Canadian Stocks Analysis

Buy List stock for November 2023: TD Bank (TD.TO / TD)

A stock that remains on my buy list for November is Toronto-Dominion Bank (TD.TO/TD). I look at TD as a core holding, because it meets all my investment requirements and it’s a stock that I would hold for a long time, while reviewing it quarterly for good measure. Here’ why.

TD has a very lean structure that plays a significant role in its expansion. It also has a solid dividend growth history, and management recently rewarded shareholders with several dividend increases. Plus, it has a significant presence in the US compared to other Canadian banks.

TD.TO Business Model

Toronto-Dominion Bank operates as a bank in North America. TD’s segments include Canadian Personal and Commercial Banking; U.S. Retail; Wealth Management and Insurance; and Wholesale Banking.

Canadian Personal and Commercial Banking offers a full range of financial products and services to approximately 15 million customers in Canada.
S. Retail offers a range of financial products and services under the brand TD Bank, America’s Most Convenient Bank. It also TD Auto Finance U.S., TD Wealth (U.S.) business.
Wealth Management and Insurance provides wealth solutions and insurance protection to approximately six million customers in Canada.
Wholesale Banking operates under the brand name TD Securities and offers a range of capital markets and corporate and investment banking services to corporate, government, and institutional clients.

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TD Investment Thesis

Over the years, TD has increased its retail focus, driven by lower-risk businesses with stable, consistent earnings. The bank enjoys the largest or second largest market share for most key products in the Canadian retail segment. TD keeps things clean and simple as the bulk of its income comes from personal and commercial banking. It has sizeable exposure in major cities like Toronto, Vancouver, Edmonton, and Calgary, combined with a strong presence in the US.

With about a third of its business coming from the U.S., TD is the most “American” bank you’ll find in Canada. If you are looking for an investment in a straightforward bank, TD should be your pick as increasing retail focus, large market share in Canadian banking, and U.S. expansion are key growth enablers for TD Bank. The 13% stake in Charles Schwab (SCHW) is another interesting growth vector.

TD.TO Last Quarter and Recent Activities

In August, TD reported a disappointing quarter with net income down 2% and EPS down 5%, but it could have been worse. TD’s results were affected by amortization charges, acquisition & integration costs, the termination fee of the acquisition of First Horizon, and strategy costs to reduce the interest rate impact on their balance sheet.

We do like a proactive bank that takes steps now instead of doing what US regional banks did a few months ago, which was nothing! Canadian Personal and Commercial Banking net income was down 1%, mainly due to higher provisions for credit losses (PCLs). US retail was down 9%, hurt by higher PCLs and termination fees on the acquisition. Wealth Management & Insurance was down 12% while Wholesale was flat. TD also announced a 5% share buyback program.

There weren’t any news about TD in October, so we are patiently waiting for the end of November to look at their earnings!

Potential Risks for TD Bank

The housing market has been a concern since 2012. However, TD seems to be managing its loan book wisely and the Canadian economy has been remarkably resilient as well. A higher insured mortgage level in the prairies seems adequate while TD continues to ride the ever-growing downtown Toronto housing market tailwind. As interest rates rise, TD’s loan book will profitably generate stronger income. However, this also comes with increased risk of defaults and slow volume growth.

TD must identify other growth vectors because consumers can’t borrow continuously, even more so with higher interest rates slowing down the economy. It is important to follow the bank’s provision for credit losses, which have risen in the latest quarters. So far, everything is under control, but a recession still looms. In early 2023, TD paid $1.6B in a settlement related to a Ponzi scheme (Stanford Litigation Settlement). While this is treated as a one-time event, it still affected their quarterly earnings report.

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TD.TO Dividend Growth Perspective

TD is a Canadian dividend aristocrat (which allows them a “pause” in their dividend increase streak). TD shareholders were lucky enough to enjoy a dividend increase in early 2020 (+6.8%), right before regulators forced a break in dividend growth. In 2021, the bank rewarded investors with a 12.7% dividend increase. It returned with a more regular increase in 2022 (+7.8%). Going forward, you can expect a mid-single-digit dividend increase as payout ratios are quite low and TD is well capitalized.

For more about dividend aristocrats and the paused dividend growth for Canadian banks, listen to my podcast.

Graph showing steadily increasing dividend payments for TD Bank over years, except when regulators forced pause during pandemic — Steady dividend growth except when regulators imposed a pause

Final Thoughts on this Buy List Stock

Its legal settlement early this year and the general economic landscape may have seemingly taken some of lustre away from TD, but it has a lot on offer for dividend-growth investors. A lean structure conducive to expansion; growth potential through its focus on Canadian retail banking, its US exposure, and its stake in Charles Schwab (SCHW); and dividend growth.

We have TD in the DSR retirement and 500K portfolio models, for both Canada and the US. A stock to consider if you’re looking for holdings in the financial sector.

Market-Beating High Yield Canadian Stocks

High yield Canadian stocks that beat the market? Yes, here are some examples. After writing so much about the virtues of low-yield, high-growth stocks, it’s time to talk a bit about high-yield stocks. To be fair, they’re not all bad investments. Some provide a fairly sustainable source of high income for investors, and some even manage to beat the market!

High yield Canadian stocks that keep giving

I searched for high yield companies that also matched the overall stock market performance of late. On October 7, the iShares S&P/TSX 60 ETF (XIU.TO) 5-year total return (capital + dividends) was about 52% and the SPDR S&P 500 ETF Trust (SPY) was about 74%. So, I search for all companies generating a total 5-year return of at least 50% and a yield of at least 6%; this returned 101 stocks.

Here are three of the Canadian stocks that provided high yields while matching or outperforming the market for total return over the last 5 years. Caution: there’s no guarantee that they will keep performing that well in the future, especially with a long-predicted recession looming. As always, do your due diligence when considering any investment.

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Capital Power (CPX.TO) 6.03%, +89.62%

Not long ago, Capital Power was a darling as its stock price defied gravity while other utilities were doing down. While the market has some reservations about utilities due to their sensitivity to interest rates, CPX continues to show a relatively strong dividend triangle. Management increased the dividend from $0.58/share to $0.615/share. A 6% increase in the middle of an “interest rate crisis” is bold and shows strong confidence.

CPX is dependent on Alberta’s economy, where it generates 56% of its electricity and 62% of its revenues. That is a concern. It means its share price tends to move up and down with the oil market. As a capital-intensive business, CPX must invest heavily and continually to generate cash flow. The market might not like additional debt to fund projects in the coming years. With interest rates rising, this debt could become a burden and obtaining liquidity from capital markets might get more difficult. Finally, weather variations can affect results as seen recently when a warm winter reduced AFFO.

Considering its wind energy projects and the robust economy in Alberta, CPX expects to increase its dividend by 6% through to 2025, welcomed news for income seeking investors. Through its successful transformation into a more diversified utility company, CPX is earning its place among robust Canadian utilities such as Fortis, Emera, and the Brookfield family.

Enbridge (ENB.TO), 7.90% yield, +50.20%

I smiled at the 50% total return for Enbridge as I remembered buying it in 2017 and selling at the beginning of 2023 with a good profit. ENB is a good example of a deluxe bond that could eventually evolve into a dividend trap!

With inflation and higher interest expenses, Enbridge faces higher operating costs. This could seriously jeopardize growth because ENB can’t find any growth vectors without getting into more debt. In September 2023 ENB announced it was taking on more debt and issuing shares to acquire a gas transmission business for $19B CAD. I like the predictable cash flow it’ll bring, but I’m concerned about the ever-increasing debt level.

Total long-term debt stands at around $80B, up from $67B in 2017; it’s time to see some debt repayments. ENB’s interest expenses are continuing to increase, and it won’t end any time soon. Since building and maintaining pipelines requires significant amounts of capital, ENB may find itself in a position where cash is short.

Enbridge operates high-quality assets, with almost impenetrable barriers to entry. There’s no doubt the business model is solid. The problem is the rising debt level. ENB won’t be able to rely on its pipelines forever; many projects were revised or paused by regulators over the past few years. TRP’s latest Keystone pipeline spills remind us of the environmental risks of this industry.

ENB has paid dividends for 65 years, with 28 consecutive years with a dividend increase. Further dividend growth is expected at around 3%. Management aims to distribute 65% of its distributable cash flow, keeping enough for CAPEX. Consult their latest quarterly presentation for their payout ratio calculation.

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Labrador Iron Ore Royalty Corp (LIF.TO) 8.89% yield, +101.4%

LIF receives a 7% gross overriding royalty on iron ore products sold by Iron Ore Company of Canada, a producer and exporter of iron ore pellets and high-grade concentrate. The mine enjoys a high-quality source of products with sufficient inventory to support future expansion. IOC is well-positioned strategically due to the high quality of the iron ore and its ability to produce higher margin pellets.

LIF’s business model depends on factors that are barely in its control; commodity prices, unions, and demand that can affect production of the underlying business. Since we only have data from 2010, we have yet to see how LIF will navigate a recession. However, we can see the effect of an iron spot price decline, and how quickly it happens, as it did in 2022.

The company must keep a large cash reserve for additional CAPEX. After all, the royalty-based business is only good if you have high-quality assets. The narrative has been quite enticing as LIF surfed on the highest iron prices in its history, and demand seemed stable. Things took a turn, and both the stock price and dividend dropped.

LIF pays a variable dividend: base payment of $0.25/share quarterly + special dividend based on royalties received. You can’t expect a stable dividend, but a yield usually in the high single-digit to double-digit! The generous yield is inflated by the royalty payments.

When iron ore trades at a high price, LIF seems the most generous stock in town. The opposite is also true. Demand for iron ore will come and go, affecting its price, and, therefore, your dividends. It’s not a bad investment if you’re able to stomach the price and dividend fluctuations.

Last thoughts about high yield Canadian stocks

As you know, I prefer higher total return over high yield. Overall, low yield high growth stocks provide higher total return, so I favor them for my dividend growth investment strategy. However, a few solid higher yield companies that match or exceed the market can be good assets to have in a portfolio. Be sure to monitor them quarterly though, to ensure they don’t become dividend traps!

Buy List – October 2023: Canadian National Railway

My buy list for October 2023 has a new entry: Canadian National Railway (CNR.TO /CNI). I just love buying Canadian National Railway when the market expects a recession!

Railways are incredibly stable because there aren’t any other assets that can replace them in North America. Yet each time transportation volumes go down, the market tends to sell them off. It happened last in 2016, and we highlighted CNR.TO / CNI back then as well. Here we go for another round!

Canadian National Railway has been known as “best-in-class” for operating ratios for many years. CNR continuously worked on improving its margins and was among the first to do so. Today, peers have caught up and all railways are managed the same way.

CNR’s transportation activities are well diversified across seven different industries. Its exclusive access to the Prince Rupert port is advantageous for intermodal transportation. CNR enjoys a very strong economic moat as railways are virtually impossible to replicate.

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CNR.TO Business Model

A transportation and logistics company, Canadian National Railway’s services include rail, intermodal, trucking, and supply chain services. CNR rail services offer equipment, customs brokerage services, transloading and distribution, private car storage, and more.

CNR’s intermodal container services help shippers expand their door-to-door market reach with about 23 strategically placed intermodal terminals, with services including temperature-controlled cargo, port partnerships, logistics park, moving grain in containers, custom brokerage, transloading and distribution, and others.

CNR’s trucking services include door-to-door service, import and export dray, interline services, and specialized services. Its supply chain services offer comprehensive services across a range of industries and product types. CNR transports more than 300 million tons of natural resources, manufactured products, and finished goods throughout North America every year.

Investment Thesis

Canadian National Railway owns unmatched quality railroad assets. With its strong economic moat, we can rely on increasing cash flows each year. There isn’t a more efficient way to transport commodities than by train.

The good thing about CNR is that investors can always wait for a down cycle to buy. Since we see railroads as attractive investments, we usually spot the opportune moment. Considering Q2 2023 results, it seems such a moment is here.

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CNR.TO Last Quarter and Recent Activities

With its Q2 results Canadian National Railway sent a strong signal that the economy is slowing down with revenue down 7% and EPS down 8% for the quarter. Revenue decreased mostly because of lower volumes of intermodal, crude oil, U.S. grain exports, and forest products. Volumes shrunk as demand for freight services to move consumer goods lowered and Canadian wildfires caused customer outages.

Rounding up the reasons for the decline were lower ancillary services including container storage, and lower fuel surcharge revenues as fuel prices decreased. CNR updated its full-year outlook, now expects flat to slightly negative year-over-year growth in adjusted EPS.

Potential Risks for CNR.TO

Railroad maintenance is capital intensive and could adversely affect CNR in the future. It’s a difficult balance to obtain an efficient operating ratio and well-maintained railroads. To maintain its network, CNR must make substantial reinvestments continually. However, CNR continues to boast one of the best operating ratios in the industry.

From time to time, CNR’s growth can be negatively affected by its dependence on the Canadian resource markets. When demand for oil, forest, or grain products is low, demand for CNR’s services obviously slows down accordingly. For example, the pandemic caused a slowdown in weekly rail traffic of about 10% over the summer of 2020. As you can see in the graph below, even that didn’t derail (couldn’t resist) CNR’s revenue much or for very long.

When the oil price is low, trucking steers some business away from railroads. CNR is a captive of its best assets since you can’t move railroads!

Get acquainted with other great Canadian stocks, read Canadian Forever Stock Selection.

CNR Dividend Growth Perspective

Canadian National Railway has successfully increased its dividend yearly since 1996. The management team ensures they use a good portion of CNR’s cash flow to maintain and improve railways, while rewarding shareholders with generous dividend payments. CNR exhibits an impressive dividend record with very low payout ratios. To learn more about payout ratios read this article.

While the business faces headwinds periodically, its dividend payment will not be affected. Shareholders can expect more high single-digit dividend increases. The railroad company kicked off 2023 with an impressive dividend increase of 8%. If you can grab CNR with a yield of approximately 2%, you’re making a good deal!

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Final Thoughts on Canadian National Railway

Despite CNR’s capital-intensive requirements and reliance on the Canadian resource markets, we believe Canadian National Railway will come sailing through the current economic downturn and maintain its dividend increases.

With CNR’s unmatched-quality railroad assets almost impossible to replicate, and its management taking on the challenges of the current environment, we could see more growth emerging from all this. Also, CNR will benefit from the cancellation of the Keystone XL pipeline which will drive demand for oil transport via railroads. With a current yield above 2%, CNR is definitely worth a look.

Why I Sold Enbridge and TC Energy

Back in February 2023, as part of my quarterly review of the DSR portfolios and my personal portfolio, I sold all shares of Enbridge (ENB) and TC Energy (TRP).

Many wonder why on earth I would do such a thing. After all, they are much beloved pipeline stocks with impressive dividend profiles; generous yields, 28 years of consecutive dividend increases for Enbridge, TC Energy not far behind with 23 years, and both are part of the 15 Canadian stocks with the longest dividend growth streaks.

Are they unsafe investments? Are their dividends at risk? Should you sell them too? The answers are 1) no, 2) no, and 3) you have to decide for yourself by doing your due diligence; review these companies quarterly to see if they are still a good fit for your investment thesis. Just because I sold them does not mean you should too.

Are Enbridge & TC Energy still safe investments?

Both companies will continue supplying an essential service and they will keep generating substantial cash flow. Like railroads, they are not going anywhere. The world needs energy and pipelines are the ones providing it. They enjoy robust contracts with their customers that, usually, are shielded against inflation and include a minimum fee that ensures the customers pay even if the pipeline is not used.

Are ENB & TRP dividends safe?

Despite their triple-digit dividend payout ratio, show in the graph below, ENB and TRP dividends are safe for now.

Let me explain. At the time of writing, the dividend payout ratio for ENB is over 200% and close to 200% for TRP, which says that they are paying more than, or close to, twice what they earn as dividends. Not good, right? Well, that’s not the complete picture here.

The payout ratio is based on earnings, and the calculation of earnings includes non-cash items such as depreciation and impairments. Non-cash items do not affect the amount of cash a company has to pay dividends.
Capital expenditures (CAPEX) are also included when calculating the earnings and payout ratio. Pipelines are capital-intensive businesses. CAPEX fund infrastructure projects, including investments that the company expects will be profitable and generate new revenue in the future.

To get a clearer picture of ENB and TRP’s ability to pay their dividends, we looked at the Distributable Cash per Share (DCF), which does not include non-cash items or CAPEX. The payout ratio, when calculated using the DCF rather than earnings, is well below 100% for both ENB and TRP. So yes, both pipelines can afford to pay their dividends based on the cash they generate. That doesn’t mean everything is perfect and rosy in pipeline land.

Reasons for selling Pipelines

While both ENB and TRP have done relatively well in our different DSR portfolios and I believe their dividend is safe for now, the dividend growth has slowed down and I don’t see much potential for capital appreciation going forward.

Slowing dividend growth for both ENB.TO and TRP.TO

ENB was increasing its dividend by 10% yearly before slowing down to 3% per year starting in 2021. TRP had 7% to 8% dividend increases until it lowered the targeted rate to 3% to 5% increases, although the last two increases were closer to 3%.

What is slowing down the dividend growth? Quite simply, it is getting more difficult for Enbridge and TC Energy to make money; inflation is pushing their costs up, and higher interest rates are making their debt more expensive.

It costs of lot money to maintain and expand pipeline infrastructure, so both ENB and TRP rely on borrowing. The rise in interest rates, started in 2022, has already increased ENB and TRP’s interest expenses. With both the U.S. Federal Reserve and the Central Bank of Canada clearly not expecting interest rates to go down in 2023, it will only get worse for ENB and TRP as they pay back their older debt, at the lower pre-2022 rates, and add new debt at the higher rates.

Inflation and increasing interest rates are hurting ENB and TRP. This will go on for a while, limiting their ability to increase their dividends. While their yields are generous, as a dividend investor, I look for robust dividend growth.

ENB & TRP shares price won’t go anywhere

In the current landscape, I do not see a lot of room for capital appreciation for ENB and TRP.

They lack growth vectors. New pipelines are difficult to build; they are subject to substantial regulations and are expensive to build. There are often delays in construction, for a variety of reasons including supply shortages, labor shortages, and regulatory complexities, which translate into higher costs, even more so now that inflation has kicked in.

ENB and TRP will also have to deal with Canadian carbon emissions taxes that are expected to increase to $170 a ton by 2030 from $40 today. Enbridge is already on board to reduce its emissions to offset this increase but doing so requires considerable capital investments.

These obstacles to growth are only made worse by the higher interest rates that make borrowing more expensive.

In closing: Why I sold Enbridge and TC Energy

Besides enjoying a generous dividend, I don’t see how ENB and TRP will make me richer over the coming years. Since my strategy is focused on total returns by selecting dividend growers, they do not meet my investing strategy. Both pipelines will either end up as deluxe bonds or dividend traps.

Having said that, I think it’s fair to say both END and TRP will continue to pay their dues for a while. There is a case for holding on to them for stability and income; however, it is essential to follow them with great attention quarterly. If you see more references in their quarterly reports to higher cost of debt, high debt ratio, impairments and charge due to delays and inflation, you’ll know that the dividend safety is under pressure.