CDI Weekly Digest 19: Nelson Answers Your Questions Edition

Thoughts on lumber, trucking, withdrawal strategies, telecoms, and lots more

(This is a free preview of the paid part of this newsletter — which includes a weekly digest where I cover multiple stocks and update subscribers on previously featured names)

This is the part of the newsletter where we go over last week’s dividend raises and decreases but, alas, there were none for the second week in a row. Sad!

I asked for your questions last week, and I got a bunch. Thanks to everyone for such a great response. This edition might run a little long as I try to answer them all, but I think I’ll get to all of them.

Let’s start out with Bob:

There are no lumber stocks in your portfolio. What’s your opinion of DBM?

I’ll first answer why there isn’t any lumber in my portfolio (outside of Stella Jones, anyway) and then move onto Doman Building Materials Group (TSX:DBM), which, until right now, I didn’t even know existed.

My reason for avoiding lumber is the same reason I avoid a lot of other commodities. Commodities have no pricing power and it’s impossible to predict the price you’ll get in the future.

Sure, you can hedge, I guess, but then you miss out on big gains if the commodity goes in your favour. So nobody hedges. They don’t want to cap that upside.

As for predicting the price of lumber in the future, I’m the first to admit I have no clue. On the one hand it seems like there’s a housing shortage in major cities in both Canada and the United States, so that would be bullish. But, at the same time, I’m skeptical Toronto’s housing shortage is solved by building triplexes when the much easier solution is to build up. Way up.

The way I play commodities is largely through royalty exposure. I own Franco-Nevada and Labrador Iron Ore, which are both royalty plays.

As for my opinion on DBM, let me first say this is my opinion after a quick look at the stock. It’s not nearly as in depth as I like to get.

First, a little intro. Doman is a Vancouver-based national distributor in the building materials and related products sector. Like Richelieu, it’s a growth-by-acquisition building materials distributor, but with a focus on lumber. It has operations throughout Canada and has been buying up assets in the United States in recent years.

I’ll start first with the positives. This is a company that has grown pretty well over the long-term. Revenue is up from $759M in 2014 to $2.5B in 2023 — and 2023’s number was down almost 20% from 2022. You can thank lumber prices for that volatility.

Earnings have also grown nicely, increasing from $0.43 to $0.87 per share during that period. The bottom line has been somewhat inconsistent over time, but the trend is up and to the right — even as the company issued stock to help pay for deals.

I also like management with skin in the game. The founder and CEO owns approximately 20% of the stock.

One big problem I can see is debt — the company owed $677M at the end of 2023, including capital lease obligations. EBITDA is projected to be about $200M in 2024. That gives us a debt-to-EBITDA ratio of over 3x, which I think it a little high for a lumber distributor. However, to its credit, the balance sheet was more levered in 2021/22 and the company did pay off some debt. It’s working in the right direction.

I’ll also note that Doman pays a $0.56 per share annual dividend, which was raised in 2022, from $0.54 per share. The payout ratio is in the 65% range, meaning it should be fine. There’s always a little uncertainty surrounding commodity dividends if the payout ratio is high, but this one looks pretty safe to me. It’s been paid consistently over the last decade excluding the a very slight hiccup in 2020.

Ultimately, I can’t get past my hatred of the lumber sector for this one, so it’s not for me. But I’ll give credit to management here — the growth story is impressive, they’ve managed to grow earnings over time, and you get a generous (and pretty sustainable) dividend to wait. They also pretty much maintained earnings even after the big lumber bull market of 2021-22 collapsed.

If you’re interested in the lumber biz, you could probably do a whole lot worse.

Next question is from Sandra:

Could you go into more detail about your retirement withdrawal strategy?

Great question. I meant to write about this months ago and never got around to it.

First, some general background. I retired from the corporate world at 39. Basically I got to financial independence, threw up my hands, and retired. I’m the epitome of the quote “a taste of freedom can make you unemployable.”

I constructed my portfolio to have a yield of approximately 4%, conveniently meshing up with the proverbial 4% rule. Although that particular rule is supposed to be pretty much foolproof, I realized I only have one shot at this retirement thing. Having to return to traditional work at 50 or 55 would be pretty disastrous, so I built in a contingency clause.

Instead of withdrawing 4% of my portfolio value each year I take out 3% and reinvest 1%.  

This strategy, combined with existing dividend increases in my account, means in a typical year my dividend income should go up about 5%. I’m confident this will be higher than inflation over time, so I’m laughing.

I do make some active income running this newsletter and from writing for Seeking Alpha, which is mostly spent on my two expensive hobbies — travel and golf. My wife also works a little — she’s a substitute teacher — so she contributes a little bit of active income to the household. But it’s the dividends that are doing the heavy lifting here.

Once the strategy has been decided upon, the next step is what accounts I should withdraw from. Basically, I do this:

  • Withdraw first from taxable/margin accounts

  • Use a tax calculator in late Nov/early Dec to figure out optimal RRSP withdrawal strategy, then withdrawal as directed

  • Add $7,000 to TFSA each year and reinvest dividends. Only withdraw from TFSA as a last resort

I took some RRSP withdrawals last year (not much, but some), and I have interest collected from a couple private mortgages I still hold, so my tax rate is never going to be zero. But it was approximately 10% last year, which is a hell of a lot less than I paid when I had a traditional job.

Justin is next.

I’d be interested in your opinion on any of these stocks: ARE, RUS, MTL.

Let’s focus on Mullen Group (TSX:MTL), which I’ve long thought was an interesting value play.

Mullen is one of North America’s largest logistics providers with a wide range of services like truckload, less-than-truckload, warehousing, logistics, transload, oversized, and so on. It’s a trucking company.

Unfortunately, it made the mistake of expanding into energy services in the early 2010s, which hit the top and bottom lines in the big way come 2015-16. Revenue was $1.4B in 2014; by 2016 that number fell to $1.03B. It didn’t surpass 2014’s high until 2021.

Even though Mullen is a diverse company which has minimized that direct exposure to oil, it’s easy to argue the company more energy dependent than most would like. More than 50% of its revenue comes from Canada’s three westernmost provinces, with 30% of revenue coming from Alberta.

Still, there are lots of interesting things here — like how cheap it is. One simple rule I like to look at is comparing a company’s earnings (or, in Mullen’s case, free cash flow) over the last decade to the stock price.

Over the last decade, Mullen generated $1.13B in free cash flow. Its current market cap is $1.15B. And free cash flow has grown over time, too. I like that; it tells me the stock is cheap — especially for a cyclical name like Mullen.

Mullen also offers an interesting margin of safety via its real estate portfolio. It owns 167 properties across Canada, leasing 179 more. These properties were acquired for a historical cost of $646M and are undoubtedly worth much more than than that. There would be some value there if it decided to spin off the real estate division as a REIT, but that doesn’t look likely.

There’s more. Murray Mullen, the CEO, has more than 40 years experience in the business and owns nearly 6% of shares outstanding. He’s been buying lately, too. The company is also repurchasing shares regularly, with the share count falling from 104M in 2019 to 90M today. The company intends to continue repurchases next year, too.

Okay, this all sounds pretty good. So why is the stock trading at less than 10x forward earnings or 7x free cash flow?

Firstly, although Mullen is a growth-by-acquisition story, it pales in comparison to TFI International (TSX:TFII). Many investors have just bought TFI and ignored the rest of the sector. Others are annoyed with the company’s three(!) dividend cuts in the last decade, especially for a company that seems to pride itself on the dividend. Finally, there’s the Alberta/oil play. Combine that with a somewhat tepid economic outlook for Canada overall, and it’s no surprise the stock is cheap.

I’ve long had my eye on Mullen and I just about pulled the trigger a few years ago. But, like so many others, I own TFI instead, and don’t see any reason to own two trucking companies. I’ll stick with that I view as the higher quality trucker.

Next up is Bob (not the same Bob as earlier)

What online brokerage do you use? Which one do you think is best?

I use a combination of Qtrade and Questrade, depending on where the various family members whose accounts I manage opened up accounts. They’re both fine places to put your capital. Any complaints I have would be minor.

I’ll take this opportunity to talk about why this question really grinds my gears. Which online brokerage you use makes zero difference to your long-term returns, and yes, that’s even factoring in how some give free trades and others don’t.

I pay $6.95 per trade at Qtrade and $4.99 at Questrade. I make, say, about 20 trades a year, or about $120. My costs are about 0.004% of my portfolio — so effectively zero.

If you have a smaller portfolio and $120 per year in trades will eat into your returns, then simply embrace a portfolio strategy with fewer moves. Reinvest your dividends less often or let savings accumulate a little bit before moving them to the brokerage account.

Hell, I pay far more for access to tools like Tikr or to the Globe and Mail for a portfolio tracker, although the latter does get me the best news coverage in the country.

Time for the rapid fire part of this edition. Matt is next:

Which telecom stock do you like best today?

I can’t believe how cheap the entire sector is, to be honest. Rogers (TSX:RCI.B) trades at less than 10× 2024’s projected free cash flow with potential to grow FCF pretty nicely in 2025 and 2026 as it realizes more synergies from Shaw.

Telus (TSX:T) trades at like 13x forward FCF with analysts expecting it to grow revenue, earnings, and, yes, FCF, this year. It should raise the dividend twice again this year and yields 6.8%. It’s probably the best telecom stock in Canada.

Quebecor (TSX:QBR.B) is even cheaper than both of those — it trades at less than 7× 2024’s projected FCF — and it has a long runway of slowly taking market share away from the incumbents ahead of it. It hasn’t been this cheap in a decade!

If Quebecor trades at its median price/FCF multiple over the last decade, it’s a $53 stock, and that’s not factoring in any free cash flow growth.

I’m tired of talking about telecom. I want to move on. But these stocks are cheap, especially if we get a little help on the interest rate side.

Worried about BCE’s dividend? Fine. I get it. So buy one of these instead.

How much does dividend yield influence your investing decisions?

It’s not particularly important today, but it used to be. I’m trying to slowly move my portfolio into higher quality names, so I’m punting some of the value plays that I’m not confident can grow earnings over time.

I’m trying to pivot the portfolio a little more towards growth and dividends that will go up over time. But the value part of me is winning out today. I just can’t get over how cheap telecoms, REITs, certain banks (TD, mostly), and utilities are today. There are multiple names in each of those sectors that are trading at decade-low valuations, plus have growth potential over time.

What’s an under the radar stock you have your eye on right now?

I can’t believe I’m saying this but I’m actually somewhat interested in IGM Financial (TSX:IGM). I’m going to write all about it next week, so stay tuned for that.

How do you have so many investment ideas? How do you keep track of so many stocks?

I’ve been covering and investing in Canadian dividend stocks for about a decade now, so I have all that experience to draw from. Once you understand the big drivers of a stock it’s just a matter of an hour or two of reading to catch up on it. Even if you haven’t looked at it in months.

Any preferred shares that are interesting?

Not really, no. The sector isn’t nearly as cheap as it was six months ago, so I’m not spending a lot of time there.

Artis has a preferred share (TSX:AX.PR.E) that yields 10.5% and just reset last fall. So you’d lock in that dividend until 2028. I don’t love Artis’s turnaround plan and think its strategy to buy Dream Office shares is… not great (why get your Dream exposure via Artis when you can just buy Dream shares?) but I think the preferred dividend should be pretty safe.

There’s a reason why it yields 10%+. There’s a lot of uncertainty around the name, and I don’t like complicated.

When I buy preferred shares I’m usually buying with an exit strategy in mind. I expect the underlying share to rally by 20-30% and then I collect the dividend to really get a nice return. I don’t see 20-30% upside potential in Artis’s preferred shares. This is a yield name, nothing more. But the yield is attractive, so I mention it.

You can view the author’s portfolio here. Nothing written above constitutes financial advice. Consult a qualified financial advisor before making any investment decisions.