In this issue:

Next Update Edition: November 13

Next regular issue: November 27

GET USED TO LOW RATES

By Gordon Pape, Editor and Publisher

Anyone hoping for a return to higher interest rates in the near future is going to be disappointed. That day has been postponed again, perhaps until 2016.

A couple of years ago, the expectation was that we could start to see higher interest rates this year as global economic growth picked up. When that didn’t happen, the conventional thinking on rate hikes shifted to mid-2015. Conservative investors who prefer to park their money in guaranteed investment certificates could hardly wait as visions of 5% GICs danced in their heads.

Well, that’s just not going to happen, at least not any time in the foreseeable future. In fact, it’s been well over a decade since five-year GICs even paid 4% annually. According to the Bank of Canada website, the highest average for a five-year certificate in the past 10 years was in July 2007 when the number came in at 3.73%. It hasn’t been close to that since.

In fact, we’re moving in the opposite direction. Back in April of this year, the average five-year rate got as high as 2.2%. Today it’s back down to 2%. The average rate over the past decade is 2.34%.

Reading between the lines, last week’s report from the Bank of Canada suggests that an upward move on interest rates in 2015 looks increasingly unlikely. The Bank projects that the Canadian economy won’t get back to full capacity until the second half of 2016 and even that forecast is problematic. In the press release announcing no change in the target overnight rate, the Bank said: “Persistent headwinds continue to buffet most economies and growth remains reliant on exceptional policy stimulus. Against a background of ongoing geopolitical uncertainties and lower confidence, energy prices have declined and there has been a significant correction in global financial markets, resulting in lower government bond yields.”

There are a couple of key points to note here. The first is the reference to “exceptional policy stimulus.” In effect, the Bank is saying that continued low interest rates combined with such programs as quantitative easing will be needed for some time to prevent the world from slipping back into recession. The U.S. Federal Reserve Board is ending its program this month just as the European Central Bank is embarking on its own.

The other phrase with broad implications is “resulting in lower government bond yields.” At the beginning of the year, almost everyone expected bond yields to rise this year, with prices falling in sync (the two move in opposite directions). That hasn’t happened. Bond yields continue to edge lower, with prices rising accordingly. As of Oct. 27, the FTSE TMX Universe All Government Bond Index was showing a year-to-date gain of 7.03%. Yields on long-term issues clearly show that bond traders do not anticipate any significant rate hikes for years to come. Canada bonds with 30-year maturities were yielding only 2.53% at the time of writing.

U.S. economic growth is somewhat more robust than here in Canada but even there the expectation of rate increases any time soon is muted. The latest consensus seems to be that the Fed will hold the line until at least the second half of next year. And even when it does move, there will be no pressure on the Bank of Canada to follow in lockstep. Higher U.S. rates would push our loonie lower against the greenback, giving an additional boost to exporters. Nothing could make Bank of Canada Governor Stephen Poloz happier.

So resign yourself to more of the same if you’re a GIC fan. The way things are going, you’ll be fortunate to keep pace with inflation.

 

Return to the table of contents…

BALANCED PORTFOLIO UPDATE

By Gordon Pape, Editor and Publisher

We are currently monitoring the performance of three portfolios designed for income investors. This one, launched in September 2011, is designed for those who are looking for a combination of above-average cash flow and reasonable risk. The initial portfolio valuation was $25,027.75.

The objective is to generate a return that is at least two percentage points more than that offered by the highest-paying GIC. Right now, the best five-year rate is 3.05% so our current target is at least 5.05% per year, including distributions and capital gains.

We make no distinction between registered and non-registered accounts, so keep in mind that the tax advantages of dividend-paying securities will be lost if they are held in an RRSP, RRIF, TFSA, RESP, etc.

Here’s a summary of how the securities we currently hold performed over the seven months since we last reviewed this portfolio in late March.

iShares 1-5 Year Laddered Corporate Bond Fund (TSX: CBO). This is a defensive short-term ETF. It’s a low-risk way to own bonds but it will never provide much of a return. Since my last review in March, the units have dropped $0.20 in market value. But we received $0.54 in distributions so we have a net gain of 1.7% over the seven-month period. That’s not much but it’s what we should expect in the current interest rate environment.

CIBC Global Bond Fund (A units) (CIB490). I added this fund to the portfolio in March to increase our bond exposure. We’ve seen a small gain of $0.21 per unit in the net asset value plus we have received distributions of $0.11 for a total return of 2.7% over the period.

Cineplex Inc. (TSX: CGX, OTC: CPXGF). It wasn’t a blockbuster summer at the movies but Cineplex still managed to add $0.41 to its share price since my last review in March. The cinema giant also raised its monthly dividend by 4.2% to $0.125 per share in the spring. I added this stock to the portfolio in September 2013 and it has given us a total return of almost 11% since then.

Freehold Royalties (TSX: FRU, OTC: FRHLF). It has been a rough time for oil producers and this royalty company hasn’t escaped. The shares are down $1.36 since my last update. We received $1.12 per unit in monthly dividends but that wasn’t enough to offset the price drop. As a result, we’re down 1.2% since I added Freehold to the portfolio in September 2013.

Inter Pipeline (TSX: IPL, OTC: IPPLF). Talk about an outstanding investment! This one is like the Energizer Bunny – it just keeps going and going and going. It’s hard to believe that a small pipeline company added $6.70 a share since last March in a lacklustre market, but that’s what happened. Plus we received monthly dividends of $0.1075 per share for a total return of almost 26% in seven months.

Brookfield Renewable Energy Limited Partnership (TSX: BEP.UN, NYSE: BEP). This renewable energy partnership also fared well over the summer, adding $3.34 per share. We also received two quarterly dividends of US$0.3875, which boosted our seven-month advance to 12.9%.

Brookfield Infrastructure Limited Partnership (TSX: BIP.UN, NYSE: BIP). This is a companion limited partnership to Renewable Energy but in this case the assets are infrastructure – everything from coal terminals and railways to power transmission lines. It has performed well for us and the shares are up $1.02 since March. We also received two dividends of US$0.48 each.

BCE Inc. (TSX, NYSE: BCE). BCE’s share price appears to be stuck in neutral. The stock is up only $0.70 since March and many analysts feel it is unlikely to move much higher for now. But the dividend is a juicy $0.6175 per quarter, which bulks the total return.

Cash. We invested $2,245.21in a high interest savings account paying 1.35%. Total interest over the latest seven-month period was $17.68.

Here’s how the portfolio stood after the close of trading on Oct. 24. Commissions have not been factored in. Canadian and U.S. dollars are treated as being at par for purposes of the calculations.

Income Investor Balanced Portfolio (a/o Oct. 24, 2014)

Security
Weight

%
Total

Shares
Average

Initial

Price
Market

Price
Book

Value
Market

Value
Cash

Retained
Gain/Loss

%
CBO
19.5
310
$20.29
$19.54
$6,277.25
$6,057.40
$673.62
+ 7.2
CIB490
8.7
225
$11.78
$11.99
$2,650.50
$2,697.75
$24.95
+ 2.7
CGX
13.4
100
$39.00
$41.66
$3,900.00
$4,166.00
$158.50
+10.9
FRU
10.5
150
$24.00
$21.78
$3,600.00
$3,267.00
$294.00
– 1.2
IPL
14.2
125
$16.05
$35.42
$2,006.25
$4,427.50
$462.56
+143.7
BEP.UN
11.4
100
$25.72
$35.24
$2,572.00
$3,524.00
$481.58
+55.7
BIP.UN
11.5
80
$26.86
$44.76
$2,148.80
$3,580.80
$435.01
+86.9
BCE
10.2
65
$42.67
$48.59
$2,773.55
$3,158.35
$308.76
+25.0
Cash
0.6
$181.81
$199.49
Total
100.0
$26,110.16
$31,078.29
$2,838.98
+29.9
Inception
$25,027.75
+35.5

Comments: Thanks in large part to Inter Pipeline, the portfolio gained 6% in the seven months since the last review in March. Cash flow during the period was $614.72. The total value, including retained cash, stands at $33,917.27. Since inception, we have a total return of 35.5%. Our average annual compound rate of return is 10.3% so we continue to run well ahead of target.

Changes: It’s time to deploy some of the large cash reserves we have built up in this portfolio. Here’s what we’ll do.

CBO – We will buy 30 shares at a cost of $19.54, for a total outlay of $586.20. That will leave us with $87.42 in cash retained.

FRU – We’ll take advantage of the price retreat to add 10 shares at $21.78, for an expense of $217.80. We will have $76.20 left over.

BEP.UN – We’ll add 10 shares to bring our total to 110. At the current price of $35.24, that will require $352.40, leaving cash of $129.18.

BIP.UN – We’ll also buy 10 shares here to increase the total to 90. The cost is $447.60. We’re a little short in our retained cash so we’ll take the extra $12.59 from the general cash fund.

BCE – We will add five shares at a cost of $242.95. We will now own 70 shares and have $65.81 in our retained cash reserve.

Also, we will sell 25 shares of Inter Pipeline for $885.50. Yes, it has been an outstanding performer but the portfolio weighting has become too high and the stock looks a little pricey at this level. We should add more bonds to the portfolio so we will spend $931.50 to buy 30 units of the iShares Canadian Universe Bond Fund (TSX: XBB). We’ll draw the extra $46 from cash.

Here is the revised portfolio.

Income Investor Balanced Portfolio (revised Oct. 24, 2014)

Security
Weight

%
Total

Shares
Average

Initial

Price
Market

Price
Book

Value
Market

Value
Cash

Retained
CBO
20.2
340
$20.19
$19.54
$6,883.45
$6,643.60
$87.42
XBB
2.8
30
$31.05
$31.05
$931.50
$931.50
0
CIB490
8.2
225
$11.78
$11.99
$2,650.50
$2,697.75
$24.95
CGX
12.7
100
$39.00
$41.66
$3,900.00
$4,166.00
$158.50
FRU
10.6
160
$23.86
$21.78
$3,817.80
$3,484.80
$76.20
IPL
10.8
100
$16.05
$35.42
$1,605.00
$3,542.00
$462.56
BEP.UN
11.8
110
$26.59
$35.24
$2,924.40
$3,876.40
$129.18
BIP.UN
12.2
90
$28.85
$44.76
$2,596.40
$4,028.40
0
BCE
10.3
70
$43.09
$48.59
$3,016.50
$3,401.30
$65.81
Cash
0.4
$140.90
$140.90
Total
100.0
$28,420.45
$32,912.65
$1,004.62
Inception
$25,027.75

Through these changes, we have increased the bond component of the portfolio by three percentage points, thus reducing overall market risk. We have also restored better balance among the equity positions, reducing the spread between the lowest and the highest weightings to 2.4 percentage points compared to four points previously. Our cash reserves, including retained dividends/distributions, have been reduced to $1,145.52. We’ll keep that in our high-interest account, which now pays 1.3%.

Readers are reminded not to make small trades unless they have a rock-bottom discount brokerage service or a fee-based account. Small quantities of five or ten shares are better accumulated through DRIP programs.

I will review this portfolio again in six months.

 

Return to the table of contents…

AFTER THE SELL-OFF

By Gavin Graham, Contributing Editor

The dramatic decline in world stock markets over the last few weeks, which saw most major indices fall by 10% or more from the highs reached earlier this summer, has left investors battered and confused.

After a long period when markets advanced steadily since the Eurozone crisis peaked in August 2012, volatility (as measured by the VIX Index) had fallen to lows not seen since before the U.S. subprime mortgage crisis in 2006-07. This means that investors were not anticipating any major moves in the stock indices, in either direction, and indicators of investor sentiment, such as the percentage of bullish as opposed to bearish stock market newsletters, had reached levels only seen before the sharp falls of 2000-02 and 2007-09.

What made the sell-off so worrying to many shareholders was that it occurred so suddenly, and at a time when there were many large Initial Public Offerings (IPOs). For example, Chinese ecommerce provider Alibaba was the biggest IPO in almost a decade when it went public in September, valuing the company at over $220 billion. The U.S. economy was apparently doing well, with unemployment down to a seven-year low of 6.1%, allowing the Federal Reserve to continue withdrawing $10 billion of its $85 billion a month of Quantitative Easing (QE) at each meeting throughout the year. China’s slowdown in GDP was being addressed by the Communist authorities who were loosening lending practices, and even Europe and Japan seemed to be showing positive signs of GDP growth, even if somewhat muted.

The underlying problems, however, were apparent to those who looked more closely at the evidence. While the U.S. (and Canada) had experienced reasonable GDP growth, after allowing for the effects of the severe winter, real wages after inflation in both countries were barely growing. Much of the fall in unemployment was due to discouraged workers leaving the workforce. China’s GDP of 7.3% in the third quarter of 2014 was the lowest in seven years, even if one believed the notoriously unreliable official statistics, and property prices were down 11% in the first eight months of 2014. Meanwhile, a 2% increase in sales tax in Japan in the second quarter of the year led to a sharp decline in Japanese GDP as consumers rushed to buy ahead of the increase. The rapidly falling Japanese yen, down 20% from its level 18 months ago, contributed to rising inflation. Finally, the weak performance of the southern European economies proved they had not fully recovered from the Eurozone crisis but only experienced a brief respite.

With company earnings only growing between 3% and 8% for most industries in 2014, the rise in the indices this year meant that they were selling at high valuations. The S&P500 Index was selling at 18 times earnings, a valuation that investors abruptly decided was too expensive, and the sell-off began. Experienced investors often warn novices to look at the bond market before they start making decisions about investing in the stock market, and bond yields for major developed countries have been falling all year. The benchmark U.S. Treasury yield began the year at 3%, with most commentators expecting a further rise in rates as the economy continued to recover.

Instead, its yield fell to around 2.5% by mid-year, and during the recent correction has fallen back below 2%, a level not seen since the middle of the Eurozone crisis in 2012. In Germany, the 10-year Bund yield has fallen to a never-seen-before low of 0.81%. Japan’s 10-year JGB yield has been below 1% for most of the last decade. The reason the latter has been so low, of course, is due to a lack of inflation, or even deflation, the symptom of an economy that is persistently growing slowly, leaving plenty of spare capacity. This is exactly the same problem that occurred during the Great Depression in the 1930s, the last time bond yields were at these levels.

Bonds strong performance this year is one of the reasons why Gordon has written several times about the importance of always including some fixed income investments in your portfolio. Government bonds especially are not correlated with stocks, and so provide valuable diversification for investors. Secondly, as that great sage Yogi Berra once said, “It’s very hard to make predictions, especially about the future.” While, as noted, many commentators expected rising inflation as economies recovered, and weaker bond markets, particularly given the withdrawal (“tapering”) of the Fed’s $85 billion a month of QE bond purchases, investor worries about the sustainability of the recovery and high valuations have proved sufficient to override these factors.

So where does the recent correction leave investors? Is the worst behind us, or, as was the case in 2010, 2011 and 2012, is it only the beginning of a bigger sell-off? More specifically, how have various sectors performed during the last few weeks, and what opportunities might have been created?

The companies that have done best over the last month, with some of them actually rising, have generally been those in the interest rate sensitive industries, such as real estate investment trusts, telecoms and utilities, while the worst hit have been the economically sensitive sectors such as materials, energy and autos.

Almost all of the REITs recommended in Income Investor, including my picks Allied Properties, Boardwalk and Canadian REIT and Gordon’s picks such as RioCan and H&R REIT, are up over the last month, while the S&P/TSX and the S&P 500 are down 3% to 4%, after a 4% to 5% rebound in the week to Oct. 22. In fact while the iShares Canadian Long-Term Bond ETF (TSX: XLB) is up 2.4% over the last month, the iShares Capped REIT ETF (TSX: XRE) is up 2.3% over the same period. The iShares Preferred Shares ETF (TSX: XPF), which is effectively a short-term bond index, is also up 0.4%, while all other equity sectors are down.

All three of the Canadian telecom companies, BCE, Rogers and Telus are up, while such utility companies as Canadian Utilities, Duke Energy, Fortis and Capstone are flat or up too. Other defensive sectors such as food and low cost retailing are also up for the month, with Empire, Metro, Canadian Tire and Dollarama all winners over that period.

Certain gold stocks are up, as the precious metal has held up, trading at US$1,245 per oz. at Oct. 22. My IWB picks Agnico-Eagle, Goldcorp and Franco-Nevada are up, but the iShares Global Gold Miners ETF is off 2.5%. Other commodity stocks such as Teck, First Quantum and Lundin have been down by 25% to 30%.

If the sell-off resumes after last week’s rebound, then it will likely be because of the same concerns over slow growth/recession and deflation that have driven the present correction. In that case, government bond yields will continue to fall, interest rate sensitive sectors should do well on a relative basis, and economically sensitive stocks will continue to be beaten up.

The usually defensive pipeline sector has been weak, with AltaGas and Enbridge both off 8% and TransCanada off 10%, as worries over falling oil and gas prices spook investors. Banks have also been mixed, with losses ranging from 2% over the last month for well regarded National Bank and RBC to 4% to 6% for the rest, as concerns over loan losses mount.

Investors should be aware that not all bonds are created equal. While sovereign government debt has done well in major economies, bonds in southern Europe from such issuers as Spain, Portugal, Italy and Greece have seen their yields rise while German yields have fallen, as potential default risk raises its head again. Likewise, high yield corporate debt (sometimes known as junk bonds) has seen its spread over investment grade debt begin to widen out during this sell-off, due to increased risk of default by highly leveraged borrowers. Even though yields on government and investment grade debt are low, investors should remember that bonds are there for the return of your capital, not the return on your capital. Well-managed interest rate sensitive stocks can provide the higher returns in this environment.

 

Return to the table of contents…

OCTOBER’S TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Monday, Oct. 27 unless otherwise indicated.

Fortis Inc. Cumulative Redeemable 4.75% First Preference Series J Shares (TSX: FTS.PR.J)

Type: Cumulate redeemable, straight preferred shares
Trading symbol: FTS.PR.J
Exchange: TSX
Current price: $24.31
Yield: 4.88%
Yield to First Call: 6.84%
Credit Rating: DBR2 Pfd-2 (low)
Entry Level: Current price
Risk Rating: Conservative
Recommended by: Tom Slee
Website: www.fortisinc.com

The business: Based in St. John’s, Newfoundland, Fortis is the largest investor-owned electric and gas distributor in Canada. With assets of almost $25 billion and annual revenues exceeding $4 billion, the company serves more than three million customers across Canada, the United States and the Caribbean. Fortis also owns hotels and commercial real estate.

The security: These are cumulative preferred shares so in the extremely unlikely event of a quarterly dividend being omitted or partially paid, the shortfall becomes a corporate liability and is owed to the preferred shareholder. The company can redeem the shares at a price of $26 on or after December 1, 2017, and then at descending prices to $25 on or after December 1, 2021.

Why we like it: This is one of the relatively few blue chip preferred shares with almost guaranteed specified dividends in perpetuity. Its Pfd-2 rating states in part that protection of capital and dividends is substantial. There is no call for redemption until 2017 and then at a price well above the current market. The present yield is equivalent to about 7% from a bond in non- registered accounts after allowance for the dividend tax credit.

Financial highlights: Fortis reported second quarter earnings of $0.22 a share, in line with expectations. The company’s current $1.4 billion capital program is on track and management plans to spend $6.5 billion over a five- year period from 2014 to 2018. Fortis’ vast Waneta Dam expansion in British Columbia should come on stream shortly and I expect to see earnings of about $1.60 a share this year with an increase to the $2 range in 2015.

Risks: It is conceivable that Fortis could fail to pay its preferred dividends during a deep, sustained recession. However, the Series J shares are cumulative and therefore the company is required to make good on any missing distributions to these shareholders. With regulated utilities accounting for 93% of the company’s assets, the Series J risk is minimal. Fortis is a quasi government entity.

Distribution policy: Dividends of $0.2969 per share are paid on the first days of March, June, September and December for a total of $1.19 per annum.

Tax implications: The dividends are eligible for the dividend tax credit if the shares are held outside a registered plan. Any profit or loss from a sale or redemption is taxed as a capital gain or loss in that year.

Who it’s for: These shares are suited for defensive investors seeking a secure, above-average return.

Action now: Buy Fortis Series J preferred shares for reliable income. – T.S.

 

Return to the table of contents…

OCTOBER’S UPDATES

Here are the updates for this month. Prices are as of the close of trading on Monday, Oct. 27, unless otherwise stated.

Bombardier 6.25% Series 4 Preferred Shares (TSX: BBD.PR.C)

Type: Perpetual, cumulative, redeemable preferred shares

Trading symbol: BBD.PR.C
Exchange: TSX
Current price: $21.09
Originally recommended: Sept. 26/13 at $23.46
Annual payout: $1.56
Yield: 7.4%
Risk Rating: Moderate risk
Recommended by: Tom Slee
Website: www.bombardier.com

Comments: All new aircraft have teething troubles, but Bombardier’s new C series airliner is shaping up to be a major setback. Originally slated for delivery in 2013, it now looks as though the Series C will make its commercial debut in the second half of 2016. Management believes the C Series can generate $8 billion (all figures in U.S. dollars) in annual revenues once the plane is in full production. Perhaps, but right now it’s earning nothing. The project is three years behind schedule and at least a $1 billion over budget. Some potential customers are losing interest.

Meanwhile, the project is burning cash at a rapid rate. Bombardier suffered a $410 million negative cash flow in its latest quarter. That is a $908 million cash drain for the year to date. The C Series program, originally pegged at $3.4 billion, has ballooned to at least $4.4 billion and that may be optimistic. It looks as though Bombardier will soon have to start borrowing a lot more money.

Nobody doubts that Bombardier will eventually launch its Series C. More debt, however, spells trouble for our recommendation. Any new loans will rank above the company’s preferred issues, which will almost certainly come under pressure while the credit agencies review their ratings.

To recap, I originally recommended the Bombardier Series 4 shares a year ago when the preferred market was taking a beating because most five-year bank reset shares were being adjusted or recalled. This particular issue had been oversold and the 6.7% yield more than compensated for its relatively low Pdf-4 Rating by Dominion Bond Rating Service (DBRS). With a return equal to about 9.5% from a bond in non-registered accounts, the shares were suitable for investors able to accept some risk. Bombardier was turning in some solid results and there was good news about the Series C.

Since then I have kept a close eye on Bombardier, something I would recommend whenever you own corporate bonds or preferred shares. Always monitor the underlying company. There is a temptation to throw fixed income investments into a drawer and assume they are unaffected by the issuer’s performance. Not true.

The company has hit three serious road bumps. First of all, earnings have been disappointing. Second, on May 29 the Series C had a major engine failure during ground tests. Finally, Dominion Bond Rating Service (DBRS) downgraded Bombardier preferred shares a notch to Pfd-4 (low) citing “further burdens caused by the uncertainty of amounts and timing of revenues from the C Series program.”

To put the downgrade in perspective, DBRS has five preferred shares ratings with Pfd-1 indicating superior quality and Pfd-5 at the other end of the scale warning that the issue is highly speculative. Bombardier’s Pfd-4 means that the dividends and capital protection is sometimes uncertain. In other words, when new aircraft costs drain the treasury, there can be cash shortages. To make matters worse, with the reduction to (low) the company is now barely meeting even this low rating.

My concern is that if Bombardier shoulders more debt, DBRS may lower its rating to Pfd-5 which means the preferred shares “have characteristics that may lead to default unless they are remedied.” The downgrade would probably result from an excessive debt/equity ratio or inadequate interest coverage rather than a lack of confidence in the Series C. However, even talk of a Pfd-5 will cause investors to back away and cause the shares to plunge. You could be locked in with an unrealized loss.

So that there is no misunderstanding, I am not suggesting that Bombardier is in trouble. The company is passing through a difficult patch and burning cash. We could see a turnaround in 2016. Nevertheless as income investors we have to factor in an increased risk. Always keep in mind that preferred shares offer very little growth potential to compensate for any uncertainty. You buy them for above average reliable income and safety. At present the Bombardier preferred shares have become a question mark.

Action now: Sell at $21.09. – T.S.

Firm Capital Mortgage Investment Corp. (TSX: FC)

Type: Common stock
Trading symbol: FC
Exchange: TSX
Current price: $12.79
Originally recommended: Jan. 16/04 at $11.30
Annual payout: $0.94
Yield: 7.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.firmcapital.com

Comments: Firm Capital’s share price has stabilized after coming under pressure during last year’s interest rate scare. The stock has traded in a narrow range between $12 and $13 since April, which is what I would normally expect from a low-profile mortgage investment company such as this.

Second-quarter results were good with profit up 6% to $4.8 million compared to just over $4.5 million the year before. However, on a per share basis profit declined to $0.239 from $0.257 due to the issuing of almost two million new shares in January.

For the first six months of the 2014 fiscal year, net income was ahead 12% to $9.8 million, up from $8.7 million in 2013.

The company said it continues to exceed its yield objective of producing a return on shareholders’ equity of more than 400 basis points over the average one year Government of Canada Treasury bill yield. Profit for the quarter ended June 30 represented an annualized return on shareholders’ equity of 9.21%. By comparison, the average Government of Canada one-year Treasury bill yield was 1.01%.

The main knock against the stock is that the monthly dividend has not increased since June 2007. The company describes it as “stable” and it certainly is that. “Stagnant” might be a more appropriate word. The one consolation is that the company usually adds an annual bonus payment in December. Last year it was $0.048 per share.

Given this history, there doesn’t appear to be much chance that the monthly dividend will increase any time soon. But even if it stays the same, we have a very nice yield of 7.3%, not counting any year-end bonus, on a relatively low-risk security.

Action now: Buy. – G.P.

Information Services Corp. (TSX: ISV)

Type: Common stock
Trading symbol: ISV
Exchange: TSX
Current price: $18.60
Originally recommended: Nov. 28/13 at $17.45
Annual payout: $0.80
Yield: 4.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.isc.ca

Comments: This small Regina-based company provides exclusive registry and information services to the Province of Saskatchewan. These include the Land Titles Registry, Land Surveys Directory, Personal Property Registry and Corporate Registry. I recommended it about a year ago as a good way to participate in Saskatchewan’s growth as the company collects a fee on every land-related transaction in the province.

Second-quarter revenue came in at $22 million, up 3.9% over the same period in 2013. Stripping out one-time items, net income was up 4.5% to $0.42 a share compared to $0.40 a share in the same period of 2013. Free cash flow was $7.9 million, up from $7.4 million a year ago.

Looking ahead, some analysts have downgraded their estimates for Saskatchewan’s growth rate for the rest of 2014 although there is no agreement on the figure. BMO Capital Markets projects 2.5% growth for the full year, down from 2.5% in the spring. But RBC Capital Markets is much more pessimistic, at 1.4%. The company’s revenue and profit are tied directly to the province’s economy so some caution is in order.

That said, the share price should remain reasonably stable and the yield is attractive on a risk-adjusted basis.

Action now: Hold. – G.P.

That’s all for this issue. Look for your next Update Edition on Nov. 13. The next regular issue will be published on Nov. 27.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Next Update Edition: November 13

Next regular issue: November 27

GET USED TO LOW RATES

By Gordon Pape, Editor and Publisher

Anyone hoping for a return to higher interest rates in the near future is going to be disappointed. That day has been postponed again, perhaps until 2016.

A couple of years ago, the expectation was that we could start to see higher interest rates this year as global economic growth picked up. When that didn’t happen, the conventional thinking on rate hikes shifted to mid-2015. Conservative investors who prefer to park their money in guaranteed investment certificates could hardly wait as visions of 5% GICs danced in their heads.

Well, that’s just not going to happen, at least not any time in the foreseeable future. In fact, it’s been well over a decade since five-year GICs even paid 4% annually. According to the Bank of Canada website, the highest average for a five-year certificate in the past 10 years was in July 2007 when the number came in at 3.73%. It hasn’t been close to that since.

In fact, we’re moving in the opposite direction. Back in April of this year, the average five-year rate got as high as 2.2%. Today it’s back down to 2%. The average rate over the past decade is 2.34%.

Reading between the lines, last week’s report from the Bank of Canada suggests that an upward move on interest rates in 2015 looks increasingly unlikely. The Bank projects that the Canadian economy won’t get back to full capacity until the second half of 2016 and even that forecast is problematic. In the press release announcing no change in the target overnight rate, the Bank said: “Persistent headwinds continue to buffet most economies and growth remains reliant on exceptional policy stimulus. Against a background of ongoing geopolitical uncertainties and lower confidence, energy prices have declined and there has been a significant correction in global financial markets, resulting in lower government bond yields.”

There are a couple of key points to note here. The first is the reference to “exceptional policy stimulus.” In effect, the Bank is saying that continued low interest rates combined with such programs as quantitative easing will be needed for some time to prevent the world from slipping back into recession. The U.S. Federal Reserve Board is ending its program this month just as the European Central Bank is embarking on its own.

The other phrase with broad implications is “resulting in lower government bond yields.” At the beginning of the year, almost everyone expected bond yields to rise this year, with prices falling in sync (the two move in opposite directions). That hasn’t happened. Bond yields continue to edge lower, with prices rising accordingly. As of Oct. 27, the FTSE TMX Universe All Government Bond Index was showing a year-to-date gain of 7.03%. Yields on long-term issues clearly show that bond traders do not anticipate any significant rate hikes for years to come. Canada bonds with 30-year maturities were yielding only 2.53% at the time of writing.

U.S. economic growth is somewhat more robust than here in Canada but even there the expectation of rate increases any time soon is muted. The latest consensus seems to be that the Fed will hold the line until at least the second half of next year. And even when it does move, there will be no pressure on the Bank of Canada to follow in lockstep. Higher U.S. rates would push our loonie lower against the greenback, giving an additional boost to exporters. Nothing could make Bank of Canada Governor Stephen Poloz happier.

So resign yourself to more of the same if you’re a GIC fan. The way things are going, you’ll be fortunate to keep pace with inflation.

 

Return to the table of contents…

BALANCED PORTFOLIO UPDATE

By Gordon Pape, Editor and Publisher

We are currently monitoring the performance of three portfolios designed for income investors. This one, launched in September 2011, is designed for those who are looking for a combination of above-average cash flow and reasonable risk. The initial portfolio valuation was $25,027.75.

The objective is to generate a return that is at least two percentage points more than that offered by the highest-paying GIC. Right now, the best five-year rate is 3.05% so our current target is at least 5.05% per year, including distributions and capital gains.

We make no distinction between registered and non-registered accounts, so keep in mind that the tax advantages of dividend-paying securities will be lost if they are held in an RRSP, RRIF, TFSA, RESP, etc.

Here’s a summary of how the securities we currently hold performed over the seven months since we last reviewed this portfolio in late March.

iShares 1-5 Year Laddered Corporate Bond Fund (TSX: CBO). This is a defensive short-term ETF. It’s a low-risk way to own bonds but it will never provide much of a return. Since my last review in March, the units have dropped $0.20 in market value. But we received $0.54 in distributions so we have a net gain of 1.7% over the seven-month period. That’s not much but it’s what we should expect in the current interest rate environment.

CIBC Global Bond Fund (A units) (CIB490). I added this fund to the portfolio in March to increase our bond exposure. We’ve seen a small gain of $0.21 per unit in the net asset value plus we have received distributions of $0.11 for a total return of 2.7% over the period.

Cineplex Inc. (TSX: CGX, OTC: CPXGF). It wasn’t a blockbuster summer at the movies but Cineplex still managed to add $0.41 to its share price since my last review in March. The cinema giant also raised its monthly dividend by 4.2% to $0.125 per share in the spring. I added this stock to the portfolio in September 2013 and it has given us a total return of almost 11% since then.

Freehold Royalties (TSX: FRU, OTC: FRHLF). It has been a rough time for oil producers and this royalty company hasn’t escaped. The shares are down $1.36 since my last update. We received $1.12 per unit in monthly dividends but that wasn’t enough to offset the price drop. As a result, we’re down 1.2% since I added Freehold to the portfolio in September 2013.

Inter Pipeline (TSX: IPL, OTC: IPPLF). Talk about an outstanding investment! This one is like the Energizer Bunny – it just keeps going and going and going. It’s hard to believe that a small pipeline company added $6.70 a share since last March in a lacklustre market, but that’s what happened. Plus we received monthly dividends of $0.1075 per share for a total return of almost 26% in seven months.

Brookfield Renewable Energy Limited Partnership (TSX: BEP.UN, NYSE: BEP). This renewable energy partnership also fared well over the summer, adding $3.34 per share. We also received two quarterly dividends of US$0.3875, which boosted our seven-month advance to 12.9%.

Brookfield Infrastructure Limited Partnership (TSX: BIP.UN, NYSE: BIP). This is a companion limited partnership to Renewable Energy but in this case the assets are infrastructure – everything from coal terminals and railways to power transmission lines. It has performed well for us and the shares are up $1.02 since March. We also received two dividends of US$0.48 each.

BCE Inc. (TSX, NYSE: BCE). BCE’s share price appears to be stuck in neutral. The stock is up only $0.70 since March and many analysts feel it is unlikely to move much higher for now. But the dividend is a juicy $0.6175 per quarter, which bulks the total return.

Cash. We invested $2,245.21in a high interest savings account paying 1.35%. Total interest over the latest seven-month period was $17.68.

Here’s how the portfolio stood after the close of trading on Oct. 24. Commissions have not been factored in. Canadian and U.S. dollars are treated as being at par for purposes of the calculations.

Income Investor Balanced Portfolio (a/o Oct. 24, 2014)

Security
Weight

%
Total

Shares
Average

Initial

Price
Market

Price
Book

Value
Market

Value
Cash

Retained
Gain/Loss

%
CBO
19.5
310
$20.29
$19.54
$6,277.25
$6,057.40
$673.62
+ 7.2
CIB490
8.7
225
$11.78
$11.99
$2,650.50
$2,697.75
$24.95
+ 2.7
CGX
13.4
100
$39.00
$41.66
$3,900.00
$4,166.00
$158.50
+10.9
FRU
10.5
150
$24.00
$21.78
$3,600.00
$3,267.00
$294.00
– 1.2
IPL
14.2
125
$16.05
$35.42
$2,006.25
$4,427.50
$462.56
+143.7
BEP.UN
11.4
100
$25.72
$35.24
$2,572.00
$3,524.00
$481.58
+55.7
BIP.UN
11.5
80
$26.86
$44.76
$2,148.80
$3,580.80
$435.01
+86.9
BCE
10.2
65
$42.67
$48.59
$2,773.55
$3,158.35
$308.76
+25.0
Cash
0.6
$181.81
$199.49
Total
100.0
$26,110.16
$31,078.29
$2,838.98
+29.9
Inception
$25,027.75
+35.5

Comments: Thanks in large part to Inter Pipeline, the portfolio gained 6% in the seven months since the last review in March. Cash flow during the period was $614.72. The total value, including retained cash, stands at $33,917.27. Since inception, we have a total return of 35.5%. Our average annual compound rate of return is 10.3% so we continue to run well ahead of target.

Changes: It’s time to deploy some of the large cash reserves we have built up in this portfolio. Here’s what we’ll do.

CBO – We will buy 30 shares at a cost of $19.54, for a total outlay of $586.20. That will leave us with $87.42 in cash retained.

FRU – We’ll take advantage of the price retreat to add 10 shares at $21.78, for an expense of $217.80. We will have $76.20 left over.

BEP.UN – We’ll add 10 shares to bring our total to 110. At the current price of $35.24, that will require $352.40, leaving cash of $129.18.

BIP.UN – We’ll also buy 10 shares here to increase the total to 90. The cost is $447.60. We’re a little short in our retained cash so we’ll take the extra $12.59 from the general cash fund.

BCE – We will add five shares at a cost of $242.95. We will now own 70 shares and have $65.81 in our retained cash reserve.

Also, we will sell 25 shares of Inter Pipeline for $885.50. Yes, it has been an outstanding performer but the portfolio weighting has become too high and the stock looks a little pricey at this level. We should add more bonds to the portfolio so we will spend $931.50 to buy 30 units of the iShares Canadian Universe Bond Fund (TSX: XBB). We’ll draw the extra $46 from cash.

Here is the revised portfolio.

Income Investor Balanced Portfolio (revised Oct. 24, 2014)

Security
Weight

%
Total

Shares
Average

Initial

Price
Market

Price
Book

Value
Market

Value
Cash

Retained
CBO
20.2
340
$20.19
$19.54
$6,883.45
$6,643.60
$87.42
XBB
2.8
30
$31.05
$31.05
$931.50
$931.50
0
CIB490
8.2
225
$11.78
$11.99
$2,650.50
$2,697.75
$24.95
CGX
12.7
100
$39.00
$41.66
$3,900.00
$4,166.00
$158.50
FRU
10.6
160
$23.86
$21.78
$3,817.80
$3,484.80
$76.20
IPL
10.8
100
$16.05
$35.42
$1,605.00
$3,542.00
$462.56
BEP.UN
11.8
110
$26.59
$35.24
$2,924.40
$3,876.40
$129.18
BIP.UN
12.2
90
$28.85
$44.76
$2,596.40
$4,028.40
0
BCE
10.3
70
$43.09
$48.59
$3,016.50
$3,401.30
$65.81
Cash
0.4
$140.90
$140.90
Total
100.0
$28,420.45
$32,912.65
$1,004.62
Inception
$25,027.75

Through these changes, we have increased the bond component of the portfolio by three percentage points, thus reducing overall market risk. We have also restored better balance among the equity positions, reducing the spread between the lowest and the highest weightings to 2.4 percentage points compared to four points previously. Our cash reserves, including retained dividends/distributions, have been reduced to $1,145.52. We’ll keep that in our high-interest account, which now pays 1.3%.

Readers are reminded not to make small trades unless they have a rock-bottom discount brokerage service or a fee-based account. Small quantities of five or ten shares are better accumulated through DRIP programs.

I will review this portfolio again in six months.

 

Return to the table of contents…

AFTER THE SELL-OFF

By Gavin Graham, Contributing Editor

The dramatic decline in world stock markets over the last few weeks, which saw most major indices fall by 10% or more from the highs reached earlier this summer, has left investors battered and confused.

After a long period when markets advanced steadily since the Eurozone crisis peaked in August 2012, volatility (as measured by the VIX Index) had fallen to lows not seen since before the U.S. subprime mortgage crisis in 2006-07. This means that investors were not anticipating any major moves in the stock indices, in either direction, and indicators of investor sentiment, such as the percentage of bullish as opposed to bearish stock market newsletters, had reached levels only seen before the sharp falls of 2000-02 and 2007-09.

What made the sell-off so worrying to many shareholders was that it occurred so suddenly, and at a time when there were many large Initial Public Offerings (IPOs). For example, Chinese ecommerce provider Alibaba was the biggest IPO in almost a decade when it went public in September, valuing the company at over $220 billion. The U.S. economy was apparently doing well, with unemployment down to a seven-year low of 6.1%, allowing the Federal Reserve to continue withdrawing $10 billion of its $85 billion a month of Quantitative Easing (QE) at each meeting throughout the year. China’s slowdown in GDP was being addressed by the Communist authorities who were loosening lending practices, and even Europe and Japan seemed to be showing positive signs of GDP growth, even if somewhat muted.

The underlying problems, however, were apparent to those who looked more closely at the evidence. While the U.S. (and Canada) had experienced reasonable GDP growth, after allowing for the effects of the severe winter, real wages after inflation in both countries were barely growing. Much of the fall in unemployment was due to discouraged workers leaving the workforce. China’s GDP of 7.3% in the third quarter of 2014 was the lowest in seven years, even if one believed the notoriously unreliable official statistics, and property prices were down 11% in the first eight months of 2014. Meanwhile, a 2% increase in sales tax in Japan in the second quarter of the year led to a sharp decline in Japanese GDP as consumers rushed to buy ahead of the increase. The rapidly falling Japanese yen, down 20% from its level 18 months ago, contributed to rising inflation. Finally, the weak performance of the southern European economies proved they had not fully recovered from the Eurozone crisis but only experienced a brief respite.

With company earnings only growing between 3% and 8% for most industries in 2014, the rise in the indices this year meant that they were selling at high valuations. The S&P500 Index was selling at 18 times earnings, a valuation that investors abruptly decided was too expensive, and the sell-off began. Experienced investors often warn novices to look at the bond market before they start making decisions about investing in the stock market, and bond yields for major developed countries have been falling all year. The benchmark U.S. Treasury yield began the year at 3%, with most commentators expecting a further rise in rates as the economy continued to recover.

Instead, its yield fell to around 2.5% by mid-year, and during the recent correction has fallen back below 2%, a level not seen since the middle of the Eurozone crisis in 2012. In Germany, the 10-year Bund yield has fallen to a never-seen-before low of 0.81%. Japan’s 10-year JGB yield has been below 1% for most of the last decade. The reason the latter has been so low, of course, is due to a lack of inflation, or even deflation, the symptom of an economy that is persistently growing slowly, leaving plenty of spare capacity. This is exactly the same problem that occurred during the Great Depression in the 1930s, the last time bond yields were at these levels.

Bonds strong performance this year is one of the reasons why Gordon has written several times about the importance of always including some fixed income investments in your portfolio. Government bonds especially are not correlated with stocks, and so provide valuable diversification for investors. Secondly, as that great sage Yogi Berra once said, “It’s very hard to make predictions, especially about the future.” While, as noted, many commentators expected rising inflation as economies recovered, and weaker bond markets, particularly given the withdrawal (“tapering”) of the Fed’s $85 billion a month of QE bond purchases, investor worries about the sustainability of the recovery and high valuations have proved sufficient to override these factors.

So where does the recent correction leave investors? Is the worst behind us, or, as was the case in 2010, 2011 and 2012, is it only the beginning of a bigger sell-off? More specifically, how have various sectors performed during the last few weeks, and what opportunities might have been created?

The companies that have done best over the last month, with some of them actually rising, have generally been those in the interest rate sensitive industries, such as real estate investment trusts, telecoms and utilities, while the worst hit have been the economically sensitive sectors such as materials, energy and autos.

Almost all of the REITs recommended in Income Investor, including my picks Allied Properties, Boardwalk and Canadian REIT and Gordon’s picks such as RioCan and H&R REIT, are up over the last month, while the S&P/TSX and the S&P 500 are down 3% to 4%, after a 4% to 5% rebound in the week to Oct. 22. In fact while the iShares Canadian Long-Term Bond ETF (TSX: XLB) is up 2.4% over the last month, the iShares Capped REIT ETF (TSX: XRE) is up 2.3% over the same period. The iShares Preferred Shares ETF (TSX: XPF), which is effectively a short-term bond index, is also up 0.4%, while all other equity sectors are down.

All three of the Canadian telecom companies, BCE, Rogers and Telus are up, while such utility companies as Canadian Utilities, Duke Energy, Fortis and Capstone are flat or up too. Other defensive sectors such as food and low cost retailing are also up for the month, with Empire, Metro, Canadian Tire and Dollarama all winners over that period.

Certain gold stocks are up, as the precious metal has held up, trading at US$1,245 per oz. at Oct. 22. My IWB picks Agnico-Eagle, Goldcorp and Franco-Nevada are up, but the iShares Global Gold Miners ETF is off 2.5%. Other commodity stocks such as Teck, First Quantum and Lundin have been down by 25% to 30%.

If the sell-off resumes after last week’s rebound, then it will likely be because of the same concerns over slow growth/recession and deflation that have driven the present correction. In that case, government bond yields will continue to fall, interest rate sensitive sectors should do well on a relative basis, and economically sensitive stocks will continue to be beaten up.

The usually defensive pipeline sector has been weak, with AltaGas and Enbridge both off 8% and TransCanada off 10%, as worries over falling oil and gas prices spook investors. Banks have also been mixed, with losses ranging from 2% over the last month for well regarded National Bank and RBC to 4% to 6% for the rest, as concerns over loan losses mount.

Investors should be aware that not all bonds are created equal. While sovereign government debt has done well in major economies, bonds in southern Europe from such issuers as Spain, Portugal, Italy and Greece have seen their yields rise while German yields have fallen, as potential default risk raises its head again. Likewise, high yield corporate debt (sometimes known as junk bonds) has seen its spread over investment grade debt begin to widen out during this sell-off, due to increased risk of default by highly leveraged borrowers. Even though yields on government and investment grade debt are low, investors should remember that bonds are there for the return of your capital, not the return on your capital. Well-managed interest rate sensitive stocks can provide the higher returns in this environment.

 

Return to the table of contents…

OCTOBER’S TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Monday, Oct. 27 unless otherwise indicated.

Fortis Inc. Cumulative Redeemable 4.75% First Preference Series J Shares (TSX: FTS.PR.J)

Type: Cumulate redeemable, straight preferred shares
Trading symbol: FTS.PR.J
Exchange: TSX
Current price: $24.31
Yield: 4.88%
Yield to First Call: 6.84%
Credit Rating: DBR2 Pfd-2 (low)
Entry Level: Current price
Risk Rating: Conservative
Recommended by: Tom Slee
Website: www.fortisinc.com

The business: Based in St. John’s, Newfoundland, Fortis is the largest investor-owned electric and gas distributor in Canada. With assets of almost $25 billion and annual revenues exceeding $4 billion, the company serves more than three million customers across Canada, the United States and the Caribbean. Fortis also owns hotels and commercial real estate.

The security: These are cumulative preferred shares so in the extremely unlikely event of a quarterly dividend being omitted or partially paid, the shortfall becomes a corporate liability and is owed to the preferred shareholder. The company can redeem the shares at a price of $26 on or after December 1, 2017, and then at descending prices to $25 on or after December 1, 2021.

Why we like it: This is one of the relatively few blue chip preferred shares with almost guaranteed specified dividends in perpetuity. Its Pfd-2 rating states in part that protection of capital and dividends is substantial. There is no call for redemption until 2017 and then at a price well above the current market. The present yield is equivalent to about 7% from a bond in non- registered accounts after allowance for the dividend tax credit.

Financial highlights: Fortis reported second quarter earnings of $0.22 a share, in line with expectations. The company’s current $1.4 billion capital program is on track and management plans to spend $6.5 billion over a five- year period from 2014 to 2018. Fortis’ vast Waneta Dam expansion in British Columbia should come on stream shortly and I expect to see earnings of about $1.60 a share this year with an increase to the $2 range in 2015.

Risks: It is conceivable that Fortis could fail to pay its preferred dividends during a deep, sustained recession. However, the Series J shares are cumulative and therefore the company is required to make good on any missing distributions to these shareholders. With regulated utilities accounting for 93% of the company’s assets, the Series J risk is minimal. Fortis is a quasi government entity.

Distribution policy: Dividends of $0.2969 per share are paid on the first days of March, June, September and December for a total of $1.19 per annum.

Tax implications: The dividends are eligible for the dividend tax credit if the shares are held outside a registered plan. Any profit or loss from a sale or redemption is taxed as a capital gain or loss in that year.

Who it’s for: These shares are suited for defensive investors seeking a secure, above-average return.

Action now: Buy Fortis Series J preferred shares for reliable income. – T.S.

 

Return to the table of contents…

OCTOBER’S UPDATES

Here are the updates for this month. Prices are as of the close of trading on Monday, Oct. 27, unless otherwise stated.

Bombardier 6.25% Series 4 Preferred Shares (TSX: BBD.PR.C)

Type: Perpetual, cumulative, redeemable preferred shares

Trading symbol: BBD.PR.C
Exchange: TSX
Current price: $21.09
Originally recommended: Sept. 26/13 at $23.46
Annual payout: $1.56
Yield: 7.4%
Risk Rating: Moderate risk
Recommended by: Tom Slee
Website: www.bombardier.com

Comments: All new aircraft have teething troubles, but Bombardier’s new C series airliner is shaping up to be a major setback. Originally slated for delivery in 2013, it now looks as though the Series C will make its commercial debut in the second half of 2016. Management believes the C Series can generate $8 billion (all figures in U.S. dollars) in annual revenues once the plane is in full production. Perhaps, but right now it’s earning nothing. The project is three years behind schedule and at least a $1 billion over budget. Some potential customers are losing interest.

Meanwhile, the project is burning cash at a rapid rate. Bombardier suffered a $410 million negative cash flow in its latest quarter. That is a $908 million cash drain for the year to date. The C Series program, originally pegged at $3.4 billion, has ballooned to at least $4.4 billion and that may be optimistic. It looks as though Bombardier will soon have to start borrowing a lot more money.

Nobody doubts that Bombardier will eventually launch its Series C. More debt, however, spells trouble for our recommendation. Any new loans will rank above the company’s preferred issues, which will almost certainly come under pressure while the credit agencies review their ratings.

To recap, I originally recommended the Bombardier Series 4 shares a year ago when the preferred market was taking a beating because most five-year bank reset shares were being adjusted or recalled. This particular issue had been oversold and the 6.7% yield more than compensated for its relatively low Pdf-4 Rating by Dominion Bond Rating Service (DBRS). With a return equal to about 9.5% from a bond in non-registered accounts, the shares were suitable for investors able to accept some risk. Bombardier was turning in some solid results and there was good news about the Series C.

Since then I have kept a close eye on Bombardier, something I would recommend whenever you own corporate bonds or preferred shares. Always monitor the underlying company. There is a temptation to throw fixed income investments into a drawer and assume they are unaffected by the issuer’s performance. Not true.

The company has hit three serious road bumps. First of all, earnings have been disappointing. Second, on May 29 the Series C had a major engine failure during ground tests. Finally, Dominion Bond Rating Service (DBRS) downgraded Bombardier preferred shares a notch to Pfd-4 (low) citing “further burdens caused by the uncertainty of amounts and timing of revenues from the C Series program.”

To put the downgrade in perspective, DBRS has five preferred shares ratings with Pfd-1 indicating superior quality and Pfd-5 at the other end of the scale warning that the issue is highly speculative. Bombardier’s Pfd-4 means that the dividends and capital protection is sometimes uncertain. In other words, when new aircraft costs drain the treasury, there can be cash shortages. To make matters worse, with the reduction to (low) the company is now barely meeting even this low rating.

My concern is that if Bombardier shoulders more debt, DBRS may lower its rating to Pfd-5 which means the preferred shares “have characteristics that may lead to default unless they are remedied.” The downgrade would probably result from an excessive debt/equity ratio or inadequate interest coverage rather than a lack of confidence in the Series C. However, even talk of a Pfd-5 will cause investors to back away and cause the shares to plunge. You could be locked in with an unrealized loss.

So that there is no misunderstanding, I am not suggesting that Bombardier is in trouble. The company is passing through a difficult patch and burning cash. We could see a turnaround in 2016. Nevertheless as income investors we have to factor in an increased risk. Always keep in mind that preferred shares offer very little growth potential to compensate for any uncertainty. You buy them for above average reliable income and safety. At present the Bombardier preferred shares have become a question mark.

Action now: Sell at $21.09. – T.S.

Firm Capital Mortgage Investment Corp. (TSX: FC)

Type: Common stock
Trading symbol: FC
Exchange: TSX
Current price: $12.79
Originally recommended: Jan. 16/04 at $11.30
Annual payout: $0.94
Yield: 7.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.firmcapital.com

Comments: Firm Capital’s share price has stabilized after coming under pressure during last year’s interest rate scare. The stock has traded in a narrow range between $12 and $13 since April, which is what I would normally expect from a low-profile mortgage investment company such as this.

Second-quarter results were good with profit up 6% to $4.8 million compared to just over $4.5 million the year before. However, on a per share basis profit declined to $0.239 from $0.257 due to the issuing of almost two million new shares in January.

For the first six months of the 2014 fiscal year, net income was ahead 12% to $9.8 million, up from $8.7 million in 2013.

The company said it continues to exceed its yield objective of producing a return on shareholders’ equity of more than 400 basis points over the average one year Government of Canada Treasury bill yield. Profit for the quarter ended June 30 represented an annualized return on shareholders’ equity of 9.21%. By comparison, the average Government of Canada one-year Treasury bill yield was 1.01%.

The main knock against the stock is that the monthly dividend has not increased since June 2007. The company describes it as “stable” and it certainly is that. “Stagnant” might be a more appropriate word. The one consolation is that the company usually adds an annual bonus payment in December. Last year it was $0.048 per share.

Given this history, there doesn’t appear to be much chance that the monthly dividend will increase any time soon. But even if it stays the same, we have a very nice yield of 7.3%, not counting any year-end bonus, on a relatively low-risk security.

Action now: Buy. – G.P.

Information Services Corp. (TSX: ISV)

Type: Common stock
Trading symbol: ISV
Exchange: TSX
Current price: $18.60
Originally recommended: Nov. 28/13 at $17.45
Annual payout: $0.80
Yield: 4.3%
Risk Rating: Moderate risk
Recommended by: Gordon Pape
Website: www.isc.ca

Comments: This small Regina-based company provides exclusive registry and information services to the Province of Saskatchewan. These include the Land Titles Registry, Land Surveys Directory, Personal Property Registry and Corporate Registry. I recommended it about a year ago as a good way to participate in Saskatchewan’s growth as the company collects a fee on every land-related transaction in the province.

Second-quarter revenue came in at $22 million, up 3.9% over the same period in 2013. Stripping out one-time items, net income was up 4.5% to $0.42 a share compared to $0.40 a share in the same period of 2013. Free cash flow was $7.9 million, up from $7.4 million a year ago.

Looking ahead, some analysts have downgraded their estimates for Saskatchewan’s growth rate for the rest of 2014 although there is no agreement on the figure. BMO Capital Markets projects 2.5% growth for the full year, down from 2.5% in the spring. But RBC Capital Markets is much more pessimistic, at 1.4%. The company’s revenue and profit are tied directly to the province’s economy so some caution is in order.

That said, the share price should remain reasonably stable and the yield is attractive on a risk-adjusted basis.

Action now: Hold. – G.P.

That’s all for this issue. Look for your next Update Edition on Nov. 13. The next regular issue will be published on Nov. 27.

Best regards,
Gordon Pape, editor-in-chief