Banks and Cable/Telecos in the Dividend Sweet Spot

 -written by Himalaya Jain, CFA - Director - Canadian Equities, Portfolio Advisory Group

With the S&P/TSX Composite Index up 3.5% on a year-to date basis, Scotia's equity strategy team remains in the procyclical camp. Central bank tightening is typically seen as an inflection point between a cyclical and defensive bias. While remaining bullish on equities in the near-term, we highlight that the Canadian equity market is trading within 5% of our strategy team's target of 14,750 for the S&P/TSX.

With this in mind, we think the spotlight will soon refocus on dividend income as an increasing contributor to total returns. In the Canadian context, we think the sweet spot for dividend income occurs at the confluence of a positive yield spread over government bonds and a dividend growth rate of at least 10%.

There is generally a trade-off between dividend yield and the growth rate of dividends. Defensive sectors tend to have higher yields but lower dividend growth, whereas cyclical sectors typically have lower dividend yields and potentially higher dividend growth rates.

 At present, we think financials, particularly Canadian banks, and cable/telco stocks are in or about to enter the dividend sweet spot. After a two year hiatus caused by the financial crisis of 2008-2009, we think dividend growth for the bank group is set to resume.

While the five-year compound average dividend growth rate of 7.4% for the bank group is healthy, dividend growth is likely to rebound to the low double-digit range in the coming years. Within the bank sector, our top picks are Royal Bank (RY), TD Bank (TD), and CIBC (CM).

The five-year trailing dividend growth rate for the cable/telco sector of 29% has been skewed by Rogers Communication (RCI.b), whose five-year compound annual dividend growth of 89% has resulted from a low starting base. Shaw Communications (SJR.b) and Cogeco (CCA) have also exhibited outsized dividend growth in recent years for similar reasons. Despite this, we note that the one-year growth rate for the cable/telco group has averaged over 10%. Our top pick within this sector is Shaw Communications (SJR.b). While this 5-year dividend growth data is backward looking, and does not indicate future growth, we highlight that many of these companies continued to raise dividends through the recent recession.

We note that there is presently no representation from the materials and industrial sectors, while Enbridge (ENB) is the lone energy stock in the sweet spot. Looking ahead, we think the there may be sweet spot candidates in the materials and energy sectors should commodity prices remain high and companies choose to return higher amounts to shareholders rather than pursue further development or acquisitions.

 For investors willing to trade dividend growth in favour of higher current dividends, we suggest Inter Pipeline (IPL.un) in the utilities sector and Allied Properties REIT (AP.un) and Cominar REIT (CUF.un) in the real estate sector.

 

The author(s) of the report own(s) securities of the following companies.

Bank of Nova Scotia,

The supervisors of the Portfolio Advisory Group own securities of the following companies. Bank of Nova Scotia, TELUS Corporation,

Scotia Capital Restriction -- U.S. (American) Bank of Nova Scotia

Scotia Capital USA Inc. or its affiliates has managed or comanaged a public offering in the past 12 months.

Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Corus Entertainment Inc., Enbridge Inc., Fortis Inc., National Bank, Power Financial Corporation, Rogers Communications Inc., Royal Bank of Canada, Shaw Communications Inc., TELUS Corporation, Toronto-Dominion Bank

Scotia Capital USA Inc. or its affiliates has received compensation for investment banking services in the past 12 months. Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Corus Entertainment Inc., Enbridge Inc., Fortis Inc., National Bank, Power Corporation of Canada, Rogers Communications Inc., Shaw Communications Inc., TELUS Corporation, Toronto-Dominion Bank, Transcontinental Inc.

Scotia Capital USA Inc. or its affiliates expects to receive or intends to seek compensation for investment banking services in the next 3 months. TELUS Corporation

Scotia Capital USA Inc. had an investment banking services client relationship during the past 12 months. Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank, Royal Bank of Canada, Toronto-Dominion Bank

Scotia Capital Restriction Bank of Nova Scotia

Scotia Capital Inc. and its affiliates collectively beneficially own in excess of 1% of one or more classes of the issued and outstanding equity securities of the following issuer(s): Bank of Montreal, Canadian Imperial Bank of Commerce, Enbridge Inc., Fortis Inc., National Bank, Power Corporation of Canada, Power Financial Corporation, Rogers Communications Inc., Royal Bank of Canada, Shaw Communications Inc., TELUS Corporation, Toronto-Dominion Bank

The Bank of Nova Scotia ("the Bank") is the parent company of Scotia Capital Inc. ("SCI"). Bank of Nova Scotia

The Bank of Nova Scotia is a Related Issuer of Scotia Capital Inc. Bank of Nova Scotia

The Fundamental Research Analyst/Associate has visited material operations of the following issuer(s): Corus Entertainment Inc., Rogers Communications Inc., Shaw Communications Inc., TELUS Corporation

Within the last 12 months, Scotia Capital Inc. and/or its affiliates have undertaken an underwriting liability with respect to equity or debt securities of, or have provided advice for a fee with respect to, the following issuer(s): Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Enbridge Inc., Fortis Inc., National Bank, Power Financial Corporation, Rogers Communications Inc., Royal Bank of Canada, Shaw Communications Inc., TELUS Corporation, Toronto-Dominion Bank

This issuer owns 5% or more of the total issued share capital of the Bank of Nova Scotia. Bank of Montreal, Royal Bank of Canada, Toronto-Dominion Bank

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