Yield-hungry investors should look to Canada's industrial sector for bargains, says a money manager who specializes in dividend-paying stocks.
Leslie Lundquist of Calgary-based Bissett Investment Management believes several industrial companies offer good value in a Canadian stock market that is poised to rebound in the second half.
"I am cautiously bullish," she says. "I think we will have positive total returns for the year in the high single digits."
The S&P/TSX Composite index, which has gone on a roller coaster ride in recent months, is essentially flat so far this year.
"The market seems fairly valued," Ms. Lundquist said. "We don't think it is enormously cheap, nor do we think it is enormously expensive since we had a bit of a pullback lately. … We probably do rise from here to the end of the year, but it may not be eye-opening gains."
Canada is an exporting nation, and the stock market will be hurt if the U.S. economy remains weak, if European economies continue to be mired in sovereign debt issues, and if China's economic growth starts to slow, she cautioned.
"It is hard to imagine that we are going to have an extremely strong market environment unless we were to see foreign countries do extremely well in terms of their economies."
Ms. Lundquist oversees $850-million in assets, mostly in the Bissett Canadian High Dividend mutual fund, which focuses on small to mid-sized Canadian companies. She began running the fund, formerly known as Bissett Income Fund, in 1998, when it was heavily invested in income trusts.
The universe of trusts has been shrinking as a result of tax law changes. With most trusts now converted to corporations, Ms. Lundquist is searching for income from traditional dividend-paying companies. Her fund has posted an average annual gain of 11.9 per cent for the 10 years ended June 30 versus 10.7 per cent for the BMO Nesbitt Burns Canadian Small-Cap Index.
"The performance has been pretty good" given that the fund has historically been more diversified and "never really had heavy resource focus, which would have been a easy thing to do in the trust arena," said Dan Hallett of HighView Financial Group. "She has always had a prudent approach in terms of looking at businesses."
Ms. Lunquist believes some of today's better buys are industrial companies. Some of her favourites include New Flyer Industries Inc., Vicwest Inc. and Morneau Shepell Inc.
"It happens that these companies were former income trusts," she said. "These are the ones that have not run up in value and in fact have come off a little bit, but they do offer good opportunities…
"Broadly, they may have come through a difficult 2010, or they are in difficult operating environment right now," she said. "We think they are good companies, and that they will do well for investors over time. In the short term, they have some issues to overcome."
Her fund has its heaviest weighting in the energy sector – oil and gas producers, pipeline funds and service providers. Oil producers should continue to do well as long as the commodity price stays at $90 (U.S.) a barrel, she said. However, despite the depressed state of natural gas prices, she prefers companies with both oil and natural gas properties.
While these two-pronged energy companies now make most of their cash from their oil properties, they will benefit as gas prices rise or oil prices slide, she said. Some of her top names in this group include ARC Resources Ltd., Baytex Energy Corp. and Zargon Oil and Gas Ltd.
Her fund has pared its holdings of pipeline securities such as Keyera Corp., Pembina Pipeline Corp. and Inter Pipeline Fund, because they have run up in value and "gotten quite expensive." In the first half of this year, she bought TransCanada Pipelines Ltd., a large-cap company, because it "offers better value."
She has also trimmed her fund's weighting in real estate investment trusts (REITs) because she no longer sees them as cheap. Instead, she has added banks such as Canadian Imperial Bank of Commerce and Royal Bank of Canada.
"If we were to start to see a rising-interest-rate environment and borrowing costs increase, that could impact the REITs badly," Ms. Lunquist said. "That would be a headwind for REITs, whereas previously interest rates were a tailwind."
Morneau Shepell Inc.
The pension-and-benefits consulting firm offers a stable dividend stream because of recurring revenue and strong customer relationships, Ms. Lundquist said. The company had a weak 2010 as its corporate customers cut costs and employees. However, its foray into employee-assistance plans is providing new opportunities for growth. The former income trust has a 7.8-per-cent dividend yield.
New Flyer Industries Inc.
The transit-bus maker, which is converting to a corporation from an income deposit security, has been hit by government cutbacks in the transportation sector, she said. But its stock should benefit when orders rebound in a stronger North American economy, and from a more understandable corporate structure. New Flyer will have a yield of 7.8 per cent after it cuts its distribution, as planned, next summer.
The company, which makes building construction products as well as grain-and-fertilizer storage bins, will benefit in an economic recovery, she said, but "we will need a few more quarters of good results before we see the market get more comfortable with the name." Vicwest, which has a 7.6-per-cent yield, is sensitive to rising steel prices, but should be able to pass on price increases to customers, she added.