If you like dividends, you will love this episode! Barry and Ernest discuss the rationale for owning Canadian Energy stocks for income. They also provide an overview of the Canadian telco industry and review whether the dividends of the big three are sustainable.
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Podcast Transcript
Barry Schwartz
Hello and welcome to the Long Term Investing podcast with Baskin Wealth Management. I’m Barry Schwartz, Chief Investment Officer. Baskin Wealth Management is an independently owned investment management firm with almost $2 billion in assets under management, providing customized wealth management solutions and services to families and foundations. In this podcast, we ignore all the noise and have conversations that make sense about the things that matter in today’s markets. It’s what we talk about with each other here in the office and we want to share those conversations with you. Please stay tuned for our legal disclaimer at the end of the episode.
We’re back with another episode of the Long-Term Investing podcast with Baskin Wealth and with Ernest Wong joining me today. Ernest, how are you doing?
Ernest Wong
Good, how are you?
Barry Schwartz
I’m doing really well, and I wanted to thank all our new followers when thank you very much for joining us. There are over 20 plus episodes, and we hope to continue this output. Try our best to do up to two to 3 or 4 of these a month, depending on if there’s anything interesting to talk about. But hopefully we’ve got no end to things to talk about Ernest. And today we want to talk about energy and dividends and the Canadian telecom stocks. Maybe we can even talk a little bit about the US telecom stocks and we’ll see where the conversation goes.
So, Ernest, I see oil prices have, I mean, on one hand, if you own energy stocks, you’re happy. On the other hand, if you want CPI and inflation to come down, you’re not happy because since about the middle of June, oil prices, gasoline prices, diesel prices have ticked up – great for energy investors, not so great for the rest of the world. But our angle today is our energy stocks, the new dividend stocks, and why should people own them for income and what has changed in the past couple of years?
Ernest Wong
I think the important thing that some people often fail to appreciate about dividends is that dividends are an end goal and result, not a goal in and of itself.
Barry Schwartz
Yeah, a company that makes a lot of money can pay dividends because it’s making a lot of money, not because the reported dividend yield is X or Y.
Ernest Wong
Right. And you and I have seen a lot of investors that get into trouble because they look at a company, they see, oh, it pays a, you know, eight, 9% dividend yield. That sounds great. Like I’m getting today maybe 5% on a GIC. And hey, that’s 4% of extra yield, right? It’s a great deal. And that’s how you get into trouble because you’re not focusing on the company’s fundamentals. And this is, I think, very relevant to the energy companies because today they’re making a lot of money and that’s why they’re able to pay dividends. It’s not because they are. Attempting to be stable cash flow, dividend payers?
Barry Schwartz
No, nothing could be further from the truth. I mean, oil prices go up and down like toilet seats and oh, you look at the last 10 or 15 years and, you know, prices went sky high, then oil went negative. It’s very hard to be a stable income provider, you know, like a rental apartment when you’re an oil and gas company, it’s just income. And oil and gas doesn’t really make sense. But maybe things have changed,
Ernest Wong
Right. And so, if you look at companies like Canadian Natural Resources or Tourmaline Oil, both of which we own, incidentally, they pay special dividends based on what energy prices are doing. So, when energy prices are high, they’ll pay more special dividends. And when energy prices are low, they’ll naturally be less. And there’s no expectation provided by the management that these special dividends are going to persist in the future.
Barry Schwartz
No, this is really the right way to think about dividends, and I think you provided some great insights. So, if you were an owner of a private company and you had a, you know, a great quarter, maybe you would pay out more dividends. But if you had you had a tough quarter or there were needs to reinvest back in the business, you wouldn’t think twice about slowing the dividend down. You would reinvest back into the business. Unfortunately, in the public markets, it doesn’t work like that unless it’s so well communicated to the investors and you have an investor base that understands it well, maybe sometimes I’ll get a good dividend, maybe sometimes it’s better for the management of the buyback of stock. Maybe it’s better right now for the management to pay down debt. But life doesn’t work like that when in public markets.
Ernest Wong
And I think it’s gotten harder over the years, especially because of all the new exchange traded funds, the ETFs and mutual funds that have dividend growth strategies.
Barry Schwartz
Right. If you’re a company and you fail to raise your dividend one year, then you get kicked out of these ETFs, correct? Then everybody sells your stock and you’re much worse off, right? So like that’s just the way it is.
But I really like this model that the energy Canadian energy companies, I’m not sure have the US energy companies adopted this special dividend case by case stance that some of the Canadian companies have been following?
Ernest Wong
I haven’t looked into it.
Barry Schwartz
Okay, well, someone will let us know. But, you know, you can see from Canadian natural resources and tourmaline oil and there’s a bunch of other smaller Canadian oil and gas companies that have a base dividend depending on oil and gas prices. And if, as you said, if things are really good, will pay out more. Maybe will buy back stock. You know, these are good problems to have, of course. And our clients, those that are comfortable owning oil and gas, they own Canadian Natural Resources and Tourmaline. Those two companies have been returning so much cash to shareholders. Ernest, just to recap, what has changed in the past few years? I mean, oil prices are high today, but not high as they’ve ever been. What’s the difference this time around versus five years ago, ten years ago?
Ernest Wong
Canadian energy sector has been through a rough eight years or so historically. Historically, Canada was able to export all of its energy to the United States but since the shale revolution and the advent of fracking the US doesn’t need Canadian oil anymore. And basically all the energy that Canada produces in Alberta got stuck there. And since we don’t have pipelines and have not still today.
Barry Schwartz
No, there’s a nine month delay on the new TMX pipeline.
Ernest Wong
Just nowhere for the oil and gas to go. So, Canadian oil and gas has traded at a very low price. I think this is changing going forward for a few reasons. Number one is that some of the projects that have been being worked on are nearing completion. So think about like TMX, Coastal Gaslink, LNG Canada. These projects are going to allow oil and gas producers to access Asian markets. And secondly is that in the US, shale energy production is declining just due to the nature of these reserves. And so Canadian like I think there’s a good case to be made that Canadian energy is going to be in for a good little while.
Barry Schwartz
Yeah. Well, I mean, the there’s so many dynamics that are involved, obviously, in oil and gas and supply demand. You have financial speculators as well. You have obviously there are the emissions carbon emissions that are negative. And you have these companies spending money on renewables as well. But, you know, our style, our approach is to look for the best run companies with strong management and we think internally fit the bill. And, you know, maybe in the past we have been negative on those companies, though years and years ago we did own a lot of oil and gas. We’re betting that the future looks brighter for some of these companies. And I’ve been saying for dividends and this is a good segue. You know, a lot of investors own companies for the income and that’s fair. You know, they supplement their retirement and of course they’re many of those dividend paying stocks have done tremendously well. But of course you have to look under the hood. And you’ve mentioned before, you know, a lot of companies that pay dividends, they have tough balance sheets. High interest rates might be impacting them with some of these oil and gas stocks. Their balance sheets have improved by leaps and bounds. And some of them are saying, you know, a year from now, six months from now, if oil prices continue to stay high, we don’t need to pay down any more debt. We’re going to return all of our free cash flow to shareholders. And so it might be time to think about adding oil and gas stocks to your portfolio for income.
Ernest Wong
No. Well said.
Barry Schwartz
Okay. So talking about income. Let’s talk about the Canadian telco market, Ernest. This is our feature discussion. Our clients own shares of TELUS and Bell Canada, which is BCE. You know, our focus obviously is we have clients with different purposes and requirements and TELUS and BC are held mostly for our more retiree portfolios and our clients looking for more stable income. You know, not every stock in our portfolio provides income. That said, these have been tough names to own over the past couple of years. So earnings, we’re going to get into the pros and cons of Canadian telcos. Go ahead.
Ernest Wong
So for the purposes of this conversation, I just really want to focus on the big three, which are Rogers, TELUS and BCE. Like in Canada, there are like the main players along with a bunch of smaller guys, like they’re SaskTel and Saskatchewan, Quebecor and Cogeco and in Ontario and Quebec. But, but those are a bit of a different story.
We’ll leave it up to the Big three, which all the consumers seem to hate but can’t live without.
So I think oftentimes many investors seem to lump all dividend payers together like there’s banks, telecoms, pipelines, REITs, utilities. Even though each of these kind of have different dynamics and in Canada, at least, I think the telcos are actually quite similar to utilities. They provide an essential service, which is they provide cell phone service, they provide Internet and maybe less relevant today, but they also provide phone and TV services.
Barry Schwartz
And some of them also are home security.
Ernest Wong
Yep, they have cross country coverage, especially for wireless. And I think the important thing to understand about the Canadian telecoms, both from a consumer and from an investment perspective, is that it’s really expensive to provide Cross Canada coverage.
Barry Schwartz
You think one of the world’s largest, uh, landmasses and rugged environment and not a very dense unless you’re talking about Toronto, Vancouver and Montreal, the population. So yeah.
Ernest Wong
And this is especially true in the rural areas. I would just searching this up – about 20% of Canadians live in rural areas.
Barry Schwartz
Yeah, and it’s probably more if you include like places like Timmins or Thunder Bay where like, these are not large cities. Yeah. And very expensive still to provide Internet service and to connect it to the major financial centers of Toronto, for example.
Ernest Wong
Right. So if you look at the major telcos, their return on assets, so like the amount of money that they make on every dollar that they spend, it’s about 3 to 4%.
Barry Schwartz
Well, that’s lousy.
Ernest Wong
It is very lousy. They are not, contrary to popular perception, they are not massively profitable cash flow machines.
And so what often happens is that the CRTC, the regulator, they will from time to time, they’ll say, hey, let’s introduce some more competition into the market. Wireless prices are too high, like Canadians are suffering from cell phone bills. So they’ll do things like maybe allowing third parties to access their networks. They’ll ban three year contracts like all these kind of little things. And so then what the big three will say is, look like we’re already making only 3 or 4%. If you hurt us even more, then we’re just going to stop investing in rural areas. And so what will happen is the CRTC will look at it and say, okay, that’s not great for Canada, that the rural areas don’t have Internet and so they’ll back off. And over time, this dynamic has led to fairly stable returns for the Canadian telcos. So in essence, they are really utilities. They have a rate of return which is somewhat guaranteed based on the regulator, and they provide an essential service and. So if you look at BCE, for example, they historically earn about 3 to 4% return on assets after debt. They earn about 13%to 15% return on equity and they pay out all their earnings as a dividend.
Barry Schwartz
Yeah. And they’re actually paying out more than their earnings on dividends. But we’ll get into that. And so if you do the math, that comes out to about 6% to 7% on the return on the price that you’re paying for BCE today. And that’s actually what you’ve received in dividends over the last decade, wasn’t it? What Charlie Munger said, that if a company earns this type of ROE, adjusted for X number of years, that will be your return. You know, don’t be surprised at if it only earns 6%, then that’s all you’re going to earn.
Nothing wrong with that if you’re comfortable earning the 6% a year. But you know, you can see from the stock prices of some of those stocks, you’ve just gotten the dividend.
Ernest Wong
Exactly. And. I think there is good reason to think that this dynamic, the dance between the regulators and the telcos, is going to favor the regulator a little bit going forward.
Barry Schwartz
Okay.
Ernest Wong
As I as we just talked about, the main leverage that these companies have is their investment in rural areas. But with new technologies like Space-x, like they don’t need to like SpaceX provides very good service.
Barry Schwartz
Yeah. No, we have country. Yeah. We have a colleague, one of our colleagues here who uses SpaceX for his area where there’s no telco available. And it’s like, it’s amazing. It’s just as fast as if I was at home and, you know, logging into his computer. It’s incredible. Although there are days when it doesn’t work as well as others,
Ernest Wong
We’ll see what happens with these types of technologies. And it’s not cheap, of course.
Barry Schwartz
Right. But, I think the main point is if these companies no longer are needed to invest in rural areas, then I think the regulator could very well say, oh, I think there’s no reason you can’t give a little bit more in the cities. And so, I think it’ll be that’s an interesting dynamic that I’m interested in over the next few decades.
So you’re not so positive about the potential return on assets from here because of a regulation risks? Ernest, what are some of the positives, of course, to the telcos going forward?
Ernest Wong
Well, I think it’s just what we talked about. These are unlike the US, importantly, they provide all types of service across like they provide alarm, they provide phone, they provide Internet, they provide TV. So, these are very stable cash flow is generally recession resistant businesses.
Barry Schwartz
Totally. And when you go on vacation and the roam like home $10 a day in the US, $15 a day, and in Europe or overseas, those are like almost free money to the telcos.
Ernest Wong
So at least from a fundamental perspective, these are very safe businesses to own. And should be counted and investors rightly view them as safe dividends.
Barry Schwartz
So, Ernest, there’s been a dynamic in the past couple of years, obviously impacts from Covid, price competition, investing in new cable. I noticed in my neighborhood, I can’t speak to your neighborhood, but like someone’s laying a lot of fiber optics. I don’t know if it was Rogers or Bell. I don’t know why, it’s so silly that there’s three of them and they seem to duplicate each other’s capital spend. But that’s a story for another day. But if you look at the free cash flow that these companies are generating today, all of them are paying out more in dividends than the free cash flow that they’re generating, although they’ll tell you, you know, we’re investing for the future. And by 2025, 2026, some of those capex are going to come down dramatically and the dividend is going to be covered. So, what should investors make of that? Is it just a function of the cyclicality of that business?
Ernest Wong
I think so. The capex, as you pointed out, has been quite high over the last few years. And that’s because they’ve been investing in 5G and laying fiber for the fiber networks that they’ve been building out. I think if you study the history of telecom, like these things typically go in cycles. And so, after they are done this capex cycle, yeah, they will probably cover their dividend again. BCE is the cleanest of these stories. They just spend on telco service, and they pay a dividend.
Barry Schwartz
Yeah. And for a utility type company, I think that’s what investors like because it’s predictable. It’s understandable they’re not doing any weird stuff with the business. That’s not true for the other two.
Ernest Wong
Rogers is a is a complete mess right now on every level. The board doesn’t seem to get along. The former CEO is suing the business.
Barry Schwartz
and they’re counter suing the former CEO.
Ernest Wong
The balance sheet is hugely levered due to the Shaw deal. So not too interested in Rogers stock at the moment.
Barry Schwartz
No. And the stock price reflects that, of course. And the stock trading in the mid-50s, I think it’s been flat for like 14 years, something like that.
Ernest Wong
And then TELUS has historically they’ve grown a little bit faster, mostly because they’re more concentrated in Western Canada, especially in B.C. They have been investing in some. Uh, generally what I would generously call adjacent verticals to the business. So, they built out a call center business, which they listed as a public company called International.
Barry Schwartz
Which proceeded to fall by 50 or 60% since they listed that stock. So not the greatest result for those that bought the spinoff.
Ernest Wong
They have a health business which provides virtual clinic care. Yeah, they have an agricultural business.
Barry Schwartz
What does that agricultural business do?
Ernest Wong
It’s just providing things like telematics and those kinds of things. And these are like internet related businesses, but not really at the core. And so, I think that investors are viewing these investments with a little bit of skepticism.
Barry Schwartz
For sure. Definitely based how poorly the international story that out I think it’s called Telus International, but the outsourcing business has not done well.
Ernest Wong
Especially since again these are supposed to be safe and predictable businesses.
Barry Schwartz
But the core business, the core business of wireless and cable for these companies excluding all the other. Investments and businesses. How’s that going?
Ernest Wong
I think it’s mostly fine. I would describe it as certainly wireless pricing is not going up.
Barry Schwartz
Yeah. In fact, it’s come down quite a very competitive. It’s a very competitive market, contrary to what you might be reading in the newspaper.
Ernest Wong
Yeah. And but then in the long term, like, they are growing subscribers as the population of Canada grows.
Barry Schwartz
I mean all these businesses face a fair share of headwinds and risks. Obviously, someone would say a tailwind is the population potential for nice growth in Canada and everybody needs a cell phone and everybody kids need a cell phone. I mean, I never had a cell phone when I was a kid, obviously, because they didn’t exist. But now everybody wants their kids 10, 11, 12, 13, to walk to work or walk to school or take the bus. People buy their kids cell phones. So, there is a pretty good certainty in that business for now. So, we talked about Rogers. TELUS, of course, is run by Darren Entwistle. So, he’s almost an owner operator type investor. Tell us, I think started as Cleanet. I can’t remember the genesis, but I think Darren Entwistle, now the chairman, still owns a significant stake in the company and still has his fingers on the pulse of the company.
Ernest Wong
Yeah. And that’s why we like it and we own the most of despite what we just talked about.
Barry Schwartz
Yeah, exactly, so, the Canadian telcos have held up admirably over the last few years versus the US telcos. I think the US telcos just a different dynamic, right? Competitive, much more competitive market as well as the investing in new wireless technology is kind of stunted their balance sheets.
Ernest Wong
Yeah, it’s a totally different market. Like they’re not even comparable. Yeah. The US is an unregulated market. The dynamics are totally different in terms of how the business is set up. So, like there’s not really a comparison between the two.
Barry Schwartz
So many investors, just to finish off our conversation on the telcos, many investors will say, okay, you know, these companies have not done well in the last few years, apart from this year, because of interest rates. And so interest rates have worked negatively for us because, you know, the dividend is less attractive. Is there a reason to believe that if interest rates peaked or started to come down, that would be positively for viewed for the telcos? Or is it just a function of all dividend paying stocks?
Ernest Wong
No, I think higher interest rates are definitely a negative for these businesses. Unlike a utility. I don’t think the regulator has any desire to allow these businesses to increase returns on equity because that would basically imply allowing them to raise prices.
Barry Schwartz
Yeah. There’s certainly no political appetite to do that, and I don’t see why there’s a need to as well. I’ve noticed that there hasn’t, maybe I’m not following it as closely, but I notice that there hasn’t been as much discussion about the telcos in the papers or by the regulators. So, I think they’ve beaten them up enough in the short term. And it’s interesting to see how these things are so cyclical.
Ernest Wong
Right. And yeah, a 13% return on equity is great when interest rates are 2%. But I think it’s still pretty good, but not as great when interest rates are 5%.
Barry Schwartz
Wonderful. So, anything you want to finish off there on the Canadian telcos?
Ernest Wong
I think, if you really look past all of it like I do think they are fairly safe investments, which are probably going to hold their value going forward. And you’re going to get a decent dividend and that’s what you’re going to get. I don’t think investors in these stocks are going to expect to be finding the next Apple.
Barry Schwartz
No, but that’s not what they’re looking for. And there’s a home in your portfolio for all different types of companies. There’s something to be said for companies without a lot of drama, like Berkshire Hathaway, for example, where there’s you know, obviously I’m probably jinxing it right now, but there’s been no drama. The company you know, the fundamentals seem to grind higher, and the stock price is not as volatile as some of these other crazy names. And maybe that’s what the Canadian telcos and some other Canadian, you know, anchor stocks provide in your portfolio.
Ernest Wong
Which makes Roger’s drama all even more spectacular.
Barry Schwartz
Exactly. I think investors do not like drama for long term investing. Although the Canadian telcos have been negative performers for dividend investors this year, they’re not. All dividend stocks are doing lousy. And yes, Ernest, of course, REITs and utilities and pipelines have had a rough start to, well, 2023, almost moving into 2024. But there have been some stalwarts, some great winners. Brookfield Asset Management, which was a spinoff from Brookfield, of course, their Investor Day is today. Maybe we’ll talk about a little bit more about Brookfield in an upcoming podcast, again, after reviewing their Investor Day for Power Corporation. So, some of the insurance companies are doing very, very well. So, you know, even some REITs are up this year. Those focused on apartment buildings or industrial, those seem to be strong performers. So don’t just lump every single stock into one factor and say it’s good or bad. Do your homework, do your research, you know, and what doesn’t work in today’s environment may very well work tomorrow, so you never know.
Ernest Wong
Well said.
Barry Schwartz
Cool. So, any books, anything you’re reading or watching that you want to share that you think our listeners would benefit from?
Ernest Wong
So in the summer I went on a family trip to LA where we were we visited the Getty Museum.
Barry Schwartz
I’ve been there. It’s fantastic.
Ernest Wong
I highly recommend it. Although maybe less interesting for young children.
Barry Schwartz
Yeah, it’s a big, it’s a big place they can run around. And while you look at the beautiful art.
Ernest Wong
So, in the gift shop, I bought a little book for ten bucks called, by the man himself, called How to Be Rich.
Barry Schwartz
Yeah, we all want to be rich.
Ernest Wong
Yeah. So, I bought the book and I read it in one sitting.
Barry Schwartz
It’s John Getty, right? John Jr.
Ernest Wong
Paul Getty, he wrote, he wrote a little book on how to be rich and it’s a fantastic book. Keep in mind that he wrote this in 1960 because he’s long dead, but, in it, he articulates a lot of the same investing and business principles that people are talking about today. Yeah. So like, one of the things that he talks about is that he thinks that a lot of companies spend way too much money on things like travel and entertainment that they should focus on maintaining a lean cost profile. I think if you look at the performance of tech companies over the last year, certainly they could have learned from this experience. And he also talks about why in 1960, again, why he thinks low cost competition from the rest of the world should not be an issue for American manufacturers. Certainly, again, a relevant topic for today.
Barry Schwartz
Right. So, it’s a great look into history. Easy to read. He made all his money from oil.
Ernest Wong
Yes, He was a strange guy who refused to pay the ransom for his grandson’s kidnapping. But, yes, he was largely in the oil business. How to Be Rich by Paul Getty.
Barry Schwartz
I’ve read that book, but I’m going to read it again. I remember seeing that book in the gift shop. A small little book I think has green cover. Great recommendation. How to Be Rich by Paul Getty. Check it out. Thank you very much for joining us today. We’ll see you back here real soon. Take care.
This podcast is for informational purposes only and any forecasts on the economy, markets or individual securities should not be viewed as investment advice, a recommendation or an offer or solicitation to buy or sell any securities. Clients of Baskin Wealth Management and the speakers on this podcast may own shares of the company’s discussion. Information on this podcast is current as of the time of production and is subject to change. If you have any questions or would like to subscribe to these podcasts, visit our website at Baskin Wealth.
