Income-paying equities: Managers insist on strong balance sheets for their energy holdings

Michele Robitaille, managing director and equity-income specialist at Guardian Capital LP, a sub-advisor to the BMO family of funds. The Guardian equity team’s mandates include BMO Monthly High Income II.

Jason Gibbs, vice president and portfolio manager at 1832 Asset Management LP. Gibbs is a senior member of the firm’s equity-income team, which has a wide range of mandates including Scotia Canadian Dividend.

Peter Frost, senior vice president and portfolio manager at AGF Investments Inc. His responsibilities include two income-oriented balanced funds: AGF Monthly High Income and AGF Traditional Income.

Q: What about the battered Canadian energy sector?

Frost: The equity market has differentiated among the companies, based on balance-sheet strength. A prime example is the integrated energy company Suncor Energy Inc.(SU), which has held in relatively well during this challenging time.

Q: How are your portfolios positioned in this sector?

Robitaille: BMO Monthly High Income has just over 20% in energy. Half of that represents exposure to production companies and the other half to the infrastructure/pipeline companies. We added a little to energy infrastructure toward the end of 2015, as some of those names became oversold in the wake of the selloff in U.S. energy-infrastructure stocks. At that stage, we added to Enbridge Inc.(ENB) and Pembina Pipeline Corp.(PPL).

Frost: I own Pembina in AGF Monthly High Income.

Gibbs: Scotia Canadian Dividend has holdings in Pembina, Enbridge and TransCanada Corp.(TRP).

Q: Michele, producers?

Robitaille: We have large holdings in ARC Resources Ltd.(ARX), Cenovus Energy Inc.(CVE), Crescent Point Energy Corp.(CPG) and Vermilion Energy Inc. (VET). Given the low commodity price and the uncertainty as to how long it will persist, we focus on the likely survivors. It comes down to balance-sheet strength and companies that entered this downturn well placed to deal with it or have since taken steps to do so. For example, Cenovus has done an equity issue and made some land sales. ARC is one of the few higher-yield energy producers that has not needed to adjust its dividend, as of yet. It has prudent management and exposure to the Montney formation (in British Columbia and Alberta), some of the highest quality land holdings in the sector.

Q: Jason?

Gibbs: I am cautious on this sector. I’ve been reducing the portfolio’s exposure to energy over the past year. Scotia Canadian Dividend currently has a weighting of 11% in the sector. There’s 5% in energy producers and 6% in the infrastructure companies. It’s hard to predict the price of oil. Similar to Peter and Michele’s point, you have to focus on those companies with the best balance sheets that can survive a low commodity-price environment. Among the producers, I own Suncor, Canadian Natural Resources Ltd.(CNQ) and Vermilion.

The low commodity price has clearly impacted the energy-infrastructure companies. While they will still see a lot of growth over the next few years as they complete their backlogs, there will not be as much growth post-2020. Having said that, the multiples on these stocks have come down sharply in the last few months. The infrastructure companies have lost the growth premiums in their valuations. At recent close, the dividend yield on TransCanada was 4.6%, and 4.7% on Enbridge. The dividends are attractive.

Frost: In assessing this, you have to believe that the dividends and cash flows are sustainable. Among the oil producers, I think that the big-cap dividend-paying high-quality companies will try to protect their dividends and bring their capital expenditures down. I cannot imagine that oil will stay at US$30 a barrel over the long haul. There will be a lot of capital-expenditure cuts around the world.

Q: Energy-services companies?

Robitaille: We owned Mullen Group Ltd. (MTL). We sold the stock in the fourth quarter of 2015. We were concerned that Mullen would cut its dividend. The company announced a dividend cut in mid-December, which was after we sold the stock.

Gibbs: The services companies are a little too cyclical for me.

Frost: I do own them. A holding, for example is U.S.-based Schlumberger Ltd. (SLB), one of the world’s largest oilfield-services companies. I also own ShawCor Ltd. (SCL), which provides pipeline coatings and is expanding its range of pipeline services. It’s a global company. I have owned it pretty much for my whole career. It’s been a strong dividend-grower over time.

The energy sector represents some 18% in both Traditional Income and Monthly High Income. On the infrastructure side, my biggest holdings are Keyera Corp.(KEY) and AltaGas Ltd. (ALA). They are in both balanced funds. They have been strong dividend growers.

Robitaille: We own both.

Frost: Keyera has a prudent management team. The company is reaping the benefits of its higher growth initiatives and it raised its dividend twice in 2015. AltaGas is a hybrid utility, power company and gas processor. I like its assets.

Among the producers, the large-caps that I own in Traditional Income are Suncor and CNQ. In the Monthly High Income, where I look for a higher yield, I focus on companies with both good balance sheets and low-cost light oil. I own Vermilion, Bonterra Energy Corp. (BNE) and Whitecap Resources Inc. (WCP).

Q: Utilities?

Gibbs: This is always a good sector to be in over the long term, because it’s playing defence. They’re simple businesses with above-average dividend yields and dividend growth. It’s a great time for infrastructure building and rebuilding, and these companies benefit from this. A new position in Scotia Canadian Dividend is Hydro One Ltd. (H). I participated in the November 2015 initial public offering at $20.50 a share. It’s a dominant utility in Ontario, which has almost 14 million people. The company has high margins. The stock has a dividend yield of about 4%. Among the portfolio’s Canadian utilities holdings, I also have weightings in Fortis Inc.(FTS) and Brookfield Infrastructure Partners L.P. (BIP.UN).

Robitaille: We continue to own Brookfield Renewable Energy Partners L.P. (BEP) and Northland Power Inc. (NPI). We sold our holding in Emera Inc. (EMA). We thought that the stock was getting a little expensive.

Frost: I own Fortis, Brookfield Infrastructure and a small position in Canadian Utilities Ltd. (CU).

Q: Telecoms?

Gibbs: The telecoms are a pretty safe place to be, particularly in this environment. There are three companies — TELUS Corp.(T), BCE Inc.(BCE) and Rogers Communications Inc.(RCI.B) — that control 90% of the Canadian market. There are high barriers to entry in this market and the companies have pricing power.

Frost: I think that 2016 will be a good year for Canadian telecom stocks. Their valuations contracted sharply in the wake of the mid-December announcement by Shaw Communications Inc.(SJR.B) that it had made a bid for WIND Mobile Corp. for $1.6 billion.

Gibbs: If this deal goes through, it will not be as material for the industry as implied by the drop in the stock prices of the incumbents. The collective market capitalization of the big three companies is about $100 billion. It will also take Shaw/Wind a couple of years to build out the proper infrastructure to compete.

Q: In addition, Corus Entertainment Inc. (CJR.B) recently announced that it would be buying Shaw Media Inc., which owns Global Television and a range of specialty channels, from Shaw Communications Inc., for $2.7 billion.

Gibbs: This will help Shaw Communications finance the acquisition of WIND. It also makes the two companies more pure plays in their fields, with Shaw Communications focusing on cable and wireless and Corus on content.

Q: What are your major holdings in the Canadian telecommunication-services sector?

Frost: I own BCE. I added it about six months ago to both the AGF balanced funds. At the time we bought it, we thought its valuation relative to the other telecom stocks was pretty good. We saw stabilization in its wire-line business. I own Shaw Communications, which is considered to be in the consumer-discretionary sector.

Gibbs: You wouldn’t call the major Canadian telecoms value stocks, but they did become more reasonable after the Shaw announcement. Scotia Canadian Dividend has holdings in Telus, Rogers and BCE. Telus would be the bigger weight. We trimmed the stocks a little during the course of last year before the Shaw announcement. There were times during the year when their valuations were overdone.

Robitaille: We own Shaw Communications and Telus, which would be our biggest holding in the telecom sector. In all, the telcos are a good stable source of dividends, with solid dividend growth. Even if that growth slows over the next numbers of years, they are still a relatively defensive part of the market.

Editor’s note: This is part three of a three-part equity-income roundtable.