The Best Investments of 2013

It was a tough year for income investors but some stocks bucked the trend. Gordon Pape looks at some of last year’s winners and explains why they did well.

It’s been a difficult year for income-oriented investors. The May spike in interest rates, which was caused by fears that the U.S. Federal Reserve Board was about to start “tapering” its quantitative easing program, not only hit the bond market but also caused a lot of collateral damage.

Many types of income securities suffered including REITs, preferred shares, and low-growth, dividend paying stocks. Most have still not recovered. As of the close of trading on Dec. 20, the S&P/TSX Capped REIT Index was down 11.8% for the year, the Capped Utilities Index had lost 9.4%, and the Preferred Share Index was down 7.6%.

Perhaps the May shock was the worst we’ll see – the markets actually responded by rising when the Fed finally announced that the tapering process would begin in January. But with rates likely to edge higher in 2014-15, pressure on bonds and other interest-sensitive securities is going to continue.

This creates a new dynamic for income investors. Many of the securities that did well from 2008 to early this year will struggle in the new environment. As a result, a change in strategy is needed. This involves increasing the percentage of dividend-paying growth securities in your portfolio. Granted, there is more risk involved in this but the alternative is a portfolio that is stagnant or may even decline in value.

This is not to say that your entire portfolio has to be growth-oriented. I don’t believe in excess at any time. You should still retain some exposure to bonds, preferred shares (preferably floating rate), and conservative dividend-paying stocks. But if you have not yet added some growth securities to your holdings, it’s time to consider them.

I took a close look at all the securities we recommended in my Income Investor newsletter in 2013 to see which had produced the best results. Not surprisingly, almost all are growth-oriented. Here are the top performers of the year.

TAL International Group (NYSE: TAL). I recommended this shipping container company in early January at $37.11 (figures in U.S. dollars). It turned out to our best pick of 2013. The shares were recently trading at $56.37 so we have a capital gain to date of 52% plus we have received dividends of $2.68 for a total return of 59% in less than a year. What is especially encouraging is that each quarterly dividend has been $0.02 higher than the one before, the latest (Nov. 27) being $0.70 a share. TAL’s dividends are directly tied to profits so this is a very positive trend pattern.

Third-quarter results reflected a continued improvement in the company’s fortunes. Adjusted pre-tax income was $1.60 per share, fully diluted, an improvement of 8.1% over the same period last year. Net income was $34.7 million ($1.03 per share) compared to $31.2 million ($0.93 a share) in 2012.

Leasing revenue was $143.9 million, up 6.4% from a year ago. Utilization averaged 97.3% for the third quarter and TAL has purchased over $620 million in new and sale-leaseback containers for delivery in 2013.

Because of the price increase, TAL’s yield is lower than when I first recommended the stock, but it is still a respectable 5%, based on the $0.70 a quarter rate.

 

FLY Leasing Ltd. (NYSE: FLY). This Irish-based international air leasing company was recommended in mid-October at $13.40 (figures in U.S. dollars). It got off to a strong start, with the shares now up to $15.92 (Dec. 27). So we have a gain of almost 19% in a little over two months.

The stock managed this advance despite a disappointing third-quarter financial report that showed adjusted net earnings of only $2.7 million ($0.07 a share) compared to $5.4 million ($0.21 a share) for the same period in 2012. For the first nine months of the fiscal year, adjusted net income was $52.5 million ($1.65 a share), down from $63.1 million ($2.43 a share) last year.

In spite of the reduced profit level, the board of directors approved an increase of $0.03 in the quarter dividend, bringing it to $0.25 a share ($1 annually). That translates to a yield of 6.2% at the current price.

The company owns 107 jets, which are on lease to 56 airlines in 32 countries. The use utilization factor during the quarter was 97%.

Cargojet Inc. (TSX: CJT). It’s a good time to be in the airline business. Activity is picking up and the stocks are reflecting the improvement in the overall climate. This stock was picked in September by one of our contributors when it was trading at $11.36 and yielding 5.2%. Its fleet of 14 cargo jets operates between 13 Canadian cities as well as in the U.S., Bermuda and Poland.

The stock now trades at $13.25 for an advance of almost 17% in less than three months. The company pays a quarterly dividend of $0.1491 per share (about $0.60 annually) to yield 4.5% at the current price.

Third-quarter financial results (to Sept. 30) showed a year-over-year increase of 3.8% in total revenue to $43.4 million. However, net earnings fell to $225,000 ($0.03 a share) from $947,000 ($0.12 a share) last year. CEO Ajay K. Virmani blamed “unforeseen aircraft maintenance, flight operations training and operating costs.”

Year to date, the company has earned $0.12 a share, well below the current dividend level. That’s a danger sign and we’ll keep a close watch on the company’s performance in 2014.

 

Premium Brands Holding Corp. (TSX: PBH). I recommended this company when it was trading at $19.49 and yielding 6.4%. Premium Brands owns a broad range of specialty food manufacturing and differentiated food distribution businesses. It has operations across Canada (with the exception of the Atlantic provinces), as well as in Nevada and Washington State.

The stock languished for a while, actually dipping briefly to the $18 range in early fall. However, it has been strong recently and was recently trading at $22.17 for a capital gain of almost 14%.

The company is coming off a strong third quarter that saw revenue increase by 13.5% to $287 million compared to $252.9 million for the same period last year. Net earnings were $5.2 million ($0.25 a share), up from $4.6 million ($0.22 a share) in 2012.

Rolling four quarters free cash flow increased to $47.2 million from $46.8 million in 2012 resulting in a dividend to free cash flow ratio of 54.7%. The stock pays a quarterly dividend of $0.3125 a share ($1.25 annually) to yield 5.6% at the current price.

pizzabox_enPizza Pizza Royalty Corp. (TSX: PZA). Everybody knows about Pizza Pizza’s tasty products. Now we’re finding out the stock is pretty tasty too. It was recommended in June at $12 and was recently at $13.25 for a 10% advance. The shares pay a monthly dividend of $0.065 ($0.78 a year) to yield 5.9%.

 

Royalty companies such as this pay out virtually all of their distributable cash flow so a high payout ratio is to be expected. That was the case in the third quarter when Pizza Pizza reported a 101% payout ratio; the year-to-date figure is 99%. But while the payout ratio is not a major concern, same-store sales growth (SSSG) during the quarter was a little light at 1.9%. For the first nine months of the fiscal year it was 2.2%, down from 2.5% during the same period in 2012. While the shares have done well, it would be nice to see stronger SSSG in the fourth quarter.

 

The pattern that we saw in 2013 is likely to continue next year. So if you want your income portfolio to outperform in the current environment, you have to be prepared to add more risk to the mix. Ask if a financial adviser if this strategy is appropriate to your needs.

 

 

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