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Colum McKinley, managing director and global equity chief investment officer, CIBC Asset Management.
The COVID-19 pandemic has had a substantial effect on equities across the board, and that includes dividend stocks in the Canadian marketplace. And we’ve seen it in this crisis, much like we’ve seen in other crises, that the initial reaction is somewhat indiscriminate. And so when we think about the attractiveness of dividend paying stocks over the long term, we think that continues to be true. But in the short term, we saw substantial volatility in the marketplace, and we saw a meaningful sell-off in all stocks, including dividend-paying stocks. And that created opportunities.
Early in the sell-off, we saw opportunities to accumulate positions in what we think are great businesses with solid and strong dividends—dividends they’ll pay to our unitholders for years to come. But we were able to accumulate those positions at very attractive prices. And I think that’s one of the keys that we have continued to recommend to investors, is we always look to volatility and think about volatility as an opportunity. And that’s true for all equities, including dividend-paying stocks.
When I think about companies that are at risk of facing dividend cuts or dividend suspensions, there’s a couple of characteristics that we have embedded in our process to ensure we avoid these types of companies. And so the first is somewhat obvious: companies with substantial leverage. This creates a challenge when you have an environment like the COVID pandemic, where cash flows and earnings are substantially pressured.
Where we have focused our efforts with companies is on looking at businesses with a couple of characteristics that we think will help them navigate and maintain their dividends through this. So, first, companies with low debt levels. And the second is related to debt also: access to liquidity—the ability to continue to finance their business through a short-term period of uncertainty.
And the second thing we’ve seen is companies focus on cost cutting. And so businesses that can quickly react and pivot and reorient to take advantage of today’s environment and to ensure that they are positioned for future success. So companies that can quickly react to reduce their cost structure to maintain cash flows to support their dividend.
There are going to be companies in the marketplace that are forced to cut or suspend dividends. I think there’s a period of time here where dividend growth and share buybacks are likely on hold, and this is very similar to what we saw during the global financial crisis.
What we’re trying to think about is both the short term and the long term. So the short term is the ability of these companies to navigate this uncertainty, and so what do they have to do to maintain their dividend today? The longer term is thinking about the normalized earnings or cash flows of these businesses and the types of excess cash that they will have available in the future to resume or increase dividends over time and also to buy back shares.
When we look three, five, 10 years out, what are the companies that are going to be able to sustain and grow dividends at very attractive rates and provide a stable source of income for our unitholders?
And so there’s a couple of areas that we think those themes are going to continue to play out. In the pipeline, in the midstream businesses, we think that the contractual relationships that they have with customers allows them to have a higher certainty around their cash flow. So companies like Enbridge we think are a great example of businesses that will be able to sustain and grow their dividends over time.
While the Canadian banks face some near-term challenges as loss provisions rise, their capital positions remain incredibly strong. Capital positions today are stronger than we had during the global financial crisis, so we have no doubt in their ability to weather this uncertainty and, in fact, come out stronger in the support that they’re providing to their customers. Much like it’s been in the past, the banks have been a great source of dividend income and dividend growth for Canadian investors. We think that’s going to continue over time.
And, finally, telecom companies. As we all have shifted our lives to living and working from home, we have become more and more reliant on the telecom companies in Canada. Their services have become mission critical for our daily lives. Again, there’s a strong contractual relationship that exists between their customers. We all have contracts for our cellphones and our internet connections at home, and we all know and see the need that we have on that on a day-to-day basis. So we think of these as businesses that are going to continue to generate excess cash flow and will be able to continue to distribute that excess cash flow to shareholders in the form of dividends.
- CIBC Monthly Income Fund