In this issue:

Next Update Edition: October 8

Next regular issue: October 22

HIGH YIELD PORTFOLIO LOSES GROUND

By Gordon Pape, Editor & Publisher

In March 2012, I launched a High-Yield Portfolio for readers seeking above-average cash flow and who were willing to live with a higher level of risk. I cautioned at the time, and since, that this is a 100% equity portfolio with no bonds to cushion losses when stock markets retreat. Therefore it is best suited for non-registered accounts where any capital losses can be deducted from taxable capital gains. Also, a high percentage of the payments from this portfolio will receive favourable tax treatment as eligible dividends or return of capital.

The portfolio had been performing well above our target return of 7% to 8% a year, but the last six months were difficult. Out of the nine positions we hold, only three posted net gains, including dividends. All the others fell, with the worst results posted by stocks in the energy sector.

Here is a rundown of the securities we own and how they have performed in the six months since our last review in March.

The Keg Royalties Income Fund (TSX: KEG.UN, OTC: KRIUF). This fund is the leading operator and franchisor of steakhouse restaurants in Canada and has a substantial presence in select regional markets in the United States. It was added to this portfolio in April 2013 when it was trading at $15.25. At the time of the last review in March, it was up to $19.80. However, like most of the securities in this portfolio, it has lost ground since then, dropping by $1.90 per share. The good news is we had a second dividend increase in 2015 in July when the payment was bumped up by 3%, to $0.0845 per month ($1.014 annually). The shares yield 5.7% at the current price.

DH Corporation (TSX: DH, OTC: DHIFF). This is one of the few stocks that managed to hold its ground over the past six months, losing only $0.02 per share. That was more than made up for with two dividends of $0.32 each. The company used to derive most of its revenue from cheque printing, but it has successfully diversified into other areas.

Vermilion Energy (TSX, NYSE: VET). We added Vermilion to the portfolio in March. Despite the weakness in the energy sector, we like this stock because of its well-diversified international holdings and good management. Even that wasn’t enough to support the share price in the face of the continued decline in oil prices, however. The only good news is that this is one of the few mid-size energy companies that hasn’t cut its dividend (at least not so far). It continues to pay $0.215 per month, to yield 6.1%.

FLY Leasing (NYSE: FLY). This Irish-based airplane leasing company saw its share price slip by $1.64 after it reported a second-quarter loss due to a non-cash impairment charge. Stripping that out, adjusted net income was US$9.5 million (US$0.23 per share). The quarterly dividend is US$0.25.

Premium Brands Holding Corp. (TSX: PBH, OTC: PRBZF). Finally, some good news. This specialty food manufacturer and distributor, which was added to this portfolio in October 2013, saw its share price jump by $5.69 since March. PBH reported record second-quarter sales and earnings in August, which fuelled the buying spree. The quarterly dividend was increased to $0.345 from $0.3125, effective with the March payment.

Morneau Shepell Inc. (TSX: MSI, OTC: MSIXF). Morneau Shepell Inc. is the largest Canadian-based firm offering benefits and pension consulting, outsourcing, as well as health management services. The shares are off $1.91 since the last update, but we continue to receive good cash flow from the monthly dividend of $0.065 ($0.78 a year). The company reported a good second quarter with normalized free cash flow up 23.1% to $16.1 million.

Pembina Pipeline Corp. (TSX: PPL, OTC: PBNPF).  As mentioned with Vermilion, all companies associated with the energy sector are being hit these days. Pembina is no different, with the shares down almost $7 since March. On the plus side, the company increased its dividend by 5.2% in May, to $0.1525 per month.

Sun Life Financial (TSX, NYSE: SLF). This blue-chip insurance company bucked the downward trend by posting a small gain of $0.67 per share since the last review. We also benefitted from a dividend increase of 5.6% in May to $0.38 per quarter.

Chemtrade Logistics Income Fund (TSX: CHE.UN, OTC: CGIFF).
Chemtrade is one of the world’s largest suppliers of sulphuric acid, liquid sulphur dioxide, and sodium chlorate and is one of the few income trusts still remaining. The share price fell by $3.40 since the last update despite good second-quarter results. Distributions remain at $0.10 per unit monthly ($1.20 a year).

The accompanying table shows what the portfolio looked like as of the close of trading on Sept. 18. The weighting is the percentage of the market value of the security in relation to the total market value of the portfolio. Sales commissions are not taken into account, and the U.S. and Canadian dollars are treated as being at par. Note that the original book value was $24,947.30. The return since inception is based on that amount. We received interest on our cash position of $6.91 during the latest period.

Income Investor High Yield Portfolio – a/o Sept. 18/15

Security

Weight
%

Total
Shares

Average Price

Book
Value

Current Price

Market
Value

Retained
Income

Gain/
Loss
%

KEG.UN

9.1

165

$15.35

 $2,533.30

$17.90

 $2,953.50

$138.65

+22.1

DH

13.7

110

$19.39

 $2,132.90

$40.35

 $4,438.50

$272.10

+120.9

VET

9.1

70

$53.84

 $3,768.80

$42.31

 $2,961.70

$105.35

-18.6

FLY 

9.6

230

$14.58

 $3,353.60

$13.54

 $3,114.20

$115.00

– 3.7

PBH  

13.2

130

$19.49

 $2,534.25

$32.84

 $4,269.20

$164.83

+80.0

MSI 

10.9

230

$12.23

 $2,813.60

$15.37

 $3,535.10

$235.75

+34.0

PPL 

9.4

95

$29.09

 $2,763.60

$33.75

 $3,206.25

$334.08

+28.1

SLF

14.8

115

$24.82

 $2,853.80

$41.55

 $4,778.25

$198.80

+74.4

CHE.UN

9.4

170

$17.06

 $2,899.40

$17.91

 $3,044.70

$272.00

+14.4

Cash

0.8

 

 

$246.61

 

$253.52

 

 

Total

100.0

 

 

$25,899.86

 

$32,554.92

$1,836.56

+32.8

Inception

 

 

 

$24,947.30

 

 

 

+37.8

Comments: When markets go south, this portfolio will inevitably feel the effects. Fortunately, the high yields mitigate the damage to some degree. The total value of the portfolio, including retained income, is now $34,391.48. Overall, we are down 3.7% since March, reducing our total return since inception to 37.8%. Our average annual compound rate of return since inception is 9.6%, still ahead of target.

I was pleased to see that despite then general downturn in share prices, not one company in our portfolio reduced its dividend. As a result, we are now looking at very attractive yields: Morneau Shepell is at 5%, Pembina Pipelines is up to 5.4%, Chemtrade is at 6.7%, and on it goes.

Changes: I do not advise changing any of the securities in the portfolio at this time. These are all sound companies and the share prices will recover when the market turns around. In the meantime, we are enjoying great cash flow.

However, we will use some of the retained income to add to a few of our positions, as follows.

KEG.UN. We’ll buy five shares for $89.50. That will bring our total to 170 and reduce retained income to $49.15.

MSI. We’ll add 10 shares for $153.70, reducing our reserve to $82.05 and bringing our total position to 240 shares.

PPL. We will buy five shares for $168.75, which will leave us with cash of $165.33.

CHE.UN. We’ll spend $179.10 to bring our total shares to 180, leaving retained income of $92.90.

Readers are reminded not to execute these small trades, because the commissions would be too high. Add to your positions through dividend reinvestment plans instead.

We will invest our cash of $1,499.03 in a high-interest savings account paying 0.8%.

The accompanying table shows the revised portfolio. I’ll review it again next March.

Income Investor High Yield Portfolio – revised Sept. 18/15

Security

Weight %

Total
Shares

Average Price

Book
Value

Current Price

Market
Value

Retained
Income

KEG.UN

9.1

170

$15.43

 $2,622.80

$17.90

 $3,043.00

$49.15

DH

13.7

110

$19.39

 $2,132.90

$40.35

 $4,438.50

$272.10

VET

9.1

70

$53.84

 $3,768.80

$42.31

 $2,961.70

$105.35

FLY 

9.6

230

$14.58

 $3,353.60

$13.54

 $3,114.20

$115.00

PBH  

13.2

130

$19.49

 $2,534.25

$32.84

 $4,269.20

$164.83

MSI 

10.9

240

$12.36

 $2,967.30

$15.37

 $3,688.80

$82.05

PPL 

9.4

100

$29.32

 $2,932.35

$33.75

 $3,375.00

$165.33

SLF

14.8

115

$24.82

 $2,853.80

$41.55

 $4,778.25

$198.80

CHE.UN

9.4

180

$17.06

 $3,078.50

$17.91

 $3,223.80

$92.90

Cash

0.8

 

 

$253.52

 

$253.52

 

Total

100.0

 

 

$26,497.82

 

$33,145.97

$1,245.51

Inception

 

 

 

$24,947.30

 

 

 

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

 

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HAVENS IN THE STORM

By Gavin Graham, Contributing Editor

The August selloff in global markets, which saw many developed markets drop between 10% and 20%, and emerging markets such as China and Brazil plummet by more than 25%, has left investors wondering which stocks or sectors might provide some shelter from the sudden burst of volatility. Some sectors, such as energy and mining, had already entered bear markets (defined as a fall of more than 20%) at the beginning of 2015, which accelerated in August. Energy issues such as Imperial Oil, Husky, and Suncor fell between 10% and 14%, and U.S. integrated oils Chevron, Hess, and ExxonMobil dropped 7.5 to 12%. Miners First Quantum and Teck Resources, which has just been downgraded to “junk” (non-investment grade) are off 20% and 7.8% respectively.

Meanwhile interest rate-sensitive stocks such as banks, utilities, and REITs had sold off on worries over rising U.S. interest rates, as I noted in my review a couple of months ago. But the pain has continued even while the Bank of Canada cut short-term interest rates another 0.25%, to 0.5%. The iShares REIT ETF is down almost 6% over the last month, taking its loss for the last 12 months to 9% (ignoring distributions), while utilities Fortis, Enbridge, TransCanada, and Emera are off between 8% and 12% in the last month.

However, such was the breadth of the market collapse in August that even sectors regarded as relatively defensive, such as consumer staples, large-cap technology, and health care, experienced sharp drops. Over the month to Sept. 14, Abbott Labs, Merck, GlaxoSmithKline, and Pfizer fell between 7.5% and 14%, while Cisco and Microsoft fell 11.5% and 8.5% respectively. Supermarkets Empire, Metro, and Loblaw lost 11.7%, 9.2% and 8.2% respectively, tobacco giants BAT and Philip Morris International dropped 9.5% and 5.8%, and consumer products titans Unilever and Procter & Gamble retreated over 10%.

Some of the selloff in what are traditionally regarded as defensive investments doubtless reflected the recent high valuations of these steady dividend-paying companies, driven by investors’ search for yield. The consumer products companies were trading at price/earnings ratios of around 20 before the selloff, quite high for groups whose revenue growth was only in the low to mid-single digits due to slow or non-existent growth in the developed markets of Europe and North America. Similarly, healthcare and supermarkets were selling at P/Es in the high teens, somewhat expensive given their low revenue growth due to patent expiries and low margins for the store chains.

Can investors still be comfortable owning these companies as core positions in their portfolios? I would suggest that they can, as the fundamentals for many of these stocks remain solid, including those that are among the recommendations in Income Investor. The most important question given the focus on income is whether the yields on the stocks are sustainable. There is little indication that any of the dividends are under threat. Indeed, some companies have raised their payouts, a sign of confidence by management in the outlook for the next couple of years.

I update some of my recommendations in these sectors below.

 

Return to the table of contents…

TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Sept. 21 unless otherwise indicated.

BMO Financial Group (TSX, NYSE:BMO)

Type: Common stock
Trading symbol: BMO
Exchanges: TSX, NYSE
Current price: C$71.33, US$53.87
Entry level: Current price
Annual payout: $3.28
Yield: 4.6%
Risk: Lower risk
Recommended by: Gordon Pape
Website: www.bmo.com

Background: It’s not often that we can buy shares in major Canadian banks that yield almost 5%, but that’s the situation right now. Despite unexpectedly good third-quarter numbers, the banking sector remains out of favour with investors, who are worried that the weakness in the economy will eventually manifest itself in reduced profits. As a result, the financial sector is off 8.6% year-to-date (as of the close on Sept. 18), thereby creating a buying opportunity for long-term income investors. We already have Scotiabank on our Recommended List, and now we will add BMO Financial Group, better known to most people as Bank of Montreal.

The business: BMO is the fourth largest of Canada’s Big Five banks with $672 billion in assets as of July 31. Established in 1817, BMO Financial Group has more than 47,000 employees and provides a broad range of retail banking, wealth management, and investment banking products and services to more than 12 million customers. It conducts business through three operating groups: Personal and Commercial Banking; Wealth Management; and BMO Capital Markets. The company also has a strong presence in the U.S. Midwest through BMO Harris Bank and BMO Private Bank.

The security: I recommend the common stock of Bank of Montreal, which trades on both the Toronto and New York stock exchanges under the symbol BMO.

Why we like it: Despite the naysayers, BMO and the other Canadian banks continue to post good results, and the unofficial oligarchy that limits the number of major players in the business ensures the on-going dominance of the Big Five. Royal Bank, TD Bank, and Scotiabank are all larger in size, but BMO has shown strong growth in recent years and has been aggressive in terms of growing its wealth management business and expanding its U.S. footprint. The dividend at the current price is a very attractive 4.7%.

Financial highlights: The bank reported third-quarter fiscal 2015 earnings (to July 31) of just under $1.2 billion, up 6% year-over-year. Earnings per share were $1.80, up 8% over last year. Return on equity was 13.6%, down from 14.4% a year ago, while provision for credit losses increased to $160 million from $130 million. The Basel III Common Equity Tier 1 ratio was 10.4%. Book value per share increased 19% from the prior year, to $55.36.

For the first nine months of the fiscal year, the bank earned about $3.2 billion. That was down slightly from 2014, although adjusted earnings were up 2%. Adjusted earnings per share for the nine months were $5.10, up 3%.

Net income from Canadian personal and commercial (P&C) banking in the third quarter was $556 million, up 6% from a year ago. That was good, but even more significant was a big 38% jump in the profits from U.S. P&C banking, which came in at $222 million.

Wealth management contributed $210 million, up 11% from last year. The only sector to show a profit decline was BMO Capital Markets, with net income of $273 million, off 11%.

Risks: A severe and prolonged recession would hit the profits of all the banks, including BMO. Bank profits are also vulnerable to a downturn in the housing market that would dry up mortgage demand and increase the potential for defaults. If a new government raises corporate taxes, that would also affect the bottom line.

Distribution policy: BMO pays a quarterly dividend of $0.82 a share in January, April, July, and October, for a total annual payment of $3.28. The last dividend increase was a $0.02 bump in July.

Tax implications: The quarterly payments are eligible for the dividend tax credit if held by Canadians in a non-registered account. U.S. residents will be assessed a 15% withholding tax unless the payments are made to a retirement plan. The withholding tax can be reclaimed by using the foreign tax credit.

Who it’s for: This stock is suitable for conservative investors who want to take advantage of the high yields currently available from the Canadian banks.

How to buy: The shares are actively traded on both Toronto and New York, and you will have no trouble getting a fill.

Summing up: Every so often, we get an opportunity to buy bank stocks at depressed prices. Of course, the shares are nowhere near the bargain basement levels they reached in 2009, but we aren’t likely to see that again.

Action now: Buy. – G.P.

 

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SEPTEMBER UPDATES

Bank of Nova Scotia (TSX, NYSE: BNS)

Type: Common stock
Exchanges: TSX, NYSE
Current price: C$59.14, US$44.64
Originally recommended: Aug 29/07 at C$50.98
Annual payout: $2.80
Yield: 4.73%
Risk rating: Conservative
Recommended by: Gavin Graham
Website: www.scotiabank.com

Comments: In its most recent quarter, Scotiabank not only recorded a 4% increase in net income, to $1.85 billion ($1.45 per share), from the same quarter a year ago – adjusting for the $555 million exceptional gain on the sale of its stake in CI Financial – but raised its quarterly dividend by $0.02, to $0.70.

Canadian banking revenues grew 15%, to $863 million, driven by good growth in loans and deposits and wider margins. Higher non-interest expenses and a slight rise in provisions for credit losses (PCL), to 0.42%, partially offset this improvement. Revenue from international banking rose 11%, to $485 million, due to good growth in Latin American loans and higher fee income, helped by currency appreciation against the Canadian dollar. Global banking and markets profit fell 20%, to $375 million, and return on equity (ROE) was down slightly, to 14.7% from 15.9%, due to an increase in Basel III Tier I capital to 10.4% from 10.2%. This was partially a result of Scotiabank’s acquisition of pension administrator Cencosud in Chile and Citibank’s Peruvian retail banking operations.

Action now: Scotiabank remains a Buy as recovery from its slowdown in the first half of the year and underperformance against other banks has left it very reasonably valued at 10.2 times earnings and a 4.8% yield. – G.G.

Canadian Western Bank (TSX: CWB, OTC: CBWBF)

Type: Common stock
Trading symbol: CWB, CBWBF
Exchanges: TSX, Pink Sheets
Current price: C$23.90, US$17.98
Originally recommended: March 26/15 at C$27.71, US$22.06
Annual payout: $0.88
Yield: 3.68%
Risk: Moderate risk
Recommended by: Gavin Graham
Website: www.cwbankgroup.com

Comments: Canadian Western Bank is down 20% from its initial recommendation, due to concerns over the slowdown in the oil-dependent Alberta economy and the possibility of higher mortgage loan losses. However, as noted in my original recommendation, PCLs rose only slightly during the last oil price collapse in 2008-09, peaking at 0.22 against 0.8 for the remaining banks and are barely half of those the Big Six chartered banks (0.16 vs. 0.35-0.45).

Having sold its property and casualty insurance business to Intact Insurance for $197million and its custodian business to Computershare for $33 million in the second quarter, CWB had exceptional earnings of $1.33 per share from the capital gains from these transactions. On an operating basis, CWB earned $51.2 million ($0.64 per share) for the third quarter ended July 31, after $5 million in securities losses, down 3%, from $55 million ($0.69 per share), but up 10% after excluding securities gains and losses on loans up 11%.

CWB remains rated A (low) by DBRS, had PCLs of 0.17, up 0.01 from the same quarter last year and has 48% of its loans outside of the Prairies (33% B.C., 15% Ontario).

Action now: Canadian Western Bank remains a Buy for its cheap valuation, strong credit profile, and attractive quarterly dividend, which was increased 4.8% in the second quarter, to $0.22 a share, giving it a yield of 3.7%. – G.G.

Diageo (NYSE: DEO)

Type: ADR
Trading symbol: DEO
Exchange: NYSE
Current price: US$109.56
Originally recommended: June 22/11 at US$81.25
Annual payout: US$4.35
Yield: 3.98%
Risk: Moderate risk
Recommended by: Gavin Graham
Website: www.diageo.com

Comments: Global drinks giant Diageo (Johnnie Walker, Smirnoff, Capt. Morgan, Tanqueray, etc.) saw revenues grow 5%, to £10.8 billion, in the year ended June 30, due to the full takeover of India’s United Spirits, but were unchanged on an organic basis. Regionally, the company saw 6% growth in Africa, which represents 13% of its sales, while a flat performance in Europe (24% of sales) was offset by 1%-2% declines in North America (32%), Latin America (10%), and Asia (21%). Operating profit before exceptional items of £3.1 billion was up 1% in organic terms but down 2% on a reported basis, partially due to the weakness of the euro, Russian ruble, and Venezuelan bolivar, which knocked £161 million off earnings.

Exceptional items also included a £217 million restructuring charge, offset by £373 million of gains on the disposal of Bushmills Irish whiskey and the Gleneagles hotel. Net profit was up 6%, to £2.4 billion (£0.952 per share), and free cash flow was up almost 50%, to £1.9 billion, while the dividend was raised 9%, to £0.564 per share.

Diageo, which derives almost 45% of its revenues from emerging markets, has seen its shares suffer over concerns that growth in consumer incomes in these regions has slowed sharply, exacerbated by declining currencies, which reduce Diageo’s reported profits and revenues.

However, sales in mainland China grew 26% in 2014, while Mexican sales grew 13% (up 5% in Latin America overall). African sales grew 6% (and in the double digits ex-Nigeria), while India sales grew 5%. In the U.S., whiskey sales were up 13%, with strong momentum in Diageo’s best-selling categories.

Action now: Diageo remains a Buy for its strong balance sheet, exposure to fast-growing markets, ability to cross-sell products, and attractive and rising dividend. – G.G.

Johnson & Johnson (NYSE: JNJ)

Type: Common stock
Trading symbol: JNJ
Exchange: NYSE
Current price: US$93.13
Originally recommended: Oct. 27/10 at US$63.81
Annual payout: US$3.00
Yield: 3.21%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.jnj.com

Comments: Healthcare and consumer products company Johnson & Johnson’s was another global company to suffer from the strength of the U.S. dollar. While second-quarter reported revenues were down 8.8%, to US$17.8 billion (all numbers US$), in organic terms they fell only 0.9%. Adjusted earnings were down 6%, to $4.8 billion ($1.71 per share, down 4%), but excluding currency movements were actually up 6.7%.

Revenues remained healthy in most divisions, with pharmaceuticals up 1%, to $7.9 billion after adjusting for currency, while consumer products sales rose 2.3%, to $3.5 billion. But medical devices sales fell 4.7%, to $6.4 billion, due to the sale of the Ortho Clinical Diagnostics division in 2014, but were up 1.4% on an organic basis as growth in cardiovascular and specialty surgery offset a flat performance in diabetes and orthopedics. And the $2 billion sale of its Cordis vascular stent business to Cardinal Health is expected to close by year-end.

JNJ raised its 2015 earnings guidance to $6.10-$6.20 from $6.04-$6.19 a share.

Action now: Johnson & Johnson remains a Buy for its rock-solid balance sheet (one of the very few AAA ratings left), good underlying revenue growth, and decent yield, with its quarterly dividend increased by $0.05, to $0.75 per share, in the second quarter of 2015. – G.G.

TransAlta Renewables (TSX: RNW, OTC: TRSWF)

Type: Common stock
Trading symbols: RNW, TRSWF
Exchanges: TSX, Grey Market
Current price: C$10.79, US$8.33
Originally recommended: Nov. 13/14 at C$12.12, US$10.95
Annual payout: $0.84
Yield: 7.8%
Risk: Higher risk
Recommended by: Gordon Pape
Website: www.transaltarenewables.com

Comments: The share price slipped over the summer despite a 9% dividend increase and good second-quarter results. There appear to have been a number of reasons for this. They include the steep drop in the price of oil, which has made alternative energy projects less attractive economically (this company invests mainly in wind farms, hydroelectric facilities, and gas-fired plants). Also, a Globe and Mail analysis concludes that the company’s net profit margin is lower than most of its competitors, indicating it is less effective at turning revenues into profits.

The company’s second-quarter results showed a slight drop in year-over-year power generation, which translated into financial returns that were below estimates. Revenue came in at about $51.3 million, up from $50 million in the same period of 2014. Comparable net earnings attributable to common shareholders increased almost four times to $22.2 million ($0.14 per share). Cash available for distribution was up to almost $39 million ($0.24 per share) compared with about $23 million ($0.20 per share) last year. That was more than enough to cover the dividends of $0.20 per share paid during the quarter.

For the first half of 2015, cash available for distribution was $69.3 million ($0.50 per share), up from $39.8 million ($0.35 per share) in 2014. Dividends paid in the first half amounted to $0.39 per share, so the current payout appears to be sustainable.

The company has announced that another dividend increase in the 6% to 7% range can be expected when its South Hedland gas-fired generating plant comes into service in 2017.

At the current price, the stock yields a very attractive 7.8%. That suggests the market sees above-average risk in this security. However, investors who are able to tolerate such risk may wish to take a position at this level.

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

Freehold Royalties (TSX: FRU, OTC: FRHLF)

Type: Common stock
Trading symbols: FRU, FRHLF
Exchanges: TSX, Pink Sheets
Current price: C$11.76, US$8.85
Originally recommended: Feb. 22/12 at C$20.37, US$20.51
Annual payout: $0.84
Yield: 7.43%
Risk: Higher risk
Recommended by: Gordon Pape
Website: www.freeholdroyalties.com

Comments: Freehold has cut its dividend for the second time in less than a year. The new amount of $0.07 a month ($0.84 a year) is effective with the Sept. 28 payment and represents a 22% decrease from the August level. Since last December, the dividend has been reduced by 50%.

The announcement was made following the release of second-quarter financial results that saw revenue decline by 30% to $38 million and funds from operations per share drop 42% to $0.32 from $0.55 in the same period of 2014. Net income per share was only $0.04, off 86% from a year ago.

Average daily production actually rose by 21%, to a record 10,617 barrels of oil equivalent per day (boe/d), but the average realized price per boe was down 43% to $38.63.

The company announced it was reducing its capital spending guidance for this year to $20 million from $25 million previously. It revised its 2015 production guidance downwards to 10,400 boe/d from 10,800 previously. It also lowered its oil price projections for this year.

Despite the weak results, the company is not standing pat. It completed an acquisition from Penn West Petroleum Ltd. of two royalty packages totaling an estimated 1,400 boe/d of 2015 average net royalty production for $318 million, prior to normal closing adjustments.

Freehold also closed an acquisition of a new royalty with Manitok Energy Ltd. for total consideration of $25 million. The transaction is expected to add 140 bbl/d of new light oil royalty production for the next eight years, declining at 10% per year thereafter.

Based on the new dividend level and the current price, the shares yield 7.4%. Hopefully, we won’t see any more dividend cuts but the possibility cannot be ruled out.

Action now: This is a good company and the share price will turn back up once oil recovers. But that could take a while. If you’re willing to wait and are satisfied with the cash flow, hold. However, if you own the shares in a non-registered account and are looking for a capital loss to offset gains elsewhere, you may wish to sell. – G.P.

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: $22.49
Originally recommended: Oct. 30/14 at $24.31
Annual payout: $1.19
Yield: 5.3%
Risk Rating: Conservative
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.fortisinc.com

Comments: The preferred share market is down across the board. In many cases, this is due to the large number of reset preferreds on the market, many of which are coming up for renewal at what are expected to be lower rates.

That is not the case here, however. These are straight preferred shares from a blue-ribbon company, paying an annual dividend of $1.19 and not redeemable until 2017. The price decline has pushed the yield to a very attractive 5.3%. Take advantage of it.

Action now: Buy. – G.P.

Canadian Utilities Cumulative Redeemable Second Preferred Shares BB (TSX: CU.PR.E)

Type: Straight (perpetual) preferred shares
Trading symbol: TSX: CU.PR.E
Exchange: TSX
Current price: $22.14
Annual payout: $1.225
Yield: 5.5%
Risk: Conservative
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.canadian-utilities.com

Comments: This is another high-quality straight preferred that has been hit by the broad turndown in the market. As a result, the yield is up to 5.5%. When interest rates rise, these preferreds will come under pressure, but that is not going to happen for a while. As a result, they look like great value at this price.

Action now: Buy. – G.P.

 

Return to the table of contents…

That’s all for this issue. Look for your next Update Edition on Oct. 8. The next regular issue will be published on Oct. 22.

Best regards,
Gordon Pape, editor-in-chief

In this issue:

Next Update Edition: October 8

Next regular issue: October 22

HIGH YIELD PORTFOLIO LOSES GROUND

By Gordon Pape, Editor & Publisher

In March 2012, I launched a High-Yield Portfolio for readers seeking above-average cash flow and who were willing to live with a higher level of risk. I cautioned at the time, and since, that this is a 100% equity portfolio with no bonds to cushion losses when stock markets retreat. Therefore it is best suited for non-registered accounts where any capital losses can be deducted from taxable capital gains. Also, a high percentage of the payments from this portfolio will receive favourable tax treatment as eligible dividends or return of capital.

The portfolio had been performing well above our target return of 7% to 8% a year, but the last six months were difficult. Out of the nine positions we hold, only three posted net gains, including dividends. All the others fell, with the worst results posted by stocks in the energy sector.

Here is a rundown of the securities we own and how they have performed in the six months since our last review in March.

The Keg Royalties Income Fund (TSX: KEG.UN, OTC: KRIUF). This fund is the leading operator and franchisor of steakhouse restaurants in Canada and has a substantial presence in select regional markets in the United States. It was added to this portfolio in April 2013 when it was trading at $15.25. At the time of the last review in March, it was up to $19.80. However, like most of the securities in this portfolio, it has lost ground since then, dropping by $1.90 per share. The good news is we had a second dividend increase in 2015 in July when the payment was bumped up by 3%, to $0.0845 per month ($1.014 annually). The shares yield 5.7% at the current price.

DH Corporation (TSX: DH, OTC: DHIFF). This is one of the few stocks that managed to hold its ground over the past six months, losing only $0.02 per share. That was more than made up for with two dividends of $0.32 each. The company used to derive most of its revenue from cheque printing, but it has successfully diversified into other areas.

Vermilion Energy (TSX, NYSE: VET). We added Vermilion to the portfolio in March. Despite the weakness in the energy sector, we like this stock because of its well-diversified international holdings and good management. Even that wasn’t enough to support the share price in the face of the continued decline in oil prices, however. The only good news is that this is one of the few mid-size energy companies that hasn’t cut its dividend (at least not so far). It continues to pay $0.215 per month, to yield 6.1%.

FLY Leasing (NYSE: FLY). This Irish-based airplane leasing company saw its share price slip by $1.64 after it reported a second-quarter loss due to a non-cash impairment charge. Stripping that out, adjusted net income was US$9.5 million (US$0.23 per share). The quarterly dividend is US$0.25.

Premium Brands Holding Corp. (TSX: PBH, OTC: PRBZF). Finally, some good news. This specialty food manufacturer and distributor, which was added to this portfolio in October 2013, saw its share price jump by $5.69 since March. PBH reported record second-quarter sales and earnings in August, which fuelled the buying spree. The quarterly dividend was increased to $0.345 from $0.3125, effective with the March payment.

Morneau Shepell Inc. (TSX: MSI, OTC: MSIXF). Morneau Shepell Inc. is the largest Canadian-based firm offering benefits and pension consulting, outsourcing, as well as health management services. The shares are off $1.91 since the last update, but we continue to receive good cash flow from the monthly dividend of $0.065 ($0.78 a year). The company reported a good second quarter with normalized free cash flow up 23.1% to $16.1 million.

Pembina Pipeline Corp. (TSX: PPL, OTC: PBNPF).  As mentioned with Vermilion, all companies associated with the energy sector are being hit these days. Pembina is no different, with the shares down almost $7 since March. On the plus side, the company increased its dividend by 5.2% in May, to $0.1525 per month.

Sun Life Financial (TSX, NYSE: SLF). This blue-chip insurance company bucked the downward trend by posting a small gain of $0.67 per share since the last review. We also benefitted from a dividend increase of 5.6% in May to $0.38 per quarter.

Chemtrade Logistics Income Fund (TSX: CHE.UN, OTC: CGIFF).
Chemtrade is one of the world’s largest suppliers of sulphuric acid, liquid sulphur dioxide, and sodium chlorate and is one of the few income trusts still remaining. The share price fell by $3.40 since the last update despite good second-quarter results. Distributions remain at $0.10 per unit monthly ($1.20 a year).

The accompanying table shows what the portfolio looked like as of the close of trading on Sept. 18. The weighting is the percentage of the market value of the security in relation to the total market value of the portfolio. Sales commissions are not taken into account, and the U.S. and Canadian dollars are treated as being at par. Note that the original book value was $24,947.30. The return since inception is based on that amount. We received interest on our cash position of $6.91 during the latest period.

Income Investor High Yield Portfolio – a/o Sept. 18/15

Security

Weight
%

Total
Shares

Average Price

Book
Value

Current Price

Market
Value

Retained
Income

Gain/
Loss
%

KEG.UN

9.1

165

$15.35

 $2,533.30

$17.90

 $2,953.50

$138.65

+22.1

DH

13.7

110

$19.39

 $2,132.90

$40.35

 $4,438.50

$272.10

+120.9

VET

9.1

70

$53.84

 $3,768.80

$42.31

 $2,961.70

$105.35

-18.6

FLY 

9.6

230

$14.58

 $3,353.60

$13.54

 $3,114.20

$115.00

– 3.7

PBH  

13.2

130

$19.49

 $2,534.25

$32.84

 $4,269.20

$164.83

+80.0

MSI 

10.9

230

$12.23

 $2,813.60

$15.37

 $3,535.10

$235.75

+34.0

PPL 

9.4

95

$29.09

 $2,763.60

$33.75

 $3,206.25

$334.08

+28.1

SLF

14.8

115

$24.82

 $2,853.80

$41.55

 $4,778.25

$198.80

+74.4

CHE.UN

9.4

170

$17.06

 $2,899.40

$17.91

 $3,044.70

$272.00

+14.4

Cash

0.8

 

 

$246.61

 

$253.52

 

 

Total

100.0

 

 

$25,899.86

 

$32,554.92

$1,836.56

+32.8

Inception

 

 

 

$24,947.30

 

 

 

+37.8

Comments: When markets go south, this portfolio will inevitably feel the effects. Fortunately, the high yields mitigate the damage to some degree. The total value of the portfolio, including retained income, is now $34,391.48. Overall, we are down 3.7% since March, reducing our total return since inception to 37.8%. Our average annual compound rate of return since inception is 9.6%, still ahead of target.

I was pleased to see that despite then general downturn in share prices, not one company in our portfolio reduced its dividend. As a result, we are now looking at very attractive yields: Morneau Shepell is at 5%, Pembina Pipelines is up to 5.4%, Chemtrade is at 6.7%, and on it goes.

Changes: I do not advise changing any of the securities in the portfolio at this time. These are all sound companies and the share prices will recover when the market turns around. In the meantime, we are enjoying great cash flow.

However, we will use some of the retained income to add to a few of our positions, as follows.

KEG.UN. We’ll buy five shares for $89.50. That will bring our total to 170 and reduce retained income to $49.15.

MSI. We’ll add 10 shares for $153.70, reducing our reserve to $82.05 and bringing our total position to 240 shares.

PPL. We will buy five shares for $168.75, which will leave us with cash of $165.33.

CHE.UN. We’ll spend $179.10 to bring our total shares to 180, leaving retained income of $92.90.

Readers are reminded not to execute these small trades, because the commissions would be too high. Add to your positions through dividend reinvestment plans instead.

We will invest our cash of $1,499.03 in a high-interest savings account paying 0.8%.

The accompanying table shows the revised portfolio. I’ll review it again next March.

Income Investor High Yield Portfolio – revised Sept. 18/15

Security

Weight %

Total
Shares

Average Price

Book
Value

Current Price

Market
Value

Retained
Income

KEG.UN

9.1

170

$15.43

 $2,622.80

$17.90

 $3,043.00

$49.15

DH

13.7

110

$19.39

 $2,132.90

$40.35

 $4,438.50

$272.10

VET

9.1

70

$53.84

 $3,768.80

$42.31

 $2,961.70

$105.35

FLY 

9.6

230

$14.58

 $3,353.60

$13.54

 $3,114.20

$115.00

PBH  

13.2

130

$19.49

 $2,534.25

$32.84

 $4,269.20

$164.83

MSI 

10.9

240

$12.36

 $2,967.30

$15.37

 $3,688.80

$82.05

PPL 

9.4

100

$29.32

 $2,932.35

$33.75

 $3,375.00

$165.33

SLF

14.8

115

$24.82

 $2,853.80

$41.55

 $4,778.25

$198.80

CHE.UN

9.4

180

$17.06

 $3,078.50

$17.91

 $3,223.80

$92.90

Cash

0.8

 

 

$253.52

 

$253.52

 

Total

100.0

 

 

$26,497.82

 

$33,145.97

$1,245.51

Inception

 

 

 

$24,947.30

 

 

 

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

 

Return to the table of contents…

HAVENS IN THE STORM

By Gavin Graham, Contributing Editor

The August selloff in global markets, which saw many developed markets drop between 10% and 20%, and emerging markets such as China and Brazil plummet by more than 25%, has left investors wondering which stocks or sectors might provide some shelter from the sudden burst of volatility. Some sectors, such as energy and mining, had already entered bear markets (defined as a fall of more than 20%) at the beginning of 2015, which accelerated in August. Energy issues such as Imperial Oil, Husky, and Suncor fell between 10% and 14%, and U.S. integrated oils Chevron, Hess, and ExxonMobil dropped 7.5 to 12%. Miners First Quantum and Teck Resources, which has just been downgraded to “junk” (non-investment grade) are off 20% and 7.8% respectively.

Meanwhile interest rate-sensitive stocks such as banks, utilities, and REITs had sold off on worries over rising U.S. interest rates, as I noted in my review a couple of months ago. But the pain has continued even while the Bank of Canada cut short-term interest rates another 0.25%, to 0.5%. The iShares REIT ETF is down almost 6% over the last month, taking its loss for the last 12 months to 9% (ignoring distributions), while utilities Fortis, Enbridge, TransCanada, and Emera are off between 8% and 12% in the last month.

However, such was the breadth of the market collapse in August that even sectors regarded as relatively defensive, such as consumer staples, large-cap technology, and health care, experienced sharp drops. Over the month to Sept. 14, Abbott Labs, Merck, GlaxoSmithKline, and Pfizer fell between 7.5% and 14%, while Cisco and Microsoft fell 11.5% and 8.5% respectively. Supermarkets Empire, Metro, and Loblaw lost 11.7%, 9.2% and 8.2% respectively, tobacco giants BAT and Philip Morris International dropped 9.5% and 5.8%, and consumer products titans Unilever and Procter & Gamble retreated over 10%.

Some of the selloff in what are traditionally regarded as defensive investments doubtless reflected the recent high valuations of these steady dividend-paying companies, driven by investors’ search for yield. The consumer products companies were trading at price/earnings ratios of around 20 before the selloff, quite high for groups whose revenue growth was only in the low to mid-single digits due to slow or non-existent growth in the developed markets of Europe and North America. Similarly, healthcare and supermarkets were selling at P/Es in the high teens, somewhat expensive given their low revenue growth due to patent expiries and low margins for the store chains.

Can investors still be comfortable owning these companies as core positions in their portfolios? I would suggest that they can, as the fundamentals for many of these stocks remain solid, including those that are among the recommendations in Income Investor. The most important question given the focus on income is whether the yields on the stocks are sustainable. There is little indication that any of the dividends are under threat. Indeed, some companies have raised their payouts, a sign of confidence by management in the outlook for the next couple of years.

I update some of my recommendations in these sectors below.

 

Return to the table of contents…

TOP PICK

Here is our Top Pick for this month. Prices are as of the close of trading on Sept. 21 unless otherwise indicated.

BMO Financial Group (TSX, NYSE:BMO)

Type: Common stock
Trading symbol: BMO
Exchanges: TSX, NYSE
Current price: C$71.33, US$53.87
Entry level: Current price
Annual payout: $3.28
Yield: 4.6%
Risk: Lower risk
Recommended by: Gordon Pape
Website: www.bmo.com

Background: It’s not often that we can buy shares in major Canadian banks that yield almost 5%, but that’s the situation right now. Despite unexpectedly good third-quarter numbers, the banking sector remains out of favour with investors, who are worried that the weakness in the economy will eventually manifest itself in reduced profits. As a result, the financial sector is off 8.6% year-to-date (as of the close on Sept. 18), thereby creating a buying opportunity for long-term income investors. We already have Scotiabank on our Recommended List, and now we will add BMO Financial Group, better known to most people as Bank of Montreal.

The business: BMO is the fourth largest of Canada’s Big Five banks with $672 billion in assets as of July 31. Established in 1817, BMO Financial Group has more than 47,000 employees and provides a broad range of retail banking, wealth management, and investment banking products and services to more than 12 million customers. It conducts business through three operating groups: Personal and Commercial Banking; Wealth Management; and BMO Capital Markets. The company also has a strong presence in the U.S. Midwest through BMO Harris Bank and BMO Private Bank.

The security: I recommend the common stock of Bank of Montreal, which trades on both the Toronto and New York stock exchanges under the symbol BMO.

Why we like it: Despite the naysayers, BMO and the other Canadian banks continue to post good results, and the unofficial oligarchy that limits the number of major players in the business ensures the on-going dominance of the Big Five. Royal Bank, TD Bank, and Scotiabank are all larger in size, but BMO has shown strong growth in recent years and has been aggressive in terms of growing its wealth management business and expanding its U.S. footprint. The dividend at the current price is a very attractive 4.7%.

Financial highlights: The bank reported third-quarter fiscal 2015 earnings (to July 31) of just under $1.2 billion, up 6% year-over-year. Earnings per share were $1.80, up 8% over last year. Return on equity was 13.6%, down from 14.4% a year ago, while provision for credit losses increased to $160 million from $130 million. The Basel III Common Equity Tier 1 ratio was 10.4%. Book value per share increased 19% from the prior year, to $55.36.

For the first nine months of the fiscal year, the bank earned about $3.2 billion. That was down slightly from 2014, although adjusted earnings were up 2%. Adjusted earnings per share for the nine months were $5.10, up 3%.

Net income from Canadian personal and commercial (P&C) banking in the third quarter was $556 million, up 6% from a year ago. That was good, but even more significant was a big 38% jump in the profits from U.S. P&C banking, which came in at $222 million.

Wealth management contributed $210 million, up 11% from last year. The only sector to show a profit decline was BMO Capital Markets, with net income of $273 million, off 11%.

Risks: A severe and prolonged recession would hit the profits of all the banks, including BMO. Bank profits are also vulnerable to a downturn in the housing market that would dry up mortgage demand and increase the potential for defaults. If a new government raises corporate taxes, that would also affect the bottom line.

Distribution policy: BMO pays a quarterly dividend of $0.82 a share in January, April, July, and October, for a total annual payment of $3.28. The last dividend increase was a $0.02 bump in July.

Tax implications: The quarterly payments are eligible for the dividend tax credit if held by Canadians in a non-registered account. U.S. residents will be assessed a 15% withholding tax unless the payments are made to a retirement plan. The withholding tax can be reclaimed by using the foreign tax credit.

Who it’s for: This stock is suitable for conservative investors who want to take advantage of the high yields currently available from the Canadian banks.

How to buy: The shares are actively traded on both Toronto and New York, and you will have no trouble getting a fill.

Summing up: Every so often, we get an opportunity to buy bank stocks at depressed prices. Of course, the shares are nowhere near the bargain basement levels they reached in 2009, but we aren’t likely to see that again.

Action now: Buy. – G.P.

 

Return to the table of contents…

SEPTEMBER UPDATES

Bank of Nova Scotia (TSX, NYSE: BNS)

Type: Common stock
Exchanges: TSX, NYSE
Current price: C$59.14, US$44.64
Originally recommended: Aug 29/07 at C$50.98
Annual payout: $2.80
Yield: 4.73%
Risk rating: Conservative
Recommended by: Gavin Graham
Website: www.scotiabank.com

Comments: In its most recent quarter, Scotiabank not only recorded a 4% increase in net income, to $1.85 billion ($1.45 per share), from the same quarter a year ago – adjusting for the $555 million exceptional gain on the sale of its stake in CI Financial – but raised its quarterly dividend by $0.02, to $0.70.

Canadian banking revenues grew 15%, to $863 million, driven by good growth in loans and deposits and wider margins. Higher non-interest expenses and a slight rise in provisions for credit losses (PCL), to 0.42%, partially offset this improvement. Revenue from international banking rose 11%, to $485 million, due to good growth in Latin American loans and higher fee income, helped by currency appreciation against the Canadian dollar. Global banking and markets profit fell 20%, to $375 million, and return on equity (ROE) was down slightly, to 14.7% from 15.9%, due to an increase in Basel III Tier I capital to 10.4% from 10.2%. This was partially a result of Scotiabank’s acquisition of pension administrator Cencosud in Chile and Citibank’s Peruvian retail banking operations.

Action now: Scotiabank remains a Buy as recovery from its slowdown in the first half of the year and underperformance against other banks has left it very reasonably valued at 10.2 times earnings and a 4.8% yield. – G.G.

Canadian Western Bank (TSX: CWB, OTC: CBWBF)

Type: Common stock
Trading symbol: CWB, CBWBF
Exchanges: TSX, Pink Sheets
Current price: C$23.90, US$17.98
Originally recommended: March 26/15 at C$27.71, US$22.06
Annual payout: $0.88
Yield: 3.68%
Risk: Moderate risk
Recommended by: Gavin Graham
Website: www.cwbankgroup.com

Comments: Canadian Western Bank is down 20% from its initial recommendation, due to concerns over the slowdown in the oil-dependent Alberta economy and the possibility of higher mortgage loan losses. However, as noted in my original recommendation, PCLs rose only slightly during the last oil price collapse in 2008-09, peaking at 0.22 against 0.8 for the remaining banks and are barely half of those the Big Six chartered banks (0.16 vs. 0.35-0.45).

Having sold its property and casualty insurance business to Intact Insurance for $197million and its custodian business to Computershare for $33 million in the second quarter, CWB had exceptional earnings of $1.33 per share from the capital gains from these transactions. On an operating basis, CWB earned $51.2 million ($0.64 per share) for the third quarter ended July 31, after $5 million in securities losses, down 3%, from $55 million ($0.69 per share), but up 10% after excluding securities gains and losses on loans up 11%.

CWB remains rated A (low) by DBRS, had PCLs of 0.17, up 0.01 from the same quarter last year and has 48% of its loans outside of the Prairies (33% B.C., 15% Ontario).

Action now: Canadian Western Bank remains a Buy for its cheap valuation, strong credit profile, and attractive quarterly dividend, which was increased 4.8% in the second quarter, to $0.22 a share, giving it a yield of 3.7%. – G.G.

Diageo (NYSE: DEO)

Type: ADR
Trading symbol: DEO
Exchange: NYSE
Current price: US$109.56
Originally recommended: June 22/11 at US$81.25
Annual payout: US$4.35
Yield: 3.98%
Risk: Moderate risk
Recommended by: Gavin Graham
Website: www.diageo.com

Comments: Global drinks giant Diageo (Johnnie Walker, Smirnoff, Capt. Morgan, Tanqueray, etc.) saw revenues grow 5%, to £10.8 billion, in the year ended June 30, due to the full takeover of India’s United Spirits, but were unchanged on an organic basis. Regionally, the company saw 6% growth in Africa, which represents 13% of its sales, while a flat performance in Europe (24% of sales) was offset by 1%-2% declines in North America (32%), Latin America (10%), and Asia (21%). Operating profit before exceptional items of £3.1 billion was up 1% in organic terms but down 2% on a reported basis, partially due to the weakness of the euro, Russian ruble, and Venezuelan bolivar, which knocked £161 million off earnings.

Exceptional items also included a £217 million restructuring charge, offset by £373 million of gains on the disposal of Bushmills Irish whiskey and the Gleneagles hotel. Net profit was up 6%, to £2.4 billion (£0.952 per share), and free cash flow was up almost 50%, to £1.9 billion, while the dividend was raised 9%, to £0.564 per share.

Diageo, which derives almost 45% of its revenues from emerging markets, has seen its shares suffer over concerns that growth in consumer incomes in these regions has slowed sharply, exacerbated by declining currencies, which reduce Diageo’s reported profits and revenues.

However, sales in mainland China grew 26% in 2014, while Mexican sales grew 13% (up 5% in Latin America overall). African sales grew 6% (and in the double digits ex-Nigeria), while India sales grew 5%. In the U.S., whiskey sales were up 13%, with strong momentum in Diageo’s best-selling categories.

Action now: Diageo remains a Buy for its strong balance sheet, exposure to fast-growing markets, ability to cross-sell products, and attractive and rising dividend. – G.G.

Johnson & Johnson (NYSE: JNJ)

Type: Common stock
Trading symbol: JNJ
Exchange: NYSE
Current price: US$93.13
Originally recommended: Oct. 27/10 at US$63.81
Annual payout: US$3.00
Yield: 3.21%
Risk Rating: Conservative
Recommended by: Gavin Graham
Website: www.jnj.com

Comments: Healthcare and consumer products company Johnson & Johnson’s was another global company to suffer from the strength of the U.S. dollar. While second-quarter reported revenues were down 8.8%, to US$17.8 billion (all numbers US$), in organic terms they fell only 0.9%. Adjusted earnings were down 6%, to $4.8 billion ($1.71 per share, down 4%), but excluding currency movements were actually up 6.7%.

Revenues remained healthy in most divisions, with pharmaceuticals up 1%, to $7.9 billion after adjusting for currency, while consumer products sales rose 2.3%, to $3.5 billion. But medical devices sales fell 4.7%, to $6.4 billion, due to the sale of the Ortho Clinical Diagnostics division in 2014, but were up 1.4% on an organic basis as growth in cardiovascular and specialty surgery offset a flat performance in diabetes and orthopedics. And the $2 billion sale of its Cordis vascular stent business to Cardinal Health is expected to close by year-end.

JNJ raised its 2015 earnings guidance to $6.10-$6.20 from $6.04-$6.19 a share.

Action now: Johnson & Johnson remains a Buy for its rock-solid balance sheet (one of the very few AAA ratings left), good underlying revenue growth, and decent yield, with its quarterly dividend increased by $0.05, to $0.75 per share, in the second quarter of 2015. – G.G.

TransAlta Renewables (TSX: RNW, OTC: TRSWF)

Type: Common stock
Trading symbols: RNW, TRSWF
Exchanges: TSX, Grey Market
Current price: C$10.79, US$8.33
Originally recommended: Nov. 13/14 at C$12.12, US$10.95
Annual payout: $0.84
Yield: 7.8%
Risk: Higher risk
Recommended by: Gordon Pape
Website: www.transaltarenewables.com

Comments: The share price slipped over the summer despite a 9% dividend increase and good second-quarter results. There appear to have been a number of reasons for this. They include the steep drop in the price of oil, which has made alternative energy projects less attractive economically (this company invests mainly in wind farms, hydroelectric facilities, and gas-fired plants). Also, a Globe and Mail analysis concludes that the company’s net profit margin is lower than most of its competitors, indicating it is less effective at turning revenues into profits.

The company’s second-quarter results showed a slight drop in year-over-year power generation, which translated into financial returns that were below estimates. Revenue came in at about $51.3 million, up from $50 million in the same period of 2014. Comparable net earnings attributable to common shareholders increased almost four times to $22.2 million ($0.14 per share). Cash available for distribution was up to almost $39 million ($0.24 per share) compared with about $23 million ($0.20 per share) last year. That was more than enough to cover the dividends of $0.20 per share paid during the quarter.

For the first half of 2015, cash available for distribution was $69.3 million ($0.50 per share), up from $39.8 million ($0.35 per share) in 2014. Dividends paid in the first half amounted to $0.39 per share, so the current payout appears to be sustainable.

The company has announced that another dividend increase in the 6% to 7% range can be expected when its South Hedland gas-fired generating plant comes into service in 2017.

At the current price, the stock yields a very attractive 7.8%. That suggests the market sees above-average risk in this security. However, investors who are able to tolerate such risk may wish to take a position at this level.

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

Freehold Royalties (TSX: FRU, OTC: FRHLF)

Type: Common stock
Trading symbols: FRU, FRHLF
Exchanges: TSX, Pink Sheets
Current price: C$11.76, US$8.85
Originally recommended: Feb. 22/12 at C$20.37, US$20.51
Annual payout: $0.84
Yield: 7.43%
Risk: Higher risk
Recommended by: Gordon Pape
Website: www.freeholdroyalties.com

Comments: Freehold has cut its dividend for the second time in less than a year. The new amount of $0.07 a month ($0.84 a year) is effective with the Sept. 28 payment and represents a 22% decrease from the August level. Since last December, the dividend has been reduced by 50%.

The announcement was made following the release of second-quarter financial results that saw revenue decline by 30% to $38 million and funds from operations per share drop 42% to $0.32 from $0.55 in the same period of 2014. Net income per share was only $0.04, off 86% from a year ago.

Average daily production actually rose by 21%, to a record 10,617 barrels of oil equivalent per day (boe/d), but the average realized price per boe was down 43% to $38.63.

The company announced it was reducing its capital spending guidance for this year to $20 million from $25 million previously. It revised its 2015 production guidance downwards to 10,400 boe/d from 10,800 previously. It also lowered its oil price projections for this year.

Despite the weak results, the company is not standing pat. It completed an acquisition from Penn West Petroleum Ltd. of two royalty packages totaling an estimated 1,400 boe/d of 2015 average net royalty production for $318 million, prior to normal closing adjustments.

Freehold also closed an acquisition of a new royalty with Manitok Energy Ltd. for total consideration of $25 million. The transaction is expected to add 140 bbl/d of new light oil royalty production for the next eight years, declining at 10% per year thereafter.

Based on the new dividend level and the current price, the shares yield 7.4%. Hopefully, we won’t see any more dividend cuts but the possibility cannot be ruled out.

Action now: This is a good company and the share price will turn back up once oil recovers. But that could take a while. If you’re willing to wait and are satisfied with the cash flow, hold. However, if you own the shares in a non-registered account and are looking for a capital loss to offset gains elsewhere, you may wish to sell. – G.P.

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: $22.49
Originally recommended: Oct. 30/14 at $24.31
Annual payout: $1.19
Yield: 5.3%
Risk Rating: Conservative
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.fortisinc.com

Comments: The preferred share market is down across the board. In many cases, this is due to the large number of reset preferreds on the market, many of which are coming up for renewal at what are expected to be lower rates.

That is not the case here, however. These are straight preferred shares from a blue-ribbon company, paying an annual dividend of $1.19 and not redeemable until 2017. The price decline has pushed the yield to a very attractive 5.3%. Take advantage of it.

Action now: Buy. – G.P.

Canadian Utilities Cumulative Redeemable Second Preferred Shares BB (TSX: CU.PR.E)

Type: Straight (perpetual) preferred shares
Trading symbol: TSX: CU.PR.E
Exchange: TSX
Current price: $22.14
Annual payout: $1.225
Yield: 5.5%
Risk: Conservative
Recommended by: Tom Slee
Updated by: Gordon Pape
Website: www.canadian-utilities.com

Comments: This is another high-quality straight preferred that has been hit by the broad turndown in the market. As a result, the yield is up to 5.5%. When interest rates rise, these preferreds will come under pressure, but that is not going to happen for a while. As a result, they look like great value at this price.

Action now: Buy. – G.P.

 

Return to the table of contents…

That’s all for this issue. Look for your next Update Edition on Oct. 8. The next regular issue will be published on Oct. 22.

Best regards,
Gordon Pape, editor-in-chief