent that BHP Billiton’s US$130 a share takeover bid for Potash Corporation of Saskatchewan (TSX, NYSE: POT) is doomed to failure and it’s not even clear that a significant boost in the offering price would do the trick. The Government of Saskatchewan escalated its opposition another notch last week with Premier Brad Wall telling The Globe and Mail that it could potentially cost his government $100 million in lost revenue, an amount he described as “a big deal”.

On another front, BHP was shot down by a Chicago judge when it tried to stop Potash Corp. from getting access to documents relating to a lawsuit that claims the Australian company systematically tried to undermine POT’s share price prior to the takeover attempt.

Meanwhile, investors continue to await the emergence of a white knight to top the BHP bid. That too is looking problematic. Rumours of significant Chinese participation in a management-led consortium, even in a minority position, have already set off alarm bells in Ottawa and there are no guarantees the federal government would give its blessing to such a deal.

This is a story that could drag on for many months. Don’t be surprised if it ends in the same way as the abortive privatization of BCE. In the meantime, POT’s price continues to slide as investors grow increasingly nervous. The shares finished the week at C$145, US$142.64.

Alimentation Couche-Tard (TSX: ATD.B). The Quebec-based convenience store chain was finally forced to take its billions and go home after Casey’s General Stores (NDQ: CASY) successfully fought off its hostile takeover bid. The Canadian company, which already has a large U.S. network, had offered $38.50 per share for Casey’s in a deal valued at $2 billion, including debt assumption (figures in U.S. currency). But Casey’s board rejected every overture and the final blow came on Sept. 23 when all eight incumbent directors were re-elected at the annual meeting. Couche-Tard conceded defeat when it let its offer expire at 5 p.m. on Sept. 30. The shares dropped 54c on the TSX on Friday to finish the week at $22.47.

 

YOUR QUESTIONS

Claymore closed-end fund

Q – I have a question about Big Bank Big Oil Split Corp. (TSX: BBO). This closed-end fund by Claymore is a collection of the top five banks and oil and gas companies. It is currently paying an 8.5% dividend, clearly more than if I held the individual companies (which, for the most part, I do own). This trend has been the case for several years now.

Am I missing something here? Is there more than just the normal closed-end fund trading below NAV phenomena?

I only have about $5,000 left for equity RRSP investment this year and was thinking this might be a better option then just choosing to buy more of one of the banks. – Rick Z., Calgary

A – Many split corporation funds have ended up promising more than they delivered and this one falls into that category. There are two parts to this fund: the capital shares to which you refer (BBO) and the preferred shares (TSX: BBO.PR.A).

BBO was launched on June 16, 2006 with an initial public offering price of $15 (the preferreds were priced at $10). It managed to climb to the $16 range in spring 2008 but has not been anywhere close to that level since although the shares have rebounded from the $5 range in late 2009. They closed on Friday at $11.30.

The capital shares currently pay a monthly distribution of 8c per unit. That would translate into a yield of 8.5% however the payments can vary significantly from one month to another. So far this year, for example, they have been as low as 5c a unit and as high as 9c. So it is not a good idea to assume that the payments being made now will remain consistent going forward.

The fund has a high MER of 1.75% and the units are very illiquid, rarely exceeding a daily volume of 3,000. This is not a security I would recommend. – G.P.

 

MEMBERS’ CORNER

Gold talk

Member comment: I remember reading years ago that, when asked whether he had a favourite stock market pick, a sage said: “Just buy what everyone is talking about”. As silly as this statement might seem, there is a lot of wisdom there. Just think of the recent run-up in oil. It defied all sense and logic re: supply vs. demand yet it went up to almost $150 a barrel. Why? Because everyone was talking about it.
 
I think it is the same with gold today. Forget logic, common sense, U.S. dollar, etc. Everyone is taking about it. Therefore, it will probably continue higher. – W.W.

Response: While it’s true that demand often increases in response to positive publicity, the result can be a bubble which eventually bursts. It may happen with gold at some point, but not now. – G.P.

 

That’s all for this week. Please note that there will be no IWB over the Thanksgiving weekend to allow our staff to enjoy this family holiday (we publish 44 times a year). Look for your next issue on Oct. 18.

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.