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Two Canadian Dividend Stocks on Sale

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In a nutshell:

  • The latest market drop did not create amazing opportunity because it only dropped five percent.
  • However, there are companies that have decreased to double-digits for a while during this bull market.
  • Here are two of my favorite Canadian stocks that are deeply undervalued.

I am not going to tell you that the market dropped like a rock last week or that there are “stocks on sale” due to the latest drop.  You have already been submerged by those kind of stories already, right?  In fact, I want to talk about companies that have been deeply suffering for a while now.  You may think the TSX is on sale right now, but in fact, it is only down five percent.  Would you rush into the store if Boxing Day could get you five percent off of your next TV?

Source : Ycharts

I am talking about real stocks on sale that are deeply discounted.

For reasons I cannot explain, Canadian stocks, especially dividend ones, are completely ignored right now.  Great companies that I found overvalued, or fairly priced at best, are now on deep discount.  The worst part is that everybody is passing by the shelves and leaving them there.  Halloween is in two weeks and if you sit tight, you will get spooked by stocks falling faster than kids eating candy.  I have a few suggestions for the most courageous.

Cineplex (CGX.TO); a Horror Movie

Cineplex is Canada’s largest movie theatre operator with a huge market share of seventy-eight percent.  Including one hundred sixty-four theatres with one thousand one hundred sixty-seven screens.  With the rise of home theatre, we would have thought that the classic cinema date would become outdated. However, Cineplex was able to improve consumers experience with various combo offers, games, and VIP treatments.

As Cineplex evolved its business model toward more premium services, it enjoys not only a huge market share, but is able to generate interesting margins.  Cineplex is also in line with a successful online streaming platform.  Finally, CGX is gradually building a serious bond with its clients through SCENE loyalty program.  From six hundred thousand members in 2006, SCENE now counts almost eight million members.

Potential Risks

A poor movie line-up, minimum wages going up to fifteen dollars an hour, and difficulties to convince the market its business model will thrive in the future; this is what is happening recently around Cineplex.  Cineplex is highly dependent on what Hollywood puts on screen for our entertainment pleasure.  2017 was a horrible year in term of blockbusters and CGX paid the consequences.  With minimum wages rising everywhere and massive reinvestment needed (in new concepts such as the REC room), margins may also get hurt.

Dividend Growth Perspective

CGX has the advantage of paying a monthly dividend around five percent, which is great for income seeking investors.  On top of that, CGX pays its distribution monthly.  While the market feared a dividend cut, the movie giant offered investors a pay raise of 3.57% a few months ago.

Management remains cautious about its payout and I have reduced our dividend growth perspective accordingly (2% for the next 10 years).  Considering its current yield, I think CGX is a great pick as its distribution will follow inflation.  A strong leadership presence and steady income should be enough to reward shareholders.

What Will Happen Going Forward

I believe that this dominant player in the movie theatre business in Canada will continue to thrive.  For a moment, investors did not believe in my investment thesis and the stock plummeted.  2017 was a terrible year in the movie industry with a lack of blockbusters and poor overall attendance.  However, this summer, CGX reassured the market with EPS up from $0.02 to $0.38 and revenue growth of +12.4% ($409M).

Source: Ycharts

CGX finally posted a great quarter and shares surged back to $30 and up.  Strong revenue growth was supported by higher attendance (+5%), stronger box office per patron (+4.4%) and higher concession revenues per patron (+9.3%).  Free cash flow surged by 142% providing more room for management to support its dividend.  After reading this, one should understand why CGX increased its dividend last month.  New Rec Rooms are also bringing additional diversification and strength to the Cineplex business model.

BCE (BCE.TO): Will it let you hang yourself in there?

BCE is the largest Canadian telecom by market cap and about twice the size of Telus.  It shows the most balanced business model among this small group.  BCE has shown a very solid dividend profile for several years and my analysis proves it will continue to rise in the future.  All BCE services are based on some sort of monthly subscription, generating a consistent base for cash flow.

When you have the possibility to invest in a strong yielder like BCE and still hope for a small stock appreciation growth, you must take a hold of it.  BCE shows a well-diversified business model and will continue to generate strong cash flow in the future.  The company is a real money printing machine.  As BCE is part of an oligopoly (Telus, Rogers and BCE controls about 90% of wireless market), there is limited competition and high barriers to entry.  Since BCE offers a wide array of products, it can increase revenue generated by each customer.

Source: Ycharts

Potential Risks

BCE debt level is not be underestimated.  BCE is a giant with a giant debt.  That giant debt is sometimes compared to a $24.1B tab at the bar.  While BCE debt to equity ratio is lower than its peers (1.18 for BCE vs 1.47 for Telus (T.TO) and 2.17 for Rogers Communications (RCI.B.TO)), the dollar is a lot higher ($14.26B for Telus and $16.19B for Rogers).  This is not a perfect situation as interest rates are now rising.

As the Canadian Government keeps pushing for more competition in the wireless industry, BCE may see additional competitors adding more pressure on margins in the future.  One day or another, a major player will take its chance in the Canadian market and price will fall (good for customers, bad for BCE!). The simple mention of Verizon pushed the stock down a few years ago.

Dividend Growth Perspective

Management maintained a high, but under control, payout ratio over the past 10 years.  BCE’s current payout ratio is at 96%, but its cash payout ratio is at 82%.  Considering BCE is a real money-making machine, those ratios are manageable.

While distribution increased steadily since 2010, the payout ratio did not move much.  BCE should remain cautious, but there is room for dividend growth.  BCE is probably the best compromise for an income seeker.  While its stock is relatively stable, shareholders enjoy a steady yield.  Since payment is secure, BCE falls into the “buy and sleep” stock.

Want More?

If you are looking for high yield stocks, I suggest you read this article to understand how I pick them.  I make sure all of my picks show a safe dividend that will increase in the upcoming years.  A high dividend yield without growth is not interesting for me.  I am also hosting a webinar about my favorite stocks on sale this Thursday.  One would just have to follow-me to get all the information.

Do not get spooked by the market – here is my favorite Dividend Stocks On Sales

On Thursday, October 18th, I will be hosting a free webinar.  I will discuss more of my favorite dividend stocks on sale.  I aimed at companies with a strong dividend profile, but that has been ignored by the market like CGX.TO and BCE.TO.

Register to the webinar here (free)

Topic: Dividend Stocks On Sales

Date: Thursday, October 18th at 1pm EDT

You must register with Webinar Ninja to attend (if you did it in the past, no new registration is required). This is completely free and the webinar is free also. Webinar Ninja is the platform we use to run all our webinars. It works well and provide an optimal experience for everybody.

  • The presentation is about 30 minutes.
  • There will be a Q&A session of about 25-30 minutes.
  • The webinar works on Google Chrome or Safari from a laptop or computer. (not compatible with smartphones or tablets)
  • If you can’t make it on time, there will be a full replay available, but you must register to access it.

Register Here

Our webinar presentations are about 30 minutes long and the rest of the hour is dedicated to your questions.  We can discuss stocks, strategies or any economic events.  I will be happy to help you anyway I can, so prepare your questions.

Disclaimer: We hold CGX.TO, BCE.TO and T.TO in our Dividend Stocks Rock Portfolio

Looking for Zombies in a Red Market

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The market is down and then down again and now it seems that everything is  turning red, right? Even on Twitter, people are quick to remind us about the worst Mondays in history:

Source: OddStats

Now that we have this wind of panic on the market, it seems that everything you will buy will turn into a zombie. Once again, media is quickly reminding us many reasons for selling:

  • Trade war with China,
  • Interest rate increasing,
  • High household debt ratio,
  • Ridiculously high household debt ratio (Canadian),
  • Canadian housing market slowing down,
  • NAFTA negotiations going sideways,
  • Oil stocks are high, oil companies must go down (again?),
  • We are at the top of a bullish market (it must go down),
  • That’s a gloomy moment on the stock market, it seems that everybody is about to die, and this will be the apocalypse.

I found 100 survivors!

Honestly, I don’t really mind if my portfolio is up or down. I don’t mind because I have faith in my investing strategy and it has been proven right over the past 6 years.  However, I can understand that many of you are freaking out right now. Nobody wants to pick a lose and see it bleed in your portfolio, I get that.

For this reason, I’ve gone through the market and tried to find companies that are showing momentum. While the market is dropping like a rock, those companies are popping like flowers during spring time (Ugh, we just got more snow this Sunday!).

When I pulled out my screener, I looked for dividend paying companies (1%+) with a dividend growth policy in place (positive 5 years dividend growth) and… double-digit return in 2018 (as of April 6th 2018). I found exactly 100 of them (keep reading, you’ll get the full list!). But I thought of present you my favorite 3 first.

Source: ycharts

03 Andrew Peller (ADW.A.TO)

I’m cheating a bit with this one since Andrew Peller doesn’t pay a 1%+ yield anymore. What’s wrong with Andrew Peller? Nothing besides the fact the stock jumped by 66% over the past 12 months. ADW’s momentum hasn’t been slowed down this year as it is currently up by 17.5% ytd.

The company is Canadian’s largest wine retailer. I’ve discussed ADW a few months ago to my DSR members when I purchased some shares for my pension account (I’m up 52% for the record). I like this company because it is a dominant player in a highly fragmented market. ADW estimates owing 14% share of total volume of the wine market and a 37% share of total volume of the domestic wine market.

Andrew Peller manages several well-known brands and keeps growing through acquisition. Back in October 2017, it purchased 3 BC wineries (Black Hills, Gray Monk & Tinhorn Creek) for $95M. While its dividend yield is low, the company increases it by double-digit on a regular basis. Hurry-up as the next dividend increase of 10% has been announced for June 2018.

02 Canadian Tire (CTC.TO)

Who said that retailers are dead? Surprisingly, in the 100 list of survivors, you will find names like Target (TGT) and Macy’s (M). I honestly think this will not be a sustainable rhythm for them. On the other side, I’m not surprised to find Canadian Tire among the surviving warriors.

CTC has 2 major advantages that help it compete against the “Amazon disruption”. First, the company owns several exclusive brands like Motomaster and Mastercraft. Canadian Tire benefits from a strong bond with Canadians and they are looking for those brands.

Second, Canadian Tire also offers a wide range of large items. It is a little bit harder to ship tires or fishing boats and remain competitive for online stores. Canadian Tires can easily sell their stuff online and arrange pick-up at their stores. The company also owns its real estate that was spun-off to create additional value under the ticker CRT.UN (CT REIT).

01 Gentex (GNTX)

This is one of my favorite “under the radar” companies. Gentex dominates its main market (auto-diming mirrors) with a whooping 92% market share. In other words; nobody does auto-timing mirrors besides Gentex. The beauty in this market is that only 25% of cars offer this feature. This will be a growing market in the upcoming years as car safety is a growing concern.

Going forward, Gentex has developed SMARTBEAM that automatically shifts from high beam to low beam while crossing another vehicle. This technology is used in Europe but hasn’t been promoted in North America yet.

Finally, GNTX is also making auto-diming windows! This is being used for airplanes to increase passengers comfort. This is another way that GNTX will be able to use its patented technology to grow in the future. Management increased its dividend again by another 10% a couple months ago.

Do you want the 100 list? Here it is!

This Friday, I’ll send the full list to all Dividend Guy’s blog newsletter subscribers. If you haven’t subscribed yet, all you need to do is to enter you email here and your will be on the list for Friday’s sending.

I hope you will find a few good stock picks out of those survivor’s!

Disclaimer: I’m long ATD.A.TO, GNTX, CTC.TO

Top 10 Canadian Stocks for a Retiree’s Portfolio

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Last week, I discussed the difference between a retirement portfolio and a retiree’s portfolio. There is a big difference between investing for the future and withdrawing from this investment to live. I put my portfolio on fast forward and took a look at trades I would do to make the switch toward a retire-ready portfolio. I was quite surprised to see how different both portfolios were.

The point is that you must think about withdrawing money once you retire. Therefore, you need cash ready to be withdrawn, and you need a strong portfolio paying healthy dividend to support your lifestyle as much as possible. In a perfect world, we would all live off our dividend and give this well-built nest egg to our children. But the reality is otherwise.

My top 10 Canadian “Retirement” Stocks

To conclude this reflection on portfolio management, I’ve done some research and handpicked my top 10 Canadian dividend stocks for retirees. I could have selected the 6 big banks, 3 telecoms and 1 energy stock, and I would have been done within seconds. I’m actually starting with 2 banks and 2 telecoms, but I tried my best to build a solid portfolio with more options.

Royal Bank (RY.TO) 3.61% yield

I know, I didn’t want to take only banks, but a Canadian dividend portfolio isn’t one without a few banks, eh? Over the past 5 years, RY did well because of its smaller divisions acting as growth vectors. The insurance, wealth management and capital markets pushed RY revenue. Royal bank also made huge efforts into diversifying its activities outside Canada. Canadian banks are protected by federal regulations, but this limits their growth. Having a foot outside of the country helps RY to reduce risk and to improve growth potential.

National Bank (NA.TO) 3.88% yield

I promise, this is the last bank of the group! I just couldn’t ignore this fast-growing regional bank! NA aimed at capital market and wealth management to support its growth. Since NA is heavily concentrated in Quebec, it concluded deals to do credit for investing and insurance firms under the Power Corporation (POW). Branches are currently going through a major transformation with new concepts and enhanced technology to serve clients. While awaiting the results, it seems wise to invest in digital features to reach out to the millennials and improve efficiency.

Telus (T.TO) 4.54% yield

Telus has been one of my favorite Canadian holdings since I established my 7 rules of dividend growth investing several years ago. Telus has been showing a very strong dividend triangle over the past decade. The company can grow its revenues, earnings and dividend payouts on a very consistent basis. Telus is very strong in the wireless industry and now attacks other growth vectors such as the internet and television services.

BCE (BCE.TO) 5.40% yield

BCE doesn’t have the same growth that Telus had over the past 5 years, but it is a very solid dividend payer. When you have the possibility to invest in a strong yielder as BCE and still hope for a small stock appreciation growth, you must take a hold of it. BCE shows a well-diversified business model and will continue to generate strong cash flow in the future.

Emera (EMA.TO) 5.67% yield

Emera is a very interesting utility now that it has completed the purchase of 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 its business as the world is slowly moving toward greener energy. Finally, EMA completed their Maritime Link project within its time limit and budget! I like when management can run large projects without going overboard with unexpected expenses.

Fortis (FTS.TO) 4.25% yield

Fortis aggressively invested over the past few years resulting in strong and solid growth of its core business. You can expect FTS revenue to continue to grow as it is expanding. Strong from its Canadian base business, the company is able to generate sustainable cash flow leading to 4 decades of dividend payments. The company has a five-year capital investment plan of approximately $14.5 billion for the period 2018 through 2022, up $1.5 billion from the prior year’s plan. Chances are most of its acquisitions will happen south of our border.

Enbridge (ENB.TO) 6.25% yield

Enbridge clients enter into 20-25- year transportation contracts. The company is already well positioned to benefit from the Canadian oil sands (as its Mainline covers 70% of Canada’s pipeline network). Now that is has merged with Spectra, about a third of its business model will come from natural gas transportation. The company has a handful of projects on the table or in development. Among those projects is the Line 3 replacement. The company expects the completion of this project in mid-2019. There are still regulatory processes to be completed, but this one could become a real growth driver.

Lassonde Industries (LAS.A.TO) 1.00% yield

A 1% yield in a retiree portfolio? Really? As much as I considered higher yielding companies, I think it’s important to add better diversification across this selection. Lassonde’s wide variety of brands enables it to occupy an important space in grocery stores. There aren’t many consumer products in Canada with such great metrics. LAS will continue to surf on many healthy products and to generate enough cash flow for future acquisitions. LAS recently completed a cost reduction program which should result in margin expansion. Lassonde may seem fairly valued according to the DDM, but this should change when management announces another dividend raise in mid-2018. Speaking of which, the dividend payment is healthy, and you can expect double-digit growth for the next decade.

CT Real Estate Investment Trust (CRT.UN.TO) 5.53% yield

I really like Canadian Tire in the Canadian investment landscape. Since CTC.A.TO pays only 2%, I decided to go with its spun-off REIT hosting their stores instead. Canadian Tire is a strong retailer with some unique advantage to fight against online giants such as Amazon. First, it owns several of its brands (and it just bought Bauer last week) providing them the exclusivity and full control over a good part of their products. Second, Canadian Tire is a loved brand by Canadians and will continue to attract many clients. Third, it also offers an online selling platform to ensure it doesn’t miss the internet boat. For all these reasons, CT REIT is probably one of the safest retail REIT in Canada.

Cineplex (CGX.TO) 5.21% yield

Cineplex had a difficult 2017. The company is working on transforming its business model toward a complete entertainment service instead of highly depending on Hollywood. As Cineplex evolved its business model toward more premium services, it enjoys not only a huge market share, but is able to generate interesting margins. Cineplex is also in line with its time with a successful online streaming platform. Finally, CGX is gradually building a serious bond with its clients through the SCENE loyalty program. From 600,000 members in 2006, SCENE now counts 7,9 million members.

Final Thoughts

This portfolio would generate a 4.50% yield. This means a retiree with $1M in hand could have $50K in cash to cover the upcoming year and receive $42,750 per year in dividend. Most companies would likely increase their payout enough to keep up with inflation. Therefore, a young retiree could easily live with $50K per year for the next 30 years with such a portfolio.

To be honest, I would probably increase the number of holdings to 30 for a $1M portfolio. 10 companies is not enough to ensure a full diversification. Imagine that Cineplex continues to go wrong. With a 10% weight, it would certainly affect our young retiree’s sleep. Since it’s not easy to find generous companies in different sectors solely in Canada, I’ll dedicate my next article on the top 10 U.S. retirement stocks.

What do you think? Do you have any holding that wasn’t part of this list?

Disclaimer: long all stocks mentioned besides CRT.UN in my DSR portfolios

Three Key Questions You Must Ask Yourself Before Purchasing A Dividend Stock

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Note this is a guest post from Dan at Stocktrades.ca. Dan is an active Canadian dividend growth investor with whom I share many investing similarities. Hope you enjoy!

-Mike

Dividend investing isn’t exactly the risky business that growth investing is. That being said, a lot of people have the misconception that dividend investing is a bullet-proof route. Although excellent income stocks tend to be resilient during adverse market conditions and often survive the lows of a bear market, you still have to find these survivors.

We’ve been in a bull market for the better part of 8 years now and dividend yields are looking a little bleak these days. The key to a successful income stock investing strategy is learning how to find sustainable dividend stocks that are going to be paying you excellent returns regardless of the market conditions.

I’ve come up with three key questions you need to ask yourself when trying to find the best dividend stocks to purchase for your portfolio. Here they are:

Does the company continually raise its dividend, and do I want them to?

When a company is raising their dividend every year it tells you quite possibly the most important trait you look for when investing in a company for the long haul. It means that revenues are increasing. A couple of companies that have stood the test of time when it comes to increasing dividend payouts are Fortis, Canadian National Railway, CIBC, and Scotiabank. I personally own all of these securities, and do not plan on letting go of them for a very long time.

Now, this isn’t to say a company that doesn’t issue an increase in dividend every year is losing money. There are a lot of ways a company can spend excess capital in a way that benefits shareholders other than issuing a dividend. An example of this would be some sort of acquisition or product development. If you are strictly looking for the passive income an excellent dividend portfolio provides, these companies may not be for you. If you’re looking to give up a little return right now for the potential of greater future growth, you may look to a dividend growth company that is looking to expand its operations.

If you’re looking for some dividend stocks that have consistently rewarded shareholders over the last 5 years, check out DGIRs list of these Canadian All-Star Dividends.

What is their payout ratio?

A lot of investors who are new to the world of dividend stocks may get sucked into drooling over the dividend yield and that yield only. One of the most important calculations you can make when considering adding a company to your portfolio is the dividend payout ratio.

This formula can’t really get much easier, so it would be extremely unwise to look past it. To calculate the payout ratio, simply take the companies dividend payment and divide it by their earnings per share. For example, a company issuing a $1 dividend per year with an EPS of $3 has a payout ratio of 33%.

Why is this ratio important? If a companies earnings per share are less than the dividend being issued, alarm bells should be going off. It’s a little bit of a rob Peter to pay Paul situation. If a company is earning less than they are paying out, they are having to dig that money out from somewhere and accruing debt. This is either a sign that the company is losing money and will inevitably drop the dividend, or in the case of a ratio above say 70%, the dividend will not be going up any time soon. Typically I look for companies with a payout ratio of less than 50%.

Is the price right, and can this stock withstand some hardships?

A lot of people who are devoted to finding the best dividend paying stocks for their portfolio often overlook the most important factor when analyzing a security they would like to purchase. You still must consider the value of the company. A company that is clearly trading over and above its value while issuing a great dividend is still no good to you if the company falls substantially. It’s a good practice to look first at the value of the company based on it’s current share price and make sure it accurately reflects it’s true value before you look at the juicy dividend.

As for the stock withstanding hardships, I decided to lump this question in at the end as it is actually determined by some of the questions I answered above. A company who has continually increased dividends year over year more than likely has the capital to survive a bear market or recession. When I think about this, the first industry that comes to my mind is Canadian Banks. While American banks were slashing dividends left, right, and center during the financial crisis, the Canadian Banks held strong and their dividends were never cut. It’s industries like this that are absolutely crucial to include in your portfolio.

Another good indicator of a company being able to withstand an economic downtown is its payout ratio. Think of it this way, who is going to survive longer without a job; the man who has been putting $1000 away a month for the last 10 years or the man who is living paycheck to paycheck. Companies with a high payout ratio are paying out most of their earnings in the form of a dividend. When an economic downturn hits, these companies cannot handle the blow in the loss of earnings. Whereas a company who’s payout ratio is 30% will have excess capital to keep their boat floating.

Wrapping it all up

Buying dividend stocks isn’t for everyone. You truly have to sit down and think about your overall investment goals before deciding this is the route you wish to take. If dividend stocks is your choice, these three questions should be considered by every investor before deciding to purchase a security. Dividend investing may be “easier” than growth investing due to the fact the volatility isn’t as harsh and the good stocks are often sitting right in front of your face in the form of fast-food chains, banks, utility companies, and any other form massive corporation in Canada today. But that isn’t to say dividend investing is easy. It’s a difficult task and you may be limiting your market returns by executing your plan incorrectly.

If you’re interested in my opinion along with numerous other contributors including Mike, check out our article on the top 15 dividend stocks in Canada. If you’ve finally got your feet wet with a practice account and are finally now looking to take the plunge, I published a Questrade review a while back highlighting one of the best brokers in Canada today. One of which I have been a client of for 7 years now. I hope you liked this article, and happy investing!

Should You Trade Aecon?

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I often have the feeling we forget about industrials. There is nothing sexy about them. There is nothing to create hype on the stock market. Even worst, this sector is not seen as a high yielding one. Still, the fact that many companies operate through cycles, there are always a few industrials for sale.

During 2016, I’ve covered many railroads and suggested Canadian National Railway (CNR.TO) and Union Pacific (UNP) to be strong buys. They both did very well over the past 20 months compared to the market:

Source: Ycharts

As industrials are often forgotten, there are always a few hidden gems to pick from. The best part is that once you have picked some, you can easily forget them in your portfolio and wait a few years before you take a second look at them. Those companies are often too big and too strong in their field to be threatened by another competitor.

One of those gems is possibly Aecon (ARE.TO). The company made news at the end of August as the company confirmed it has engaged BMO Capital Markets and TD Securities to look into a possible sale of the company. Shares jumped 20% upon that news (please note that they don’t have a buyer yet). Should you trade based on the news or wait to see what is happening? Let’s dig deeper.

Business Model

Aecon provides construction and infrastructure development services to private and public sector customers throughout Canada (roughly 50%-50%). It also provides services to the energy and mining sectors, as well.

Source: ARE Q2 2017 presentation

As you can see in the graph above, it has been quite a bumpy ride in term of earnings over the past 10 years. However, the future looks bright for Aecon as the Liberal government has the firm intention to boost infrastructure spending by $35 billion. On August 25th, the stock surged as ARE hired an adviser to explore a potential sale of the company (source Bloomberg).

I guess it’s good timing for everybody since both revenues and EPS were going down this year. Before the news, the stock was also down 25%. This makes me a little bit worried about the sudden jump. I don’t like buying stocks based on thin air…

It’s a good thing I dug deeper to find out that revenues were affected by the sale of Quito Airport Concession in 2015 (impacting results up to June 30th 2016) and EPS were hit by a onetime restructuring expense. The latter has probably be done to make the company valuable for potential buyers. After adjustments, EPS would still be lower than 2016, but it would be more acceptable. You can imagine this is only normal since the bulk of the company’s projects are in both the mining and energy sectors.

Investment Thesis

Macroeconomics is a strong tailwind that Aecon will benefit from in the upcoming years. The need for new infrastructure in Canada is obvious. “Aecon is currently pursuing projects at the bidding or qualification stage and have total capital costs in excess of C$25 billion,” ARE founder John Beck said then. “We are very positive on the impact this level of investment and pipeline of projects will have on Aecon’s growth and margin profile.”

While both mining and energy sectors are down, infrastructure spending may help ARE to grow in the upcoming years. We are talking about billions to be spent for the next decade:

Source: ARE Q2 2017 presentation

In the energy sector, we also see some improvements. The Ontarian government is also expected to spend $12.6 billion to refurbish its nuclear energy network. There are several pipeline projects on the table (TransCanada Energy East and TransCanada Keystone XL to name a few). Then again, energy and mining industries are cyclical. It’s always a good thing to buy companies related to those fields during the down cycle.

The tale of a potential sale will just add some excitement to this newly named Canadian Dividend Aristocrat.

Potential Risks

As shares jumped by over 20% in a single day upon the sale potential, the risk of seeing this gain fade is real. Infrastructure construction projects are capital intensive and there are often unexpected expenses. A project that goes sideways can drop a company’s earnings in a heartbeat.

Aecon’s revenues and earnings haven’t followed a straight uptrend and the company went through many bumpy rides. There is potential, but don’t expect a smooth ride with this one.

Dividend Growth Perspective

The company has recently joined the elite group of Canadian Dividend Aristocrats. They should be able to maintain its 8%-9% dividend growth rate for a while as the project pipeline seems to increase steadily.  Between 2011 and 2017, the dividends more than doubled.

Source: ARE Q2 2017 presentation

As Aecon]s business is capital intensive, I didn’t expect to find such low payout ratios. Management definitely has a company in good standing and benefits form lots of room for future increase.

Source: Ycharts

Valuation upside -8%

When I looked at how the market valued ARE over the past 10 years, I couldn’t see any trends:

Source: Ycharts

For this reason, I decided to ignore the PE valuation and focus on the DDM. I’ve used a double stage dividend discount model to determine ARE value. I’ve followed management guideline with an 8.5% dividend growth rate for the first 10 years and reduced it to 6% afterward. Unfortunately, Aecon seems fully valued at this price:

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $0.50
Enter Expected Dividend Growth Rate Years 1-10: 8.50%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $26.10 $19.43 $15.43
10% Premium $23.92 $17.81 $14.15
Intrinsic Value $21.75 $16.19 $12.86
10% Discount $19.57 $14.57 $11.58
20% Discount $17.40 $12.95 $10.29

Please read the Dividend Discount Model limitations to fully understand my calculations.

Final Thoughts

Overall, I think ARE could be a great addition to an already diversified portfolio. This is a strong company with solid dividend perspectives. On the other side, the valuation isn’t perfect due to the recent share price surge. Based on the dividend potential, Aecon seems a good fit for any dividend growth investors.

Disclaimer: long CNR.TO, UNP

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