Financially Strong Canadian Dividend Growth Stocks & Their Credit Ratings

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My investing plan involves buying and hopefully holding great dividend growth companies for a long period of time while collecting the growing stream of dividends that will eventually help cover retirement costs and inflation. For this strategy to work I need companies to be able to survive and thrive over the very long term. This is why, as a long term dividend growth investor, I place a lot of weight in the financial strength of a company before investing.

With that in mind I thought it would be interesting to come up with a laundry list of Canadian dividend growth stocks that exhibit signs of financial strength.

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As a starting point I used the May 31, 2016 version of the Canadian Dividend All-Star List which is an excel spreadsheet of Canadian companies that have increased their dividend for five or more consecutive years in a row. Currently there are 88 companies in the list with a dividend streak of 5 years or more. I decided to make one exception and added Bank of Montreal [BMO.TO Trend] into the mix, bringing the total to 89.

We in Canada are known for our “Big 5” banks so I decided to add BMO as it was the only bank that wasn’t already on the list. BMO has a dividend streak of 4 years, a history of regular dividend increases and “BMO Financial Group is the longest-running dividend-paying company in Canada” (Source: BMO investor relations website).

What is a financially strong company?

I’m not going to go into too much detail here as I’ve already written an article on the topic, but ideally you are looking for a company with low debt, a reasonable or low payout ratio and reliable, strong and growing cash flows.

Related article: Financial Strength: A Key Element in High Quality Dividend Growth Stocks

For today’s purposes we are going to focus primarily on credit ratings and debt ratios to help whittle down our list. You can then use this list to further analyze other aspects of financial strength like the payout ratio and cash flows.

Credit Rating Passing Criteria

To quickly assess the financial strength of a company it is easiest to just look at the credit rating. Ideally I like to see a credit rating of BBB+ or higher from S&P. S&P doesn’t cover all the Canadian companies in my list so I looked up the credit rating for each company in the list from four rating agencies: S&P, DBRS, Moody’s and Fitch. The table below highlights in green the ratings that I consider a passing grade from the four agencies.

When a company had more than one credit rating I chose the lowest of the available options. I’ll use Royal Bank of Canada [RY.TO Trend] as an example. They were rated AA by DBRS, AA- by S&P, Aa3 by Moody’s, and AA by Fitch. The Aa3 from Moody’s and AA- from S&P were the lowest of the four, but Moody’s had a negative outlook whereas S&P had a stable outlook so the Moody’s rating was picked.

Some companies in the list are small companies and others have no debt which can sometimes mean they are not rated by one of the four agencies. In cases where there wasn’t a credit rating from any of the four agencies I used two debt ratios to grade the companies.

Debt Ratios Passing Criteria

To pass my financial strength test I required an interest coverage ratio of 4:1 or higher and a long term debt/equity ratio of 50% or less.

I decided on a debt/equity ratio requirement of 50% or less as Lowell Miller lists it as one of his financial strength requirements in his book The Single Best Investment: Creating Wealth with Dividend Growth.

For small non-financial companies an interest coverage ratio of 4:1 is generally thought to be about equivalent to a BBB rating. In January 2016, Aswath Damodaran ran the data on the link between interest coverage ratios and credit ratings by looking at all rated companies in the United States. The results for non-financial service companies with a market cap of less than $5 billion are highlighted in the table below.

Source: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ratings.htm

The table above doesn’t specify an equivalent interest coverage ratio to a BBB+ rating, but BBB is pretty close. I think between the debt/equity and interest coverage ratios we are around a similar pass level to the BBB+ credit rating, albeit we are using a much cruder method than the rating agencies use.

The Results

Of the 89 companies I looked at 47 passed with the other 42 failing. One thing that surprised me was the number of companies with no long term debt at all. In total there were 8 companies without any long term debt.

I had limited space on the website so I’ve also included an excel spreadsheet that has a bit more information like all of the credit ratings, not just the lowest. Download it here: Financially Strong Canadian Dividend Growth Stocks & Their Credit Ratings May 31, 2016.

Without further ado here are the results sorted by dividend streak length. Hopefully you find the list a useful starting point for further analysis.

Disclosure: I own shares of Bank of Nova Scotia, Canadian Utilities, Canadian Western Bank, Enbridge Inc., Ensign Energy Services, Home Capital Group Inc., National Bank of Canada, Rogers Communications, and Suncor Energy. You can see my portfolio here.