David Kimberley
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Updated 21 Sep 2022
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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 reported its half year results for the period ending 30/06/2022. In an extremely challenging period for markets globally, the trust delivered NAV total returns of 3.4% and share price total returns of 2.5%. The trust’s benchmark, the S&P/TSX High Dividend Index, delivered total returns of 7.3% during the same period. However, the trust outperformed the S&P/TSX Composite Index, which declined by 1.5% over the reporting period.
  • Part of the underperformance relative to the benchmark was due to MCT’s underweight position in energy. Whereas the benchmark had a weighting of 32% to the sector, the trust’s average exposure was 27% in the reporting period. Energy companies in the benchmark delivered returns of 36% in the first half of the year.
  • Dividends per share for the period totalled 2.85p, with two interim dividends of 1.275p paid in January and April. Over 70% of MCT’s holdings have increased their dividends since June 2021 and the trust’s dividend coverage ratio stood at 1.12x at the period end, up from 0.95x in 2021 and 0.71x in 2020. MCT paid another 1.275p interim dividend in July.
  • The managers note Canada’s macroeconomic outlook remains strong. The country is a net energy exporter, meaning it can both benefit from increasing demand and protect itself from the sort of problems many energy-importing European countries are now facing. The Bank of Canada has also been proactive in raising rates to combat inflation and the Canadian dollar has increased by close to 13% relative to GBP in the year to 15/09/2022.
  • Chairman of the board Michael Phair said: “Canada is a secure net exporter of oil and natural gas and should benefit from Europe’s growing focus on energy independence over the coming years. Its rate of inflation remains below that of the United States and Europe, supporting the purchasing power of Canadian consumers. Cyclical sectors such as energy, financials and real estate also serve as effective hedges against inflation for U.K. investors. We are optimistic [MCT’s managers] will continue to perform well in the current inflationary environment and build upon its longstanding track record.”

Kepler View

Middlefield Canadian Income (MCT) is one of the only closed-ended funds on the market today offering investors dedicated exposure to Canadian equities. The trust managers seek to deliver a quarterly dividend to shareholders, with the portfolio typically overweight to real estate investment trusts (REITs) as the managers seek to achieve this.

Canada has emerged as an attractive investment proposition since the start of the year. The country is a net exporter of energy and its stock market has large weightings to the sector, as well as to financials and utilities, all of which look capable of either managing or benefitting from inflationary pressures. Moreover, valuations in the Canadian stock market remain lower than their US peers. Given that many Canadian companies make a substantial portion of their revenues in the US, they arguably offer a means of accessing the US economy at lower valuations than US-listed peers.

It may be that investors are starting to recognise these potential benefits as MCT’s discount has narrowed since the end of June. The shares are up 10.6% on a total return basis, while the NAV has risen by 6.1% over the same period. Nonetheless, the trust continues to trade at a steep discount of close to 14%.

MCT’s portfolio has three pillars: financials, energy and REITs. Canadian financials performed well versus their US peers in the first half, and notably all of the big six have raised their dividends since November 2021. The Bank of Canada has raised rates, while domestic inflation has been lower than that in the US, a helpful combination. Energy equities performed well in the first half. While this helped MCT in absolute terms, the trust was underweight the sector versus its high dividend benchmark at the start of the year – although this is no longer the case.

The largest sector position for the trust is REITs. These have sold off as interest rates have risen, and were the largest negative performer in absolute and relative terms. However, the managers point out REITs can provide a useful hedge against inflation, and argue that this pullback has increased the value opportunity in the sector, especially in high-quality issuers with lower levels of debt and credit-worthy tenants. We note the majority of the trust’s REIT holdings saw double-digit growth in lease renewals during the second quarter of this year.

Moving forward, the trust’s exposure to energy companies and financials may support its income objective, as commodity prices remain high and banks benefit from higher interest rates. But it’s plausible that the REIT holdings may drive returns for shareholders as well. Assuming that performance in the sector is strong and investors start to be more optimistic, then we may see a narrowing of REIT discounts that could provide an uplift to the MCT portfolio. In our view the value in MCT’s portfolio coupled with the share price discount make the shares look attractive.

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