PIM: Diversified Income Portfolio

Paul Borisoff - Sep 07, 2017


The Diversified Income Portfolio* was unchanged in August (0.0%) – and remains up 4.9% in 2017.  In comparison our benchmark was up 0.6% in August - and is now up 1.4% in 2017.  Over the most recent 12-month rolling period the portfolio is up 8.7% compared to our benchmark which is up 2.1%.

* These returns are reported as a composite, time-weighted, rate-of-return (gross of fees, net of transaction charges) for all accounts in this mandate.  Long-Term Returns/Benchmark Numbers will be reported in our Quarterly Updates.

After dropping 1.9% in July, the Canadian bond market rebounded 1.4% in August (as measured by the FTSE TMX Canada Bond Index - 60% of our benchmark) as fear levels ratcheted back up once again, partly due to the North Korean situation.  In 2017 the Canadian bond market is now up 1.8%, while it is still down 1.4% over the last year. 

While a strong bond market is usually supportive of high-dividend equities, the S&P/TSX Composite High Dividend Index (40% of our benchmark) was hit quite hard in August closing down 0.7% - after being down almost 2.5% in late August.  As of August 31st this index is now up 0.7% in 2017, and 7.3% over the last year.

The Canadian dollar finished August effectively unchanged from the end of July.  It is up ~8.6% since the end of April and up ~ 7.1% in 2017 which has negatively impacted the value of our U.S. dollar positions (~10.7% of the portfolio at month-end).


The sell-off in many high quality names in August, coming after the last few months of sideways to down “income” markets, created some very attractive opportunities.  We took advantage of the volatility over the last few weeks and put a fair bit of money to work.  We expect to see some very strong returns into year-end as many areas where we are positioned look significantly oversold.

Recent Portfolio Adjustments and Updates:

We sold two positions in August in order to reposition funds into opportunities that offered better risk/reward ratios in our opinion.  We sold our 1.7% position in Cominar REIT at $12.70 per unit realizing a net 7.0% loss on this position including distributions (we added this position back to the portfolio in September and October 2016 at $14.71 per unit after having had past success with the company).  We also sold our 2.7% position in Freehold Royalties at $13.86 per unit.  While Freehold has been one of the better performing energy names over the last few years, there has been an absolute massacre in most areas of the “energy space” recently – including some very large and very high quality companies – which we added to the portfolio in recent days. Our average cost on Freehold was $12.76 per unit acquired in July 2015 (last purchased at $10.89 in August 2015) - and we realized a net return of 18.7% over our holding period including dividends.  The proceeds from these two sales, and some of our cash holdings were then invested as follows:
 

  1. We bought a new 1.0% position in Enbridge Inc. at $49.33 per share (4.9% yield).  In an August 16th report titled “It’s Time to Pound the Table on Enbridge” Canaccord Genuity analyst David Gailson pointed out that Enbridge had drifted below $50 per share – and was now sporting the highest yield in recent history (since 2001).  Over the last 10 years Enbridge has on average yielded 38 basis points higher than the 10-year Government of Canada Bond (less than 0.50% higher) –and was now over 3.0% higher.  This analyst has a “Buy” on Enbridge with a $59.00 Price Target and has highlighted several times in the past that Enbridge’s targeted 10% to 12% annual dividend per share growth through 2024 is “best in class compared to all Canadian yield-based instruments.” Enbridge has approximately 17,000 employees and is Canada’s largest natural gas distribution provider, and operates the world’s longest crude oil and liquids transportation system – with a market capitalization currently in the $82 billion range.  When we acquired our positon in August Enbridge was down 12.6% in 2017 (very close to its 52-week low of $49.20 per share) – and finished August at $49.92.  The average 12-month consensus price target is currently $61.85 per share (Bloomberg).
     
  2. We increased our position in Parkland Industries to approximately 3.3% of the portfolio from 2.3% at $25.82 per share (4.5% yield) which lowered our average cost to $26.80 per share.  As mentioned last month Parkland Industries is now the largest independent fuel and related products distributor in Canada – with a market capitalization of ~$3.6 billion after recently acquiring all of the shares of Chevron Canada R&M ULC which included 129 additional Chevron branded retail service stations principally located in Metro Vancouver. Like many energy related names PKI has been subject to indiscriminate extreme selling pressure recently – which is providing some very attractive opportunities.  PKI closed August at $27.02 per share.  Canaccord Genuity currently has a “Buy” rating on PKI ($38.00 price target), while the current consensus price target is $35.04 (Bloomberg).
     
  3. We increased our exposure to AltaGas (ALA) from 0.8% of the portfolio to 1.8% buying shares at $27.69 (7.6% yield).  AltaGas is a large diversified energy company focused on natural gas infrastructure – gathering and processing, power generation, and currently serves 575,000 regulated utility customers by delivering natural gas to homes and businesses.  Our original 0.8% position was bought via their $31.00 financing this February to finance their purchase of WGL Holdings for $8.4 billion in February – a large stand-alone utility based in Washington D.C. that generates power via natural gas, and is planning on growing power generating assets in solar, wind, fuel cell, along with battery storage.  The company’s WGL acquisition is proceeding as planned, and is expected to support 8-10% annual dividend growth through 2021 – and allow the company to maintain its conservative payout ratio of 50-60%.  ALA closed August at $27.69 per share. The current consensus 12-month price target is $33.65 (Bloomberg).
     
  4. We increased our position in Crius Energy Trust again, this time to 3.0% at $9.19 per unit (8.7% yield) from 2.3% after the shares dipped in August after reporting a mediocre quarter.  Like almost everything energy related, the shares looked quite oversold in mid-August – which saw Raymond James initiate coverage on the company with an “Outperform Rating” and $12.00 Target price.  If you recall we had recently reduced our position in Crius Energy Trust from 3.1% of the portfolio to 1.5% at $10.70 in April this year, and then added back to our position at $9.80 in June prior to our additional purchase this month at $9.19 (our average cost is now $8.94 per unit).  Crius Energy Trust closed August at $9.57 per unit – and the current consensus 12-month price target is $11.90 (Bloomberg).
     
  5. We increased our direct equity position in American Hotel Income Properties REIT (HOT.UN) from 3.5% to 4.5% in August at $9.13 per unit (8.9% yield) after the company report a lackluster quarter – which triggered a sharp decline from the previous month’s close of $9.91 per unit.  The company now owns 113 hotels which total over 11,500 rooms, located in 90 cities (32 states).  HOT has a very experienced management team and has been expanding quickly – part of the reason for the poor equity performance recently (the Canadian equity market has had trouble digesting the frequent financing transactions recently that have supported the company’s flurry of accretive transactions in the U.S.  However, at current prices this REIT looks very attractive to us.  The current consensus 12-month price target is $11.25 per unit (Bloomberg) –an expected 12-month return of ~34% including distributions (based on month-end price of $9.01).  
     
  6. We bought a new 0.9% position in the Exchange Income Corp (EIF) 6.00% 31MAR21 $31.70 convertible debenture at 105.98. EIF closed August at $33.26 per share (up 15.3% in August) which moved our new convertible up to 111.00 at month-end.  We also continue to own a 2.5% position in the EIF 5.50% 30SEP19 $36.80 convert which closed August at 101.00 – and can also provide significant upside if the analysts are right on where the shares are headed over the next year (current average consensus 12-month price target is $42.73 per share - Bloomberg).  EIF’s recent share price volatility is due to a public battle with an aggressive American short-seller – which is why we chose to exit our equity position in July.  Our convertible debenture positions have minimal downside in our opinion (back to par value 100) as the company has lots of flexibility and options to refinance as required – not to mention a current market capitalization of just over $1 billion of shareholder money at risk in front of ussupported by significant insider buying.  Our new convert position would have an intrinsic value of ~135 if the share price hits the consensus target price prior to our debenture maturing or being called (~ 116 for our 5.50% 30SEP19 $36.80 convert position).
     
  7. We bought a new 0.9% position in the AG Growth International (AFN) 5.25% 31DEC18 $55.00 convertible debenture at 109.00.  AFN closed August at $58.15 per share – so this convert is already “in-the-money” by $3.15 and has an intrinsic value of 105.70.  The convert provides significant upside potential if the underlying AFN shares approach the average consensus price target – now at $68.43 per share (recently bumped up by many analysts after strong quarterly results).  AFN is a Canadian based manufacturer of agricultural equipment – focusing on grain handling, storage and conditioning products for both farm and commercial markets.  The company’s market capitalization is approximately $940 million.
     
  8. We increased our position in the Premium Brands (PBH) 4.60% 31DEC23 $107.00 convertible debenture from 0.9% to 1.8% at 110.76.  Our average cost is now 105.38 in the model portfolio.  PBH reported strong quarterly results in August resulting in a number of analyst upgrades (the current consensus 12-month price target is $104.63).  PBH manufactures and distributes both “specialty foods’ and “premium foods” under approximately 40 different Brand names including Harvest, Grimm’s, Frebey, and Fletcher’s to name a few.  They are also a large supplier of freshly made and packaged sandwiches (i.e. the largest supplier to Starbucks of ready-made sandwiches and wraps for example).  PBH has a third “sandwich plant” coming on line in shortly – this latest one in Phoenix, Arizona, and sports a current market capitalization of ~$3 billion.


Finally, we are pleased to report that our 2.2% position in DREAM Global REIT that we bought back in July at $10.39 per unit (7.7% yield) closed August at $11.26 per unit (up 8.4% from our recent purchase).

Summary:

At month-end the portfolio’s cash position was sitting at ~5.6% and our convertible debenture exposure was approximately 36.7%.  Total Cash and Fixed Income exposure including our four 3rd party specialty fixed income manager positions was ~67.6% at month-end - basically unchanged from the end of July.  We expect that the recent changes to the portfolio will leave us well positioned to deliver solid returns over the balance of 2017, and the next year. 

We continue to strongly believe that the portfolio’s composition and flexibility offers a substantially improved risk/reward trade-off compared to an “income portfolio” relying only on government bonds and pure stock market exposure to drive returns and income. 

Please do not hesitate to contact me if you have any questions or concerns.

Sincerely,

Paul J. Borisoff
Senior Vice President, Portfolio Manager, Senior Investment Advisor

Canaccord Genuity Wealth Management
609 Granville Street, Suite 2200, Vancouver, BC  V7Y 1H2
T: 604.643.7083 | TF: 1.800.663.1899| F: 604.601.5942
E: paul.borisoff@canaccord.com | borrisoffcoxwealth.com