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Value Update I, 2009:

With another slide in equity markets I thought I would take a moment for a regular update on some of my trading activities over the past month.

RSP Activity:

Part of my investing discipline is choosing companies which have Enduring Value and I believe every portfolio needs a solid collection of generals; strong and strategic. General Mills (GIS) fits these criteria as a boring, stable and growing business with sustainable operations in a global food industry dominated by giants. I hold a number of consumer staples companies, but I hold GIS in a higher regard for the fiscal responsibility of its management team, their achievements in tight cost controls and the diversified nature of their core product portfolio. I doubled my position at $52.00 which I feel offers attractive long-term value for a company with a solid dividend of $1.72 (3.31% yield, 45% payout), forward P/E of 13.7 (2009 EPS: $3.80) and equally impressive ROE.

Smuckers (SJM) is another consumer staple that I own and reported very strong operating results for their third quarter. The acquisition of Folgers from Proctor & Gamble (PG) in 2008 had an immediate positive effect on both margins and cashflow even though earnings were down slightly related to implantation costs of the acquisition. I doubled my position at just under $36.00 with SJM offering a stable dividend of $1.28 (3.60% yield, 37% payout), impressive EPS and book value growth and manageable debt.

United Parcel Service (UPS) is a company I’ve had my eye on adding to since first acquiring shares in May of 2008. This is a company with a significant operating moat that continuously operates against its competition with impressive margins when you consider their global scale. With fuel costs coming down, a concentration by management on further cost reductions and a dividend of $1.80 (4.68% yield, 51% payout) this is a company that has often been cheap during periods of economic weakness and expensive during periods of economic strength.

I also sold another significant component of my holdings in the PowerShares Crude Oil Double Short ETF (DTO). This is part of my Canadian dollar hedge strategy that I’ve been weaning down over the past six months as the price of crude oil slipped along with the CDN$. I have been asked my a few readers to outline this strategy and I will post this at some point in the future.

Portfolio as of February 28th
YTD Return: -10.8%
Yield: 4.54%

DivG Activity:

There should be no surprises that I added to my positions in Fortis (FTS), Bank of Nova Scotia (BNS), Royal Bank (RY), Manulife (MFC), Sunlife (SLF) and Saputo (SAP) over the past month. Each of these companies is a core holding of my portfolio and despite market concerns over their operations I believe their current valuations are quite attractive.

The Canadian banks have all reported quarterly earnings and despite some weakness their capital ratios are strong, dividends at historical highs and loan loss provisions increasing. There will be losses for these banks as the economy worsens, but their relative strength against global peers and an ability to now expand operations into new markets with weakened competition make them excellent long-term investments. While the short-term focus of the market remains pessimistic a long-term investor has to take the proper perspective. I like to explain my continued investments in TD Bank (TD), BNS and RY to my investing peers as if I were standing in the middle of a dense forest. As giants fall to the ground after losing their balance from rotting foundations (US/Global Banks) there are trees with stronger roots that will race to fill the void of sunlight that rushes in. It would appear to anyone captivated by the bearish sentiment of the media that the global financial system is in ruins, but it’s important to realize as a long-term investor that there will always be companies that thrive in an environment of chaos and seek out strategic opportunities during period of weakness. Our banks are well capitalized and as the economy turns to a recovery at some point in the future (2009? 2010?) they will deploy the additional capital they carry into new business opportunities, acquisitions and strengthening their core retail operations. The void left by crumbling financials around the world is leaving a vacuum of prospective business that other companies will fill just like in every crisis within an industry. The strong get stronger.

FTS and SAP should be self-explanatory; each has suffered a decline in valuation as nearly everything is hit with the deteriorating expectations of the market. Both companies have stable earnings, adequate cashflows to cover their dividends and are trading at valuations that a long-term investor should be seriously examining. These stocks are considered defensive and for a portfolio heavy with financials or commodities they offer an element of diversification that is often required to avoid significant volatility. Each is boring and rarely report exciting news, but their growth prospects are attractive as they continue to expand their operations led by management teams that are fiscally conservative.

Portfolio as of February 28th
YTD Return: -12.03%
Yield: 6.76%

Fixed Income:

The Bond Guide will be published later this month, but I continue to observe the debt markets with a keen interest as a student who continues to learn about investing. I consider debt investing as the final frontier in my path to securing a balanced education in DIY investing. While I don’t have $5,000 to throw around towards 4-5 individual corporate bonds for the fixed income component of my overall portfolio I have been watching with interest to see what I can learn from the current market for future opportunities.

Global financial companies (bank & insurance) have been slaughtered the past 18 months; that’s obvious. European banks have been nationalized, US based financials weren’t far behind them and nearly every other bank has seen their market capitalization crumble regardless of the strength of their operations or earnings. Banco Santander SA (STD) is the largest bank in Spain and biggest in Latin America. I wasn’t interested in holding the common equity of STD since I already had adequate exposure to the common shares of its fellow Spanish bank Banco Bilbao Vizcaya (BBV) but I’ve patiently watched STD’s four sets of preferred shares (A, B, C & I) for advantageous opportunities.

Preferred shares, which I’ve talked about here before, are a special breed of equity that generally trade at face value ($25) and pay a regular dividend on a quarterly basis. The benefit of preferred shares versus common is that an investor gains preferential (hence “preferred”) claim to profits, dividends and capital of the company. Cutting or cancelling the dividend of the common stock is a common practice of companies of late, but in order to cut the preferred dividend all dividends on the commons would have to cease first. Cutting the preferred dividend would be the equivalent of capital suicide (see Nortel) since a company would be indicating to investors they no longer had the cashflow to cover payment of their dividend obligations and this would subsequently cause them to have trouble raising equity in the debt markets.

The A-series of preferreds of STD (STD.PR.A) were issued in November of 2007 at a value of $25 with a dividend of $1.70 per share (6.80%). As they traded down in value below $15 the yield on the preferreds increased above 11%. When I assessed risk reward of the investment I came to the conclusion that I was being adequately compensated in both the potential of dividend income and capital gains for the equity I planned to invest. On an adjusted cost base (ACB) of $12.40 I stand to receive an annual yield of 13.71% and eventual capital gain (if it ever reached $25) of 101.6%. If I intend to hold the investment, STD is able to remain well capitalized and payments of the dividends are sustained over a five year period the return on my investment (ROI) could be substantial. The risk of course is that the common dividend is suspended, the preferred dividend is subsequently suspended and the bank fails. But on a risk/reward basis I felt the investment was prudent and made a choice based on my analysis of the company.

Two other fixed income investments I made were in KVT & KVR. These two securities are a different breed of investment known as a CorTS. I won’t go into detail here, but I will be posting on my activities with these securities on March 16th.

Disclosure: I have invested interests in all companies mentioned in this post.

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{ 4 comments… add one }
  • Jae Jun March 6, 2009, 4:50 pm

    Looking forward to your bonds post. I’m looking more into it but I too dont have enough cash to buy several bonds.

  • Nurseb911 March 6, 2009, 6:53 pm

    That’s my problem as well. If I’m going to do it I want to have enough capital to diversify among 4-6 bonds minimum. That would be more than my entire FI allocation at the moment (not including my immediate savings). This is a great opportunity to learn potentially like I did back in 2000-2002 before I began seriously investing in equities.

  • Anonymous March 14, 2009, 3:01 pm

    what is the tax implication on those Banco Santander preferred shares??

    I am assuming you are buying them as ADR’s on the New york stock exchange.

    Since the payments are “dividends”, and not interest, as they are on a regular corporate bond….I can also assume that the payments would be subject to the 15% withhiolding tax levied by the US govt.

    As well they would be treated as regular income here in Canada, and subject to your hightest marginal tax rate.

    Also you are taking currency risk into the equation!

    Maybe buying a canadian prefeered issue such as Brookfield Asset Mamnagement might be a better choice.,,,,,what do you think?

  • Nurseb911 March 14, 2009, 4:01 pm

    I hold my non-Canadian fixed income, preferred shares and common shares within my RSP.

    The benefit is that the US withholding tax (15%) does not apply and I retain my full dividend/distribution. For the moment I haven't had any problems.

    For Canadian preferreds I'm currently holding an issue from Brookfield, Enbridge, Power Financial, Westcoast Energy & a SplitCorp from Life & Banc (LBS.PR.A).

    For currency risk I have a hedging policy within my RSP to help offset any appreciation/depreciation of the Canadian Dollar. That post will appear in the future on this site.

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