McMurtry Investment Report Newsletter – March 2019

For many Canadian and US private investors, investing in dull and boring interest sensitive sectors is frequently ignored.

The three most common sectors in this group are REIT’s, Utilities and Consumer Staples. I have purposely not included energy infrastructure companies like Enbridge as they are part of the Energy sector and are still cyclical in nature without having any material commodity exposure.

Domestically these three sectors represent 11% of the benchmark market index while in the US their weight is 13.4%. This is clearly a significant weight and should not be ignored.

These interest sensitive groups have traditionally paid higher dividends than the other equity sectors except for Financials and Energy Infrastructure which always pay a good dividend.

The largest equity sectors by market weight in Canada are Financials, Energy, Materials and Industrials for a combined total of 72.6% of the market.

In the US Technology, Healthcare, Financials and Communication Services represent 58.8% of the S&P 500 index.

Based on the significant market weight of the four top equity sectors in Canada and the US, many investors simply forget about investing in the other sectors. This is not a good strategy.

Historically the interest sensitive sectors are much less volatile than the overall market. While their growth rates are lower, the combination of high dividends and low price volatility make these sectors attractive long term investments.

The interest sensitive sectors perform relatively worse than the overall market in a period of rising rates. This is because they have higher debt levels and are not growing their earnings and cash flows nearly as fast as other sectors. Conversely in a declining rate environment these sectors tend to outperform the market.

Taking into account the global economic slowdown especially in China and Europe and the muted inflationary outlook, the probability of interest rate increases is diminishing. This outlook may change later in the year but markets are fixated on what is happening right now.

My criteria for selecting companies in these interest sensitive groups has not changed. I still prefer companies with rising earnings and cash flows, strong balance sheets, low dividend payouts and rising dividends. Exposure to other countries is also attractive provided that this enhances long term growth prospects and does not place these companies in financial difficulties. I do not like high dividend yield plays only, preferring to invest in companies that have the ability to increase dividends over time. A high dividend yield with limited dividend growth prospects is not what I like to see.

In the REIT sector there are many companies in diverse industries. There are retail, industrial, apartment, hotel and retirement home ones to consider for investment. My preference continues to be in the apartment and industrial / logistic sectors where the current fundamentals remain strong and where cash flow growth is leading to dividend increases.

In the consumer staples area, there are a lot of headwinds currently that need to be addressed. We all saw the share price collapse recently of Kraft Heinz. This company is experiencing very stiff competition both from healthier niche brands available online through Amazon in addition to retail private label brands like Costco’s Kirkland. While there are industry problems, companies like Unilever are better able to deal in the current environment. The latter company is much more nimble than Kraft Heinz and its revenues are much more global than many US consumer companies. Loblaws is doing well in this period despite rising minimum hourly wages and increased price regulations in the generic drug area. This is a result of its strong management. Alimenation Couche Tard continues to benefit from its management’s ability to quickly integrate major acquisitions both domestically and globally.

Lastly the utilities sector is experiencing nice growth in green energy – solar and wind specifically in many areas of the world. Companies like Algonquin and Northland Power are growing their cash flows and increasing their dividends accordingly.