Weak markets do hold promise

Building an investment portfolio is a particularly difficult task at potential turning points in the market.

At market lows, investors not only have to be aware of additional downside risk, but must worry if they’re getting into stocks too early.

And at market tops, an investor’s major concern is whether he’s making the classic mistake of buying at the highs.

But when markets are down, investors can make big gains when things do turn around.

Consider the performance of the five-stock mini-portfolio we unveiled in February 2009.

The five names — Automatic Data Processing Inc. (ADP-NASDAQ, $77.37), Bank of Montreal, (BMO-TSX, $73.82), Enbridge Inc. (ENB-TSX, $50.65), and consumer goods stocks Johnson & Johnson (JNJ-NYSE, $98.26) and Tim Hortons Inc. (THI-TSX, $60.92) — have since averaged total returns of 150 per cent.

But those returns may be impossible to replicate over the months ahead, now that the current bull market has just completed its fifth year.

Since stocks bottomed out in March 2009, the TSX Composite Index has gained 93 per cent.

Meanwhile, the S&P 500 Index has surged almost twice as much with a 184 per cent advance that has taken it to new highs. After gains of that magnitude, it would only seem natural to assume that the easy money has been made in this rally and incremental gains will now be more difficult to come by.

Despite a market that’s likely to become more challenging as the bull continues to rampage, we released our inaugural model portfolio of 15 stocks on March 3.

When it comes to investing, we reasoned, there’s no time like the present, right?

In building our portfolio, we faced a dilemma. Should we load up on energy and commodity producers because of their attractive valuations and dividend yields?

Or should we shun these sectors because of their cyclicality? Moreover, what about the current advanced stage of the economy?

Eventually, we decided to include a significant number of these stocks based on our opinion that they could benefit from the expected acceleration in global growth this year and next.

But we balanced these cyclical candidates with several stocks in defensive sectors.

Our portfolio initially consisted of 10 Canadian Stocks and five U.S. stocks. Here are five from the Canadian stocks portion:

Fortis Inc. (FTS-TSX, $31.48). Canada’s biggest investor-owned gas and electric utility, Fortis continues to grow through targeted acquisitions, with its pending purchase of Arizona-based UNS Energy being its fourth big deal over the past decade.

This US$4.3 billion acquisition increases Fortis’ geographic diversification, as U.S. regulated utilities will make up one-third of the company’s total assets.

In the first full year after the deal closes, which is expected by the end of 2014, the acquisition is expected to be accretive to net earnings per share.

To its credit, Fortis has raised its annual dividend for 41 consecutive years — a record for a Canadian public company.

This record is backed by the company’s stable cash flows, with regulated utilities and hydroelectric generation expected to account for 97 per cent of assets after the UNS deal is finished.

Yield tops four per cent

In the meantime, we believe the 13 per cent decline in Fortis stock from its 52-week high in May 2013 represents a great buying opportunity. The company now boasts a dividend yield of just over four per cent.

Hudson’s Bay Co. (HBC-TSX, $18.82). The iconic Canadian retailer of consumer goods was taken private in 2006, only to go public in 2012.

Known for years as The Bay, the company bought luxury retailer Saks Inc. in November 2013.

Hudson’s Bay stock could have significant upside from the potential monetization of its real estate.

Meanwhile, in February, the company completed the sale and leaseback of its Queen St. flagship store and Simpson Tower office complex in Toronto for $650 million, with sale proceeds earmarked to reduce debt.

Several analysts think the spinoff of Hudson’s Bay’s remaining stores, which total roughly 15 million square feet, into a REIT could unlock huge value, similar to that realized by Loblaw Cos. (L-TSX, $46.90) last year.

Manulife Financial Corp. (MFC-TSX, $21.41). Manulife had a banner year in 2013, climbing 55 per cent.

And the Toronto-based financial services giant may be able to build on that performance this year thanks to rising bond yields and strong equity markets.

In 2013, Manulife’s net income jumped 73 per cent to $3.1 billion, while its core earnings rose 16.4 per cent to $2.6 billion or $1.34 a share.

Although its insurance revenue fell 13 per cent to $2.8 billion in 2013 due to lower sales in Japan and the U.S., its wealth management revenue rose 37 per cent to a record $49.7 billion.

Indeed, funds under management grew almost 13 per cent to $599 billion at year-end, setting a record for the 21st consecutive quarter.

In the meantime, Manulife boasts several catalysts that may help propel its stock higher.

For starters, it appears to be on track to meeting its goal of $4 billion in core earnings by 2016, with profitability and growth driven by expansion in Asia, as well as its strong position in North America.

Manulife also has a strong capital ratio of 248 per cent, which gives it room to raise dividends when its core earnings stabilize.

In addition, the company continues to hedge its sensitivities to both lower interest rates and equity markets.

For our part, we now rate Manulife as a “buy” with a price target of $24 a share. The stock has a dividend yield of 2.4 per cent.

Talisman Energy Inc. (TLM-TSX, $11.17). More than most other stocks in our portfolio, Talisman has a higher degree of risk.

But by the same token, it also has significant upside if it succeeds in its strategy of selling non-core assets and using the proceeds to pay down debt which, at year-end, was $4.8 billion.

Talisman reportedly made progress last year on its four main priorities, as it cut capital spending by 20 per cent, improved operating efficiency and reduced costs while announcing more than $2 billion in asset sales.

Meanwhile, Talisman may find support at current depressed levels from its discount valuation relative to its peers.

Carl Ichan, the American activist investor who has a 7.3 per cent stake in Talisman, has nominated two members to its board.

Although the company’s attractive slew of assets in North America and Asia has given rise to occasional takeover speculation, its debt load and other baggage may put off serious bidders.

Nevertheless, for investors who can handle a moderate degree of risk, Talisman is an interesting value proposition.

Toronto-Dominion Bank (TD-TSX, $51.61). The Green Machine should benefit from a steepening of the yield curve. Not only could this boost TD’s net interest margin, but it could also widen its exposure to the U.S. economy.

Bank tops the list

With over $900 billion in assets, TD is the biggest Canadian bank according to that metric, as well as the second-biggest by market cap.

It’s also one of the 10 biggest banks in the U.S., boasting more branches south of the border than in Canada.

TD made a great start to the current fiscal year, posting a record profit in the first quarter.

Indeed, its adjusted net income rose six per cent from a year ago to $2 billion, while its revenue jumped 15 per cent to $7.6 billion.

The gains in the profit column were led by a 44 per cent surge in net income for TD’s wholesale banking business which, in turn, was buoyed by higher trading revenue, as well as higher advisory and underwriting fees.

In Canadian retail banking, TD saw net income rise five per cent to a record $1.3 billion, reflecting solid growth in both loans and deposits, higher assets under management, along with favorable credit performance.

Retail business shines

In the U.S., TD’s retail business also did well, posting a five per cent rise in net income to US$398 million. Not only did this reflect strong volume growth, it also reflected contributions from Toronto-Dominion’s recent acquisitions.

In February, TD raised its quarterly dividend 9.3 per cent to $0.47 a share. In fact, over the past five years, it has raised dividends by an average of 6.8 per cent annually.

Although TD has slipped about two per cent since hitting a record high on March 24, a repeat of its first quarter performance could see it power ahead to new highs over the rest of this year.


Elvis Picardo is vice president, research, as well as portfolio manager at Global Securities Corp. in Vancouver. He owns stock in both Manulife Financial and Talisman Energy.


Investor’s Digest of Canada, MPL Communications Inc.
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