During the month of February, several Canadians will make an RRSP contribution in order to benefit from a tax deduction from their income. For this reason, you will be among many to have fresh cash in your account and wonder where to invest your money.
Using the 7 dividend growth investing principles, I’ve identified three companies offering growth opportunities for 2017.
Agrium (AGU) & Potash (POT)
I’ve included those two companies as the same entity since in the upcoming months, Agrium and Potash will proceed with a merger of equals. Potash corporation would own 52% of the new entity and Agrium would own the remaining 48%. I’ve always preferred AGU over POT for the simple reason that its business model is less volatile. POT is highly dependent of volatile commodities market as it is the world’s largest fertilizer producer. AGU sells fertilizer products to over 1,500 retail and wholesale locations across Canada and the United States. Agrium is the leader in the U.S. market with 17% market share where the second position shows 7% (source Motley Fool). This company is also evolving in a highly-fragmented market leading to more growth-by-acquisitions opportunities in the future.
How both company will benefit to each other? Well, Potash is in a relatively uncomfortable situation with the ever-decreasing price of Potash, forcing POT to cut its dividends twice in 2016. Adding more diversification and stability to its revenue source is the primary goal. On the other hand, Agrium will benefit from a vertical integration leading to a better control over its costs. As AGU already shows growth vectors through potential acquisitions, the company will be able to benefit from stronger cash flow due to the synergy created with POT.
The synergy created by this merger will create a giant in the fertilizer industry. In the event of commodities price bounce back, the new AGU-POT will be in the best position to benefit from this situation.
There is always an additional risk to enter in a position of a company that is about to make an important financial move. While Agrium business model already shows growth opportunities, Potash desperately needs such merger to continue navigating through challenging economic perspective in this industry.
The expected synergy might not be as strong as anticipated and Potash cash flow problems (it cut their dividends twice in 2016) might affect Agrium dividend policy.
Speaking of which, the dividend perspectives at this point are hard to assess. I believe that the new giant of fertilizer will benefit from both a vertical integration and additional cash flow coming from direct sales through Agrium network. Therefore, I think the new company will pay a dividend and will aim at increasing it in the years to come.
I will use a double stage dividend discount model to determine the value of the other two companies in this article. Unfortunately, I can’t perform such assessment for AGU-POT.
Emera is a very interesting utility now that they have completed the purchase of the Florida based TECO energy. EMA now shows $28 billion in assets and will generate revenues of about $6.3 billion. It is well established in Nova Scotia, Florida and four Caribbean countries.
This utility counts on several “green projects” with hydroelectricity and solar plants. This decreases the risk of future regulations affecting their business as the world is slowly moving toward greener energy.
The biggest risk that could face Emera is a rapid rise in interest rate. As they have pursued a growth-by-acquisitions strategy and they have used more debts to finance the Maritime Link, higher interest rate would slow down Emera’s appetite for growth projects in the future.
Emera has been increasing its dividend payment each year for over a decade now. With the purchase of TECO energy, management intends to continue its tradition. The company forecast a 8% dividend growth rate throughout 2020 while targeting a payout ratio of 70-75% (Emera Investors Presentation). At 4.5% dividend yield, this is a keeper for several years.
As I rather use conservative numbers, I have decided to use a 5% dividend growth rate for the next 10 years and increase it to 6% after this period. The fact is that EMA built a stable business model and shows interest in growing by acquisitions, and will sustain the dividend growth policy. Here are the details of my calculation:
Source: Dividend Toolkit excel spreadsheet calculator
Telus shows a perfect balance of stability, dividend increase, and financial performances. Strong from its mobile revenues, Telus is now observing television services as a growth vector. Telus has built a solid brand through stellar client service enabling the company to show the best customer satisfaction surveys.
Source: Telus investor FACT sheet
I like that Telus evolves in an oligopoly where there are two other major competitors: BCE (BCE) and Rogers Communications (RCI.B.TO). Among those three companies, they control 80% of the mobile market shares. Current federal regulations and the fact that Canadians are well tied to those companies makes it very difficult for any world telecom giants to enter this market.
While the oligopoly protects a part of TU business, it also limits its growth potential. The Canadian market will eventually be saturated as there is a maximum of cell phone services one can have. This is one of the reasons why Telus is going after television clients at the moment. Long term growth perspectives may not become very exciting in a few years from now if the company doesn’t create new growth vectors.
Telus has aggressively increased its dividend payout over the past 5 years going from $0.29/share to $0.48/share. This had pushed the dividend payout ratio higher (75%), but the company still has enough room to increase it for several years to come. I now expect the dividend growth to slow down to high single digit (6-7%).
In order to perform the DDM on Telus, I’ve used a 7% dividend growth rate for the first 10 years and reduced it to 6.5% after this period. Considering Telus evolves in an oligopoly, its economic environment shouldn’t change rapidly and should help management keep their dividend growth policy. Here are the details of my calculations:
Note that figures are in CAD but Telus trades on both markets (TSE:T or NYSE:TU).
Final Thoughts – I prefer Emera
While I own those three companies (long AGU, no position in POT), if I had to pick up only one out of this group, it would be Emera. The company shows a solid business model. The years to come look bright considering management’s intention to grow their distributions by 8% each year.
Disclaimer: I hold AGU, EMA, TU in my Dividend Stocks Rock portfolios.
The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.