Ranking the moat of popular Canadian dividend stocks

As investors, we often talk about the moat of a company. What does this mean exactly?

A company’s moat, sometimes referred to as the economic moat, is the competitive advantage a company has over competitors. The stronger the moat, the harder it is for competitors to enter the field and disrupt profits and market share. In other words, having a strong moat is a good thing for a company because it allows the company to maintain profitability, gross margin, potentially grow market shares, and more importantly, fend off competitors. 

A few months ago, Joseph Carlson ranked the moat of popular stocks and made up four categories of moat:

• Stronghold – Strongest moat
• Castle Wall – 2nd strongest moat
• Wood Fence – strong but has weaknesses
• Picket Fence – OK moat can fall apart easily
• Open Field – very weak moat, open to competition

As you can see, a stronghold means the company has an extremely strong moat. Meanwhile, an open field means the company has a very weak moat and competitors can easily enter the market without much difficulty.

I thought it would be interesting to rank the moat of some popular Canadian dividend stocks. 

Ranking the moat of popular Canadian dividend stocks

Let’s have some fun and rank the moat of some popular Canadian dividend stocks, shall we? 

Stronghold – the Big Six (Royal Bank, TD, Bank of Nova Scotia, Bank of Montreal, CIBC, and National Bank)

Why do the Big Six all have a Stronghold moat? 

First of all, how often do you hear someone changing banks? I would say hardly ever.

Sure, some people may become really annoyed with their bank after many years and switch, but you certainly don’t hear people switching their bank every month or every year just because they want to take advantage of the latest promotion. 

The reality is that switching from one bank to another is extremely painful because numerous procedures and updates need to be made (for example, preauthorized payrolls and payments). Not to mention the potential fees you would have to pay to close accounts and/or transfer funds. 

From a competition point of view, Canadian banks are highly regulated and a lot of capital is required to create a brand new bank. The new bank would also need to have many physical branches to service its customers (note: with online banks, the need for physical branches is slowly going away). Finally, there are a lot of regulations and the Canadian federal government restricts foreign competition. Essentially, it’s nearly impossible for a new bank to enter the Canadian market and take a significant amount of customers away from the Big Six. 

Wood fence – Manulife 

Manulife offers three key services – insurance, such as life, health, dental, disability, and travel insurance, wealth and asset management like retirement plan services, and financial planning. 

Its core business, insurance, is largely undifferentiated, meaning the term life insurance from Manulife and its competitors like Sun Life and Great-West Life are more or less identical. When someone shops for insurance, it really boils down to price and the coverage. And unlike switching banks, it is relatively easy to switch your insurance from one provider to another. You just stop paying one insurer and start paying the other insurer. 

One of the key reasons why Manulife only has a wood fence moat is because of fierce competition. Domestically, Manulife faces Sun Life, Great-West Life, Canada Life and other). Internationally, Manulife faces competition like MetLife, Prudential, AIG, and others. There are also some local insurers that Manulife may have to face. In recent years, there have been many different online insurers like PolicyMe, Nesto, and World Nomads that have entered the insurance space, competing against Manulife. Furthermore, most Canadian banks also have insurance arms, allowing them to offer insurance services to their clients. 

It’s more or less the same story on the wealth and asset management side. This service is not really differentiated. Manulife has no real competitive edge over its competitors. Furthermore, more and more people are preferring index funds over high MER mutual funds. Therefore, the fee compression from passive investing may be hurting Manulife. 

Another reason for labelling Manulife as a Wood Fence rather than a Castle Wall is due to Manulife’s vulnerability to low interest rates. Insurance companies like Manulife set money aside that hasn’t been paid out to claimants and invest that money in “safe” assets. This is called the float. When the interest rates are low, Manulife can’t earn enough on its float, which reduces the company’s profitability. 

Stronghold – TC Energy, Enbridge, and Pembina Pipeline Corp

I would categorize pipeline companies like TC Energy, Enbridge, and Pembina Pipeline Corp as having a stronghold moat.

Why? 

Pipelines are the most cost-effective way to transport oil and gas. It is cheaper and easier to transport oil and gas via pipelines than by rail. Due to environmental concerns, it is more and more difficult to get new pipeline approvals. Therefore, it is nearly impossible to create extensive pipeline networks, making the existing pipeline networks more valuable than before (Enbridge’s Mainline system transports 30% of North American crude, spanning over 3,000 km. The Keystone XL took 13 years of review and approval but was cancelled in the end).

Even if a new pipeline network is approved, it would take billions and years to build the new pipeline network and get it operational….as well as many years, if not decades, to build.

TC Energy, Enbridge, and Pembina typically sign long term contracts with the energy producers to transport oil and gas. Because of the long term nature of these contracts, the business is very stable, and it is extremely hard for smaller pipeline companies to win immediate contracts. 

Stronghold – Fortis

Electricity and natural gas are considered non-discretionary; they are day-to-day essentials for Canadians. Because electricity and natural gas are essential, there needs to be a way to distribute them. 

The utility space is well-regulated, hence ensuring stable profits and very few surprises for utility companies like Fortis. For the most part, Fortis operates as a monopoly in the utility markets the company serves. For example, although in BC you can get natural gas from independent companies other than FortisBC, Fortis still owns the pipelines and delivers the gas to your home or business. (And with the rollout of data centres which require huge amounts of energy, a company like Fortis will see its moat become even stronger).

Castlewall – Telecoms, BCE, Rogers, and Telus 

Right now in Canada, there are three key telecom players, BCE, Telus, and Rogers that dominate the market, in essentially an oligopoly structure. 

It is very difficult and costly to build cellular infrastructure that can cover Canada, both in major cities and rural areas. Essentially, it would require billions of dollars and many years to build such a cellular infrastructure. Competitors like Freedom Mobile – and others – still suffer from spotty coverage. 

The Canadian government more or less limits foreign ownership, so it is extremely difficult for foreign telecom companies like AT&T and Verizon to enter the Canadian market. 

I didn’t categorize the telecoms as having a Stronghold moat and a slightly weaker Castle Wall moat because data via satellite could potentially disrupt cellular data services in the near future. Having said that, telecoms are beginning to embrace and adopt this new technology; for example, Rogers is now offering beta services for its Satellite-to-Mobile service.  

Stronghold – Canadian National Railway, Canada Pacific Kansas City Limited 

There’s no doubt that both Canadian National Railway and Canada Pacific Kansas City Limited have a Stronghold moat. Both companies have irreplaceable infrastructure. Building a competing rail network nowadays is nearly impossible, given the vast amount of land required and all the regulatory barriers. In other words, there’s an extremely high barrier to entry.

For railway companies like CNR and CP to be effective and efficient, they need extensive coverage of rail networks. But if you don’t already own such extensive coverage of rail networks, it is nearly impossible to build one. Hence, it is nearly impossible for a new competitor to enter this field and compete against CNR and CP. Now it may be possible for a competitor to build one line across a certain geographical area or region, but certainly not across North America.

Castlewall – Brookfield Infrastructure Partners 

Brookfield Infrastructure Partners is one of the largest owners and operators of critical global infrastructure networks which facilitate the movement and storage of energy, water, freight, passengers, and data. These infrastructures are unique and extremely hard to replicate and are geographically diversified. 

But why didn’t Brookfield Infrastructure Partners get a Stronghold moat and instead only get a weaker Castlewall moat from me? 

The only reason I wouldn’t categorize Brookfield Infrastructure Partners as Stronghold is that the company operates more like a sophisticated infrastructure fund rather than an operating business. There’s no unified network (like CNR’s rail network or Enbridge’s pipeline network). 

Furthermore, Brookfield Infrastructure Partners’ assets are somewhat disconnected (i.e. utilities in Colombia and Brazil, railways in Australia and South America, toll roads in various countries, data centers and cell towers in various countries). These assets do not create synergies with each other. So a competitor could buy some of these assets and disrupt Brookfield Infrastructure Partners. 

Finally, several similar companies operate in the same way as Brookfield Infrastructure Partners – Blackstone, KKR, and OMERS. When it comes down to it, it’s all about having a strong management and a large amount of capital. For BIP to continue to succeed, the management needs to be able to find and execute good deals. In a hot market, it may become increasingly more difficult to find good deals or the deals may become more expensive. To put it simply, a strong management is crucial to BIP’s continuing success.

Picket Fence – Loblaw

Despite being the largest grocery retailer in Canada with over 2,500 stores across Canada, I believe Loblaw operates in a commoditized industry with very little customer loyalty. In the grocery space, the key factors to win customers are low price and location convenience. There is very little customer loyalty. If an item is cheaper at Walmart or Save-On-Foods, customers can easily shop there rather than a Loblaw store. 

The intense competition is another reason why I categorized Loblaw as having a Picket Fence moat. Loblaw faces global giants like Walmart and Costco, which control approximately a third of the Canadian grocery market volumes. Then there are other domestic competitors like Metro, Sobeys, Save-On-Foods, Safeway, IGA, etc. Unlike the banking and telecom sectors, no regulations are preventing foreign competition from entering the Canadian grocery market, so brands like Aldi have established themselves in Canada, creating fierce competition in the low cost grocery space (good for consumers). 

Because of the fierce competition, Loblaw operates with extremely thin margins, typically around 5% or below. This is one of the thinnest margins among the Canadian grocers. So this leaves Loblaw with little room for sustainable competitive advantages or pricing power over its competitors. 

Although Costco also operates in low margins, it differentiates itself by operating in a membership-based model, generating profits from the annual membership fees. Walmart also operates in a similar below 5% margin space but due to the massive scale globally, it has significant cost advantages over Loblaw. 

Loblaw has created PC Optimum to try to gain customer loyalty but in my opinion hasn’t created sufficient barriers to its perceived moat. For example, if I can find an item at both Loblaw, Walmart, Costco, and Save-On-Foods, I typically look at the price first. I don’t really care how many loyalty points I earn. 

Note: I would probably put Canadian Tire in the same category as Loblaw- having a Picket Fence moat. You could argue Canadian Tire might be slightly higher than Picket Fence because the sector isn’t as commoditized as the grocery space but I certainly wouldn’t put Canadian Tire in the Wood Fence moat category. 

Summary – Ranking the moat of popular Canadian dividend stocks

Here you have it, ranking the moat of some popular Canadian dividend stocks. I actually can’t think of any popular Canadian dividend stock as having no moat (i.e. open field). Maybe that’s why all of these stocks are popular, because they all have a moat. I suppose if a company doesn’t have a moat, it wouldn’t be able to stay competitive and profitable, hence my inability to think of some. Having said that, if you could suggest some Canadian dividend paying stocks with no moat, I would love to hear from you.

What do you think about my ranking?