As interest rates decline, is now the time to consider dividend stocks?

[AUDIO LOGO]

With interest rates trending lower, some investors may be turning their attention to other parts of the market beyond tech, including some Canadian dividend payers. Joining us now to discuss is Jennifer Nowski, VP Director and Portfolio Manager with TD Asset Management. Jennifer, welcome back to the program.

It's good to be here.

As they say, as the poets once said, the times are a-changing. We went through a high interest rate environment. We've seen borrowing costs beginning to ease, particularly in this country, and in the bond market. What does that mean for the environment for some of these dividend payers?

With bond yields declining, that creates a more positive or supportive backdrop for some of the dividend paying equities, in the sense of improved fundamentals but also a potentially better funds flow. Looking at the fundamentals side, lower interest rates result in lower interest expenses for the company. It also means investors start applying a lower discount rate to the stock. So it leads to potentially improved valuations.

Looking at the funds flow side, Canadians have been seeing GIC rates, for example, that they haven't seen in many, many years. So those were very attractive. Now that they might be coming down, investors who are income oriented might start taking another look again at some of the higher dividend yielding equities. If you look at sectors like utilities, REITs, communication services, financials, pipelines, you can find dividend yields in the range of, say, 3% to 5%-plus depending on the name. So as a result of these lower bond yields, we have seen a pick up in the share prices for some of these sectors over the course of the summer.

Yeah, there's been some definitely interesting moves over the course of the summer. When we talk about dividend payers and some of the biggest names on the Canadian market, of course, those include the Canadian banks. We've just been through another bank earnings season. What's the takeaway?

So the banks all just reported over the past week or so, or two, and generally, the results were for steady operational results as well as some early signs that maybe the banks are nearing the end of the provision for credit losses normalizing. So starting with the positive side, it was a good quarter operationally. Pre-tax, pre-provision growth was positive. And that's as the banks kept a better control over their expense base, which had been kind of a challenge a year ago. So operating leverage was positive.

As well, the core Canadian P&C banking division performed well, with loan growth up in low, mid-single digits, and NIMS were stable. Lastly, the banks remained well capitalized. Their common equity tier one ratios are around 13%. And so as they don't need to raise as much capital, the banks have turned off the discounts they used to offer on their dividend reinvestment plans. As well, some of the banks are buying back shares.

Now, the thing investors have been watching is this normalization in the provision for credit losses. It was at low levels a year or two ago, and it was normalizing as expected. The challenge with this is that it does weigh on total EPS growth. Now, this quarter, there was variations across the bank group in terms of PCLs. And there could still be some lumpiness. However, there were early signs that it's starting to kind of flatten out a bit sequentially. So that's something that investors will continue to watch.

Now, what will drive PCLs going forward? The rate environment is certainly one. And with the Bank of Canada lowering rates again yesterday, that takes some of the pressure off consumers. And the other key is unemployment remaining somewhat stable.

So that's a very key part of the Canadian market, obviously, the financials, the banks. Obviously, the energy trade is important. Let's start with the actual price of oil. If someone's been tracking it through the summer, it's been pretty choppy.

Yeah. And it's kind of pulled back a bit recently. And really, that's driven by two things. One is perhaps demand coming in a bit lighter. But the other remains this continued focus on supply and what OPEC+ is doing. So starting first on the demand side of the equation, this year is shaping up to be a more normal year in terms of demand. There's been a lot of disruptions the past few years due to the pandemic and the impact that had on transportation.

This year, oil demand growth is resuming its more normal correlation with global GDP growth. As well, the main source of demand growth is the non-OECD countries, particularly in Asia, especially China and India. And that's where maybe we're seeing things come up short of expectations, with Chinese demand struggling in light of slower economic growth there.

Turning to the supply side, the focus really is on OPEC+. There is some supply growth outside of OPEC. But within OPEC, they have a fair amount of spare capacity. And so the question for the market is what they'll do with this. Earlier in the spring, they had indicated that they were looking to bring some of this spare capacity back onto the market. However, they gave themselves a lot of outs in terms of, it depends if the market needs it.

Now, given that demand appears to be coming in weaker, there were more questions about what they're going to do. Some early reports today may be that they might adjust these plans. But it's something to continue to watch because OPEC+ discipline remains critical for supporting balanced oil market.

A lot of powerful global forces. When we talk about the oil trade, we take it back home to some of the Canadian oil sands companies. We had results from them over the summer as well. What do they look like?

So the trend with the Canadian oil sands players continues to be a financial discipline. So they've spent the past few years really controlling their CapEx expenses, lowering their debt levels significantly, as well as being more disciplined about returning that cash to shareholders. So even if, say, oils or WTI is in the 70s, these Canadian oil sands stocks will have a free cash flow yield in the high single digits, which is still very attractive. And now that they've hit these debt targets, they're returning the majority of that, and in some cases, all of that, to shareholders in the form of dividends and buybacks.

Now, the other thing to highlight with them, especially coming out of the quarter and as we look forward, is the continued focus on lowering operating costs. So OpEx came in fairly well this quarter. They benefited a bit from volume growth, as well as lower energy and natural gas costs. However, going forward, there's still a continued focus on driving these operating costs per barrel lower.

Part of it will come from a bit of volume growth, but it's also real operational improvements in terms of how they're managing their maintenance and turnarounds, the productivity of their fleet, lowering energy consumption, and things like that. So I think it's just a good sense that these companies continue to maintain their focus on financial discipline.

Of course, the product moves through pipelines. Pipelines are interesting. In the energy basket, people think of the utilities. Let's talk about the pipeline stocks and the utilities. They are considered stable businesses. What's the trend here?

So their earnings continue to remain very stable as these businesses are highly contracted or regulated. The interesting thing to look out for going forward is their opportunities to capitalize on US power demand growth. Now, US power demand has been roughly flattish the past decade. However, it's now expected to start growing due to the increase in demand from electrification, AI and data centers, as well as nearshoring.

Now, for Canadian domiciled pipelines and utilities, some of them actually have fairly sizable US operations. So they're exposed to this trend. On the utilities side, they benefit from growing demand in their territories, as well as transmission and generation opportunities. And on the gas side, the power demand is going to need to be met from all sorts of sources, including gas and renewables. And these companies have renewable generation divisions. They also would be able to supply those potentially new gas plants with new gas lines.

Of course, for the gas pipelines player, the other big growth area is LNG. And that's what's kind of changing more in the nearer term and is a driver of their growth. Now, the caveat to all this is that it's still early days. It will still take time to play out. And some of these companies are quite large. So although directionally positive, it is more of a marginal positive, but something we're watching for in the sector. [AUDIO LOGO]

[MUSIC PLAYING]