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
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
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.
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.
The Bristol Gate Team