2011 Q2 Newsletter June 30, 2011
The second quarter (Q2) of 2011 proved to be a difficult period for equity markets. Commodity prices for oil, copper, gold as well as other metals and materials declined. While these drops represented a small retreat from very high levels the impact on equities and our holdings was magnified by investor fears. These doubts were further encouraged by a slowing in United States job growth. Another negative element was resurgent fears of a debt default by the Greek government.
Canadian economic growth slowed from 2010 but strong job creation continued in Q2. The Canadian economy has created more jobs than before the recession. The United States economy still lags far behind in job creation.
By the end of Q2 these fears began to recede and the equity market rallied but the damage had been done. We experienced modest negative returns for Q2 but are still up on a year to date basis.
LDIC’s overall performance for all investment mandates was -3.4% in Q2. This was better than the -5.8% experienced by the S&P TSX.
For the year-to-date LDIC’s overall performance was +2.3% versus the -1.1% for the S&P TSX. LDIC’s independent investment mandate performance returns year-to-date was: Conservative Returns 8.2%; Income 5.7%; Balanced 5.4%; Growth 0.7%; Aggressive Growth -4.3%. These performance returns are consistent with the overall downward pressures of the equity markets.
The S&P 500 in the United States grew by 1.0% in Q2 and 6.5% before allowance for the decline in the US dollar.
Four of our top ten holdings gained during Q2. The top performers were Cineplex with a gain of 15.4% Keyera Facilities with a gain of 11.1% and TransCanada with a gain of 7.7%. Six positions ended in negative territory. The overall average gain was 1.21%.
Average yield for the top ten equities at June 30th was 5.34%.
Major Portfolio Exits/Additions
We undertook a major rebalancing of the accounts’ holdings in Q2 to better position them for the year ahead. We also aligned a number of industry-like positions to consolidate into our strongest positions on a go forward basis. Such as, we switched our holdings of the Royal Bank to the Bank of Montreal (BMO) and National Bank. Our analysis convinced us BMO and National had better prospects over the next year to eighteen months than the Royal Bank. TD Bank remains our largest bank holding overall. We also switched our holding of Fortis Inc. to Provident Energy. Fortis Inc. reached our target expectations.
Bank of Montreal (switch from Royal Bank)
Bank of Montreal is Canada's fourth largest bank by market capitalization, with 983 domestic branches and 286 branches in the U.S. BMO has amongst the highest quality loan book of its Canadian peers with concentration in commercial and industrial loans which represent approximately 30% of total loans outstanding. A strong balance sheet means dividends are adequately funded, share buy-backs are possible, and Tier 1 capital is well in excess of pro forma Basel III requirements. Following Harris Bank, U.S. exposure has continued to grow with the more recent acquisition of Marshall & Ilsley (M&I), and BMO has ramped up advertising expenses to gain share in a more competitive domestic market. The current discounted earnings multiple relative to the Canadian peer group is primarily related to concerns about credit quality within the newly acquired M&I loan book and we feel these concerns are unjustified. We expect M&I deal overhang will disappear and the relative forward multiple will revert to a premium.
Provident Energy (switch from Fortis)
Provident Energy represents a pure midstream energy business, natural gas liquids midstream services and marketing. With processing and storage facilities located in Edmonton and Fort Saskatchewan, Provident is ideally located to capitalize on large growth initiatives in the Montney and Canadian oil sands recovery projects. Provident has expressed some interest and would be the likely suitor for an approximate $2.5 billion midstream business being sold by BP. However, we do not think they will overpay for these assets and would prefer to capitalize on more than $900 million in strategic organic growth projects with internal rates of return in excess of 15%. An accretive acquisition would be viewed positively by the market, as would increased financial flexibility if they do not win the asset. Provident’s payout ratio is amongst the lowest in the group at 67% which makes them well equipped to raise the dividend to protect valuation and yield in light of a potential rising rate environment. Provident has tax pools of nearly $1 billion that are expected to last through 2014. We look for continued EBITDA growth to meet or exceed an annual guidance range of 5-7%.
We remain optimistic the balance of 2011 will be positive for equity markets. The growing demand for metals, energy and other materials such as fertilizer is a long term phenomena. It is propelled by a growth in world population from $2.3 billion in the 1950s to over $7 billion today. Much of this population growth is in Asia, particularly in China and India. The growth in the Asian economies is the underlying driver of high prices for oil, copper, ironer, coal, potash and many other commodities.
Our cautiously positive view is tempered by the reality there are still many problems remaining in the debt circumstances of Greece, Ireland, Portugal and Spain to be worked through. We do expect some continued volatility in Q3 as these problems occupy a prominent place in the coverage of
President and CEO