Canadian corporations have racked up a hefty debt load to feed the country’s dividend habit.
Over roughly the past decade, corporate debt has tripled as companies have binged on ultracheap financing in part to keep money flowing to investors through dividends and share buybacks.
The country’s corporate balance sheet now bears a record amount of debt, owing primarily to those sectors that are most generous with shareholder payouts – namely telecoms, pipelines and utilities.
“Companies have been under pressure to borrow. They know their shareholder base is looking for income and safety,” said Martin Roberge, a portfolio strategist at Canaccord Genuity.
But the demand for yield could ultimately backfire as rising interest rates expose high levels of debt, particularly in dividend-rich sectors. “Beware,” Mr. Roberge said, “many of these perceived ‘defensive’ stocks.”
At the peak of the most recent business cycle in 2009, Canadian corporate debt for companies in the S&P/TSX Composite Index topped out at just under $200-billion, excluding the financial sector. That number now sits at $614-billion, Mr. Roberge said.
To give a better idea of how that compares with other markets, Mr. Roberge calculated net debt as a proportion of sales for all non-financial companies. For the main Canadian index, that number comes to 0.62. In other words, it takes 62 cents of debt to generate every dollar of sales.
By contrast, companies in the U.S. S&P 500 Index require just 33 US cents of debt per dollar of sales.
In fact, Canada has one of the most indebted corporate sectors in the developed world. Among the world’s 25 largest developed markets, only Belgium and Israel have higher levels.
While excessive household debt in Canada has become a much-publicized risk, corporate borrowing has attracted far less scrutiny. In fact, corporate Canada is generally given a pass in the conversation over domestic indebtedness.
“This is no time for complacency over domestic balance sheet risks,” writes David Rosenberg, chief economist at Gluskin Sheff + Associates Inc., pointing out that corporate debt is also reaching alarming levels when compared to the size of the economy.
“For all the talk of pristine corporate balance sheets, debt-to-GDP on this score is rapidly approaching 70 per cent for the first time ever, having taken out the near-55-per-cent cycle peaks in the past,” Mr. Rosenberg said.
In an era of universally cheap money, it has been even cheaper for Canadian borrowers to access long-term financing. For the past five years, the yield on Canadian 10-year government debt has materially lagged the comparable U.S. yield. Right now, those yields sit at about 2.1 per cent and 2.8 per cent, respectively.
Not only did minuscule bond yields shrink the cost of corporate borrowing, it also pushed savers into the stock market in search of income. And when global commodity prices tipped into a downturn starting in 2011, investors increasingly gravitated to non-resource stocks paying dividends.
Meanwhile, Canadian dividend payers have readily obliged the demand for shareholder payouts. With a current dividend yield of about 3 per cent on the S&P/TSX Composite Index, compared with a yield of about 2 per cent on the S&P 500, the Canadian stock market has long been considerably more generous in that respect.
“This became a theme, almost cultish,” said Patrick Horan, a portfolio manager with Agilith Capital.
So eager have companies been to cater to the theme of dividend growth, and so loath have they been to cut dividends and face investors’ wrath, many have sustained and boosted payouts disproportionate to their own growth, Mr. Horan said. And many have done so with borrowed money.
While every sector of the Canadian stock market has become more indebted since 2008, the biggest increases have been seen in the high-yield sectors, including utilities, telecoms and pipelines, Mr. Roberge said. (Financials and real estate were excluded from the analysis.)
For example, total debt carried by utilities companies within the S&P/TSX has increased sevenfold over the past 10 years, and now sits at about $110-billion, Mr. Roberge said.
“We’re testing the capacity of some defensive stocks to pay their dividends, especially when it comes to the pipes,” he said. The recent decline in shares of Enbridge Inc. by 23 per cent since early January has pushed the pipeline company’s dividend yield up to nearly 7 per cent – an indication that the market may doubt Enbridge’s ability to sustain dividend growth.
Even while Enbridge’s earnings per share have declined over the past couple of years, the company’s dividend has grown considerably over that time, Mr. Horan said.
“Companies have propagated a dividend growth story, even when they had no business doing that.”