Gravitas: Mortgage Shock

November 03, 2023 | Michael Newton


The Newton Group Insights

If you are a Canadian with a mortgage, renewing over the next few years may be weighing on your mind. And if you are in a variable rate mortgage the pain is already settling in. How much higher will your payment go? This week RBC Capital Markets produced a terrific report and has tried to quantify the potential impact:

Canadian Banks: A Review of Mortgage Payment Shock

Here are the key takeaways, in our view, (i) 20%, 26% and 23% of the Canadian banks’ mortgage books will renew in 2025, 2026, and 2027, respectively, (ii) assuming a 6% renewal rate, the average payment will increase 25%, 32% and 46% in 2024, 2025 and 2026, respectively, (iii) the bank's provision for credit losses (PCLs) could go meaningfully higher, (iv) banks are being proactive by reaching out to clients well ahead of renewal to suggest increasing monthly payments, switching to a fixed rate or making a lump sum (all well and good if you have room in the budget to do so, a big assumption), and (v) mortgage payment shock will likely impact loan/revenue growth for the banks. Lots of great tidbits on mortgages in this note, worth the read. Overall, the note only supports our less than favourable view on the bank group. We continue to believe there are few catalysts for the bank group over the near-term, but plenty of headwinds (slowing loan growth, higher funding costs/lower margins, regulatory pressures, rising delinquencies, etc.). For total return investors, we believe an underweight allocation remains warranted. Our Core Portfolio only has a 5% weight in one Canadian bank. However, for income-focused investors, and have a long-term holding period, then they are good to own. Our Cash Flow Portfolio has a 9% weight in three Canadian banks. For perspective, Canadian Banks make up over a quarter the S&P/TSX benchmark.

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(-) Apple (AAPL-US) beat Q4 analyst earnings and revenue estimates but revealed that overall sales fell for the fourth quarter in a row. Tim Cook said iPhone sales remain strong in China, despite the firm posting weak results for the country. Shareholders are worried about a potential regulatory crackdown on Apple’s smartphone, as China and America fight a tech war. Meanwhile America’s FTC accused Amazon of using an algorithm that artificially increased prices on competitor sites that were tracking Amazon. The firm rejected the accusation, which forms part of the regulator’s antitrust lawsuit. Owned in Core, Cash Flow and US Portfolios.

(+) BCE (BCE) reported a healthy quarter with revenues up 1.2% Y/Y largely due to slightly higher service revenue driven by wireless and residential internet subscriber growth and the financial contributions from previous acquisitions. This is partially offset by a 3.9% decline in product revenue and lower advertising revenue as media businesses are still struggling to retain ad dollars. Wireless performance was strong with 231,213 total cell phone and connected device net subscriber activations, representing the second best ever quarterly result. As the competitive environment within the Telcos continue to increase, it’s a positive to see 3.9% wireless service revenue growth as BCE continued to compete for customers. This was also a record quarter for fibre internet net activation at 104,159, with BCE being nicely on track to achieve its 85% planned broadband buildout target by year end. Furthermore, 2023 guidance was reconfirmed, and the stock continues to trade at a discount to its long-term average. Shares currently yield 7.37%. Owned in Core and Cash Flow Portfolios.

(+) Canadian Natural Resources (CNQ-T) This was a solid quarter for CNQ on the back of in-line production and AFFO that came in above street estimates. Importantly, net debt improved by $0.5B on a sequential basis to $11.5B and the CNQ is on pace to reach its $10B target by Q1/24. Recall that once achieved, the company plans to increase its return of capital to 100% of excess free cash flow. In the meantime, we believe investors will be pleased with the 11% dividend increase. CNQ has repurchased $2.2B in stock year-to-date. All-in, this was another good quarter for CNQ and reinforces over longer-term conviction in the setup for CNQ and senior E&Ps. Valuation remains attractive at a 12% FCF yield on 2024 estimates. Owned in Core and Cash Flow Portfolios.

(+) Cenovus Energy (CVE-T) The Calgary-based company reported net income of $1.86-billion, or 97 cents per share, for the quarter ended Sept. 30, compared with $1.61-billion, or 81 cents per share, a year earlier. Supply cuts from OPEC+ countries led by Saudi Arabia and Russia kept the crude oil market tight. That provided a boost to U.S. oil prices, which climbed 9.4 per cent on an average, sequentially during the quarter. Owned in Core Portfolio.

(+) DraftKings (DKNG-US) Shares popped after the sportsbook company reported third-quarter revenue that topped Wall Street’s expectations. Revenue increased 57% to $790 million and monthly unique payers jumped 40% year over year to 2.3 million. Owned in Opportunity Portfolio.

(+) Enbridge (ENB-T) delivered a beat relative to consensus expectations with EBITDA coming in 4% ahead of street expectations. We believe the recent utility acquisitions will ultimately underpin longer-term growth. However, we believe the near-term focus will be on the fact that ENB issued equity and took on greater debt to get the deal done. Put differently, we believe shares may be range bound until we get some integration progress and/or balance sheet improvement. Shares yield 7.67%. Owned in Cash Flow Portfolio.

(-) Franco Nevada (FNV-T) Cobre Panama is the most important asset in Franco Nevada's portfolio, responsible for 17% of its total value. First Quantum signed an original contract with the government of Panama. There were negotiations with the government, and recently a new contract, more favourable to Panama, was enacted into law. Opposition parties in Panama are against the new arrangement with First Quantum, and there were 6 days of protest with many thousands of people on the streets. To quell the protest, the government announced a binding referendum for December 17, 2023. The stock declined around 9% this week, so we could think that the market is assigning a 50% probability of the referendum being successful. If the referendum does not pass, then the previous contract should be in effect, and the miner should theoretically negotiate a new contract. The reality is that they might not be able to operate. If the mine does not produce, the streamers do not get any compensation. First Quantum will seek compensation in international tribunals, which is a lengthy process with uncertain outcomes. It is now difficult to evaluate Franco Nevada's value proposition amidst uncertainty Panama. Owned in Core Portfolio.

(+) Monster Beverage (MNST-US) Sales for the company’s Monster Energy Drinks segment increased 13.7% to $1.71B during the quarter. Sales for the company’s Strategic Brands segment, which primarily includes the various energy drink brands acquired from Coca-Cola, as well as the company’s affordable energy brands, increased 11.2% t to $98.8M. Gross profit as a percentage of sales was 53.0% vs. 51.3% a year ago. The increase in the gross margin rate was primarily the result of pricing actions in certain markets, decreased freight-in cost, and decreased aluminum can costs. Owned in Opportunity Portfolio.

(~) Nutrien (NTR-T) reported EBITDA that was roughly 5% below street estimates. The variance was driven by a combination of lower sales and realized prices across the retail, nitrogen, and phosphate segments. On the flip side, sales and realized prices rebounded in the potash segment and surpassed consensus estimates by ~11% on EBITDA. Management left its FY23 midpoint EBITDA unchanged but did narrow the range. One way to interpret this is that earnings visibility is starting to return to the forefront and in turn, could spark increased confidence amongst investors. From our perspective, NTR continues to trade at an undemanding valuation of ~6.4x EBITDA (5-year avg of ~7.3x) but we also acknowledge that borrowing costs remain high and will likely cause farmers to defer fertilizer purchases until the upcoming spring planting season. I am concerned however that NTR may be subject to tax-loss selling given that shares are down 28% YTD. Owned in Core Portfolio.

(+) Pembina Pipeline (PPL-T) Another strong quarter from Pembina and it appears that the company is firing on all cylinders. In a world where we constantly hear about project costs being adjusted higher, this update from PPL should be received well by the market. On Trans Mountain, PPL has put this on the back burner as it is not eligible to participate in the first phase of Canadian government’s divestment process. Overall, a solid quarter and we remain buyers of the name at these levels. Shares yield 6.02%. Owned in Cash Flow Portfolio.

(-) Restaurant Brands International (QSR-T) delivered a modest top-line miss, however EBITDA came in 100 bps above street estimates and in turn, drove the 6% beat in EPS. It operates through four segments: Tim Hortons (TH), Burger King (BK), Popeyes Louisiana Kitchen (PLK), and Firehouse Subs (FHS). From a franchise level, PLK and FHS produced the strongest prints relative to consensus expectations, but this is largely immaterial in our view as the lion share of EBITDA is driven by TH and BK. Comps at TH was in-line at 6.8% while BK came in at +7.2%, missing the street by 140 bps. As a result, we believe this will be a focus amongst investors. Unit growth was largely stable on a sequential basis at +4.2% which we would argue isn’t bad given the slowing economic environment. Recall that management plans to brings unit growth back up to 5% in 2024. All-in, we believe the quarter should be enough to support the current share price. QSR is trading at a FCF yield of ~4.4% (5-year avg of ~3.9%) versus highly franchised peers at ~4.2%. Owned in Core Portfolio.

(~) Royal Bank of Canada (RY-T) The bank has injected about $2.95 billion into its U.S. unit City National Bank so far this year to bolster its capital, making one of the biggest annual infusions of funds since acquiring the Los Angeles-based bank in 2015. City National disclosed the numbers in a regulatory report in the United States late on Monday, which also showed that it posted a net loss attributable to the bank of $1.59 billion for the first three quarters of the year. The necessity of RBC's intervention is a negative read-through, highlighting CNB's struggles to navigate through a tough operating environment. Owned in Core and Cash Flow Portfolios.

(+) Starbucks (SBUX-US) soared after the coffee store chain posted better-than-expected earnings for its fiscal fourth quarter. The company’s same-store sales also rose by 8%, driven by higher average checks and a 3% increase in customer traffic to Starbucks cafes. Owned in Core and US Portfolios.

(+) Shopify (SHOP-T) shares soared after key metrics come in strong ahead of holiday quarter. Total revenue increased 25% to $1.7B compared to the prior year. The revenue growth was 30%. Gross Merchandise Volume increased 22% during the quarter to $56.2B vs. $54.4B consensus. Monthly recurring revenue increased 32% to $141M, driven by continued growth across all of SHOP's subscription plans. Shopify Plus contributed $44M, or 31%, of MRR compared with 33% of MRR a year ago. Owned in Core Portfolio.

(+) Super Micro (SMCI-US) shares gained after the artificial intelligence-focused data center provider provided a stronger-than-expected outlook for the coming quarter, resulting in a sigh of relief from investors. The company expects net sales to be between $2.7B and $2.9B, above the $2.52B estimate. Adjusted earnings are forecast to be between $4.40 and $4.88 per share, well above the $4.11 per share analysts anticipated. The San Jose, California-based company makes products such as rackmount servers and GPU servers, motherboards, and chassis, and ethernet switches and adapters. Owned in Opportunity Portfolio.

(+) Telus Corporation (T-T) Overall, a pretty uneventful quarter. The dividend was raised 7% and 2023 guidance was reiterated. T currently trades at 8.2x , below its 3y average of 8.8x and remains attractive given its industry leading NAV and Dividend growth profile. Shares yield 6.09%. Owned in Core and Cash Flow Portfolios.

(+) Uber (UBER-US) Shares of the rideshare companies rose after Uber and Lyft agreed to pay a total of $328 million to settle wage-theft allegations from drivers in New York state. Owned in Opportunity Portfolio

Weekend Reading

RBC MacroMemo - October 31 - November 20, 2023 Yields rise / Curve un-inverts / Recession odds rise / Markets signal weakness / Hamas-Israel conflict / Inflation rolls over / U.S. economic data weakens/ Canada wobbles / China rebounds RBC

The Netflix Effect Despite receiving scant coverage, the biggest business story last week was Netflix's quarterly earnings. The numbers were striking: NFLX profits hit $1.6 billion (up 20% from a year earlier) and the platform added 9 million new subscribers. Meanwhile, the company is raising prices. GALLOWAY

11 Things I Learned About Investing You don’t become a great investor by reading about great investors. But it's Friday. Why not indulge a little? ALCHEMY

The Christmas Tree Effect Interesting article from David Epstein, author of Range, on the tendency to add rather than subtract. The Christmas Tree Effect occurs when we continue adding new features to a system (like ornaments on a tree) and eventually end up hurting the overall system, even if each individual new feature is a positive. DAVID EPSTEIN

To be a good investor you have to train yourself to overcome the negativity bias. That's the tendency of humans to obsess about bad experiences, much more than they do about good ones. "Our sensitivity to the world is asymmetric, giving priority to what registers as negative." WITHIN WITHOUT

Here’s what Apple really means when it says ‘shot on iPhone’ Take a look at an Apple Event shot on iPhone 15 Pro. The team behind the curtain talks process. The director shoots in low light with amazing results — while treating iPhone 15 Pro like a real pro camera. YOUTUBE

Average is not the same as median… If you randomly pick stocks in any given sector, your most likely outcome is that you will have lost money after 10 years. Of course, the big winners in the market make up for all those losses of the median stock. KLEMENT


"Successful contrarian investing requires us to live with discomfort, for being "wrong" and alone. But bargains do not exist in the absence of fear."

- Robert Arnott