David Kimberley
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Updated 17 Apr 2023
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Middlefield Canadian Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

  • Middlefield Canadian Income (MCT) has released its results for the year ending 31/12/2022. The trust saw NAV total returns of -2.9% and share price total returns of 5.4% during the period, both in sterling terms. The S&P/TSX High Dividend Index, MCT’s benchmark, increased by 5.3% during the period, also in sterling terms.
  • NAV underperformance was due to the managers’ underweight position in energy, which enjoyed a strong year due to the price shock caused by the war in Ukraine. Interest rate hikes also hurt the trust’s overweight position to real estate.
  • Share price performance during the period meant that MCT’s discount narrowed from 13.9% to 7.5%. However, since the period end, the trust’s discount has widened again to 11.1%, as at 14/04/2023.
  • The trust’s long-term track record remains strong. Since launch in July 2006, MCT has delivered annualised NAV total returns of 7.3%, compared to 6.8% for the benchmark.
  • Gearing facilities were used prudently throughout the year, with a range of 14.6% to 19.1%. The average level of gearing was 17.0% for the period.
  • Dividends for the period totalled 5.1p per share, with a strong dividend coverage ratio of 1.16. This strong coverage, as well as the prospect of higher income earnings from the underlying portfolio, meant the board approved a 0.1p increase to the dividend target for 2023.
  • MCT Chairman Michael Phair said: “We remain confident in the investment manager’s ability to execute on its actively managed investment strategy. The fund’s unique Canadian equity-income focus offers an attractive investment proposition for UK investors in the current environment. Given our positive outlook on the Canadian economy, together with the fund’s increased marketing efforts and shareholder engagement, we believe the fund’s shares represent a compelling investment opportunity.”

Kepler view

Middlefield Canadian Income (MCT) remains one of the only closed-ended funds available to investors in the UK that provides dedicated exposure to Canadian equities. The trust is designed for income investors, with the managers aiming to pay a quarterly dividend.

Canada has long offered an attractive alternative source of income for dividend investors. One attraction has been its proximity to the US. Canadian companies generate a sizeable proportion of their revenues in the world’s largest economy. However, equity valuations have typically been lower and there is a stronger dividend culture. For instance, on 12/04/2023, the MSCI Canada Index had a forward P/E ratio of 12.6, compared to 18.4 for the MSCI US Index. And at the end of March, the Canadian index had a TTM dividend yield of 3.2%. The US index’s equivalent yield was 1.6%.

Some of the macroeconomic turmoil we’ve seen over the past 18 months has also worked in Canadian companies’ favour. Like the UK, financials make a hefty proportion of the Canadian equities market, with a 35.3% weighting in the MSCI Canada Index at the end of March. Rising rates may prove beneficial here, with the Royal Bank of Canada and National Bank of Canada both reporting higher earnings in March.

Arguably of greater significance today are Canada’s energy exports. As we noted in our latest research on MCT, Canada is energy independent and now supplies over half of US oil and gas imports. The country is also a stable democracy, making it a more reliable partner for buyers. As a result, Canada has remained more immune from the price pressures the war in Ukraine has created in the hydrocarbons markets, and has arguably gained from them.

This goes some way in explaining MCT’s performance last year. Higher revenues and an improved dividend cover ratio were in part the result of energy companies having greater earnings and thus paying higher dividends – a trend that’s likely to continue in 2023. However, MCT has also long been overweight to Canadian real estate and was underweight energy in 2022. Canadian REIT valuations were hit by interest rate hikes, which crimped performance.

MCT manager Dean Orrico has not changed course and added to several REIT holdings, some of which were trading at discounts in excess of 40%. There was good reason for this. Whereas energy markets are erratic and may only provide short-term gains, the long-term outlook for Canadian real estate remains strong. This is largely due to supply and demand dynamics. Canada has embarked on a drastic plan to grow its economy through immigration and c. 2m people are expected to move to the country from 2021 – 2025, a huge increase for a country with a population of 38m. Even prior to this, the country was facing a huge housing shortage and the Canada Mortgage and Housing Corporation estimates Canada will need an additional 5m housing units to be built by 2030.

It is hard to see how these dynamics will dissipate in the near term. We’re also seeing signs that these are supporting valuations. For example, Summit Industrial Income REIT was acquired at a nearly 20% premium to NAV at the end of 2022. Industrials in major cities are also reporting <2% vacancy rates, with similar dynamics playing out in multi-family and apartment rentals.

The fact that Dean substantially upped his stake in MCT last year, purchasing 70,000 shares in October alone, is a sign of his and the managers’ confidence in this strategy. This is not a guarantee of success but clearly they see reason to be optimistic about Canadian REITs and the wider MCT portfolio, and we think it is worth a closer look for investors seeking diversification in an income-oriented portfolio.

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