Could Better Days Be Ahead For Canada's Big Dividend Stocks?

Canadian dividend stocks have struggled under the weight of high interest rates recently. Are these stocks poised to benefit if rates begin to come down? Michael O’Brien, Managing Director at TD Asset Management, discusses the dividend landscape with MoneyTalk’s Greg Bonnell.

Greg Bonnell: It's been a tough year for the big Canadian dividend-paying stocks, central banks, of course, hiking rates aggressively. But as we see some signs that inflation could be cooling in this country, could there be better days ahead for those stocks?

Joining us now to discuss, Michael O'Brien, Managing Director and Head of Core Canadian Equities at TD Asset Management. Michael, great to have you back on the show. We got it from inflation print today. We're seeing headline come down. This is what we want to see. When it comes to these big blue-chip Canadian dividend players, I think a lot of people are wondering what's happening in this space.

Michael O’Brien: Yeah, it's been a tough year for these names. And when you think about it, Greg, this is typically-- these are the names that are supposed to be the sleep-at-night portion of your portfolio, the steady names that you don't have to worry about. But it's been a pretty tough year.

And so I think really to unpack why they've struggled, we can go through a number of the larger names. They all kind of have company-specific or idiosyncratic stories around them. But at the end of the day, I think it's pretty clear that it's been this big rise in interest rates that have really pressured the valuations of these stocks. People are finding alternatives in cash and bonds and GICs.

And so I think really, if you want to see that trade turn around, if you want to see better days, you have to have a view that interest rates are close to peaking here, not to say that they necessarily have to come down right away. But if you gain a little bit of confidence that maybe rates aren't going a lot higher, then it might be an interesting time to start poking around these names.

Greg Bonnell: Before the pandemic, of course, there was the TINA trade. There is no alternative. And suddenly, you enter the pandemic. And there was no alternative. And now you're talking about money market funds. You're talking about GICs, all those other instruments that are giving the yield, some of these dividend players. It's interesting about the dividend players because it can be twofold. They're competing with cash instruments for that yield. But they also carry a lot of debt.

Michael O’Brien: Yes. Well, and there's a third element of that, too. But you're absolutely right. There's the competition from the higher rates. They do tend to be pretty capital-intensive businesses, which usually coincides with pretty good debt load. Obviously, those are key reasons why they're interest-sensitive stocks. That explains a big portion of why they tend to struggle when rates are high.

The other attribute that investors traditionally have looked to in these names, though, that's sort of separate from this, is they don't tend to be that economically sensitive. Whether you're talking about your telephone companies, your cable companies, you're not going to give up your cell phone. You're not going to give up your internet connection.

Regulated utilities, some of these pipeline companies that are heavily contractual revenue streams, they don't tend to be as sensitive to the ups and downs of the economy. And so it's been an interesting year where interest rates have gone up because, frankly, growth has come in a little bit better and inflation has stayed a bit hotter through 2023 than maybe we thought at the beginning of the year.

But in Canada specifically, if we start to see the economy cooling a little bit-- and we saw a little bit of relief this morning in the inflation print, which was nice -- in that type of environment, if people start looking at these more as that steady performer in their portfolio from a fundamental perspective as opposed to a rate-sensitive name that's being beaten up by higher interest rates, that could change the way people look at the stocks here.

Greg Bonnell: You talked as well about apart from these sort of bigger macro issues, some of these blue-chip dividend payers in Canada, whether it's a BCE (BCE, BCE:CA) or maybe it's a Trans-Canada pipeline, they have their own issues, too. So you have all these other issues. Plus, an investor might take a look at some of these names and say, oh, I'm not too sure about these. Walk me through a few of them.

Michael O’Brien: Sure. Well, if you look at the big pipeline names, which are very large-index weights and obviously very closely followed by all of us, TC Energy (TRP, TRP:CA), the old TransCanada pipeline, and Enbridge (ENB, ENB:CA), they're both trading at some whopping dividend yields here. They really catch your attention in the 7% to 8% range.

But I think as we've all learned over time, sometimes the higher-dividend yield is a sign that investors have fundamental concerns about the sustainability of, can they continue to grow the dividend? Can they continue to sustain the dividend?

In both cases, TC Energy and Enbridge, their dividend payout ratios are quite high. So you could argue they're a little bit out ahead of their skis in terms of the dividend payout ratios. And TC Energy specifically, they've kind of gotten extended. But they're also having a little bit of trouble getting some of these very large pipeline projects across the finish line. They've had some cost overruns.

I mean, the most important one of these is Coastal GasLink, which is meant to connect the natural gas fields of British Columbia to LNG Canada, which is supposed to come online in 2025. This has been several billion dollars over budget. They've had to do an equity raise. They've had to sell some assets.

So those are all legitimate concerns. If they can get Coastal GasLink across the finish line this fall the way they're hoping to without any more cost overruns, that will certainly remove one overhang on the stock. But them and Enbridge both, they still have, at the end of the day, debt levels that are probably a bit higher than they should be, payout ratios that are a bit higher than they should be, which just means they're a little bit handcuffed in what they can do.

So the way I look at this is I think what we should expect is a slower pace of dividend growth out of these two, which were always dividend growth stalwarts. I think the dividend growth rate for those two names is going to be lower going forward than we've been used to.

Greg Bonnell: What about the telecom space? I mean, there's that old saying of the widows-and-orphans stocks. And people would have perhaps put BCE in that bucket or a TELUS (TU, T:CA) in that bucket. Those stocks also getting hit this year.

Michael O’Brien: Yes, absolutely. And so when you think about those names, one of the reasons why they were widows-and-orphans stocks is they didn't have a lot of competition. You had a phone company. You had a cable company. Obviously, as technology has developed over the last couple decades, they've been thrown into direct competition. But even there, historically the Canadian market's been very stable, the big three, oligopoly and wireless.

I think one of the dynamics that's changed this year obviously is with Shaw-- or with Rogers (RCI, RCI.B:CA) completing its Shaw acquisition and then being asked to divest Shaw's wireless business in Freedom Mobile to Québecor, that's changed the competitive dynamic. It's put a new competitor into western Canadian landline. It's also put a new competitor into the wireless market.

And so I think investors have been apprehensive about how aggressively these companies will compete on price, what that means for margins, is there room for four players? So I think that's been one of the big issues facing both those companies.

The other part similar to Enbridge and TC Energy is both of these companies have elevated payout ratios. We've looked to them for steady dividend growth in the past. They've delivered it up to this point. But in both cases, when you look at the amount of debt they have on their balance sheet, when you look at where the dividend-payout ratios are in relation to their earnings and their free cash flow, they're a little bit stretched.

So people are raising some questions around, can TELUS continue to grow its dividend at 7% to 10% the way they've promised? Can BCE continue to deliver that 5% dividend growth that investors have gotten used to? So those are some of the question marks around them. So those are dogging these individual stocks, but then I point to the utility names where there is no hair on the stocks.

Greg Bonnell: Regulated industry.

Michael O’Brien: They're regulated industry, relatively clean stories, but they've had the same pressure on their share prices as the pipeline and telecom names, which, again, leads us back to interest rates being the culprit.

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