Canada's big independent brokerages, Canaccord Financial and GMP Capital, are facing another rough quarter as financing activity for smaller-cap companies has yet to rebound from last year's doldrums, meaning cost cutting is going to be a focus.
"The profitability of the independent brokerages in Canada remains very reliant on the level of underwriting activity in the small-and-mid cap resource sector," Macquarie Capital Markets analyst Sumit Malhotra wrote in a report on the sector. "Unfortunately for the brokers, based on our review the level of deal flow thus far in calendar 2012 has been very slow, which suggests investors and issuers have not (yet?) embraced the ‘risk-on’ trade."
Mr. Malhotra, one of the only big-name analysts to cover the space, reckons that given the pressure on the revenue line, both GMP and Canaccord will focus on reducing expenses.
What Mr. Malhotra doesn't foresee is a reduction in the regular dividend from either company. Instead, look for them to stop buying back shares instead, as a way to conserve capital. Why keep the dividend over the buyback?
"Given downward pressure on compensation, dividends another way for staff to get paid. At the risk of stating the obvious, the reduction in revenue for the broker/dealers will clearly have a detrimental impact on employee compensation as well."
Given that about half the shares of Canaccord are owned by staff, and about a quarter of GMP's shares are owned by workers, the dividends flow largely to employees.
"In other words, we think maintenance of the dividend at current levels does provide an income benefit to employees and other stakeholders at a time that operating performance has been less than ideal, and expect the brokers to maintain the level as long as it is feasible."