(This was originally shared with Canadian Dividend Investing newsletter members in October, 2023)
Dividend investors everywhere are lamenting the decline of their portfolios. It seems like we’re seeing value evaporate every time the bond rate ticks a little bit higher.
I prefer to look at this in a different way. This is a buying opportunity, a chance to lock in attractive yields when the market hates most dividend players. But in a world full of seemingly depressed dividend stocks, where should investors look?
As I always say, it depends on your goals. Folks looking to maximize their dividend income today will fish in a different pond than those looking for a lot of growth in the future. Both methods have merit, depending on what you want those investments to do.
Your author, for instance, has a mix of higher yielding securities and dividend growth stocks. I target a 4% total yield for the portfolio and hope for a 4-5% annual dividend increase. I feel this is a reasonable compromise between getting paid today and ensuring I have ample dividend growth to be able to afford to eat tomorrow.
The enticing thing about high yield stocks is just a few of them added into your portfolio can really make a difference from an income perspective. To use a simple example, say you have a $1M portfolio paying an average 3% dividend, for total income of $30k. If you take 10% of that portfolio — or $100,000 — and invest it in stocks yielding 8%, your portfolio yield goes from 3% to 3.5%. Or, to put it another way, your yield goes up 17%.
Many of the best high yield opportunities, in this author’s opinion, are in the preferred share market. Preferred shares offer higher dividend safety than common shares, — since they’re higher in the proverbial pecking order — terrific after-tax yields thanks to Canada’s dividend tax credit, and capital gains potential once interest rates go back down.
Yes, there are some junky ones, but the preferred share market is littered with good companies paying attractive yields, high payouts that are sustainable.
Here are three of the best opportunities in the preferred share market I’m seeing today.
Sagen MI Canada
Thanks to the recent sell-off in Sagen MI Canada’s (TSX:MIC.PR.A) preferred shares, the yield has recently popped to a hair more than 8%. As I write this — which is a few days before publication — the yield is 8.07%.
Sagen MI is Canada’s second-largest mortgage default insurer behind only CMHC. It was previously a publicly traded company under the name Genworth Mortgage Insurance. Your author owned it for a few years, where I enjoyed the excellent dividend, the succulent profits from the business, and the cheap valuation. Many speculators who were convinced the Canadian mortgage would collapse had short positions against the stock, which often acted as a bit of an anchor and helped keep the price down.
This was exactly the kind of business Brookfield would be interested in, and the company purchased Genworth in 2020 via its private equity arm, Brookfield Business Partners (TSX:BBU.UN). Sagen’s results are lumped into the rest of BBU’s financial division in its quarterly and annual reports, but Sagen releases separate results so preferred shareholders can see how the company is doing.
It turns out Sagen is still doing pretty well. The company is comfortably profitable, earning $636M in net earnings last year. It also has a robust balance sheet with capital ratios well above each of Canada’s largest life insurers. Sagen’s LICAT is nearly 190%; the best a life insurer can do is Sunlife’s approximately 140% LICAT.
Sagen is also a beneficiary of higher interest rates. It has a fixed income portfolio worth nearly $6B. This means that for every 1% increase in interest rates it will pocket an additional $60M in earnings.
Meanwhile, there are 4M preferred shares outstanding. The current payout is $1.3520 per share for a total of just over $5.4M per year. The increased earnings from the bond portfolio will cover the preferred share dividends ten times and we’d still have room left over.
I’ll note these are perpetual preferred shares too, meaning that $1.35 dividend is the same forever. Reset preferred shares, meanwhile, adjust their rates every five years. These ones are simple, and your author and his tiny brain like that.
The risk here is investors are pricing in some sort of housing collapse now that mortgages are resetting with higher rates. I could go on forever about why I think that won’t happen, but all I’ll say is the company has a ridiculously conservative balance sheet just in case the you-know-what hits the fan. They’re prepared for some bad things to happen. That’s exactly the kind of prudence I like to see.
Something interesting is happening with one series of Brookfield Renewable’s preferred shares, specifically the Series 18 preferred shares that trade under the ticker symbol BEP.PR.R.
Most everything connected to Brookfield is a little complicated — they just can’t help themselves, they’re financial engineers — and this issue of preferred shares is included. They’re a perpetual preferred share (that’s the easy part) that are paid dividends from a the Canadian corporation part of Brookfield Renewable (wut?), making them eligible for the dividend tax credit.
This preferred share is probably as close as Brookfield gets to issuing something pretty normal, actually.
The opportunity here is this preferred share is getting kicked out of the S&P/TSX Preferred Share Index, meaning the ETFs that own this preferred share are forced to boot it from their portfolios. This, naturally, sends shares lower. Especially in an illiquid market like the Canadian preferred share market.
Here’s a chart over the last month. That’s a big ol’ yikes, kids.
These preferred shares are redeemable every five years at the par price of $25 per share. The earliest they can be redeemed is in 2027, and even then, investors are paid an extra premium if they’re any earlier than 2032.
These perpetual preferred shares pay $1.3750 per year, good enough for an 8.9% yield as I write this. Yes, Brookfield Renewable has a lot of debt, and even a lot of preferred shares outstanding. But the company is on pace to generate more than US$1B in FFO in 2023, with analysts expecting that to grow to approximately US$1.2B in FFO in 2024. Meanwhile, it paid approximately US$100M in dividends to all its preferred shareholders in 2022. That gives us a very nice payout ratio.
And remember, preferred share dividends must be paid before common share dividends are paid. So these are safe, even if the common share dividend goes kaput.
The other thing I’ll note is Brookfield Renewables is stuffed with contracted utility assets. These offer inflation protection, highly predictable cash flow, and a certain amount of growth potential as it pushes through price increases. These are dependable assets that commanded a premium valuation just a few months ago.
Your author is no fan of Canaccord Genuity (TSX:CF). I don’t think its wealth management division is anything worth getting excited about, and the investment bank is subject to wild swings in earnings depending on the appetite for IPOs and whatnot. I’d much rather own Canada’s largest banks and get my exposure to the sector that way.
The company’s management group — led by CEO Dan Daviau and Chairman David Kassie — tried to take the company private earlier this year, but the deal was reportedly scuttled based on an unrelated regulatory issue with one of its subsidiaries.
After reaching highs of more than $11 on the takeover offer, Canaccord’s common shares have been falling pretty much ever since. The current price is just over $7 per share, close to a 52-week low.
After saying all that, one of the first things I learned about the preferred share world is you can still like the preferred shares of a company without liking the common shares. After all, preferred shares are more like bonds, and in an environment like today’s we’re essentially buying distressed preferred shares.
So what makes Canaccord’s preferred shares attractive? Firstly, the company has been profitable pretty consistently over the last five(ish) years. It still has wild swings in profitability depending on investment banking, but the wealth management business is pretty consistent. It has a strong cash balance, although much of that is required by regulators, and a reasonably strong balance sheet. It is also repurchasing what management views as undervalued shares.
Preferred share dividends are also quite affordable. They should cost the company approximately $13M per year. Operating income, meanwhile, was approximately $80M last year. Or, to put it another way, the wealth management business did $36M in operating income in its most recent quarter. The wealth management business alone is easily enough to pay the preferred share dividends.
In short, we’re looking at Canaccord’s ability to pay its bills here, not necessarily grow into the next great financial services company. And they pass that test quite easily.
Canaccord has two preferred shares outstanding, the Series A and Series C preferreds. We’re more interested in the Series C, which trades under the ticker CF.PR.C. It is a rate reset preferred share, which last reset at a dividend of $1.6680 per share back in 2022. That works out to a succulent 10.4% yield today. This rate is locked in until 2027, when it’ll reset at the rate of the five-year Government of Canada bond rate plus 4.03%.
Note that the reset rate is based on the preferred share’s $25 par value. So based on where the bond trades today, we’d get the following reset:
- Bond yield: 4.18%
- Plus 4.03%
- Equals 8.21% yield on a $25 par value, or $2.0525
- Which works out to a yield of 12.5% based on today’s price of $16.41
Nobody knows what the five-year Government of Canada bond will yield in five years, of course, but the example above just goes to show the lucrative yield you could potentially have in 2027 if rates truly are higher for longer. And if not, the current yield is good until 2027. You’re free to continue collecting that until then, and then make your decision at that point.