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David Kimberley
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Updated 20 Sep 2023
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Disclaimer

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 published its results for the half-year period ending 30/06/2023. The trust saw a total return on net assets of -3.3%, compared to a 0.4% return on the trust’s benchmark, the S&P/TSX Composite High Dividend Index.
  • Underperformance was due to the trust’s underweight exposure to materials, as well as negative selection effects in the trust’s holdings in the utilities and financials sectors.
  • Since inception in 2006, MCT has produced an annualised NAV total return of 6.9%, compared to the TSX Composite Index’s return of 6.2% over the same period.
  • MCT continues to invest heavily in Canadian real estate. The trust was overweight by 18% at the period end. Performance for the sector was flat in the first half of the year but inflation-linked contracts, a rapidly increasing population, and the prospective end of the rate hiking cycle look to be more supportive of valuations in the near term.
  • The trust’s net gearing levels ranged between 19.4% and 20.4% during the period, reflecting the managers’ confidence in the prospects of the underlying portfolio.
  • Two interim dividends of 1.30pps were paid during the period, a 2% year-on-year increase compared to 2022, continuing the trust’s impressive dividend growth track record. Dividend coverage stood at 1.09x during the period.
  • MCT’s discount widened from 7.7% to 15.2% over the first half of the year. The discount remains at 15.4% as at 15/09/2023, compared to a ten year historical average of 10.9%.
  • MCT Chairman Michael Phair said: “While interest rates are expected to be elevated for some time, it is expected that central banks in both Canada and the United States are nearing completion of their current tightening cycles. Accordingly, we have noted a growing list of individual stocks that are starting to break out of recent trends which supports our view that market breadth is improving. We expect a rotation into more reasonably priced value names will occur over the coming months, which bodes well for the fund’s attractively priced dividend-paying holdings.”

Kepler view

Middlefield Canadian Income (MCT) provides investors with dedicated exposure to the often overlooked Canadian equity market. The managers seek to take advantage of Canada’s strong dividend culture and pay a quarterly dividend to shareholders.

The trust has a large overweight position to real estate, which was approximately 24% of NAV at the end of August, compared to c. 5% in the benchmark. In many ways, Canadian real estate mirrors the dynamic we’re seeing in the UK, with limited supply and lots of demand.

This is in large part due to the high levels of immigration that Canada is currently experiencing, something that is being actively encouraged by the government. From 2021 to 2025 it is forecast that approximately 2m people will move to Canada, a country with a population of around 40m people. That is positively impacting rates in residential real estate, but also proving supportive of logistics and industrials.

Despite these positives, Canadian REITs have been trading at some of the widest discount levels of the past two decades. Indeed, during that period, REIT discounts have only widened to the levels we’ve seen in the past 18 months twice – once when the pandemic hit and prior to that during the financial crisis.

If MCT’s discount does ultimately tighten, we see its REIT holdings as likely to be the primary driver. Canada has seen comparatively lower levels of inflation, with the most recent CPI print coming in at 3.3%. MCT manager Dean Orrico has also argued that Canada is at the end of the rate hiking cycle. Should that prove to be true, then the trust’s REIT holdings are well-positioned to benefit.

Part of the reason for those lower levels of inflation is that Canada is a net energy exporter. This is also reflected in the portfolio, with the trust currently overweight to both energy and pipelines. As the past two years have shown, the demand for hydrocarbons is not going to disappear overnight and Canada is a reliable supplier of them.

In the same vein, we think MCT is likely to appeal to anyone looking for stable, reliable income, combined with capital growth. Assuming we do not see any unexpected spikes in inflation, then this may ultimately prove to be an attractive entry point, with REIT discounts narrowing in the underlying portfolio and MCT shares providing some additional upside by mirroring that process.

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