Franklin Bissett Dividend Strategies Update: A Q&A with Les Stelmach and Ryan Crowther

The dividend strategies are positioned more defensively now than a year ago, with overweight positions primarily in consumer staples, utilities and telecoms. Is that a reflection of your views on the markets in the near term or the result of your bottom-up selection process?

It’s a bit of both. Our views on the market are, in part, formed by our opinions on valuations. Across our analysts’ coverage, we have discounted cash flow-based valuations that consider common macroeconomic variables, such as interest rates. Given the run in equities, companies in some sectors are more often at the high end of the price-to-value spectrum. They look expensive to us.

We are still cautious about the overall economic environment, which informs our analysts’ views on cash flows and earnings for consumer-sensitive or cyclical sectors. Companies with cash flows underpinned by contractual cash flows, those operating in “needs-based” businesses, and those with a high degree of earnings visibility look like better places to be at this juncture. An added benefit is that most of these sectors feature businesses with very attractive dividend yields that are fully covered by free cash flow, which is important for us.

Information technology (IT) is the top-performing Canadian sector year to date. The dividend portfolios are underweight this sector in Canada as they do not hold Shopify and Constellation Software. Open Text is the sole Canadian IT company held in the portfolios. Why do you like Open Text and what is its exposure to AI? What about the exposure to U.S. IT companies?

Open Text is a significant holding. It’s been one of our best performers so far this year, but that hasn’t been enough to keep up with the rest of the sector.

The company is by no means a pure play on AI. Its outperformance has been more a case of accretive acquisitions, which they are currently doing a great job of integrating, than anything to do with AI. But they do have a great story to tell when it comes to AI. In fact, the CEO just published an interesting AI writeup in August talking about industry dynamics in the context of AI and the opportunities for the company.

Open Text’s business model has always been about empowering enterprises to implement technology, whether information management and analysis, documentation or security. It’s a natural extension of the business that they would play this role in AI. It won’t be as direct as in, say, NVIDIA’s case, but for them it is material.

In the case of our IT holdings in the U.S. dividend component, we don’t have a pure AI play. A company like CISCO, for example, is more of an old-school name. But they are absolutely seeing opportunities in AI-related network hardware and software.

The Financials sector is the largest underweight in the portfolios, while the relative allocation to banks is neutral. Banks reported their quarterly results two weeks ago. What are your views on the Financials sector and banks specifically, considering the economic risks?

We are still cautious; the full effect of the significant cumulative increase in interest rates has yet to be fully felt by borrowers. Mortgage and other term debt renewals will likely be a pain point for some borrowers over the next couple of years, and we are watching loan loss provisions closely. Currently, those provisions are not alarming.

Capital market activity has been weaker, and that is a cyclical pressure on profitability. We saw expense growth in the past several quarters, with labour and technology driving the increase. But the banks continually adjust to the business environment, and so we have recently seen evidence of workforce reductions as spending is curbed.

On the whole, we see the large Canadian banks as being exceptionally well-capitalized today, and financial regulators such as OSFI (Office of the Superintendent of Financial Institutions) were early with nudging banks to improve capital ratios. We have recently added to our bank holdings, just picking away on weakness. But we would be poised to buy more aggressively should the right circumstances emerge.

While current dividend yields in the portfolios remain higher than those of the benchmarks, it seems that average current yields are closer to benchmark than usual. Are you putting less emphasis on higher-distributing companies in this environment?

If we are seeing yield drift one way or the other, it’s not related to any intention to shift emphasis. As always, we work from the resulting fundamentals and valuation assessments .

Canadian Pacific Kansas City is a good example of where we have been finding opportunities in lower-yielding securities with secular growth. When buying undervalued securities, we expect the lower yield will be offset by capital appreciation.

Reaching for yield is not important, in our view. We can build a portfolio with yield emphasis, but we never start with a yield and work back; we can get to the same place in terms of yield with a fundamental approach. This way, we don’t overlook total return potential.