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The Canada Report
Vol. 1, No. 1
January 16, 2008
In This Issue
By Gordon Pape, Editor and Publisher
Welcome to the first issue of The Canada Report, a newsletter dedicated to providing U.S. investors with expert opinion on the Canadian economy and in-depth analysis of the best securities the country has to offer.
This monthly letter was created in response to growing investor interest in America’s northern neighbor and an increasing desire by many U.S. citizens to diversify their portfolios internationally.
Unlike some other Canadian newsletters you may have encountered, The Canada Report is not a penny stock advisory. Nor will we focus on a single type of security, such as income trusts.
What we are is a newsletter for conservative investors who are looking for high-quality securities with above-average profit potential. We believe that Canada is in a unique position to provide these opportunities and our mandate is to deliver that information to you in practical, down-to-earth terms, month after month.
The Canada Report is a completely independent newsletter. We are not associated with any brokerage firm, we do not promote any companies or organizations, we do not offer money management services, and we do not accept any type of compensation for mentioning or recommending securities. Our only business is the communication of top-quality information from some of the most respected and experienced people in the Canadian investment business.
Among the subjects you will find covered in The Canada Report are the following:
1. Economic commentaries on the outlook for Canadian growth, employment, housing, inflation, interest rates, etc.
2, Commentaries on industry segments of special interest to U.S. investors, with a special focus on energy.
3. Analysis and outlook for the Canadian dollar.
4. Securities recommendations for common stocks, income trusts, and exchange-traded funds. Our focus will be on securities that are highly liquid and readily available to U.S. investors. Many of the securities in The Canada Report will be interlisted on U.S. exchanges, such as the NYSE and Nasdaq. International companies that are not Canadian-based but which do significant business in Canada will also be eligible for inclusion.
5. Cross-border tax issues, where appropriate.
Although The Canada Report is a new letter, our company has been in the investment newsletter business for 12 years. We currently publish three newsletters designed primarily for Canadian investors: Mutual Funds Update, The Income Investor, and our flagship publication, the Internet Wealth Builder. All these newsletters have a high success rate and The Canada Report’s contributing editors are also associated with one or more of them.
Although both The Income Investor and the Internet Wealth Builder have American subscribers, some of their recommendations (such as mutual funds) are only available to Canadian residents. Therefore, we decided that the interests of U.S. readers would be better served by creating a newsletter specifically designed to meet their needs and concerns.
Every issue of The Canada Report will contain at least one new recommendation. However, we will not swamp you with choices. The Canadian market is small compared to that of the U.S. and it becomes even smaller when we narrow the focus to high-quality companies with good liquidity. Moreover, we understand that most American investors don’t wish to overload their portfolios with Canadian securities but rather to obtain modest diversification. That’s why we will limit our selections to the best of the best.
As with our other newsletters, we never make a recommendation and then leave readers to figure out what to do next. All our picks will be updated on a regular basis, with buy, sell, or hold guidance. That includes any losing positions – and good as our experts are, we don’t guarantee that every selection will be a winner. However, based on the track record of our other letters, we’re confident that the great majority of our selections will make money for you.
There’s something else that makes us different from most other newsletters – we genuinely care about the success of our readers and we do our best to respond to your comments, questions, and (hopefully few) complaints. However, we cannot provide personal one-on-one advice – you will need to consult your financial advisor for that. You can send any emails directly to me: Gordon.pape@buildingwealth.ca.
Now read on, enjoy, and prosper!
Gordon Pape is the publisher of five investment newsletters and the author of more than 20 books on finance and money management.
Here are the experts who will be providing you with their authoritative advice and commentary on Canadian securities in the months to come. All of them are based in Canada so they have first-hand knowledge of the latest political and economic events in the country and what they mean for investors.
Gordon Pape, editor and publisher. Gordon is Canada’s best-known financial writer. He is the author of more than 20 books on investing and money management and is the editor and publisher of five financial newsletters. His columns on investing appear in several magazines and on major Canadian websites and he is frequently quoted in the media. He divides his time between Toronto and his winter home in Fort Myers Beach, Florida.
Gavin Graham, contributing editor. Gavin is chief investment officer of Guardian Group of Funds (GGOF), a Toronto-based money management company with extensive expertise in income trusts and dividend-paying stocks. His qualifications include an MA in Modern History and membership in the Hong Kong Institute of Investment Analysts. Gavin managed investments for many years in the U.K., the U.S., and Hong Kong prior to joining GGOF in 1999. He is a regular market commentator, who appears frequently in The Globe and Mail and National Post, both national newspapers in Canada, as well as on television and radio. He is based in Toronto.
Tom Slee, contributing editor. Tom has had a long and distinguished career in the financial field. He spent many years in the insurance business managing pension money, with an emphasis on fixed-income securities. Prior to retiring, he held a senior position at Revenue Canada (now the Canada Revenue Agency) for several years, so he is an authority on tax matters as well as securities. He has been a financial commentator for several leading Canadian publications and is both a certified financial analyst (CFA) and certified general accountant (CGA). He resides in Toronto.
Glenn Rogers, contributing editor. Glenn is a successful businessman and entrepreneur who has held senior managerial positions in both Canada and the United States. He is an active investor with a high success rate in his selections. He currently resides in Victoria, British Columbia.
By Gavin Graham, Contributing Editor
In the world of investments, it’s a good rule of thumb that whatever has been happening will continue to happen until something major occurs that changes the direction of events. Thus, once central banks such as the U.S. Federal Reserve (the Fed), the Bank of Canada, and the Bank of England begin reducing (or increasing) interest rates, the process will continue for a long time and move a long way.
The Fed has reduced the rate at which it lends to its member banks (the fed funds rate) three times since August, 2007 by a total of one percentage point to 4.25%. The Bank of Canada and Bank of England have begun the process by reducing interest rates once each by a quarter-point (to 4.25% and 5.5% respectively). I believe it is safe to assume that 2008 will see further interest rate cuts.
How far the process will go is unknown at this stage, but one should never underestimate how low rates can go. When Alan Greenspan started cutting rates on Jan. 2, 2001 from 6.5% to 6%, I don’t recall many commentators who forecast that the fed funds rate would finish at 1% in mid-2003, falling 5.5 percentage points in two and a half years. Similarly today, not many analysts are forecasting more than a fall to 3% by the end of 2008, down another 1.25 points from the present level, although one or two of the more bearish commentators are looking at negative real interest rates (interest rates minus inflation), which implies a fed funds below 2.5%.
The situation is not as clear-cut in Canada, where the retiring Governor of the Bank of Canada, David Dodge, raised rates by a quarter-point to 4.5% as recently as last August because of concerns about the booming western Canadian resource-based economy. Contrary to what was happening in the U.S., house prices in provinces like Alberta, British Columbia, and Saskatchewan shot up more than 25% annually in both 2006 and 2007, leading the Bank to worry about inflationary pressures.
However, Mr. Dodge (whose term ends on Jan. 31) had a track record of raising interest rates in response to inflation concerns, as he did in 2003, only to reverse himself shortly afterwards. The reason is simple: raising interest rates in Canada while its major trading partner is cutting them (75% of Canada’s exports go to the U.S.), only leads to one result: a higher Canadian dollar.
The Canadian dollar, popularly known as the “loonie” after the picture of a Canadian loon (a type of water bird) on the Canadian $1 coin, rose more than 20% against the U.S. dollar in 2003, the first time that Mr. Dodge chose to go in the opposite direction to the Fed. The result was that short-term investment money chased after a more attractive interest rate than could be obtained in U.S. dollar deposits. In 2007, the loonie was up by almost 17%, despite the fact that Canadian rates were lower than in the U.S. In this case, a major factor was the anticipation of the rate differential narrowing in favour of the Canadian dollar.
A rise in the value of the loonie has virtually the same effect as an increase in interest rates, slowing down the economy as Canadian exports to the U.S. become less competitive. Manufacturing companies, especially the auto industry, and some resource sectors like forestry suffer accordingly.
A stronger loonie also reduces the inflationary pressures that led the Bank of Canada to raise rates in the first place, as imported goods such as technology and capital equipment, as well as energy and raw materials that are priced in U.S. dollars, all become cheaper. Residents of states bordering Canada will probably have noticed the large number of Canadian license plates at shopping malls near the border last fall, as parity between the loonie and the greenback for the first time since the 1970s brought waves of shoppers over the border in search of bargains.
For a U.S. investor, this has resulted in Canadian stocks being one of the best-performing investments over the last six years, as the loonie has appreciated by almost two-thirds (from US$0.63=C$1 in February, 2002 to US$1.02=C$1 in January 2008) while the S&P/TSX Composite Index has doubled over the same period in Canadian dollar terms. The net result is that the total return earned by U.S. investors holding Canadian stocks has been more than double the 67% that S&P 500 delivered over the same period.
The intention of this publication is to look at some of the Canadian investments that are easily available to U.S.-based investors. It is highly unlikely that the next few years will see the same type of move in the currency to add to U.S. dollar-based returns and we encourage readers not to factor expectations of a continued rise in the loonie into their investment decisions.
That said, the plain fact is that at the present time the fundamentals in Canada are superior to those of the U.S. In Canada, the resource boom has enabled the federal government and most provinces to run budget surpluses to accompany the trade and current account surpluses that the country has traditionally enjoyed.
As I remarked at the beginning of the article, trends in investment, once begun, tend to continue for longer than most observers expect. Given the dampening effect of the housing slowdown on U.S. consumer spending and government revenues, it is difficult to see U.S. interest rates not being substantially lower by the end of 2008.
In Canada, on the other hand, the new Governor of the Bank of Canada, Goldman Sachs alumni Mark Carney, may reduce interest rates a couple of times to avoid the loonie rising back to US$1.10=C$1, as happened briefly in November. However, the country is still enjoying the benefits of the resource boom and will not need or want to cut interest rates as far as the U.S. Therefore, it is reasonable to expect the loonie to remain near or a little higher than its present level and those Canadian companies not exposed to the domestic U.S. economy will continue to do well.
Elsewhere in this issue, you’ll find an updated report on an income trust that I first recommended to Canadian investors almost three years ago, Canadian Oil Sands Trust (TSX: COS.UN). It is the purest play on the massive oil sands reserves in northern Alberta, which have helped to make Canada the largest supplier of oil and gas to the U.S. for the last decade.
Since I made the original call, investors are ahead more than 150% in Canadian dollar terms (combined capital gain and distributions). I believe there is a lot more profit to come from this long-life resource. And it’s just one of the many great opportunities we’ll be telling you about in The Canada Report in the coming months.
Gavin Graham is Chief Investment Officer for Guardian Group of Funds (GGOF). He is based in Toronto.
The Securities and Exchange Commission (SEC) does not make it easy for U.S. investors who wish to invest directly in Canadian stocks – or the stocks of any other country for that matter.
SEC rules do not allow U.S. brokerage firms to trade directly on international exchanges. The ostensible reason for this is to protect American investors who might otherwise become victims of fraud or manipulation on poorly-regulated foreign stock exchanges. As a result, many major Canadian companies are now interlisted in New York, primarily on the NYSE and Nasdaq. Overseas companies have turned to ADRs and similar types of securities to make their shares more accessible to the U.S. market.
Brokerage firms with offices or affiliates in Toronto are able to buy Canadian securities for their clients. But if your broker doesn’t offer this service, the only choices available right now are to switch to another company or buy non-interlisted stocks over-the-counter. Unfortunately, OTC trades can be expensive and shares of smaller companies or trusts trade infrequently.
Urged on by Canadian Finance Minister Jim Flaherty, the SEC is now putting together a plan that will enable American investors to trade directly on foreign exchanges, through U.S. brokers. However, no timetable has been set for implementation of the plan nor is there any guarantee that the Toronto Stock Exchange will be one of the initial beneficiaries.
So for the moment, the status quo prevails which is why we will emphasize interlisted stocks in The Canada Report. We will provide updates as the situation develops. – G.P.
By Tom Slee, Contributing Editor
Here we are in the first month of a new year and that means it’s time to dust off the old crystal ball. Before doing so, however, I would like to remind everybody that predictions, my own included, are the weakest link in the investment process. They are really just educated guesstimates, especially in uncertain times like these when there are no economic groundswells. As a matter of fact, right we are now faced with all sorts of conflicting signals and numbers. Nevertheless, it’s important have an outlook in order to build an investment strategy. So here, with all the usual caveats, is my 2008 forecast.
As you know, we are off to a bad start. In addition to the normal uncertainties, investors are grappling with three almost entirely new problems. First, global economies are no longer responding to the usual stimulants. Central bank rate cuts and infusions of cash have so far had minimal impact on a serious credit crunch and the all-important London inter-bank offered interest rate (LIBOR) remains stubbornly high. That means the institutions are reluctant to lend each other cheap money because “subprime” has undermined their confidence. Even blue-chip balance sheets are suspect. Second, European and emerging countries seem unable to come to terms with a weak U.S. dollar and may not pick up the slack as North American business activity slows. Last, but not least, the American economy is no longer the preeminent global growth engine. Indeed, one leading economist thinks that it has become the caboose, at least for a while. All these factors are going to play out in 2008.
My feeling is that the weakening greenback poses the greatest threat to markets this year. The U.S. dollar’s sharp decline is now starting to bite. Down 40% against the euro over the past seven years, it’s being blamed for labour strikes in the Middle East, lost jobs in Europe, and the end of an era of globe-trotting rich Americans. The decline is also spurring U.S. inflation as imports, especially energy, become more expensive. That in turn may eventually (but not immediately) force the Federal Reserve to raise, rather than lower, interest rates and drive down stock prices in the process. In Canada, manufacturers, bucking a relatively strong loonie, will find it increasingly difficult to sell across the border.
The credit squeeze is likely to be less of a problem mainly because it’s solvable. Central bankers are already banging heads and forcing institutions to play ball. At the same time, foreign investors are injecting new capital into Wall Street’s beleaguered banking system. Warren Buffet’s new Berkshire Hathaway Assurance Corp. has started guaranteeing bond issues. A floor is being established.
As to America’s declining power, this is something the world (and Americans) will have to learn to live with. The U.S. economy dominated international markets for almost 100 years because there was no real competition. That has changed. The European Union and other trading blocs are flexing their muscles, attracting new money that would normally flow to North American markets. Last August, the U.S. Treasury reported a net outflow of $163 billion, the first time since 1998 that foreign investors were net sellers of American investments.
What does it all mean for investors in 2008? Well, at the risk of seeming shell-shocked from last year’s market roller coaster, I think that the outlook is promising. Of course, things are grim at the moment and the media keeps piling on the agony. But at times like this I am reminded of the old trading adage: “what the market knows isn’t worth knowing”. Or, to put it another way, any so-called news is old hat. So we should ignore most of the present wreckage and focus any forecasts on the unknowns that are likely to matter over the next 12 months. They will determine where stock prices go.
Let’s start with the U.S. economy, which according to many pundits is already in or tottering on the edge of a recession. I disagree. Certainly growth has been slowing. The consensus is that U.S. GNP growth was about 0.6% in the fourth quarter 2007 and will be approximately 1.2% during this present quarter. That would be like slamming on the brakes after a surprisingly strong 4.9% surge in the third quarter, but it’s not a recession. In fact, based on those numbers, U.S. GNP should grow 1.9% in 2008. Canada, meanwhile, could post a respectable 2% advance, compared to about 2.5% in 2007.
Even if I am too optimistic and we have a shallow recession it would not be the end of the world. Over the last 50 years, recessions, defined as two or more quarters of negative economic growth, have on average lasted 10 months. That means we should be in recovery mode before year-end and stocks, discounting the improvement, will already be gathering strength.
My feeling, however, is that there will be no recession, primarily because the Federal Reserve is almost bound to step in and slash interest rates if the numbers sour. We could see U.S. central interest rates as low as 3.5% or even 3% regardless of inflation and a shrinking greenback. The people in Washington are not going to sit by and watch the economy tank during a Presidential election year.
The key is how this anticipated slow growth translates into corporate earnings. The consensus is that both Canadian and U.S. profits will post gains in the 12% range. This seems to me to be far too high, especially as the financial sector, which will continue to suffer, now accounts for a large part of the numbers. I think that we should look for average earnings growth in the 8% to 9% range on both sides of the border, most of that coming in the second half.
As to the market, well it’s anybody’s guess during the first six months. As a matter of fact, one prominent American forecaster said just that. His headline read: “2008 Outlook: I Don’t Know”, which is correct and amusing but not much help. I feel that we should brace for volatility and road bumps over the next quarter or so and then sideways movement followed by an upward trend as fundamentals take hold. It’s a mug’s game trying to call the market precisely but a target of 15,000 on the S&P/TSX Composite Index, about 10% above the current levels, seems reasonable.
When it comes to tactics, take full advantage of the expected volatility in 2008. In particular, keep an eye open for dividend-paying blue chips that have been depressed by sharp corrections. They often offer unusual bargains. For instance, Royal Bank (NYSE: RY) was yielding more than 4% recently. This is Canada’s biggest bank, it does not face any unmanageable subprime problems, and the dividend is rock solid. It’s just one example of the many good values we will be telling you about in The Canada Report.
Tom Slee managed millions of dollars in pension money for many years. He is a certified financial analyst and a certified general accountant.
TOP
Despite what some investors may think Canadian income trusts (also known in the U.S. as “royalty trusts” and “canroys”) are still around and continue to churn out strong cash flow.
Many Americans became disenchanted with trusts (in fact, some were downright livid!) after Canadian Finance Minister Jim Flaherty broke a Conservative Party campaign promise by announcing an income trust tax in an infamous press conference on Halloween night, 2006.
Legislation putting the tax in place was passed by the Canadian Parliament in mid-2007. However, and this is a point many U.S. investors have missed, it does not take effect until Jan. 1, 2011. For the next three years, it continues to be business as usual for the trusts.
Moreover, when the tax does take effect, some trusts will be able to cushion its effect thanks to tax credit pools they are building. Others will face a minimal hit because they have extensive overseas operations that already incur tax and this has been built in to their distribution policy.
Another point worth noting is that although the original tax rate was set at 31.5%, it will not actually be that high. Tax changes announced last fall reduced it to 29.5% in 2011 and to 28% in 2012.
The past year saw more than 20 mergers and takeovers in the trust sector, most of them at handsome premiums over the trading price. Unfortunately, some investors had bailed out in the weeks immediately following Mr. Flaherty’s announcement and so did not benefit.
Our advice to those still holding positions in quality trusts is to retain them, continue to collect the healthy distributions, and wait to see what happens as the tax deadline approach. Takeover activity has slowed recently because of the credit crunch but we expect to see it pick up again in 2009 and 2010.
We will be recommending some trusts in The Canada Report that we believe have good future prospects, despite the pending tax. – G.P.
TOP
Dividends paid by Canadian companies that trade in New York are usually deemed to be “qualifying dividends” for U.S. tax purposes. Distributions from some (but not all) Canadian income trusts are also believed to qualify, although in most cases the trusts are relying on third-party opinions for this assumption.
All dividends and trust distributions are subject to a 15% withholding tax, paid to the Government of Canada. However, this may be claimed as a foreign tax credit when you file your return. (For the record, dividends from U.S. companies paid to Canadian residents are subject to the same treatment.)
Recent changes to the Canada-U.S. Tax Treaty eliminated all withholding taxes on cross-border interest payments.
Most large Canadian companies and trusts post website guidance for U.S. investors each tax season. Readers may also wish to consult their personal tax advisor. – G.P.
OUR RISK RATINGS
All recommendations in The Canada Report will include a risk rating. Readers are urged to pay close attention to these and to ensure that any purchase decisions fall within their personal risk tolerance. Here is how to interpret the ratings.
Very conservative: Risk of loss is extremely low.
Conservative: Probability of loss is low, but there is downside potential in adverse markets.
Moderate risk: There is some risk of loss, although it may be offset to some degree by certain factors such as good cash flow.
Higher risk: These selections are usually capital gains driven and are likely to experience significant price volatility.
JANUARY’S TOP PICKS
Here are our top picks for this month. Prices are as of mid-morning trading on Jan. 16.
Kinross Gold Corp. (NYSE: KGC)
Type: Common stock
Trading symbol: KGC
Exchange: NYSE
Current price: $21.61
Entry level: Current price
Risk Rating: Higher risk
Recommended by: Gordon Pape
Website: www.kinross.com
The business: Kinross is the third-largest primary gold producer in North America in terms of reserves. Based in Toronto, the company has been in business since 1993 and operates nine mines in several countries including the United States, Brazil, Chile, and Russia. Kinross has more than 5,000 employees.
The security: We recommend the purchase of the common shares of Kinross, which trade both in New York and Toronto.
Why we like it: The rapid rise in the price of bullion in recent months has focused attention on major gold producers. We especially like the prospects for Kinross at this time for these reasons:
New projects. The company has three new projects in the works which are scheduled to come on stream over the next two years. They are the Buckhorn Mountain Project in Washington state which is scheduled to start up in the second half of this year; the Kupol Project in Siberia, a rich high-grade gold-silver deposit which is expected to produce 413,000 ounces of gold equivalent annually (Kinross’s share) once production begins later this year; and the Cerro Casale Project in Chile, a jointly-owned venture with Barrick Gold, which the company says is one of the largest undeveloped gold/copper deposits in the world, with reserves of 23 million ounces of gold and six billion pounds of copper.
Overall, management estimates that production will increase more than 60% in the next two years, from 1.6 million ounce of gold in 2007 to 2.6 - 2.7 million ounces in 2009.
Declining cost profile. Kinross expects its production cost per ounce to drop as the new projects come on stream, making it unique among senior gold producers.
No-hedging policy. The company has not hedged any of its production through forward sales. This means it is enjoying the full benefit of the recent surge in the price of bullion.
Undervalued. Kinross shares have made a big move in recent months. However, the stock still appears to be undervalued in relation to such peers as Barrick (NYSE: ABX) and Goldcorp (NYSE: GG) and in a recent research report RBC Capital Markets speculated that this could result in the company becoming a takeover target.
Financial highlights: RBC analyst Stephen Walker and associate Ryan Dolan estimate that the company’s earnings per share will almost triple this year, from an estimated 34c in fiscal 2007 to 94c a share in 2008. They look for another big move in 2009, with earnings per share reaching $1.39. They have a target price of $24.50 on the stock but say that a successful ramp-up of the Kupol Project and the $470 million expansion at the Paracatu mine in Brazil would suggest a target of $31 or higher.
Risks: As with any gold producer, the share price will be directly influenced by the price of bullion. So investors should expect volatility, which is why we give the shares a “higher risk” rating. Also, the price is currently at an all-time high. Some investors may prefer to wait for a pull-back, although there is no guarantee that will happen any time soon.
Cash flow: Kinross does not pay any dividends. This is strictly a capital gains play.
How to buy: The shares trade on both Toronto and the New York Stock Exchange. The stock is highly liquid – trading volume on the NYSE is usually in excess of three million shares daily.
Summing up: Despite its recent price run-up, Kinross Gold is still an undervalued stock that offers good capital gains potential if bullion prices continue to rise.
Action now: Buy. – G.P.
Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF)
Type: Income trust
Trading symbol: COS.UN, COSWF
Exchange: TSX, Pink Sheets
Current price: C$37.03, US$37.20
Entry level: Current price
Risk Rating: Moderate risk
Recommended by: Gavin Graham
Website: www.cos-trust.com
The business: This company is a major player in the Alberta Oil Sands through its 36.74% interest in the Syncrude Project, located near Fort McMurray. Syncrude operates oil sands mines and an upgrading facility that produces a light, sweet crude oil.
The Syncrude consortium was formed in 1964 with the official opening of the project and the first barrel shipped in 1978. Other Syncrude partners include Imperial Oil Resources (25%); Petro-Canada Oil and Gas (12%); Conoco-Phillips Oil Sand Partnership II (9.03%); Nexen Oil Sands Partnership (7.23%); Mocal Energy Limited (5%); and Murphy Oil Company Ltd. (5%).
The security: Canadian Oil Sands Trust (COS) is currently structured as an income trust. However, management is evaluating alternatives, including possible reversion to a corporate structure before the trust tax takes effect in 2011. The corporate tax rate in Alberta is less than the planned trust distribution tax.
The shares trade on the Toronto Stock Exchange. They are not listed on any U.S. exchange but do trade over the counter through the Pink Sheets.
Why we like it: Most conventional oil companies have proven and probable reserves of about 12 years. The Oil Sands reserves, in contrast, have a much greater life expectancy. Syncrude has proven and probable reserves of five billion barrels, representing a lifespan of approximately 35 years at current capacity. There is potential to extend reserve life beyond the year 2050 as the leases are developed.
Syncrude is currently producing about 375,000 bbl/d (barrels of oil per day) but has plans in the works to increase that to as much as 500,000 bbl/d after 2016.
The shares offer good cash flow (the quarterly distribution was recently increased 38%).
Financial highlights: For the quarter ended Sept 30, Canadian Oil Sands saw a 45% increase in its operating income to C$484 million and a 58% increase in its net income to C$361 million (C75c per unit) as the benefits of a full quarter of the Stage 3 upgrader were realized. With a US$4.57 per barrel increase in the price of oil received, to US$81.23, and a C$4 (16.5%) fall in operating costs per barrel to C$20.48, reflecting the efficiencies from full operation, the full benefits of the capital investment program are being seen.
Risks: The trading price of COS shares will be affected by movements in crude oil prices. A significant drop in the oil price seems unlikely, but if a deep worldwide recession takes hold it is a possibility.
The recent announcement of the increase in royalty rates by the Alberta government should not affect COS as it, like Suncor, has a separate royalty agreement. While the government has said it wishes to renegotiate these, they are binding contracts and while both companies have indicated a willingness to discuss some modifications with Alberta, at the end of the day they cannot be compelled to break the agreements, which run to 2015. In fact, Canadian Oil Sands has already seen its royalty rate rise from 1% to 25% in the second half of 2006 as it exhausted all of its tax breaks in building Stage 3 of its upgrader at Fort McMurray but still managed to increase profits by one-third.
Other concerns are escalating construction costs in the Oil Sands, which could significantly increase the expense of further expansion, and the possibility of some kind of carbon emissions tax.
Distribution policy: With the latest increase, COS now pays a quarterly distribution of C55c a unit (C$2.20 annually), to yield 5.9%. at the current price. The trust has posted a notice on its website saying: “As Canadian Oil Sands Trust has not made an election to be treated as a partnership for U.S. tax purposes, we believe we are considered a corporation for U.S. tax purposes with a portion of the distributions paid by the Trust qualifying as dividends for U.S. tax purposes.”
How to buy: If at all possible, members are advised to buy units on the Toronto Stock Exchange where they are highly liquid and actively traded. The Pink Sheets should only be used if TSX access is unavailable, as volume is low and it may take some time to get a fill. If you use the Pink Sheets, place a limit order.
Summing up: COS is an excellent way to participate in the booming Alberta Oil Sands while enjoying good cash flow in the process. The long life of the reserves makes these shares doubly attractive.
Action now: Buy. – G.G.
Rogers Communications (NYSE: RCI)
Type: Common stock
Trading symbol: RCI
Exchange: NYSE
Current price: Rogers: $37.95
Entry level: Current price
Risk Rating: Moderate risk
Recommended by: Tom Slee
Website: www.rogers.com
The business: Rogers is the dominant cable company in the large Toronto market and the number one provider of wireless services in Canada with 7.2 million subscribers. It has extensive media interests including 51 radio stations, 69 consumer and trade magazines, and several television channels. The company also owns the Toronto Blue Jays baseball team and the domed stadium they play in.
The security: I recommend the purchase of the common shares of Rogers, which trade both in New York and Toronto.
Why we like it: In markets like these, Rogers stands out as an excellent defensive stock. It has the best fundamentals within the growing Canadian telecom industry and this is going to pay off. The company continues to gain wireless market share and enjoys strong cable franchises in the lucrative Toronto and Ottawa regions.
Rogers’ overall credit quality, once highly suspect, has improved substantially over the last two years. As a result, it’s well positioned to compete in Industry Canada’s forthcoming auction for advanced wireless services (AWS) although the results are bound to create more competition.
This company has a strong, well-established franchise, excellent cash flow, and good growth potential. The share price has taken a hit in this market correction, making it even more attractive.
Financial highlights: Third-quarter profit rose an impressive 75% to $269 million, up from $154 million the year before (financial results in Canadian dollars). Revenues were $2.6 billion compared to $2.3 billion in 2006. Once again, the wireless business delivered and Rogers cracked the seven million subscriber mark during the quarter. However, and this is what I find reassuring, other segments also showed healthy growth. Cable, Digital Internet, and even Home Phone added customers. CEO Ted Rogers said: “This was a quarter that some of you might consider to be on the boring side”. If that’s the case, I would welcome more “boring” results.
Management has indicated that 2007 free cash flow will exceed $1 billion. Given the already over-capitalized balance sheet, that had analysts speculating about increased dividends and share buybacks this year. No sooner said than done: on Jan. 7 the company announced that it is doubling the annual dividend to $1 a share and implementing a plan to buy back $300 million worth of its class B shares.
With margins improving, we should see earnings of about $2 a share in 2008 and as much as $2.40 next year.
Risks: There is a lot of competition in the Canadian wireless industry, which could temper the company’s 2008 results. However, reports are that Rogers will be the first to offer the Apple iPhone in Canada and may have exclusivity on it for some time.
There has also been concern that Rogers may face competition from Vancouver-based Telus in the field of GSM technology – Rogers is the only Canadian company to offer the service now. However, that is probably many months away and would represent a significant investment for Telus.
Distribution policy: With the increase announced this month, Rogers stock will now pay a quarterly dividend of C25c per share.
How to buy: The shares trade on the NYSE under the symbol RCI. The stock is reasonably liquid although it will occasionally trade less than 100,000 shares in a day. However, you should have no problem being filled.
Summing up: This is the premier cable and wireless company in Canada and the stock represents good value at the current price.
Action now: Buy Rogers with a target of $55, with a proviso that the stock is likely to be buffeted by a volatile market in the first half of this year. – T.S.
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