In This Issue

• Buy and Hold Portfolio still strong
• Glenn Rogers picks Cummins
• Glenn Rogers’ updates: Westport Innovations, American Railcar Industries
• Low rates to stay awhile
• Gordon Pape’s updates: Wells Fargo, CGI Group, Student Transportation, TD Advantage Balanced Income Portfolio
• Next issue July 28

BUY AND HOLD PORTFOLIO STILL STRONG

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By Gordon Pape, Editor and Publisher

The IWB Buy and Hold Portfolio was launched in mid-June 2012. It was designed for people who don’t want to spend a lot of time reviewing their positions and are not interested in active trading. This portfolio focuses on individual stocks, although it also includes a bond ETF.

The goal was to concentrate on blue-chip stocks that offered long-term growth potential plus regular dividend payments. We included both Canadian and U.S. issues, and each original stock was given a 10% weighting. We added a 20% bond weighting to provide some downside protection in the event of a stock market plunge of the 2008 variety.

At the time, we stated that the objective was to generate decent cash flow and slow but steady growth. We used several criteria to choose the stocks, including long-term growth profile, industry leadership, good balance sheet, solid dividend record, and relative strength in bad markets. Given the nature of the portfolio, the intention was to make changes only when absolutely necessary. I did not set a target rate of return at the time but 8% annually would be appropriate for a portfolio of this type.

These are the securities we selected with some comments on how they have performed since our last review on Jan. 22. Prices are as of mid-day on July 16.

iShares Canadian Universe Bond Index ETF (TSX: XBB). This exchange-traded fund represents our only bond position. It tracks the performance of a broad spectrum of Canadian bonds, both government and corporate. Bonds were not expected to do well this year; however, they’ve turned out to be surprisingly strong due to the persistent low interest rate environment. The shares are up 1.5% since our last review in January, and we have received distributions of $0.427 per unit for a total return of 2.9% in six months. That may not seem like a lot, but it’s much better than anyone expected from the bond market at the start of the year.

BCE Inc. (TSX, NYSE: BCE). BCE shares have come under pressure recently because of Ottawa’s latest move to attempt to create a fourth major wireless provider in Canada. However, the stock is still higher than it was last January, and the company pays a healthy dividend of $0.6175 per quarter ($2.47 annually). Our total return in the past six months was 6.4%.

Brookfield Asset Management Inc. (TSX: BAM.A, NYSE: BAM). Brookfield shares have been on a tear. The stock is up from $41.70 at the time of the January review to almost $48 now. Including dividends of US$0.36 per share, our six-month total return on this one is 15.9%.

Canadian National Railway Co. (TSX: CNR, NYSE: CNI). CN continues to go from strength to strength. The stock is up more than $12 since January, and we have received dividends of $0.50 a share for a total return of 21.6% in that time. Yes, the dividend yield is a low 1.4% ? which just goes to show that dividends aren’t everything. CN is our second-largest gainer to date with a total return of 75%.

EnbridgeInc.(TSX, NYSE: ENB). Pipeline companies continue to run into resistance in their efforts to build new capacity, but they remain comfortably profitable based on existing assets. Enbridge has been one of our mainstays for years, and it continues to produce good returns. Over the past six months, we’re ahead 10.2% on this one.

Toronto Dominion Bank (TSX, NYSE: TD). TD stock split two for one at the end of January, so we now own 130 shares instead of the original 65. Bank stocks have done well this year, and TD is no exception with a total return of 14.2% since the time of our last review.

AT&T Inc. (NYSE: T). This giant U.S. telecom finally emerged from the doldrums to post a total return of 12.1% since our last review. The shares gained more than $3, and we are receiving a handsome dividend of US$0.46 per quarter.

McDonald’s Corp. (NYSE: MCD). The stock has rebounded after closing 2013 on a down note. The shares are up more than $4 since my last review, and with the high quarterly dividend of US$0.81 per share, we have a total return of 6% in that time. That’s the lowest among all our stock selections over the period, however, so I’ll be keeping a close watch on this one.

Walt Disney Corp. (NYSE: DIS). Mickey Mouse continues to pay off big time for us. The share price is up another $10 since January, giving us a six-month return of 14%. There were no dividends during the period as the company makes payments only once a year. This has been the biggest winner in our portfolio to date with a total return of 85.9%.

Cash. At the time of the last review, our cash reserves were $2,621.42. We invested that money at 1.35%, earning $17.69 in interest.

Here is the status of the portfolio as of mid-day on July 16. For simplicity, the Canadian and U.S. dollars are considered to be at par and trading commissions are not factored in.

IWB Buy and Hold Portfolio

(a/o July 16/14)

Comments: The total value of the portfolio, including accumulated dividends, is now $68,102.63. At the time of the June 2012 launch, it was $49,945.40, so we have a total return in 25 months of 36.4%. That works out to an average annual compound rate of return of 16.05%.

That’s very gratifying, but don’t expect it to continue indefinitely. We’ve benefitted from strong markets since the launch without a single correction of any magnitude. That will change at some point, and the true buy-and-hold investor will ride it out when it happens.

Changes: The bond component of the portfolio is down to 16.7%. We need to strengthen that so we will have more of a cushion when the inevitable correction hits. Also, the positions in CN Rail and Walt Disney have become too high due to price appreciation.

Therefore, we will sell 10 shares of CNR for $715.10, reducing our total to 100. We will sell five shares of DIS for $428.70, dropping the total to 85. We will use the proceeds plus some of the accumulated dividends from XBB to buy 50 more units of the bond ETF at a cost of $1,544.50, bringing the total position to 400.

We will add to our position in BCE by purchasing 10 shares for $486, using accumulated dividends. This brings our total to 130 shares. We will also use accumulated dividends to buy another 15 shares of AT&T at a cost of $547.35. We now own 175 shares of this stock.

A reminder: I do not recommend doing small trades unless you are using a discount broker and paying minimum commission. These transactions are only for purposes of this model portfolio. The most effective way to add small position to your own portfolio is by using DRIPs (dividend reinvestment plans).

Here is the revised portfolio. I’ll revisit it again in six months.

IWB Buy and Hold Portfolio

(revised July 16/14)

Gordon Pape’s new book, RRSPs: The Ultimate Wealth Builder, is now available in both paperback and Kindle editions. Go to: http://astore.amazon.ca/buildicaquizm-20

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GLENN ROGERS PICKS CUMMINS

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Contributing editor Glenn Rogers is back this week with a new stock selection in the engine and powertrain industry. Glenn is an entrepreneur, businessman, and active investor who has worked in both Canada and the U.S. He and his family live in Southern California. Here is his report.

U.S. natural gas discoveries and reserves have ballooned over the last two years. You can thank hydraulic fracturing (“fracking”) and other technological breakthroughs in drilling for that surge in supply. Together, abundant U.S. and Canadian supplies have created enough of a price differential for natural gas over gasoline and diesel fuels to make natural gas a potentially attractive alternative.

As a result, interest is finally growing in powering large long-haul vehicles like tractor-trailers, which still transport most of the goods and services in North America, with natural gas-powered engines. Vancouver, B.C.-based Westport Innovations Inc. (TSX: WPT, NDQ: WPRT), which we recommended last June, has been at the forefront of natural gas engine technology (a complete update follows below). However, this week, we will look at one of Westport’s largest partnerships, Cummins Inc. (NYSE: CMI).

Based in Columbus, Indiana, Cummins Inc. is one of the largest diesel engine manufacturers in the world, operating in 190 countries with over 48,000 employees. The company had sales of over $17 billion (all figures in U.S. dollars) in 2013, with net income of $1.4 billion. It competes with companies like Caterpillar Inc. (NYSE: CAT) and Deere & Company (NYSE: DE) and has been doing so successfully since 1919. Cummins also manufactures a number of components for the power generation industry, including engines, controls, alternators, and so on.

But the product line it is developing with Westport is what first got me thinking about the company. Cummins supplies engines for companies like Volvo, Daimler, Ford, Chrysler, and others. The most substantial part of its business is still traditional diesel engines, but as the infrastructure for natural gas stations along the major U.S. freeway systems is built out (more on that later), the company will have a unique opportunity to secure its existing customer base and expand into new ones.

Famed oil and gas investor T. Boone Pickens has been pushing this idea for a number of years, and here’s why: There are more than 10 million natural gas vehicles in operation around the world, but only about 130,000 are in the United States. The opportunity to convert not only 18-wheelers but also refuse and recycling trucks along with mass transit buses is significant.

In Los Angeles, just north of where I live, there are 2,800 natural gas buses in operation already. One of the hurdles to mass conversion has been adequate refueling infrastructure. However, that is being addressed by companies like Clean Energy Fuels Corp. (NDQ: CLNE), which are building a national system of natural gas refueling stations along the major transportation routes in the U.S.

In the past, the knock against natural gas engines was that they were not powerful or efficient enough to power the big rigs that move most of our goods and services. But now the collaboration between Westport and Cummins has been bringing to market engines that can do that job. The new engines are winning converts amongst the key group that uses them, the drivers and the owners of the transportation companies, who see the opportunity to save money with a cleaner alternative to the power plants they currently employ.

Cummins just increased its dividend payout by nearly 25% (for a yield of 2.04%), which will return an additional $114 million to investors annually. The company also added another $1 billion to its share repurchase plan. The board is committed to returning 50% of full-year operating cash flow to its shareholders through this combination of dividends and stock buybacks. That is still only 20% of estimated earnings in 2014, so the company can afford it – and it’s been paying dividends since 1948.

The stock is not particularly expensive with a price/earnings ratio of 18.41. True, Goldman Sachs did take the company off its conviction buy list recently, which caused the shares to sell off modestly, but Goldman still ranks Cummins a buy. This is a very solid company with a long history that now has an opportunity to benefit from a generational change in power plants. Given the run-up in the market, a good dividend payer with solid earnings always deserves a look.

Action now: Buy Cummins Inc. (NYSE: CMI) with a target of US$170. The shares closed on Friday at US$152.74.

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GLENN ROGERS’ UPDATES

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Westport Innovations Inc. (TSX: WPT, NDQ: WPRT)

Originally recommended on June 18/12 (#21221) at C$29.70, US$28.99. Closed Friday at C$18.78, US$17.54.

As I detailed in my column, Westport is a major partner of Cummins Inc., but it has also partnered with Weichai in China and Tata Motors Ltd. (NYSE: TTM) in India, two countries where heavy pollution, very expensive gasoline prices, and rapidly expanding vehicle counts make the move to natural gas engines imperative. Given that natural gas is a much cleaner fuel and that costs continue to fall, emerging markets will need to adapt quickly to new technologies.

The stock has been on a roller coaster ride since we last updated it last October at C$25.01, US$24.53. It has traded between $12.42 and $33.88 over the last 52-week period, and is up 40% since the company reported fiscal first-quarter earnings (period ending March 31) in early May.

Revenue was up 39% for the first quarter over the previous year. But the company reported a consolidated net loss of $23.9 million ($0.38) compared with a loss of $31.8 million ($0.57 per share) a year earlier. Granted, the loss was reduced by nearly 30%, but it was still a loss. The company also restructured its debt at rates that are still too high. But most of the debt is unsecured, so if Westport moves to profitability over the next 12 months, it will still be able to drive some of those interest rates down.

Westport is rich in intellectual property with 327 patents, well ahead of its major competitors, making the company an interesting acquisition target down the road. The financial outlook is improving and the market is expanding, so if you can tolerate the volatility, there could be some significant upside to the shares.

Action now: Buy with a target of $25.00

American Railcar Industries Inc. (NDQ: ARII)

Originally recommended on Feb. 18/13 (#21307) at $40.95. Closed Friday at $66.69. (All figures in U.S. dollars.)

This American rail hopper and tank car maker has gained 63% since we recommended it back in February, so it’s been a great pick for us.

American Railcar reported first-quarter consolidated earnings from operations of $36.5 million ($0.97 per share, fully diluted), compared with $31.2 million ($0.84 per share) in the same period a year ago, a gain of 17%.

However, total consolidated revenue fell 6.7%, to $182.12 million from $195.11 million a year ago. The company cited decreased manufacturing revenue of $154 million, which was down 11% from the same period a year ago. Railcar leasing and revenue services both showed improvement, growing 80% and 5% respectively since the first quarter of 2013.

Over the past couple of years, there has been growing demand for tank cars especially, given the growing need for rail delivery of crude oil around North America. This is only likely to increase as obsolete tanker cars are being quickly replaced following the tragedy in Lac Mégantic, Quebec last year. Demand remains strong for new cars as well, and will likely continue strong until more pipelines are built.

However, legendary investor Carl Icahn resigned as chairman of the board on July 2, a position he’s held since 1994, although he still controls 55.7% of the company’s outstanding shares. Still, the chart doesn’t look great. Share price has slipped 7% since the beginning of July and is down 14% from its record intraday high of $77.50 in early March. My recommendation is to ring the register on this one and take profits of about 63%.

Action now: Sell.

– end Glenn Rogers

 

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LOW RATES TO STAY AWHILE

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If we’re to take the words of our central bankers at face value, low interest rates will still be around though most of 2015 and perhaps into 2016.

Last week’s Bank of Canada statement and the quarterly Monetary Policy Report (MPR) were gloomy about the prospects for a speedy economic recovery, both here and internationally.

Governor Stephen Poloz used the words “serial disappointment” in reference to global economic performance and said the BoC remains “preoccupied with downside risks to economic activity and the fundamental drivers of inflation.” Translation: Interest rates aren’t going up any time soon.

In fact, the Bank is so concerned that it has dialed back its forecast for Canadian economic performance for the rest of this year. The prediction now is that our economy will grow by 2.3% in the third quarter and 2.4% in the fourth quarter. That’s down from 2.6% and 2.5% previously. However, the inflation forecast has been raised to 2% in the third quarter, up from 1.8% in the earlier forecast.

Slower growth plus higher inflation. That’s not a good mix by any economic standard. However, the tepid growth outlook gives Mr. Poloz and company an excuse to keep the key target rate at 1% for the foreseeable future. That will help to keep the loonie in check – if speculators were to believe a hike is coming soon, they would drive the value of our dollar higher. That would deal a serious blow to Mr. Poloz’s hopes for an export-driven recovery.

U.S. Federal Reserve Board chair Janet Yellen followed a similar line last week by suggesting in testimony before Congress that the unemployment situation in the States is not as bright as it seems because many people have given up and stopped looking for work. She told the Senate Banking Committee that the Fed needs to be “quite cautious” in its monetary policy, referring to the “false dawns” that have sparked premature predictions of a strong economic recovery. Her remarks were interpreted as signaling the Fed will retain its low interest rate policy at least until next year.

Prolonging the low interest cycle into mid-2015 and perhaps beyond has several important implications for investors. They include:

A continuation of the hot housing market. Low mortgage rates mean that houses in most parts of the country are affordable, even as prices rise. If there is a housing bubble, as many analysts claim, the most effective way to gradually deflate it is through modest interest rate hikes. It doesn’t look like that is going to happen any time soon.

A stronger bond market. Bonds have performed much better this year than anyone expected with the DEX Universe Bond Index up over 5% at the time of writing. Rising interest rates are bond killers, so the longer they remain low, the better things will be for bond investors.

Premium valuations for dividend stocks. High dividend stocks are vulnerable when rates rise. But when rates are low, investors are willing to pay up for above-average cash flow. Given the choice between a 5% dividend on a blue-chip stock and a 2.5% rate on a five-year GIC, most smart investors will opt for the higher return. – G.P.

 

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GORDON PAPE’S UPDATES

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Wells Fargo & Co. (NYSE: WFC)

Originally recommended on Jan. 28/13 (#21304) at $35.14. Closed Friday at $51.28. (All figures in U.S. dollars.)

The largest bank in the U.S. beat analysts’ expectations and raised its dividend, but the shares lost ground anyway.

Wells Fargo reported second-quarter net earnings of $5.7 billion ($1.01 per share, fully diluted). That was up 4% (3% on an EPS basis) compared with the same period of 2013.

Revenue was down slightly to $21.1 billion from $21.4 billion a year ago. However, the result beat forecasts, which had predicted revenue of $20.8 billion. Return on equity was 13.4%.

The bank reported strong growth in both loans and deposits. Average loans over the quarter were $831 billion, up 4% from the second quarter of last year. Average deposits were $1.1 trillion, up $91.7 billion (9%).

Wells Fargo implemented a healthy 17% increase in the dividend during the quarter, raising the payout to $0.35 a share effective with the May 7 distribution. It had been $0.30 previously. At the current price, the shares yield 2.7%. As well, the company repurchased 39.4 million shares during the quarter under a normal course issuer bid.

“Our results reflected strong credit quality driven by an improved economy, especially the housing market, and our continued risk discipline,” said CEO John Stumpf. We are committed to both maintaining strong capital levels and returning more capital to our shareholders.”

Despite the good results, the share price dropped $0.32 on July 11, the day the financials were released. The stock hit an all-time high of $53.08 on July 3, so it appears there is some profit-taking going on.

Action now: Buy. Take advantage of the pullback to establish a position or add to an existing one.

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

Originally recommended on Aug. 20/12 (#21229) at C$24.42, US$24.66. Closed Friday at C$38.32, US$35.70.

Despite the setback caused by the fiasco of the launch of the Obamacare website in the U.S., CGI reported strong results for the second quarter of fiscal 2014 (to March 31). Revenue increased 7% to $2.7 billion while net earnings more than doubled to $230.9 million ($0.73 a share, fully diluted) compared with $114.2 million ($0.36 a share) in the same period of fiscal 2013.

Cash from operating activities was $350.7 million, up from $147.2 million the year before. Return on invested capital was 13.4%, compared with 11.1% last year. The company’s backlog increased by $1.5 billion, to $19.5 billion.

Net debt was $2.7 billion at the end of March, representing a net debt-to-capitalization ratio of 35.6% compared with 43% at the end of March 2013. The company had approximately $1.5 billion in available cash and unused credit facilities.

“Our strong performance in the quarter is a clear reflection of our ongoing ability to execute our business model on a global basis,” said CEO Michael E. Roach. “Our ability to generate increased cash from operations is becoming more visible as we complete the $525 million investment in our integration program. Looking ahead, our focus will be on intensifying the expansion and conversion of our pipeline of opportunities into bookings and high quality revenue, reflecting our diversified market coverage.”

During the quarter, the company repurchased 346,700 shares for $11.5 million, at an average price of $33.08 under a normal course issuer bid.

Since the results were released, CGI has announced several major new and renewed contracts. They include a 21-month deal with Desjardins Group to provide support for that company’s acquisition of the Canadian business of State Farm Insurance; a four-year extension of its service contract with Yellow Pages Group; and a contract with the State of Michigan for systems modernization. Other contracts announced included deals with Michelin, Volvo, the European Commission, and the U.S. General Services Administration.

Most Canadians have not heard of Montreal-based CGI Group, but it is the fifth largest independent company in the world providing services in information technologies and business process management. It has 68,000 employees worldwide.

In my last review in December, I rated the shares as a Hold because I felt the price was getting ahead of itself. In fact, the stock is down slightly since that time, despite the good financial results. We have already taken half profits of 46% on this one, so let’s continue to maintain existing positions.

Action now: Hold.

Student Transportation Inc. (TSX, NDQ: STB)

Originally recommended by Yola Edwards on April 18/05 (#2515) at C$8.70 (adjusted). Closed Friday at C$7.05, US$6.57. Updated by Gordon Pape.

Despite the harsh winter weather, this school bus transportation company reported slightly improved financial results for the third quarter of fiscal 2014 (to March 31). Revenue came in at $138.3 million compared with $120.5 million for the same period in 2013. Net income was $2.6 million ($0.03 per share), up from $1.8 million ($0.02 a share) last year.

“The operating results for the third quarter were negatively impacted by the extreme winter weather conditions throughout North America during the period,” said CEO Denis J. Gallagher. “While we experienced harsh weather issues in the second quarter during November and December, weather conditions worsened in January and February and continued into the first part of March in some operating areas. Our deferred revenue at the end of the third quarter totaled $7.2 million as a result of weather related school cancellations. As we have seen historically, we do recover substantially all these contracted days and generally about half of that revenue falls to our Adjusted EBITDA line. In addition to such revenue deferrals, we did experience higher than normal additional labour, fuel and maintenance costs due to the extreme severity of this year’s winter.”

For the first nine months of the fiscal year, revenue increased to $346.9 million from $301.4 million and adjusted EBITDA was $56.2 million compared with $50.8 million for the first nine months of fiscal 2013. However, the company reported a net loss of $3.3 million ($0.04 per share) for the nine months compared with a loss of $2.9 million (also $0.04 per share) the year before.

This has been a chronic problem with STB and is the reason why I rate the stock higher risk. The yield is attractive, but the company rarely manages to show a profit, which makes the dividend suspect. This is not a stock that is suitable for conservative investors.

Action now: Hold.

TD Advantage Balanced Income Portfolio (TDB2060)

Originally recommended on Feb. 13/12 (#21206) at $11.01. Closed Thursday at $11.98.

I recommended this fund of funds as a good choice for conservative investors, and especially suitable for RRSPs. At the time I picked it, the portfolio consisted of five other TD funds: Canadian Core Plus Bond, Global Dividend, Divided Growth, Canadian Equity, and Global Multicap. Since then, Global Dividend has been replaced with the TD U.S. Large-Cap Value Fund, while Global Multicap has become Global Growth.

This remains a very low-risk portfolio with 62% of the assets in bonds, 2% in cash, and the rest in Canadian, U.S., and international stocks. Canadian securities account for 77% of the total.

The fund posted a gain of 10% over the year to June 30, which was very good for a portfolio that is so heavily weighted to bonds. The two-year average annual compound rate of return to that point was 7.5%. The MER is 1.97%, and the minimum initial investment is $2,000.

Action now: The fund is still a Buy for conservative investors.

 

That’s all for this week. We will be back on July 28.

Best regards,

Gordon Pape