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About this podcast

In this episode, Stu Kedwell, Co-Head of North American Equities, discusses the outlook for dividend growth in cyclical companies, particularly in energy, materials and other commodity stocks. Stu also talks about how ESG is considered when investing into these types of companies in order to evaluate their sustainability over the long term. [12 minutes, 11 seconds] (Recorded January 12, 2022)

Transcript

Hello and welcome to The Download. I'm your host, Dave Richardson, and it's everyone's favorite day, Stu’s days. A little late this week. Busy people here on the podcast, particularly the co-head of North American Equities at RBC Global Asset Management, always busy, Stu Kedwell. Stu, how is it going?

Great. Thanks for having me, Dave, as always. Before we begin, I need to congratulate you on thirty years with RBC. There's a lot of Canadians who are better off for it. So, let's start with congratulations.

Wow. Thanks Stu, and right back at you, you're at 25, and you look a lot younger than me, so you fared much better. You clearly are taking care of yourself a lot better. That's why podcasts are good, because they're audio, not video. We hopefully never get to some of these podcasts that do the simulcast with video along with the audio; we're probably not going to ever get there.

I doubt it.

It would favor you. By the way, you're so busy because you're watching Boston sewage these days. Is that your new thing?

Well, that was an interesting statistic this morning. I'm not sure it would be a job that I would want, but someone is measuring the Covid in the Boston sewer system, and it has come down quite precipitously from the middle of December. Just another way of trying to figure it out. When there's not all the testing going on, people are looking for new ways to try and figure out how different municipalities are doing. And I think I saw the chart for Ottawa on Twitter today, which also may have hit its peak. So always new ways of looking at things.

Always different ways of looking at things, in these unprecedented times. Stu, what I wanted to talk about today. Because we've really seen early in 2022, in terms of where money is moving around, yields have moved higher on government treasuries. We saw an inflation print this morning in the U.S. at 7%, which is the highest in 40 years. We've seen this rotation around within the market towards a lot of cyclical names: energy names, metals, things of that nature, banks, and financial institutions. Which tends to be quite favourable to the Canadian market. But instead of just focusing on those sectors from the potential for their stock appreciation, since you have managed a dividend portfolio for a number of years in Canada; you've got your dividend “aristocrats”— and perhaps the Canadian banks represent that. A lot of other companies just consistently pay dividends, they have consistent earnings flows, cash flows. Typically, always paying, increasing their dividends. And then you have the whole commodity complex— the oils, the metals— that tends to be a little bit more erratic. What we've seen is a period where prices of those underlying commodities was weak, dividends were slashed, cut or eliminated. Now we're starting to see a lot of these firms, as the underlying prices have increased, they're flush with cash flow, and they're starting to look at increasing dividends, paying special dividends. I'm just wondering, how do you manage and think about the dividends from those types of companies versus the way you think of it in other sectors of the economy where the dividend is more consistent and predictable?

It's a great question. What you tend to do is try and think about these businesses through the cycle. We know we're going to own some of them for a very long period of time, and we know that there will be periods of time when the cash is a little skinny— maybe what we've gone through in the last 12-month period. But there are other times where the cash is prodigious. There's a couple of things that you're really sitting down when you're looking at those businesses. The first is the length of the reserves that they have in the ground. We don't want to run out of reserves during a period of low commodity prices. If you can find a business with 25, 30, 35 years of reserves, you know that you're going to participate a number of times in some really strong cash flow. The second thing is, you want those reserves to be reasonably low cost, so that even during the periods of down prices, the business never needs additional equity to get through that period of time. In other words, the amount of resources that I own on a per share basis doesn't go down during the bad times. The next thing you want is, when companies go to put capital to work, will they be able to build new facilities, new mines at cost structures that are going to be competitive, and are they going to be able to get through it by using the cash flows that they generate? Again, you never want to see equity issued at the wrong time on one of these cyclical businesses. If those cases hold, then the cure to low prices is low prices, and quite often as the business starts to move higher, you're going to get a good, strong return. If you think about some of the fertilizer businesses that we own in Canada, you go see the mine and there's many kilometers underground and there's years and years of resources, and those mines will be producing things like potash, and what have you, for a very long period of time, and they generate significant cash flow when prices are strong. That's the case across our investments in copper, our investments in oil and things like this. The key is, we want to own as much of the resources on a per share basis throughout the cycle.

We talked about the ESG side of this as well, and everyone's going to come at this— individual investors anyways— with their own views on what they want to own, or not own, and how they want to assess that sustainability and the way these firms are extracting these natural resources. Does that play at all to your thinking in terms of that longevity of the business and sustainability of the business?

No question. Sitting down with these management teams, we get to have a lot of great discussions with all of them, and we want to understand how they're reducing the carbon intensity of their production as time passes, because that will be really important to the terminal value of the business a number of years down the road. In some cases, valuations are higher multiples— by that I mean, for a potash business, you might be in the eight to ten times cash flow, because people have views that the sustainability of potash for many years into the future is higher. Some of the oil and gas businesses don't have quite those same robust multiples because people worry how long will the consumption last down the road? We think that there's going to be many years of consumption, relative to what's taking place today, and are quite encouraged by some of the plans to reduce the carbon intensity of the production. The carbon intensity of the usage is a different question and that's a bit more of a societal issue that is being dealt with carbon taxes and all sorts of things. But when we look at the production of these goods, we want to see the carbon intensity of that production going down.

We've done some podcasts with Melanie Adams and others who focus on the metrics and measures of portfolios and how effective they are in managing around those ESG concerns, so I'd encourage people who are interested or concerned about this aspect of investing in these sectors for dividends to go and listen to those podcasts to get a deeper understanding of how a portfolio manager can be directed and steered to make sure that they're keeping those issues front of mind as they're making decisions around investments. One other thing just popped into my mind though, as you were going through your answers, Stu. The whole idea of going to a potash mine and going underground and looking at everything they've got there and talking to management. As an investor, is that something you need to do to really understand the longevity of the asset, the way the business is operating? Or can someone look at numbers that are being produced? Are there numbers out there that an individual investor could take a look at and get a pretty good understanding of the longevity of the assets and how effective the management is in terms of executing and producing at low cost those resources and getting their market?

Well, you can certainly get a flavor for the numbers, but there's nothing that quite beats a visit to the facility to see the scale of the enterprise. Today when you're talking about inflation, another angle that we should discuss in all this is the replacement cost. Something was built a long time ago and you go and see it and you're just like, wow, this is quite an operation; you can almost in your head sit there and say: on the darkest days in the stock market, I can imagine, this is not something that's replaceable. It gives you a little bit more confidence to go into those stocks on those days and make a purchase. The other thing too is always, you get in the door and you see the commitment to worker safety is always on the board at a good operation. When you get inside the door you can see how it's maintained, how clean it is. All these things speak to how the company approaches long-term value.

Again that comes back to the sustainability question; an issue like that, treating your employees right, taking care of your people, is a big part of success in business. Always has been, but it's much more understood, I think today, in terms of how that drops to the bottom line. Well Stu, that's really interesting. I think investing, in a lot of ways, comes down to the same basic principles. We've talked about them on many of our discussions. That long-term view, and understanding that you're going to own a business over the long haul, you're going to see ebbs and flows in the business. Same thing here in these businesses which tend to have wider ranges. But again, as you're holding long term, you're going to see these big ebbs and flows and you expect that, you anticipate it, and you manage around that as you include these assets in your portfolio.

That's bang on, Dave.

Wow, that's good. I'm hoping all our listeners are learning about investing listening to this podcast. I'm learning too, along with everyone, because I get to talk to great people like Stu Kedwell. Well, Stu, thanks again for joining us and again, congratulations on a long time with great success in your current role.

Well, same to you, Dave. Thanks very much and thanks to all our listeners and have a great day.

Disclosure

Recorded: Jan 18, 2022

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