For quite some time, there was high demand to create an all-Canadian model portfolio that income-based investors can use to identify new ideas and opportunities to develop a more significant and consistent passive income stream.

Our Dividend Growth and High Yielding model portfolios, although income-based, are a blend of both Canadian and US stocks. So, we created the Equal Weight Hybrid Dividend Model Portfolio for those who wanted an all-Canadian portfolio with a bit of a unique twist.

The portfolio is structured to provide equal-weight exposure to practically every sector outside of healthcare, of which Canada simply doesn’t have enough income-paying companies worthy of inclusion.

From there, we take two companies from each sector, one that focuses on yield and the other that focuses on the dividend growth. Remember that company quality always comes first here, as yield or dividend growth should typically be one of the last things you look at when analyzing companies.

But, after they pass all of our other checks, we structure the portfolio to provide a very nice blend of yield and dividend growth, hence the “Hybrid” name.

In this e-mail, we’ll cap off our income model portfolios and have a look at this one. Because this portfolio adheres to an equal weight strategy, it will be rebalanced to have a 5% weighting in each of its 20 holdings.

Let’s get started.

As a whole

This all-Canadian portfolio has struggled a bit in 2023. The portfolio has lost 2.97%, including dividends, while the TSX has only lost around 1.10%. The reasonings for this are pretty simple. This portfolio contains a lot of rate-sensitive companies.

In fact, many of the most popular companies in the country are susceptible to interest rates here in Canada. Think stocks like Telus, Bank of Montreal, Granite REIT, and Equitable Bank. Even small cap stocks inside of this portfolio, like Jamieson Wellness, which is struggling right now due to a large acquisition it took on primarily utilizing debt, or an income fund like A&W, which tends to become less attractive as fixed income rates go up, are at the mercy of policy rates.

This is a situation that an investor who is heavily allocated toward Canadian stocks ultimately has no way to avoid. However, if rates aren’t at the top yet, we’re confident they’re somewhat close to the top. And in that case, this portfolio has a chance to do well moving forward.

The good

The highlights of this portfolio throughout the first six months of the year are, no doubt, OpenText (TSE:OTEX), Equitable Bank (TSE:EQB) and Quebecor (TSE:QBR.B).

The reason for this? Primarily discounted valuations based on general fears from the market. In the case of OpenText, large-scale acquisitions involving a bit of debt spooked the market over the last calendar year. They drove the company’s share price so sharply downwards that it was trading at valuations not seen for over a decade.

October 2022 turned out to be a wonderful time to add the company, as it has returned over 50% since. We’re happy we stuck this out and kept OpenText on the Bull List despite some of the worst sentiment we’ve seen toward the company in a long time. They have a long history of execution in regards to merging acquisitions into the fold.

Even in the low $50 range, we’re still quite bullish here, as the company is still trading at only 7.8 times forward earnings and at a 20% discount to historical averages.

In the case of Equitable Bank (TSE:EQB), mortgage fears drove the company to trade at one of the most significant discounts to book value in the last decade.

If we remove the COVID-19 crash, considering it was so short-lived and Equitable recovered so quickly, there is only one other time in the last ten years that Equitable traded at less than 0.8x book value, which was where it was at during October 2022 lows. That was a brief stint in 2017 during the Home Capital Group mortgage scandal.

Investors are right to be somewhat cautious about Equitable Bank’s loan book quality. It heavily relies on Canadian mortgages, which are facing the fastest pace of rate increases we have ever witnessed. However, this overshadowed many of the things the company is doing right.

For example, 47% of the company’s loan book is insured. In the event of a default, Equitable Bank is covered by a crown corporation such as the Canadian Mortgage and Housing Corporation. This adds a bit of a security blanket to the company if the situation goes sour with the Canadian housing market.

In addition to this, the bank is growing its deposit-based accounts at a lightning-fast pace, and it is continuing to diversify itself away from mortgages. Reverse mortgages, savings accounts, GICs, and even US dollar accounts. The company continually adds new products and forces more Canadians to at least contemplate switching.

I swapped from a major banking institution earlier this year to Equitable and witnessed a $45-60 swing in banking fees. Instead of paying $15 monthly, I’m making anywhere from $30-45 monthly.

Overall, Equitable Bank remains the largest financial position in my portfolio, and I’m fairly bullish on the company’s ability to continually steal market share from the larger oligopoly financial institutions in Canada.

With Quebecor, a former Dividend Bull List stock, the valuation disconnect was confusing. It was most likely because the company is aggressively attempting to grow outside of its home province, Quebec. One of its most aggressive moves as of late was the acquisition of Freedom Mobile, which cost the company $2.17B, primarily financed through a credit facility.

During times like 2020 and 2021, where market euphoria is high, and policy rates are low, acquisitions tend to drive bullish price movements in almost all cases. However, fast forward to 2022 and 2023; any acquisitions, particularly those that require debt, typically lead to sharp declines in price.

This is great for long-term accumulators, as it allows them to buy companies that may see interest rates impact the bottom line over the short-term but ultimately will be just fine over the long term.

Overall, the proceeds from the profits made on these three major positions will allow us to fill up some positions in laggards as we attempt to maintain an equal weighting inside this portfolio. And with that said, let’s talk a bit about those laggards.

The bad

Allied Properties (AP.UN) has had a challenging year. The office REIT is down 13% this year and has been consolidating for the past few months. That said, the three best-performing office REITs (of which Allied is one) are all down between 10 and 15% this year. This is not all that surprising as several headwinds have impacted the industry, most notably the shift to work at home, which has left many traditional office buildings empty.

Couple that with the fact that there have been two significant distribution cuts in the industry, and investors are likely a little skittish. However, it is important to remember that operationally Allied is performing well. The company is in one of the better financial positions. It has the best interest coverage ratio and the second-best leverage ratios in the industry, and this was before the recent announcement that it found a buyer for its data centre portfolio.

Allied sold its UDC portfolio for $1.35B, slightly above IFRS value. Upon closing, the company plans to improve its financial profile and re-invest in core assets. In our opinion, the current period of consolidation is an opportunity.

Jamieson Wellness (JWEL) has also dragged down the portfolio. Down by 17% this year, Jamieson is likely also dealing with negative market sentiment. Operationally, the company is doing just fine, but we suspect its major inroads into the Chinese market and rising rates are weighing on the company.

In general, companies that rely on China as a key source of growth will do well when the Chinese market is buoyant. However, when it struggles, the pendulum swings the other way and, in some cases, quite significantly.

Jamieson recently announced that it closed its acquisition of its Chinese distributor and sealed its partnership with DCP Capital, effectively bringing all operations in-house. This is a good thing, but the recent tensions with Taiwan will likely spook investors on the surface.

On top of those Chinese partnerships/deals, it also closed on the Nutrawise acquisition in the second half of last year, and as such, its debt profile took a jump. Given the rising rates, investors are punishing companies that use debt to fund acquisitions.

This, however, is short-sighted. Last quarter, the company reiterated its full-year outlook despite some of the recent headwinds.

Keeping on the theme of rising rates, perhaps no sector has been as impacted as utilities. High CAPEX companies are taking it on the chin this year as investors have shifted from traditionally safe and reliable dividend plays to comparable yielding guaranteed income products.

This is a natural cycle, but once again is short-sighted. True, the allure of locking in a 5% yield without the risk of losing capital is an enticing proposition. It may also be appropriate depending on your investing goals, risk tolerance, etc. However, as we always say, our focus is on total returns. Eventually, utilities and other high-yielding companies will rebound.

This is why we aren’t all that concerned with Northland Power (NPI), the worst-performing stock in the portfolio with a year-to-date loss of 27.05%. As a result, NPI, which has never been that high of a yield company, is now yielding 4.5%, a rate not seen since pre-pandemic.

Surprisingly, NPI, which has historically been one of the more reliable renewable utilities, is far underperforming its peers. One of the reasons we have Brookfield Renewables (BEPC) as a foundational stock is because we believe it to be best-in-class. With that in mind, we aren’t surprised that it is the best-performing renewable in a down year. We expect that out of such a stock. However, many smaller and less reliable renewables are outperforming Northland Power and, in some cases, quite significantly.

One of the headwinds that hit the company recently was that its most recent $500M debt issuance came in a coupon (9.5% for 60 yrs) that was higher than expected. While the company is now fully funded in Fiscal 2023 (no need to issue equity), the higher coupon will hit cash flow expectations by approximately 1-2%. Not the end of the world, but this is an environment where investors react poorly to any type of negative surprise.

In conclusion

Overall, we don’t see too many reasons to change this portfolio other than a fine-tuning of allocations to get the portfolio back to an equal weight structure. The proceeds from the sales of stocks that have done well, like Equitable Bank, OpenText, Quebecor, Granite REIT and Waste Connections, should get positions like Jamieson Wellness, Allied Properties REIT, and Northland Power back to strong weightings in the portfolio as we feel it is only a matter of time before they bounce back.

That wraps it up for the Income Model Portfolio reviews as well. We hope you enjoyed the fine-tuning and commentary on each one. And remember, if you missed the prior e-mails where we went over the other two portfolios, simply log in to your account and head to the newsletter tab.

What’s coming up

Next week we’ll release our July Value Calls, where we cover stocks featured here at Premium that we feel provide strong value at this current moment.

It is one of the most popular releases here every month, so stay tuned.