Investment Commentary

Report to Investors 3rd Quarter 2020

There is so much to worry about – a second wave of COVID, US Presidential elections, ongoing global trade tensions, large government deficits, and high market volatility to name a few concerns. In an environment where dividend futures are implying a double digit decrease for the broader market through 2022 and overall anxiety remains high, good things are still occurring in many specific situations.

According to JP Morgan and based on the current Index composition, 77 companies within the S&P 500 have raised their dividends during the COVID pandemic. At Bristol Gate we know that a commitment to pay a fast rising dividend in good, and more importantly, difficult markets is often indicative of a strong competitive advantage. We know that market leading companies in attractive markets with good stewards of capital who reinvest in attractive projects are generally better investments than those who are not. We believe focusing on such companies skews the already attractive asymmetry in equity markets (they rise more often than they fall) further in our favour.

Although we manage “dividend funds”, we generally steer clear of traditional dividend paying sectors such as Real Estate and Utilities. While 75% of the Utilities sector and two thirds of Real Estate firms in the S&P 500 have raised their dividends this year, the companies overall have funded that growth by issuing shares. They essentially take from Peter to pay Paul. We prefer our dividend growth not be driven by financial engineering.

Exhibit 1. S&P 500 Dividend Actions and Total Shareholder Yield by Sector

Source: JP Morgan.  

Our efforts remain focused on situations with high, sustainable dividend growth. We believe the combination of our dividend growth model providing more accurate dividend forecasts than other relevant benchmarks and our fundamental analysis corroborating the durability of high dividend growth beyond the model’s one year horizon continues to afford us an opportunity to outperform the overall market over a full cycle with lower risk as we have done in the past.

Our differentiated focus relative to most other dividend related strategies has served us well in the current environment. Year to date, high growth/low yielding dividend stocks have materially outperformed their counterparts.

Exhibit 2. YTD Returns (in USD) of S&P 500 Dividend Stocks

Note: Returns are averages for stocks in the relevant growth, yield or all dividend paying universes. Dividend growth universe represents 408 S&P 500 stocks that paid a dividend in the prior year. Dividend yield and all universes represents 415 stocks that currently pay a regular dividend. BGU represents the Bristol Gate US Equity Strategy.

Source: Bristol Gate Capital Partners, FactSet, Bloomberg.  

Bristol Gate US Equity Strategy (all returns USD)

The US Equity Strategy gained 9.4% in the third quarter compared to the 8.9% rise for S&P500 Total Return Index®.

Cintas, Danaher and Sherwin-Williams were the three largest relative contributors during the quarter, each benefiting in some respect from the COVID environment. Cintas is seeing hospital systems order more gown and cleaning services plus a general uptake in sanitizer and protective equipment across its client base. Danaher is experiencing higher demand for its diagnostic testing kits and a surge in bioprocessing, genomic and automation solutions from biotech and pharmaceutical customers searching for a COVID vaccine. Sherwin has seen unprecedented demand from its do-it-yourself paint customers as working from home has given them more time to work on their homes.

American Tower, Allegion and Tyson were the largest relative detractors this quarter. American Tower declined due to a push out of site leasing activity and potentially higher near term churn after signing a 15 year master lease agreement with T-Mobile. Although near term earning expectations declined, we viewed the long term visibility the deal brought as a positive. Allegion fell due to COVID related disruptions in the commercial and institutional construction/replacement markets. Tyson suffered temporary plant closures and significant stresses on its supply chain due to COVID breakouts while the company’s food service segment also struggled as dining out declined.

Year to date, the Strategy has return 2.4% compared to the Index’s 5.6%. Index returns have been dominated by a handful of technology and technology related, primarily non dividend paying stocks. The Strategy continues to outperform the broader dividend paying universe by a meaningful amount.

There were no position changes in the quarter and all securities were re-balanced to equal weights on September 23, 2020.

Exhibit 3. US Equity Strategy Returns and Risk

Net Returns

Bristol Gate Canadian Equity Strategy (all returns CAD)

The Canadian Equity Strategy gained 9.3% in the third quarter compared to the 4.7% rise for S&P/TSX Composite Index®. Stella Jones, FirstService and Canadian National Railway were the three largest relative contributors, while Enbridge, TC Energy and OpenText were the largest relative detractors.

Exhibit 4. Canadian Equity Strategy Returns and Risk

Net Returns

Higher home improvement spending benefited Stella Jones and FirstService. Stella Jones posted record sales in its residential lumber, while also showing strong results in its rail ties segment, as railway companies pushed ahead with line maintenance projects. FirstService showed resiliency in its business model of diverse revenue sources, benefiting from increased U.S. home sales. Canadian National Railway managed its network and costs effectively in the volatile COVID demand environment.

On the other hand, the pandemic and ensuing travel restrictions and stay at home orders have significantly impacted demand for fossil fuel, resulting in a decline in oil prices. Pipeline companies like Enbridge and TC Energy are not directly exposed to the commodity prices, but lower prices result in lower volumes as clients are less eager to ship oil. While prices and volumes have recovered from their lows there is still some way to go to reach pre-COVID levels and continued uncertainty around this has caused both names to underperform. OpenText has delivered strong results post-COVID driven by its cloud related revenue, but management’s conservative guidance and no news on the M&A front gave us the opportunity to add more shares during the rebalancing process, as the name underperformed for the quarter.

Year to date, the strategy is ahead of the S&P/TSX by approximately 60ps despite not owning Shopify, the largest weight in the Index. The non-dividend paying stock has cost the strategy almost 336bps of relative performance.

There were no position changes in the quarter and securities were re-balanced to equal weights on September 23, 2020.

Firm Update

We continue to work from home, but probably like many of you, are eager to return to a more normal environment as soon as practical, missing some of the daily interactions with co-workers. Despite the market and operational challenges brought about by COVID, our AUM/AUA is approaching CAD $1.9 billion as of September 30, 2020 and compares to CAD $1.2 billion at the same time last year.

We thank our clients for their continued support.

Yours sincerely,

The Bristol Gate Team

Important disclosures

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively. Past performance is not indicative of future results.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. The S&P/TSX Composite Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2019 by ACA Performance Services.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events.

Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.

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