A banner year for income investors
Income investors did well in 2009, says a U.S. expert, especially with Canadian income trusts — and they can do more of the same in 2010.
It was rough going there for a while, but it turned out pretty well.
Income investors who hung on through the first, difficult months of 2009 had a banner year — “at least those who stuck with positions in strong companies.”
So says Mr. Roger Conrad in the pages of Personal Finance, one of America’s top advisories for income investors.
Mr. Conrad publishes a chart called “Up from the Ashes” showing how different groups of high-yield investments did during the bear market of 2007-2009 and during the subsequent bull rally starting in March 2009.
Performance was based on total returns — capital gains plus dividends.
The top “bull performance” belonged to Canadian income trusts with a total return of 104 per cent. Right behind it were Real Estate Investment Trusts (Canadian and American REITs) at 103 per cent.
Since he is perhaps America’s foremost expert on Canadian investments, the performance of Canadian trusts is no revelation to him. And he doesn’t think it is liable to fall off in 2010.
Let’s get a complete perspective. We’ll see what went right (and what didn’t) in 2009 and what is liable to go right or wrong in 2010.
We will focus on the Canadian content, but there are also some interesting U.S. investments in the mix.
Taking a punch
“Not everything survived the historic economic and credit stress tests of the past two years plus,” says this analyst. “Many weak and debt-burdened businesses found once-outsized dividends too much to bear.”
But as the economy bounces back, there will be fewer examples of dividend delinquents, he adds.
Since the heady days of mid-2007 gave way to the credit crisis, the quality of each investment has been critical. Mr. Conrad re-states one of this advisory’s guiding principles — don’t chase high yields. “We look at only those backed by strong companies capable of taking a punch.”
By sticking with just such companies, this advisory’s Income Portfolio has prospered for two reasons, he adds.
First, it has largely avoided the sort of wholesale company meltdowns “that are impossible to come back from.”
Second, credit risk continues to ease up. Credit spreads are falling, even for firms with lower quality credit ratings. In fact, the analyst adds, if “we erred last year, it was underestimating the power of easing credit.”
How will all that carry over into 2010?
Balance and conquer
The credit markets may have thawed, but not for everybody, warns Mr. Conrad. There is still a good deal of debt to be paid off.
And more failures are likely. Banks, commercial real estate and debt-dependent retailers in the U.S. lead the list. The analyst makes his key point once again: “No high yield is worth its salt unless there’s a strong and growing business behind it.”
And whether there is sluggish growth or rising inflation in 2010, growth in one’s portfolio is “the best possible insurance that near-term losses will be recovered.”
His approach is to “balance and conquer” — hold a broad mix of high-quality, high-yielding investments spread around different sectors.
The biggest gains
The torrid run of Canadian income trusts since March, writes Mr. Conrad, was largely due “to the lessening of credit fears, which triggered gains in energy prices and the Canadian dollar.” Those positive trends are likely to continue in 2010, he says.
“But ironically, the biggest gains are likely to come from trust conversions to corporations, as companies cut dividends far less than expected, if at all.”
Each of the trusts in the Income Portfolio remains a buy, he informs his readers. The list is headed by Canadian Apartment Properties REIT (TSX-CAR.UN; OTC-CDPYF), which is trading at $14.03 and yielding 7.7 per cent on its $1.08 distribution.
Vermilion Energy Trust (TSX-VET.UN; OTC-VETMF), this analyst’s favourite in oil and gas, trades at $32.80 and yields 7 per cent on a distribution of $2.28. Finally, there is Yellow Pages Income Fund (TSX-YLO.UN; OTC-YLWPF), which Mr. Conrad has stuck with through some tough times. It trades at $5.40 and yields a rather high 14.9 per cent on a distribution of $0.80.
Quality like clockwork
We can pass on several groups of investments in this portfolio that are of less interest to Canadians — U.S. REITs, junk bonds and master limited partnerships (which involve a tax liability for Canadians at any rate).
But some U.S. stocks in the portfolio are not without interest. Mr. Conrad likes smaller U.S. banks that are “adding deposits and high quality loans like clockwork.” He particularly likes Arrow Financial (NASDQ-AROW). It trades at $25 and yields 4 per cent on its dividend of $1.00.
Oil prices went up last year, but refining margins and natural gas did not. So this analyst likes super oil firms like America’s Chevron (NYSE-CVX) and Italy’s Eni (NYSE-E) that have the resources to weather the storm. Chevron is at $78.82 and yields 3.5 per cent on a dividend of $2.72. Eni stands at $52 and yields 5.8 per cent on its $2.93 dividend.
Regulated utilities have not soared with the market, but Mr. Conrad thinks three are bound to catch up. Dominion Resources (NYSE-D) trades at $39 and yields 4.5 per cent on a $1.75 dividend. Southern Company (NYSE-SO) trades at $33 with a yield of 5.2 per cent on its $1.75 dividend. And Xcel Energy (NYSE-XEL) is at $21 and yielding 4.6 per cent on a dividend of $0.98.
“The group everyone loves to hate is also the cheapest relative to its current growth rate,” concludes the analyst. That group is telecoms. Verizon Communications (NYSE-VZ) is growing on the strength of smart phones. The shares are at $33 and the yield is 5.7 per cent on a $1.90 dividend. Frontier Communications (NYSE-FTR), which lagged behind in 2009, is moving phone customers to broadband. Its shares are showing signs of recovery at $7.80, and the yield is 12 per cent on a $1 dividend.
The point cannot be made too often, as far as this analyst is concerned. Those who want a banner year in 2010 won’t just be buying high dividend yields, they’ll be buying companies strong enough to support the dividend — and raise it.
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