In this issue:

Next Update Edition: October 9

Next regular issue: October 30

INVESTING IN EXPENSIVE MARKETS

By Tom Slee, Contributing Editor

Markets keep barrelling along and now even the skeptics are along for the ride. A recent leading New York Times article entitled “Welcome To Everything Boom” said it all. Stocks, bonds, emerging markets, urban office towers, Iowa farmland, you name it; they are trading at prices well-above historic norms. At BlackRock, the world’s largest investment asset manager, chief strategist Russ Koesterich feels there are no longer any bargains out there. Far too much money is chasing very few opportunities.

It’s an astonishing situation primarily caused by two forces now working at cross-purposes. First and foremost, our markets have been badly distorted by the Federal Reserve’s massive quantitative easing program. Back in August 2008, the Fed owned its normal portfolio of US$900 billion in fixed income securities when the international banking system collapsed. Desperate times called for desperate measures and the central bank promptly embarked on an unprecedented asset-buying spree designed to keep interest rates low and the system flooded with cash. It was supposed to be a relatively small short- term program but that proved to be wishful thinking.

As I write, six years later, the Fed is still buying bonds, albeit at a slower rate, and now holds an incredible US$4.4 trillion of financial assets. Central banks in Britain, Japan and the Eurozone have adopted similar policies. There has never been market intervention on this scale before and experts have continually warned about bad long-term side effects. Economists pointed out that you cannot turn the securities markets on and off like a tap. How right they were.

The buying program was complex. In a nutshell, central banks siphoned off trillions of dollars worth of prime securities and private investors are now engaged in a bidding war for whatever is left. We have a huge imbalance. Institutions are awash with cash they would normally allocate to the bond market but there is almost no worthwhile product. Unable to live with the microscopic bond yields available, money managers have been gobbling up stocks, real estate and anything else offering a decent return.

The second force at work is globalization. Years ago, countries were to a large extent financially self-contained. For instance, the Japanese economy and stocks boomed for a long time while here in North America we spluttered and drifted aimlessly. There was relatively little interaction between these two markets because the mechanics were difficult. But that is no longer the case, at least not on a macro-scale. Nowadays, vast sums of “hot money” flow between countries at the press of a button. When the Fed started reducing its buying program last year, U.S. and Canadian interest rates were supposed to rise as the recovery gained traction. Instead, because of plummeting European economies, we have seen a surge of offshore money pouring into our bond markets and driving rates even lower. Foreign buyers are replacing the Fed’s traders.

There is another disturbing crosscurrent at work. These very low interest rates are becoming counterproductive. Cheap money is supposed to stimulate the economy. Now that everything is becoming expensive, however, companies are having second thoughts about buying new assets to grow and increase job opportunities. Most recent corporate earnings growth has come from cost cutting and acquisitions rather than organic expansion. The recovery could continue to flounder. It all adds up to a difficult environment for small income investors. However, it’s not a lost cause.

For a start, I am not nearly concerned as the managers at BlackRock. These markets are not hopelessly overpriced. The real trouble is that relatively high valuations are widespread. In 2000, stocks were much more expensive during the high-tech bubble but we had an attractive bond market as an alternative. At present nothing is cheap. Yet sitting on the sidelines in cash is bad idea. These markets could move sideways for a while and for income investors, time is money. You have to put assets to work.

I suggest you maintain your long-term investment strategy but become even more diversified. Because all the sectors are expensive, we are now vulnerable across the board. We could see a correction almost anywhere so spread the risk. At the same time opt for quality. There is little incentive in these markets to reach for yield and become more exposed. To give you an example, Province of Ontario 5.50% bonds due June 2, 2017 are trading at $110.42 to yield 1.57%. Paramount Resources 8.25% bonds due December 13, 2017 are priced at $104.00 and yield 3.11% – only 154 basis points more. Normally we see a 400 to 600 basis point spread between senior governments and junk bonds.

More specifically, if you have funds to invest and need fixed, reliable income, take a look at convertible debentures. This small market is far too thin for the institutions and as a result it contains overlooked issues that represent good value. For once, being a small investor is an advantage. Because these hybrid securities are unusual, however, it’s worthwhile briefly recapping their major characteristics.

Convertible debentures are primarily debt obligations. Like conventional bonds, they pay guaranteed regular interest at a set rate. The debentures mature on a predetermined date, at which time investors are repaid their capital. They are also convertible into a specific number of common shares and as a result trade to some extent as equities. These issues are actually listed on the Toronto Stock Exchange however they are few and far between. Only 180 investment grade convertible debentures are trading there.

The reason I like these investments right now is they provide a reasonable yield and potential long-term growth. Most important, as a bond they have downside support if the underlying stock drops in value as well as reliable income. Premium Brands Holding Corporation 5.5% Convertible Unsecured, for instance, is attractive at present levels. See the September updates section for more details.

Tom Slee managed millions of dollars in pension money during his career and is an expert in fixed income securities.

 

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SEPTEMBER’S TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Monday, Sept. 22 unless otherwise indicated.

Milestone Apartments REIT

Type: Real estate investment trust
Trading symbols: MST.UN, MSTUF
Exchanges: TSX, Pink Sheets
Current price: C$10.81, US$10
Entry level: Current price
Annual payout: $0.65
Yield: 6%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.milestonereit.com

The business: Based in Dallas, Milestone REIT is the largest real estate investment trust listed on the TSX that focuses solely on the United States multifamily sector. The portfolio consists of 57 multifamily garden-style residential properties, comprising 18,772 units that are located in 12 major metropolitan markets throughout the Southeast and Southwest United States. The REIT operates its portfolio through its internal property management company, Milestone Management, LLC, which has more than 900 employees across the United States.

The security: The REIT completed its initial public offering (IPO) in March 2013, issuing 22.85 million units at a price of $10 each for proceeds of $228.5 million. The shares initially traded as high as the $10.50 range but then slumped to as low as $9.25 in December before rallying.

Why we like it: With the probability of higher interest rates next year, I prefer residential REITs right now because they have more flexibility to raise rents than companies which focus on office buildings and malls, where contracts are normally for longer terms. I also like this REIT’s focus on the U.S., where the housing market is gathering strength.

Milestone is highly desirable because of its garden style and extensive amenities. A typical development consists of 200-plus units of two to four stories, with plenty of green space, swimming pools, tennis courts, clubhouses, fitness centres, business centres and access gates. Amenities include in-unit washers, dryers and fireplaces. The company operates in high-growth areas of the U.S. with properties in Texas, Arizona, Utah, Colorado, Florida, Georgia and Tennessee.

Management is growing by acquisition and last week announced a $74 million deal to buy the Villas at Shadow Creek, a 560-unit multifamily facility in Houston, Texas. It is 95% occupied with average monthly rents of $1,200 per unit.

Income seekers will be especially attracted by the REIT’s higher-than-average yield, currently running at 6%.

Financial highlights: Second-quarter results were encouraging. Adjusted funds from operations (AFFO) came in at $11.1 million ($0.20 per unit), up from $9.9 million (also $0.20 per unit) in the same period of 2013. Note that the REIT reports in U.S. dollars.

For the first half, AFFO was just over $22 million ($0.42 per unit) compared to $13 million ($0.26 per unit) in 2013. The first half payout ratio was 71%, down from 78% a year ago.

During the quarter, Milestone made acquisitions in Orlando, Florida and Atlanta, Georgia for a total cost of $78.7 million.

Risks: Interest rate risk must always be considered when making a decision about buying REITs. At the moment, it appears there is unlikely to be any significant upward move in rates for the next year or so. Last week’s announcement by the U.S. Federal Reserve Board that rates would stay at current levels for a “considerable time” was interpreted as signaling no move before mid-2015. The Bank of Canada has also indicted it is in no rush to raise rates. That said, rate hikes will come at some point and Milestone’s share price could be negatively impacted when that happens.

Since all the REIT’s properties are in the U.S., currency risk must also be taken into account. A rise in the value of the loonie would erode the value of any U.S. dollar denominated assets, as we saw during the period from 2002-2012 when our currency moved sharply higher.

As well, there are the normal business risks that are part of any operation. Overall, I rate this security as moderate risk.

Distribution policy: The REIT pays monthly distributions of C$0.05417 per unit (C$0.65 per year) to yield 6% at the current price.

Tax implications: For tax purposes, distributions to Canadians will be considered as income, return of capital (ROC) or a combination of both. In 2013, the entire amount paid out was treated as return of capital. This means no tax is payable immediately but the cost base of the shares is reduced by the amount deemed as return of capital. The net effect is to increase the capital gains tax liability when the shares are eventually sold. There is no guarantee that all future distributions will receive ROC treatment; the amount will vary from year to year.

Distributions paid from the REIT’s “current or accumulated earnings and profits” (as determined for U.S. federal income tax purposes) generally will be subject to the U.S. withholding tax at a rate of 15%, unless the shares are held in an RRSP or RRIF. This may be claimed back under the foreign tax credit. 

U.S. shareholders will not be subject to any withholding tax and income payments will be treated the same as if they were received from a U.S. REIT.

Who it’s for: Milestone shares are suitable for investors seeking above-average yield who are willing to accept a little more risk.

How to buy: The shares trade actively on the TSX and you should have no trouble being filled. They are also listed on the over-the-counter Pink Sheets in the U.S. but the average daily volume is very light (only 375 shares). If you must buy there, place a limit order and be patient.

Summing up: Milestone REIT offers investors an opportunity to participate in the U.S. multifamily residential market with attractive properties in high-growth areas.

Action now: Buy. – G.P.

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

 

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GAVIN GRAHAM’S UPDATES

Prices are as of the close of trading on Monday, Sept. 22 unless otherwise stated.

Diageo plc (NYSE: DEO)

Type: Common stock
Trading symbol: DEO
Exchange: NYSE
Current price: US$118.58
Originally recommended: June 22/11 at US$81.25
Annual payout: US$3.46
Yield: 2.9%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.diageo.com

Comments: Leading global spirits producer Diageo reported weaker revenues and earnings for the year that ended June 30. Net profit was down 8.2% to £2.25 billion (all currency amounts in pound sterling unless otherwise indicated) from £2.45 billion on revenues down 8.5% to £13.9 billion. Ironically, while there was growth in North America and stability in Western Europe, the traditionally faster-growing emerging markets (42% of revenues) suffered from falling currencies and specific weaknesses.

These included the anti-extravagance campaign in China, with sales at its Shui Jing Fang baiju maker (a fiery spirit made from grain) down 78% as central government clamped down on government entertaining. Latin American currencies in such markets as Venezuela and Argentina displayed exceptional weakness, while a significant increase in excise duties in Ireland, a major market due to its ownership of Guinness, led to a 4% decline in revenues.

However, the company has introduced a cost-cutting exercise to save £200 million a year by June 2017, and raised the final dividend by 9% to £0.32 a share. With its recent purchases of Turkish raki maker Mey Icki for US$2.1 billion in 2011 and a controlling stake in India’s largest spirits maker United Distillers for US$1.9 billion in 2014, Diageo is well-equipped to benefit from faster growth in the emerging markets once their currencies stabilize. The company also remains well diversified by product and geography.

Action now: Buy. – G.G.

Unilever plc (NYSE: UN)

Type: Common stock
Trading symbol: UN
Exchange: NYSE
Current price: US$40.54
Originally recommended: Sept. 26/12 at US$37.12
Annual payout: US$1.51
Yield: 3.7%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.unilever.com

Comments: Unilever, the third largest global consumer products company, saw a similar pattern to Diageo, with growth in emerging markets (57% of revenues) offset by weaker currencies. So while underlying sales growth was 3.7%, with emerging markets up 6.6%, revenues decreased 5.5% to €24.1 billion (all currency amounts in Euros) in the first half to June 30, 2014, with currency effects deducting 8.5%.

Operating profits were up 13% to 4.4 billion and net profit up 12% to €3 billion, but this reflected disposals of its Ragu and Bertolli pasta sauce businesses and more recently its Slim-Fast division. Core earnings per share were up, but by only 2% to €0.78 per share. Personal care, the largest division with revenues of €8.6 billion saw 4.5% underlying sales growth. Refreshments (ice cream and drinks) were up 5.1% to €4.9 billion and home care up 6.8% to €4.5 billion. The company’s second biggest division, food, was down 0.5% at €6.1 billion.

CEO Paul Polman noted that “markets have been challenging and we have experienced a further slowdown in the emerging markets while developed markets are not yet picking up.”

Still, the company is known for its conservative balance sheet, excellent exposure to emerging markets and is repositioning away from slow growth mature food brands into faster-growing home and personal care.

Action now: Unilever remains a Buy. – G.G.

Johnson & Johnson (NYSE: JNJ)

Type: Common stock
Trading symbol: JNJ
Exchange: NYSE
Current price: US$107.88
Originally recommended: Oct. 27/10 at US$63.81
Annual payout: US$2.80
Yield: 2.6%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.jnj.com

Comments: U.S. healthcare giant Johnson & Johnson (J&J) reported strong revenue growth in the second quarter that ended June 30. Its pharmaceutical division was up 21.1% to $8.5 billion (all dollar amounts in U.S. currency), led by sales of new Hepatitis C drug Olysio and anticoagulant Xarelto. Medical devices revenues only rose 0.7% to $7.2 billion but consumer products sales rose 2.4% to $3.4 billion. Overall sales rose 9.1% to $18.5 billion, net earnings by 12.2% to $1.66 per share. The company raised its guidance slightly for 2014 to $5.85 to $5.92 from $5.80 to $5.90. Domestic sales in the second quarter rose 36.6% while overseas sales rose by 6.8%.

Patent expiries such as the proton pump inhibitor Aciphex are an ongoing issue. J&J has also had product recall issues over hip joints and stents. But the positives continue to outweigh the problems. They include J&J’s global scale, well-diversified product lineup, strong growth in pharmaceuticals, its largest division and rock solid balance sheet.

Action now: Buy. – G.G.

Ag Growth International (TSX: AFN, OTC: AGGZF)

Type: Common stock
Trading symbols: AFN, AGGZF
Exchanges: TSX, Pink Sheets
Current Price: C$42.25, US$38.18
Originally recommended: Dec. 23/09 at C$33.72, US$31.32
Annual Payout: $2.40
Yield: 5.7%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.aggrowth.com

Comments: Ag Growth is a manufacturer of agricultural storage, grain handling and processing equipment in North America and internationally. Its business is driven by volumes rather than prices, so the record North American grain crop of 2013 has led to record revenues, and the company anticipates continued strong growth in 2014.

Ag Growth had record revenues of $198.5 million and adjusted EBITDA of $36.8 million for the first half of 2014 that ended June 30. Net profit of $24.9 million ($1.11 per share) was up 52%. In the U.S., revenues of $110.8 million were up 27% on the previous year and 19% above the all-time high. Canadian revenues of $53.8 million were up 35% and 17% above the previous best. International sales of $ 33.9 million primarily to Ukraine, Russia and Latin America were also at record levels, up 26% on the year and 7% on previous highs.

This was despite the conflict between Ukraine and Russia, as the International Finance Corporation (IFC) is encouraging Ag Growth to participate in a project to sell its grain storage and processing machinery to the 60% of Ukrainian farms that fall below the level required for bank financing. The IFC provides the funding, while for larger farms, Canada’s export credit agency is providing insurance on a case-by-case basis.

In Latin America, five mid-size orders will produce $20 million in sales in the next year and Ag Growth has begun manufacturing in Brazil. It is also spending $30 million on two new green field plants at subsidiaries in Illinois and South Dakota, to be ready by the end of next year to address capacity constraints.

Action now: Ag Growth remains a Buy for its steady expansion, both geographically and by product line and its solid finances. – G.G.

Capital Power Corp. (TSX: CPX, OTC: CPXWF)

Type: Common Stock
Trading symbols: CPX, CPXWF
Exchanges: TSX, Grey Market
Current price: C$26.97, US$24.39
Originally recommended: Jan. 30/14 at C$22.60, US$19.32
Annual Payout: $1.36
Yield: 5%
Risk rating: Moderate risk
Recommended by: Gavin Graham
Website: www.capitalpower.com

Comments: Since I recommended it in January, Alberta-based electric utility Capital Power has seen a strong rise in its share price. That’s because the overhang from the sale of shares by its former parent ENMAX was no longer seen as an issue. Its most recent sale in December last year reduced ENMAX’s holding to below 20%.

Capital Power’s revenues and normalized net earnings for the six months to June 30 were down 20% to $548 million and 27% to $32 million ($0.39 per share) due to lower Alberta power prices and lower generation from its power plants. But management showed their confidence by raising the quarterly dividend by 7.9% from $0.315 per share to $0.34 per share.

Funds from operations (FFO) were down by a smaller amount from $191 million to $177 million, and the company reiterated its forecast of FFO of between $360 million and $400 million for all of 2014 after taking a $20 million payment from its coal supplier Gennessee Mines into account.

Capital Power is expanding its generation platform, with its new Calgary-based Shepard Energy Centre. Seventy-five per cent of its output is contracted at fixed prices for three years, coming on stream early next year. In addition, after adding three new wind plants since 2012, the new 270-megawatt K2 wind farm in Goderich, Ont. is due on stream in the second half of 2015. It is expected to cost Capital Power about $310 million.

Action now: Capital remains a Buy for its expansion plans, along with its rising dividend, well-diversified energy plants, both by type and geography, and its solid balance sheet. – G.G.

DH Corporation (TSX: DH, OTC: DHIFF)

Type: Common stock
Trading symbols: DH, DHIFF
Exchanges: TSX, Pink Sheets
Current price: C$32.96, US$29.88
Originally recommended: Oct. 24/07 at C$19.06, US$19.81
Annual payout: $1.28
Yield: 3.9%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.dhltd.com

Comments: DH Corporation (formerly D+H, short for Davis + Henderson), has successfully transformed itself from a Canadian cheque printer into a provider of electronic financial solutions to the Canadian and U.S. mortgage and finance industry. This happened due to last year’s US$1.2 billion acquisition of Harland Financial Services (HFS), which has 5,400 banks and credit unions as clients.

As a result, what DH describes as lending processing and banking technology solutions accounted for 74% of its $552 million in adjusted revenues (up 49.7%) for the half year that ended June 30. Cheque printing accounted for the remaining 24%. The U.S. accounted for 42% of revenues, compared with 14% in the same period the previous year, while adjusted EBITDA rose 69.7% to $171.7 million and adjusted net income rose 57.7% to $90.3 million ($1.12 per share). Earnings per share only rose 15.5% due the extra shares issued to acquire HFS.

DH maintained its $0.32 per share quarterly dividend, repaid $10 million in debt to continue reducing its net debt/EBITDA to 2.79 times from 3.05 times after the HFS purchase and is cross-selling its different products to its much larger client base.

Action now: DH remains a Buy for its successful expansion into financial solutions and decent cash flow generation from cheques and software. – G.G.

 

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SEPTEMBER UPDATES

Here are some additional updates. Prices are as of the close of trading on Monday, Sept. 22, unless otherwise stated.

Premium Brands Holding Corporation 5.5% Convertible Unsecured (TSX: PBH.DB.C)

Type: Convertible subordinated debentures
Trading symbol: PBH.DB.C
Exchange: TSX
Current price: $102.40
Conversion premium: 22.83%
Yield to maturity: 4.67%
Entry level: Current price
Risk Rating: Moderate risk
Recommended by: Tom Slee
Website: www.premiumbrandsholding.com

Comments: Premium Brands Holding Corporation was established in 2009 as the successor to Premium Brands Income Fund. Based in Richmond, B.C., the company owns a wide range of specialty food manufacturing and food distribution businesses across Canada. It sells both its own products and those of third parties to approximately 25,000 convenience stores, hotels and small chains. Revenues of $1.1 billion last year generated an operating profit of $88 million.

The subordinated debentures bear interest at 5.5% per annum and mature on June 30, 2019. They are convertible at any time into common shares of Premium Brands at a price of $29.25. In other words, you receive $34.188 common shares for every $1,000 debenture. The company can pay the holder cash instead of stock at conversion based on the market price of the stock. It can also redeem the debentures on and after June 30, 2016 at $100 if the common shares are trading at 125% of the conversion price.

The company is well positioned to benefit from long-term and emerging consumer trends. These debentures yield 225 basis points more than five-year conventional corporate bonds and offer growth potential.

A severe economic downturn could hurt revenues because most of Premium Brands products are specialty and discretionary foods. However, the debentures are well protected and with the stock at $24.21 the conversion price of $29.25 represents an acceptable 21% premium, down sharply from 39% when we first recommended these debentures. The company is also expected to earn about $1.20 a share in 2014 and we could see an increase to the $1.50 range next year.

Standard “Brands” convertible debentures are good quality investments that straddle the relatively expensive bond and stock markets. They provide above-average interest income and a growth hedge against rising interest rates.

Action now: Buy. These convertible debentures are suitable for more defensive investors seeking guaranteed income and some eventual growth. – T.S.

Brookfield Renewable Energy Partners (TSX: BEP.UN, NYSE: BEP)

Type: Limited partnership
Trading symbols: BEP.UN, BEP
Exchanges: TSX, NYSE
Current price: C$34.11, US$30.88
Originally recommended: July 22/09 at C$16.62, US$15.50
Annual payout: US$1.55
Yield: 4.5%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.brookfieldrenewable.com

Comments: I reviewed this partnership in the last issue but there has been a new development that pushed the price of the shares higher. On Sept. 15, Brookfield Renewable reported that it is increasing the target for annual distribution increases to between 5% and 9%. The previous target had been for hikes of 3% to 5%.

Management said the move reflects the partnership’s “positive long-term fundamentals and strong organic growth prospects, including attractive inflation-linked contracts, growing cash flows tied to an improving economy and rising energy prices, and a robust development pipeline of projects with premium return potential.”

In a presentation to investors in New York on the same day, management said the partnership expects to invest between US$500 million and US$700 million in new developments over the next five years. The investments will be funded through internally generated cash flows and there are no plans to issue new shares, which would dilute the payouts. The new projects have the potential to add $140 million to funds from operations (FFO) by 2019.

The partnership, which holds only renewable energy assets, also expects to benefit from higher power prices in the coming years, based on the expectation of higher gas prices, increased demand as economic activity picks up, and the decommissioning of coal-fired plants and nuclear facilities. Alberta’s new premier, Jim Prentice, is on the record as saying one of his goals is to close down that province’s coal plants, replacing them with renewable power sources.

Brookfield Renewable currently has US$19 billion in assets under management, located in Canada, the U.S., Brazil and Europe. To see the complete presentation, go to the Brookfield Partners website at www.brookfieldrenewable.com and click on the link to the 2014 Brookfield Renewable Energy Partners Investor Meeting. 

Action now: Buy. These shares are especially suitable for socially responsible investors. – G.P.

B&G Foods Inc. (NYSE: BGS)

Type: Common stock
Trading symbol: BGS
Exchange: NYSE
Current price: US$28.30
Originally recommended: April 30/14 at US$31.21
Annual payout: US$1.36
Yield: 4.8%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.bgfoods.com

Comments: B&G’s share price dropped sharply in July after the company released second-quarter financial results and lowered its guidance for net income in the 2014 fiscal year by 3.1% to a range of $1.54 to $1.60 per share (all dollar amounts in U.S. currency).

At first glance, the second-quarter numbers didn’t look so bad with revenue increasing by 26.1% to $202.9 million. However, most of that gain was due to acquisitions with core business volume growing by just 2.8%. Worse, the company gave back 1.7% of that increase in the form of price reductions.

Adjusted EBITDA increased by 8.8% but CEO David Wenner admitted he “expected better.” He went on to say, “We continue to see added expenses due to our rapid growth over the past year. As we work through these issues we are reducing our adjusted EBITDA guidance for fiscal 2014 to a range of $204 million to $209 million, which at the mid-point of the range represents a 12.2% increase over 2013.”

Second-quarter net income using GAAP standards was $16.1 million ($0.30 a share, fully diluted). That compared to a loss of $1.4 million ($0.03 per share) in the same period last year. For the first half of the fiscal year, net income was $33.9 million ($0.63 per share) compared to $18.2 million ($0.34 per share) in 2013.

The stock currently pays a quarterly dividend of $0.34 a share ($1.36 annually). Based on the revised guidance, the dividend appears to be safe but we are unlikely to see another increase until the financials show more improvement.

As a reminder, B&G Foods and its subsidiaries manufacture, sell and distribute a diversified portfolio of high-quality, branded shelf-stable foods across the United States, Canada and Puerto Rico. Based in Parsippany, New Jersey, B&G Foods’ products are marketed under many recognized brands. These including Ac’cent, B&G, Baker’s Joy, Cream of Wheat, Emeril’s, Grandma’s Molasses, Maple Grove Farms, Old London, Red Devil, Regina, Rickland Orchards, Sa-són, Sugar Twin, TrueNorth, Underwood, Vermont Maid and Wright’s. B&G Foods also sells and distributes two branded household products, Static Guard and Kleen Guard.

Action now: Buy. The pullback in the share price has pushed the yield up to 4.8%, from 4.1% at the time of the original recommendation. The shares are especially well suited for investors who want some U.S. dollar cash flow in their portfolios. – G.P.

TransCanada Corp. (TSX, NYSE: TRP)

Type: Common stock
Trading symbol: TRP
Exchanges: TSX, NYSE
Current price: C$60.68, US$55.02
Originally recommended: July 24/03 at C$25.25, US$17.87
Annual payout: $1.92
Yield: 3.2%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.transcanada.com

Comments: TransCanada shares surged last week after Reuters put out a report that the pipeline giant has attracted the interest of some U.S. hedge fund companies who see it as a potential takeover target. According to the report, some of the company’s largest shareholders have been contacted by merger and acquisition specialists who see big profit potential in getting control of TransCanada and breaking up the company.

On Friday morning, TransCanada issued a statement in which it defended its current structure. It read: “TransCanada firmly believes its current corporate form, asset base and financial strength provide critical underpinning to execute the company’s industry-leading $38 billion capital program which is expected to generate significant, sustainable growth in future cash flow, earnings and dividends.

“TransCanada understands the value placed on sustainable growth in cash flow, earnings and dividends, and is wholly-committed to the ongoing enhancement of shareholder value including continuous evaluation of the company’s approach to capital allocation.”

At first glance, it’s hard to give much credence to this takeover talk. TransCanada is a huge company, with a market cap approaching $45 billion. Moreover, any takeover bid would face daunting regulatory and political hurdles. TransCanada not only owns and operates many strategically important pipelines but it also owns a large stake in Ontario’s Bruce nuclear reactor and in coal and gas power plants in Alberta. It’s difficult to imagine the federal government allowing the takeover of such a key player in Canada’s energy sector by foreign interests under any circumstances. Permitting the break-up of the company is almost unthinkable. Active traders who agree that the takeover scenario is unlikely may wish to sell now and chalk up some profits. Otherwise, maintain your positions but don’t add to them at these levels.

Action now: Hold. – G.P.

That’s all for this issue. Look for your next Update Edition on Oct. 9. The next regular issue will be published on Oct. 30.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Next Update Edition: October 9

Next regular issue: October 30

INVESTING IN EXPENSIVE MARKETS

By Tom Slee, Contributing Editor

Markets keep barrelling along and now even the skeptics are along for the ride. A recent leading New York Times article entitled “Welcome To Everything Boom” said it all. Stocks, bonds, emerging markets, urban office towers, Iowa farmland, you name it; they are trading at prices well-above historic norms. At BlackRock, the world’s largest investment asset manager, chief strategist Russ Koesterich feels there are no longer any bargains out there. Far too much money is chasing very few opportunities.

It’s an astonishing situation primarily caused by two forces now working at cross-purposes. First and foremost, our markets have been badly distorted by the Federal Reserve’s massive quantitative easing program. Back in August 2008, the Fed owned its normal portfolio of US$900 billion in fixed income securities when the international banking system collapsed. Desperate times called for desperate measures and the central bank promptly embarked on an unprecedented asset-buying spree designed to keep interest rates low and the system flooded with cash. It was supposed to be a relatively small short- term program but that proved to be wishful thinking.

As I write, six years later, the Fed is still buying bonds, albeit at a slower rate, and now holds an incredible US$4.4 trillion of financial assets. Central banks in Britain, Japan and the Eurozone have adopted similar policies. There has never been market intervention on this scale before and experts have continually warned about bad long-term side effects. Economists pointed out that you cannot turn the securities markets on and off like a tap. How right they were.

The buying program was complex. In a nutshell, central banks siphoned off trillions of dollars worth of prime securities and private investors are now engaged in a bidding war for whatever is left. We have a huge imbalance. Institutions are awash with cash they would normally allocate to the bond market but there is almost no worthwhile product. Unable to live with the microscopic bond yields available, money managers have been gobbling up stocks, real estate and anything else offering a decent return.

The second force at work is globalization. Years ago, countries were to a large extent financially self-contained. For instance, the Japanese economy and stocks boomed for a long time while here in North America we spluttered and drifted aimlessly. There was relatively little interaction between these two markets because the mechanics were difficult. But that is no longer the case, at least not on a macro-scale. Nowadays, vast sums of “hot money” flow between countries at the press of a button. When the Fed started reducing its buying program last year, U.S. and Canadian interest rates were supposed to rise as the recovery gained traction. Instead, because of plummeting European economies, we have seen a surge of offshore money pouring into our bond markets and driving rates even lower. Foreign buyers are replacing the Fed’s traders.

There is another disturbing crosscurrent at work. These very low interest rates are becoming counterproductive. Cheap money is supposed to stimulate the economy. Now that everything is becoming expensive, however, companies are having second thoughts about buying new assets to grow and increase job opportunities. Most recent corporate earnings growth has come from cost cutting and acquisitions rather than organic expansion. The recovery could continue to flounder. It all adds up to a difficult environment for small income investors. However, it’s not a lost cause.

For a start, I am not nearly concerned as the managers at BlackRock. These markets are not hopelessly overpriced. The real trouble is that relatively high valuations are widespread. In 2000, stocks were much more expensive during the high-tech bubble but we had an attractive bond market as an alternative. At present nothing is cheap. Yet sitting on the sidelines in cash is bad idea. These markets could move sideways for a while and for income investors, time is money. You have to put assets to work.

I suggest you maintain your long-term investment strategy but become even more diversified. Because all the sectors are expensive, we are now vulnerable across the board. We could see a correction almost anywhere so spread the risk. At the same time opt for quality. There is little incentive in these markets to reach for yield and become more exposed. To give you an example, Province of Ontario 5.50% bonds due June 2, 2017 are trading at $110.42 to yield 1.57%. Paramount Resources 8.25% bonds due December 13, 2017 are priced at $104.00 and yield 3.11% – only 154 basis points more. Normally we see a 400 to 600 basis point spread between senior governments and junk bonds.

More specifically, if you have funds to invest and need fixed, reliable income, take a look at convertible debentures. This small market is far too thin for the institutions and as a result it contains overlooked issues that represent good value. For once, being a small investor is an advantage. Because these hybrid securities are unusual, however, it’s worthwhile briefly recapping their major characteristics.

Convertible debentures are primarily debt obligations. Like conventional bonds, they pay guaranteed regular interest at a set rate. The debentures mature on a predetermined date, at which time investors are repaid their capital. They are also convertible into a specific number of common shares and as a result trade to some extent as equities. These issues are actually listed on the Toronto Stock Exchange however they are few and far between. Only 180 investment grade convertible debentures are trading there.

The reason I like these investments right now is they provide a reasonable yield and potential long-term growth. Most important, as a bond they have downside support if the underlying stock drops in value as well as reliable income. Premium Brands Holding Corporation 5.5% Convertible Unsecured, for instance, is attractive at present levels. See the September updates section for more details.

Tom Slee managed millions of dollars in pension money during his career and is an expert in fixed income securities.

 

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SEPTEMBER’S TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Monday, Sept. 22 unless otherwise indicated.

Milestone Apartments REIT

Type: Real estate investment trust
Trading symbols: MST.UN, MSTUF
Exchanges: TSX, Pink Sheets
Current price: C$10.81, US$10
Entry level: Current price
Annual payout: $0.65
Yield: 6%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.milestonereit.com

The business: Based in Dallas, Milestone REIT is the largest real estate investment trust listed on the TSX that focuses solely on the United States multifamily sector. The portfolio consists of 57 multifamily garden-style residential properties, comprising 18,772 units that are located in 12 major metropolitan markets throughout the Southeast and Southwest United States. The REIT operates its portfolio through its internal property management company, Milestone Management, LLC, which has more than 900 employees across the United States.

The security: The REIT completed its initial public offering (IPO) in March 2013, issuing 22.85 million units at a price of $10 each for proceeds of $228.5 million. The shares initially traded as high as the $10.50 range but then slumped to as low as $9.25 in December before rallying.

Why we like it: With the probability of higher interest rates next year, I prefer residential REITs right now because they have more flexibility to raise rents than companies which focus on office buildings and malls, where contracts are normally for longer terms. I also like this REIT’s focus on the U.S., where the housing market is gathering strength.

Milestone is highly desirable because of its garden style and extensive amenities. A typical development consists of 200-plus units of two to four stories, with plenty of green space, swimming pools, tennis courts, clubhouses, fitness centres, business centres and access gates. Amenities include in-unit washers, dryers and fireplaces. The company operates in high-growth areas of the U.S. with properties in Texas, Arizona, Utah, Colorado, Florida, Georgia and Tennessee.

Management is growing by acquisition and last week announced a $74 million deal to buy the Villas at Shadow Creek, a 560-unit multifamily facility in Houston, Texas. It is 95% occupied with average monthly rents of $1,200 per unit.

Income seekers will be especially attracted by the REIT’s higher-than-average yield, currently running at 6%.

Financial highlights: Second-quarter results were encouraging. Adjusted funds from operations (AFFO) came in at $11.1 million ($0.20 per unit), up from $9.9 million (also $0.20 per unit) in the same period of 2013. Note that the REIT reports in U.S. dollars.

For the first half, AFFO was just over $22 million ($0.42 per unit) compared to $13 million ($0.26 per unit) in 2013. The first half payout ratio was 71%, down from 78% a year ago.

During the quarter, Milestone made acquisitions in Orlando, Florida and Atlanta, Georgia for a total cost of $78.7 million.

Risks: Interest rate risk must always be considered when making a decision about buying REITs. At the moment, it appears there is unlikely to be any significant upward move in rates for the next year or so. Last week’s announcement by the U.S. Federal Reserve Board that rates would stay at current levels for a “considerable time” was interpreted as signaling no move before mid-2015. The Bank of Canada has also indicted it is in no rush to raise rates. That said, rate hikes will come at some point and Milestone’s share price could be negatively impacted when that happens.

Since all the REIT’s properties are in the U.S., currency risk must also be taken into account. A rise in the value of the loonie would erode the value of any U.S. dollar denominated assets, as we saw during the period from 2002-2012 when our currency moved sharply higher.

As well, there are the normal business risks that are part of any operation. Overall, I rate this security as moderate risk.

Distribution policy: The REIT pays monthly distributions of C$0.05417 per unit (C$0.65 per year) to yield 6% at the current price.

Tax implications: For tax purposes, distributions to Canadians will be considered as income, return of capital (ROC) or a combination of both. In 2013, the entire amount paid out was treated as return of capital. This means no tax is payable immediately but the cost base of the shares is reduced by the amount deemed as return of capital. The net effect is to increase the capital gains tax liability when the shares are eventually sold. There is no guarantee that all future distributions will receive ROC treatment; the amount will vary from year to year.

Distributions paid from the REIT’s “current or accumulated earnings and profits” (as determined for U.S. federal income tax purposes) generally will be subject to the U.S. withholding tax at a rate of 15%, unless the shares are held in an RRSP or RRIF. This may be claimed back under the foreign tax credit. 

U.S. shareholders will not be subject to any withholding tax and income payments will be treated the same as if they were received from a U.S. REIT.

Who it’s for: Milestone shares are suitable for investors seeking above-average yield who are willing to accept a little more risk.

How to buy: The shares trade actively on the TSX and you should have no trouble being filled. They are also listed on the over-the-counter Pink Sheets in the U.S. but the average daily volume is very light (only 375 shares). If you must buy there, place a limit order and be patient.

Summing up: Milestone REIT offers investors an opportunity to participate in the U.S. multifamily residential market with attractive properties in high-growth areas.

Action now: Buy. – G.P.

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

 

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GAVIN GRAHAM’S UPDATES

Prices are as of the close of trading on Monday, Sept. 22 unless otherwise stated.

Diageo plc (NYSE: DEO)

Type: Common stock
Trading symbol: DEO
Exchange: NYSE
Current price: US$118.58
Originally recommended: June 22/11 at US$81.25
Annual payout: US$3.46
Yield: 2.9%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.diageo.com

Comments: Leading global spirits producer Diageo reported weaker revenues and earnings for the year that ended June 30. Net profit was down 8.2% to £2.25 billion (all currency amounts in pound sterling unless otherwise indicated) from £2.45 billion on revenues down 8.5% to £13.9 billion. Ironically, while there was growth in North America and stability in Western Europe, the traditionally faster-growing emerging markets (42% of revenues) suffered from falling currencies and specific weaknesses.

These included the anti-extravagance campaign in China, with sales at its Shui Jing Fang baiju maker (a fiery spirit made from grain) down 78% as central government clamped down on government entertaining. Latin American currencies in such markets as Venezuela and Argentina displayed exceptional weakness, while a significant increase in excise duties in Ireland, a major market due to its ownership of Guinness, led to a 4% decline in revenues.

However, the company has introduced a cost-cutting exercise to save £200 million a year by June 2017, and raised the final dividend by 9% to £0.32 a share. With its recent purchases of Turkish raki maker Mey Icki for US$2.1 billion in 2011 and a controlling stake in India’s largest spirits maker United Distillers for US$1.9 billion in 2014, Diageo is well-equipped to benefit from faster growth in the emerging markets once their currencies stabilize. The company also remains well diversified by product and geography.

Action now: Buy. – G.G.

Unilever plc (NYSE: UN)

Type: Common stock
Trading symbol: UN
Exchange: NYSE
Current price: US$40.54
Originally recommended: Sept. 26/12 at US$37.12
Annual payout: US$1.51
Yield: 3.7%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.unilever.com

Comments: Unilever, the third largest global consumer products company, saw a similar pattern to Diageo, with growth in emerging markets (57% of revenues) offset by weaker currencies. So while underlying sales growth was 3.7%, with emerging markets up 6.6%, revenues decreased 5.5% to €24.1 billion (all currency amounts in Euros) in the first half to June 30, 2014, with currency effects deducting 8.5%.

Operating profits were up 13% to 4.4 billion and net profit up 12% to €3 billion, but this reflected disposals of its Ragu and Bertolli pasta sauce businesses and more recently its Slim-Fast division. Core earnings per share were up, but by only 2% to €0.78 per share. Personal care, the largest division with revenues of €8.6 billion saw 4.5% underlying sales growth. Refreshments (ice cream and drinks) were up 5.1% to €4.9 billion and home care up 6.8% to €4.5 billion. The company’s second biggest division, food, was down 0.5% at €6.1 billion.

CEO Paul Polman noted that “markets have been challenging and we have experienced a further slowdown in the emerging markets while developed markets are not yet picking up.”

Still, the company is known for its conservative balance sheet, excellent exposure to emerging markets and is repositioning away from slow growth mature food brands into faster-growing home and personal care.

Action now: Unilever remains a Buy. – G.G.

Johnson & Johnson (NYSE: JNJ)

Type: Common stock
Trading symbol: JNJ
Exchange: NYSE
Current price: US$107.88
Originally recommended: Oct. 27/10 at US$63.81
Annual payout: US$2.80
Yield: 2.6%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.jnj.com

Comments: U.S. healthcare giant Johnson & Johnson (J&J) reported strong revenue growth in the second quarter that ended June 30. Its pharmaceutical division was up 21.1% to $8.5 billion (all dollar amounts in U.S. currency), led by sales of new Hepatitis C drug Olysio and anticoagulant Xarelto. Medical devices revenues only rose 0.7% to $7.2 billion but consumer products sales rose 2.4% to $3.4 billion. Overall sales rose 9.1% to $18.5 billion, net earnings by 12.2% to $1.66 per share. The company raised its guidance slightly for 2014 to $5.85 to $5.92 from $5.80 to $5.90. Domestic sales in the second quarter rose 36.6% while overseas sales rose by 6.8%.

Patent expiries such as the proton pump inhibitor Aciphex are an ongoing issue. J&J has also had product recall issues over hip joints and stents. But the positives continue to outweigh the problems. They include J&J’s global scale, well-diversified product lineup, strong growth in pharmaceuticals, its largest division and rock solid balance sheet.

Action now: Buy. – G.G.

Ag Growth International (TSX: AFN, OTC: AGGZF)

Type: Common stock
Trading symbols: AFN, AGGZF
Exchanges: TSX, Pink Sheets
Current Price: C$42.25, US$38.18
Originally recommended: Dec. 23/09 at C$33.72, US$31.32
Annual Payout: $2.40
Yield: 5.7%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.aggrowth.com

Comments: Ag Growth is a manufacturer of agricultural storage, grain handling and processing equipment in North America and internationally. Its business is driven by volumes rather than prices, so the record North American grain crop of 2013 has led to record revenues, and the company anticipates continued strong growth in 2014.

Ag Growth had record revenues of $198.5 million and adjusted EBITDA of $36.8 million for the first half of 2014 that ended June 30. Net profit of $24.9 million ($1.11 per share) was up 52%. In the U.S., revenues of $110.8 million were up 27% on the previous year and 19% above the all-time high. Canadian revenues of $53.8 million were up 35% and 17% above the previous best. International sales of $ 33.9 million primarily to Ukraine, Russia and Latin America were also at record levels, up 26% on the year and 7% on previous highs.

This was despite the conflict between Ukraine and Russia, as the International Finance Corporation (IFC) is encouraging Ag Growth to participate in a project to sell its grain storage and processing machinery to the 60% of Ukrainian farms that fall below the level required for bank financing. The IFC provides the funding, while for larger farms, Canada’s export credit agency is providing insurance on a case-by-case basis.

In Latin America, five mid-size orders will produce $20 million in sales in the next year and Ag Growth has begun manufacturing in Brazil. It is also spending $30 million on two new green field plants at subsidiaries in Illinois and South Dakota, to be ready by the end of next year to address capacity constraints.

Action now: Ag Growth remains a Buy for its steady expansion, both geographically and by product line and its solid finances. – G.G.

Capital Power Corp. (TSX: CPX, OTC: CPXWF)

Type: Common Stock
Trading symbols: CPX, CPXWF
Exchanges: TSX, Grey Market
Current price: C$26.97, US$24.39
Originally recommended: Jan. 30/14 at C$22.60, US$19.32
Annual Payout: $1.36
Yield: 5%
Risk rating: Moderate risk
Recommended by: Gavin Graham
Website: www.capitalpower.com

Comments: Since I recommended it in January, Alberta-based electric utility Capital Power has seen a strong rise in its share price. That’s because the overhang from the sale of shares by its former parent ENMAX was no longer seen as an issue. Its most recent sale in December last year reduced ENMAX’s holding to below 20%.

Capital Power’s revenues and normalized net earnings for the six months to June 30 were down 20% to $548 million and 27% to $32 million ($0.39 per share) due to lower Alberta power prices and lower generation from its power plants. But management showed their confidence by raising the quarterly dividend by 7.9% from $0.315 per share to $0.34 per share.

Funds from operations (FFO) were down by a smaller amount from $191 million to $177 million, and the company reiterated its forecast of FFO of between $360 million and $400 million for all of 2014 after taking a $20 million payment from its coal supplier Gennessee Mines into account.

Capital Power is expanding its generation platform, with its new Calgary-based Shepard Energy Centre. Seventy-five per cent of its output is contracted at fixed prices for three years, coming on stream early next year. In addition, after adding three new wind plants since 2012, the new 270-megawatt K2 wind farm in Goderich, Ont. is due on stream in the second half of 2015. It is expected to cost Capital Power about $310 million.

Action now: Capital remains a Buy for its expansion plans, along with its rising dividend, well-diversified energy plants, both by type and geography, and its solid balance sheet. – G.G.

DH Corporation (TSX: DH, OTC: DHIFF)

Type: Common stock
Trading symbols: DH, DHIFF
Exchanges: TSX, Pink Sheets
Current price: C$32.96, US$29.88
Originally recommended: Oct. 24/07 at C$19.06, US$19.81
Annual payout: $1.28
Yield: 3.9%
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.dhltd.com

Comments: DH Corporation (formerly D+H, short for Davis + Henderson), has successfully transformed itself from a Canadian cheque printer into a provider of electronic financial solutions to the Canadian and U.S. mortgage and finance industry. This happened due to last year’s US$1.2 billion acquisition of Harland Financial Services (HFS), which has 5,400 banks and credit unions as clients.

As a result, what DH describes as lending processing and banking technology solutions accounted for 74% of its $552 million in adjusted revenues (up 49.7%) for the half year that ended June 30. Cheque printing accounted for the remaining 24%. The U.S. accounted for 42% of revenues, compared with 14% in the same period the previous year, while adjusted EBITDA rose 69.7% to $171.7 million and adjusted net income rose 57.7% to $90.3 million ($1.12 per share). Earnings per share only rose 15.5% due the extra shares issued to acquire HFS.

DH maintained its $0.32 per share quarterly dividend, repaid $10 million in debt to continue reducing its net debt/EBITDA to 2.79 times from 3.05 times after the HFS purchase and is cross-selling its different products to its much larger client base.

Action now: DH remains a Buy for its successful expansion into financial solutions and decent cash flow generation from cheques and software. – G.G.

 

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SEPTEMBER UPDATES

Here are some additional updates. Prices are as of the close of trading on Monday, Sept. 22, unless otherwise stated.

Premium Brands Holding Corporation 5.5% Convertible Unsecured (TSX: PBH.DB.C)

Type: Convertible subordinated debentures
Trading symbol: PBH.DB.C
Exchange: TSX
Current price: $102.40
Conversion premium: 22.83%
Yield to maturity: 4.67%
Entry level: Current price
Risk Rating: Moderate risk
Recommended by: Tom Slee
Website: www.premiumbrandsholding.com

Comments: Premium Brands Holding Corporation was established in 2009 as the successor to Premium Brands Income Fund. Based in Richmond, B.C., the company owns a wide range of specialty food manufacturing and food distribution businesses across Canada. It sells both its own products and those of third parties to approximately 25,000 convenience stores, hotels and small chains. Revenues of $1.1 billion last year generated an operating profit of $88 million.

The subordinated debentures bear interest at 5.5% per annum and mature on June 30, 2019. They are convertible at any time into common shares of Premium Brands at a price of $29.25. In other words, you receive $34.188 common shares for every $1,000 debenture. The company can pay the holder cash instead of stock at conversion based on the market price of the stock. It can also redeem the debentures on and after June 30, 2016 at $100 if the common shares are trading at 125% of the conversion price.

The company is well positioned to benefit from long-term and emerging consumer trends. These debentures yield 225 basis points more than five-year conventional corporate bonds and offer growth potential.

A severe economic downturn could hurt revenues because most of Premium Brands products are specialty and discretionary foods. However, the debentures are well protected and with the stock at $24.21 the conversion price of $29.25 represents an acceptable 21% premium, down sharply from 39% when we first recommended these debentures. The company is also expected to earn about $1.20 a share in 2014 and we could see an increase to the $1.50 range next year.

Standard “Brands” convertible debentures are good quality investments that straddle the relatively expensive bond and stock markets. They provide above-average interest income and a growth hedge against rising interest rates.

Action now: Buy. These convertible debentures are suitable for more defensive investors seeking guaranteed income and some eventual growth. – T.S.

Brookfield Renewable Energy Partners (TSX: BEP.UN, NYSE: BEP)

Type: Limited partnership
Trading symbols: BEP.UN, BEP
Exchanges: TSX, NYSE
Current price: C$34.11, US$30.88
Originally recommended: July 22/09 at C$16.62, US$15.50
Annual payout: US$1.55
Yield: 4.5%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.brookfieldrenewable.com

Comments: I reviewed this partnership in the last issue but there has been a new development that pushed the price of the shares higher. On Sept. 15, Brookfield Renewable reported that it is increasing the target for annual distribution increases to between 5% and 9%. The previous target had been for hikes of 3% to 5%.

Management said the move reflects the partnership’s “positive long-term fundamentals and strong organic growth prospects, including attractive inflation-linked contracts, growing cash flows tied to an improving economy and rising energy prices, and a robust development pipeline of projects with premium return potential.”

In a presentation to investors in New York on the same day, management said the partnership expects to invest between US$500 million and US$700 million in new developments over the next five years. The investments will be funded through internally generated cash flows and there are no plans to issue new shares, which would dilute the payouts. The new projects have the potential to add $140 million to funds from operations (FFO) by 2019.

The partnership, which holds only renewable energy assets, also expects to benefit from higher power prices in the coming years, based on the expectation of higher gas prices, increased demand as economic activity picks up, and the decommissioning of coal-fired plants and nuclear facilities. Alberta’s new premier, Jim Prentice, is on the record as saying one of his goals is to close down that province’s coal plants, replacing them with renewable power sources.

Brookfield Renewable currently has US$19 billion in assets under management, located in Canada, the U.S., Brazil and Europe. To see the complete presentation, go to the Brookfield Partners website at www.brookfieldrenewable.com and click on the link to the 2014 Brookfield Renewable Energy Partners Investor Meeting. 

Action now: Buy. These shares are especially suitable for socially responsible investors. – G.P.

B&G Foods Inc. (NYSE: BGS)

Type: Common stock
Trading symbol: BGS
Exchange: NYSE
Current price: US$28.30
Originally recommended: April 30/14 at US$31.21
Annual payout: US$1.36
Yield: 4.8%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.bgfoods.com

Comments: B&G’s share price dropped sharply in July after the company released second-quarter financial results and lowered its guidance for net income in the 2014 fiscal year by 3.1% to a range of $1.54 to $1.60 per share (all dollar amounts in U.S. currency).

At first glance, the second-quarter numbers didn’t look so bad with revenue increasing by 26.1% to $202.9 million. However, most of that gain was due to acquisitions with core business volume growing by just 2.8%. Worse, the company gave back 1.7% of that increase in the form of price reductions.

Adjusted EBITDA increased by 8.8% but CEO David Wenner admitted he “expected better.” He went on to say, “We continue to see added expenses due to our rapid growth over the past year. As we work through these issues we are reducing our adjusted EBITDA guidance for fiscal 2014 to a range of $204 million to $209 million, which at the mid-point of the range represents a 12.2% increase over 2013.”

Second-quarter net income using GAAP standards was $16.1 million ($0.30 a share, fully diluted). That compared to a loss of $1.4 million ($0.03 per share) in the same period last year. For the first half of the fiscal year, net income was $33.9 million ($0.63 per share) compared to $18.2 million ($0.34 per share) in 2013.

The stock currently pays a quarterly dividend of $0.34 a share ($1.36 annually). Based on the revised guidance, the dividend appears to be safe but we are unlikely to see another increase until the financials show more improvement.

As a reminder, B&G Foods and its subsidiaries manufacture, sell and distribute a diversified portfolio of high-quality, branded shelf-stable foods across the United States, Canada and Puerto Rico. Based in Parsippany, New Jersey, B&G Foods’ products are marketed under many recognized brands. These including Ac’cent, B&G, Baker’s Joy, Cream of Wheat, Emeril’s, Grandma’s Molasses, Maple Grove Farms, Old London, Red Devil, Regina, Rickland Orchards, Sa-són, Sugar Twin, TrueNorth, Underwood, Vermont Maid and Wright’s. B&G Foods also sells and distributes two branded household products, Static Guard and Kleen Guard.

Action now: Buy. The pullback in the share price has pushed the yield up to 4.8%, from 4.1% at the time of the original recommendation. The shares are especially well suited for investors who want some U.S. dollar cash flow in their portfolios. – G.P.

TransCanada Corp. (TSX, NYSE: TRP)

Type: Common stock
Trading symbol: TRP
Exchanges: TSX, NYSE
Current price: C$60.68, US$55.02
Originally recommended: July 24/03 at C$25.25, US$17.87
Annual payout: $1.92
Yield: 3.2%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.transcanada.com

Comments: TransCanada shares surged last week after Reuters put out a report that the pipeline giant has attracted the interest of some U.S. hedge fund companies who see it as a potential takeover target. According to the report, some of the company’s largest shareholders have been contacted by merger and acquisition specialists who see big profit potential in getting control of TransCanada and breaking up the company.

On Friday morning, TransCanada issued a statement in which it defended its current structure. It read: “TransCanada firmly believes its current corporate form, asset base and financial strength provide critical underpinning to execute the company’s industry-leading $38 billion capital program which is expected to generate significant, sustainable growth in future cash flow, earnings and dividends.

“TransCanada understands the value placed on sustainable growth in cash flow, earnings and dividends, and is wholly-committed to the ongoing enhancement of shareholder value including continuous evaluation of the company’s approach to capital allocation.”

At first glance, it’s hard to give much credence to this takeover talk. TransCanada is a huge company, with a market cap approaching $45 billion. Moreover, any takeover bid would face daunting regulatory and political hurdles. TransCanada not only owns and operates many strategically important pipelines but it also owns a large stake in Ontario’s Bruce nuclear reactor and in coal and gas power plants in Alberta. It’s difficult to imagine the federal government allowing the takeover of such a key player in Canada’s energy sector by foreign interests under any circumstances. Permitting the break-up of the company is almost unthinkable. Active traders who agree that the takeover scenario is unlikely may wish to sell now and chalk up some profits. Otherwise, maintain your positions but don’t add to them at these levels.

Action now: Hold. – G.P.

That’s all for this issue. Look for your next Update Edition on Oct. 9. The next regular issue will be published on Oct. 30.

Best regards,
Gordon Pape, editor-in-chief