8 Canadian Wide-Moat Dividend Growth Stocks (2024)

This post originally appeared on Dividend Growth Investing & Retirement.

As dividend growth investors, we know that wide-moat stocks make a good starting point, but it is just one of many considerations on our hunt for high-quality dividend growth stocks.

Which of these companies with strong sustainable competitive advantages make good dividend growth investments?

To help answer this question:

I’ve identified all the Canadian wide-moat dividend growth stocks.
I ranked them using a quality scoring system that includes overall safety, financial strength, credit ratings, moat analysis, and dividend safety.
I’ve provided some additional dividend metrics like yield, valuation, dividend streaks, future dividend growth estimates, etc. so you can get a better sense of which stocks to focus on.

From my other article, we already know that according to Morningstar, there are a total of 9 Canadian Wide-Moat stocks:

Of these 9, I consider 8 as dividend growth stocks.

Due to its lack of recent dividend growth Constellation Software Inc. (CSU) is the odd one out. Constellation Software pays a $1.00 USD quarterly dividend but hasn’t increased it since early 2012.

The 8 others all have dividend streaks over 5 years, with the exception of Canadian Pacific Railway Ltd. (CP, TSE:CP) which has 4 years of consecutive dividend increases.

That said, CP Rail already announced a 15% dividend increase in July 2020, so its streak remains alive, and it’ll be updated to 5 years at the end of the year.

Ok, let’s dig into the quality rankings of each dividend growth company...

Dividend Growth Quality Rankings

I’m basing my Canadian quality rankings on David Van Knapp’s quality snapshot scoring system.

David Van Knapp’s Quality Scores

In lesson 20 of David Van Knapp’s dividend growth investing lessons series, he summarizes his quality snapshot scoring system as the following:

Source: David Van Knapp’s DGI Lesson 20: My ‘Quality Snapshot’ Grading System

The scoring system is comprised of five different factors:

Safety Ranks from Value Line,
Financial Strength Grades from Value Line,
S&P Credit Ratings,
Morningstar Moat Ratings, and
Dividend Safety Scores from Simply Safe Dividends.

For a more in-depth explanation refer to his article, or for that matter, take a look at his whole series of dividend growth investing lessons. It’s a resource so good that you will keep referring back to it.

I really like this methodical approach for analyzing the quality of US dividend stocks, BUT…

For Canadian companies, it doesn’t work as well, as the various stock research companies don’t cover a lot of Canadian stocks. For example, Value Line typically only covers the larger Canadian stocks.

However, just because Value Line or another stock research company doesn’t cover a Canadian stock doesn’t mean it’s not a high-quality company. As a result, I’ve tweaked David’s system to make it more suited for Canadian coverage.

Introducing the Canadian Quality Ranking System...

Canadian Quality Ranking System

I’ve kept David’s system the same, but I’ve supplemented it with additional criteria when a stock isn’t covered by one of the research companies.

Here’s what I came up with.

Here is a summary of how I evaluate each of the five quality factors.

Overall Safety - Factor #1

1st Choice = Value Line’s Safety Rank | 2nd = Judgement

First, I try to use Value Line’s Safety Rank, which is a combination of a stock’s weekly price stability over a five-year period and its financial strength.

Safety Rank = Price Stability + Financial Strength

Here’s the link to Value Line’s more in-depth explanation of their scoring system.

High safety ranks come from highly stable prices and a strong financial strength. Low scores, the opposite.

If the Value Line rating isn’t available, I have to use my own judgement.

Overall Safety Judgement Factors

To come up with a score out of 5 for overall safety I’ll look at a number of different factors.

I start with looking at safety scores of comparable companies that Value Line does cover and then looking more into the specific price stability and financial strength factors that make up the safety rank.

Financial Strength - Factor #2

1st Choice = Value Line’s Financial Strength Grade | 2nd = Morningstar Financial Position Grade

If Value Line’s Financial Strength grade isn’t available, I’ll use Morningstar’s Financial Position grade.

Credit Rating - Factor #3

1st Choice = S&P | 2nd = DBRS | 3rd = Fitch | 4th = Moody’s | 5th = Debt Metrics (D/C & Interest Coverage)

First, I’ll check the 4 major credit rating agencies.

If I can’t find a credit rating from one of the rating agencies (Standard & Poor's (S&P), DBRS, Fitch, or Moody’s), I use a combination of the Debt-to-Capital ratio and Interest Coverage ratio.

Interest Coverage Ratios and Synthetic Credit Ratings

Using the research of Aswath Damodaran on the link between interest coverage ratios and credit ratings, I use the table below to find a synthetic credit rating.

Source: Ratings, Interest Coverage Ratios and Default Spread by Aswath Damodaran

The table above only works for non-financial firms, so don’t use this for banks, insurance companies, etc.

Debt-to-Capital Ratio

A debt-to-capital ratio of 50% or less is used as a pass/fail metric for the higher points (4 & 5).

If the debt-to-capital ratio is higher than 50%, then the highest possible points are 3.

You can’t get a 4 or 5 if the debt-to-capital ratio is above 50%, regardless of how good the interest coverage ratio is.

Why a debt-to-capital ratio of 50% or less?

Well, this was one of the criteria mentioned in "The Single Best Investment: Creating Wealth with Dividend Growth," written by Lowell Miller:

“Half debt and half equity would give you a debt/capitalization of 50%. Except in specific cases weʼll be discussing later, your company should not have a ratio of more than 50%. In other words, it should not have - unless there is a compelling reason to make an exception - more debt than equity.”

Moat - Factor #4

1st Choice = Morningstar Analyst Rating | 2nd = Morningstar Quantitative Rating

If I can’t find a moat rating from a Morningstar analyst, then I’ll use their quantitative (computer figures it out instead of a human) moat rating.

I think the quantitative ratings are less reliable, as they don’t get the same level of scrutiny as analyst ratings. As a result, I’ve knocked wide-moat quantitative ratings down a point in my ranking system.

A wide moat, from an analyst, gets 5 points, but a wide-moat quantitative rating only gets 4.

Dividend Safety - Factor #5

1st Choice = Simply Safe Dividend Score | 2nd = Judgement

First, I try to use the Simply Safe Dividend Score, which uses a score out of 100 to rate the dividend safety of a company.

Source: Simply Safe Dividends

If the dividend safety score isn’t available from Simply Safe Dividends, I use my judgement.

Dividend Safety Judgement Factors

To come up with a score out of 5 for dividend safety, I’ll look at a number of different factors like:

Payout Ratios,
Dividend History,
Financial Health,
Etc.

Quality Scores for Every Canadian Wide-Moat Dividend Growth Stock

Putting all that together for the 8 Canadian wide-moat dividend growth stocks, I came up with the following:

Unsurprisingly, well-known Canadian blue chips like CN Rail (CNI, TSE:CNR), Royal Bank (RY, TSE:RY), and Toronto-Dominion (TD, TSE:TD) tied for the highest score.

At the bottom, with a score of 16, is Enbridge. Considering the higher payout ratio, the difficulty all energy companies have been facing and the average credit rating, I’m not too surprised.

I know Enbridge’s high yield is enticing, but from a quality perspective, it’s a riskier investment right now.

Digging Deeper - Additional Dividend Analysis

Now that we have quality scores for all 8 companies, let’s dig more into some specific dividend metrics so you can get a better sense of which stocks to focus on.

The Banks - Royal Bank of Canada and The Toronto Dominion Bank

Both have high yields over 4%, reasonable payout ratios of 60% or less, good dividend safety scores of 80, and are undervalued according to Morningstar.

Dividend growth over the past decade has been at high single digits, and in TD’s case, got up to 10% for the 3- and 5-year average dividend growth rates.

Value Line is expecting this dividend growth to continue. Over the next 3-5 years, it estimates annual dividend growth of 6.5% for Royal Bank and 8% for TD.

Source: Royal Bank and TD August 7, 2020 Value Line Reports

In the shorter term (1-2 years), I’d expect lower dividend growth than Value Line is guiding, due to the global pandemic.

If I had to pick one, I’d choose TD for the higher yield, slightly better dividend growth prospects and because it is a bit more undervalued.

Besides the banks, the only other undervalued stock is Enbridge.

Enbridge Inc.

Enbridge’s quality score (16/25) and its dividend safety are on the low end, so I consider this a riskier investment.

I understand that the company’s high dividend yield, at over 8%, coupled with double-digit dividend growth over the past decade is, enticing. Just understand that it comes with added risk.

The high dividend growth of the past will drop, and the dividend is only borderline safe (Enbridge’s dividend safety score is 57).

Source: Simply Safe Dividends

Considering the high EPS and free cash flow payout ratios, coupled with relatively high debt, I’m not surprised by the borderline dividend safety rating.

That said, a 63% payout ratio based on TTM operating cash flow means the dividend is covered by cash flow.

In fact, Enbridge’s own dividend policy is to pay out roughly 65% of what it calls Distributable Cash Flow (DCF) in dividends. In September 2020, the company reaffirmed its DCF guidance of $4.50-4.80, and it is guiding for 5-7% DCF growth to 2022.

Source: Enbridge Investment Community Presentation (September 2020)

Enbridge pays an annual dividend of $3.24, so if you trust the company's guidance, it currently has a DCF payout ratio of 67.5-72%. This is already above its target of 65%.

Enbridge Dividend Growth Estimates

Over the next 3-5 years, Value Line estimates average annual dividend growth of 5%.

Source: Enbridge August 28, 2020 Value Line Report

Using Enbridge’s guidance, I’d estimate 0-5% dividend growth over the next few years.

Assume a 65% DCF payout ratio at the end of 2022. If Enbridge comes through:

At the very top of its guidance ($4.80 2020 DCF + 7% growth in 2021 and 2022), you are looking at roughly 5% annual dividend growth until the end of 2022.
At the bottom of its guidance ($4.50 2020 DCF + 5% growth in 2021 and 2022), you are looking at no (0%) dividend growth until the end of 2022.

IF (and this is a big IF) everything goes according to plan in the middle of a global pandemic, you are looking at +8% dividend yield from a wide-moat stock with 24 years of increasing dividends with 0-5% annual dividend growth over the next two years.

Doesn’t sound so bad, right?

But if something major goes wrong...

Say the company finds another growth project and take on more debt but it doesn’t go to plan, or
Something causes earnings to drop.

Then you might be looking at a dividend cut from the lower earnings/DCF.

Bottom line: Do I think Enbridge will cut the dividend?

No, but with lowish quality and dividend safety scores, it’s not an investment I’d make if you plan to rely on the dividend income.

All that to say, I agree with what Simply Safe Dividends managed to say in two words, Enbridge’s dividend is “Borderline Safe”.

Canadian National Railway Co.

This is a high-quality stock I’d love to own for its long dividend streak and high dividend growth. Unfortunately, it’s a perennial low yielder.

There’s been a few times in the past where it has gotten close to a 2.5% yield, and I probably should have just bought it then.

Currently, it’s overvalued, so until the price comes down, it’s not really on my radar.

Dividend growth in the near term for CN Rail looks like it won’t be as high as it has been in the past. The most recent dividend increase was 7%, and Value Line’s estimate is an average of 7.5%/year over the next 3-5 years. Not quite the double-digit raises from the past decade.

Source: Canadian National Railway, August 21, 2020 Value Line Report

If you are looking for higher dividend growth, it might be worth looking more into its competitor, CP Rail.

Despite CP’s less impressive dividend history, it is showing more promise for future dividend growth, with Value Line estimating 13.5%/year over the next 3-5 years.

Source: Canadian Pacific Railway NSYE:CP August 21, 2020 Value Line Report

That said, CP’s yield, at less than 1%, is even lower than CN’s already low 1.6%.

The Low Yielders - Franco-Nevada Corp. (FNV, TSE:FN), Waste Connections Inc. (WCN, TSE:WCN), Canadian Pacific Railway Ltd., and Enghouse Systems Ltd. (OTCPK:EGHSF, TSE:ENGH)

I prefer to invest in high-yield, high-dividend growth stocks.

With yields of less than 1%, these 4 stocks aren’t really on my radar.

Plus, Morningstar thinks they are all currently overvalued.

For someone looking for high dividend growth, say over 10%/year, Enghouse Systems and Canadian Pacific Railway seem better positioned than Franco-Nevada Corp. and Waste Connections Inc.

Enghouse doesn’t have a dividend growth estimate from Value Line, but I’d still expect high future dividend growth from the company. Historic dividend growth rates were above 15%, its most recent dividend increase was almost 23%, and it has very low payout ratios and very little debt. All good signs.

As I mentioned before, Value Line gives CP a future average annual dividend growth estimate of 13.5%. Whereas Waste Connections Inc. gets an 8.5% estimate and Franco-Nevada Corp. has 6.5%.

At the end of the day, all four of these companies have low yields and are overvalued. I’m not interested.

Summary

As dividend growth investors, we know that wide-moat stocks make a good starting point, but it is just one of many considerations on our hunt for high-quality dividend growth stocks.

We want to know which of these companies with strong sustainable competitive advantages make good dividend growth investments.

To help answer this question, first, I identified all 8 Canadian wide-moat dividend growth stocks:

Canadian National Railway Co.
Canadian Pacific Railway Ltd.
Enbridge Inc.
Enghouse Systems Ltd.
Franco-Nevada Corp.
Royal Bank of Canada
The Toronto-Dominion Bank
Waste Connections Inc.

Then I ranked them using a quality scoring system that includes overall safety, financial strength, credit ratings, moat analysis, and dividend safety:

And finally, to narrow the list down, I provided some additional dividend metrics, like yield, valuation, dividend streaks, future dividend growth estimates, etc.

Only 3 of the 8 (Enbridge, Royal Bank of Canada, and The Toronto-Dominion Bank) were undervalued.

Enbridge’s high yield (+8%) is enticing, but its lowish quality score and dividend safety score of borderline safe, make it a riskier investment.

I was more interested in the banks.

Both Royal Bank and TD have high yields over 4%, reasonable payout ratios of 60% or less, and good dividend safety scores of 80, but if I had to pick one, I’d choose TD. TD has a higher yield, slightly better dividend growth prospects and is a bit more undervalued than Royal Bank.

Disclosure: I own shares of Enbridge and TD.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

1.39K

Follower

I'm a Canadian investor focusing on dividend growth investing as a way to reach early retirement.