Full episode: Market Call for Monday, September 11, 2017
Teal Linde, portfolio manager and publisher of the Linde Equity Report
FOCUS: North American large and mid-caps
Canadian market weakness in 2017 increases its relative attractiveness versus the U.S. Market
Year to date, the Canadian market is the worst performing stock market among the G7 countries with a return of -1.5 per cent, compared to the best performing market (Italy) at 14.4 per cent and the United States at 10.7 per cent. The Canadian market’s relatively high exposure to the energy sector, which has performed poorly in 2017, and relatively low exposure to the information technology and health care sectors, which have performed well, explains a great deal of the weakness. In addition, the Canadian financial sector, Canada’s largest, has also performed relatively poorly compared to its global cousins.
Canada’s underperformance compared to other countries comes in spite of projections its economy will grow fastest of any G7 nation in 2017, and close to the top in 2018. However, such strength has caused the Bank of Canada to raise interest rates faster than was generally anticipated; this has investors nervous that the Bank might slow the economy too fast or cause too much strength in the Canadian dollar, hurting exporters.
Given the backdrop of expanding economic activity, which is why the Bank of Canada is confident enough to raise interest rates, it would seem Canada’s underperformance in the global market context seems exaggerated. Amid market weakness, the attractiveness of many Canadian stocks is increasing, relative to their U.S. counterparts, and Canada is becoming a more interesting place to look for investment opportunities.
ROYAL BANK OF CANADA (RY.TO)
Royal Bank is Canada’s largest bank by market capitalization and one of the top 15 in the world. It has 81,000 employees with 16 million clients worldwide. It aims to be the undisputed financial services leader in Canada and the preferred partner to corporate, institutional and high net worth clients and their businesses in the United States. RBC’s Capital Markets and Wealth Management divisions in the U.S. are of large enough scale to successfully compete and expand in the U.S. Combined with its upper teens ROE, Royal Bank is better positioned to achieve profitable growth in the U.S. while TD, BMO and CIBC compete in other more competitive areas in the U.S. market. Despite being Canada’s leading bank in the fastest growing economy in the G7, Royal Bank’s stock has underperformed over the last several months, resulting in its stock trading at an attractive 12 times 2017 expected earnings. Last purchased on September 6, 2017 at $90.96.
TIDEWATER MAINSTREAM AND INFRASTRUCTURE (TWM.V)
Headquartered in Calgary, Tidewater’s main focus is offering natural gas processing services, which are becoming increasingly infrastructure intensive (and thereby offering greater growth opportunities) due to the liquids rich gas, which is more valuable than dry gas, coming out of today’s much deeper gas wells. As a relatively new and smaller company with a $430 million market cap, Tidewater trades at a substantial discount to its peer group. On an enterprise value (market cap + debt)/EBITDA, Tidewater trades at a 50 per cent valuation discount to its peers, which include Enbridge Income Fund, Pembina, Inter Pipeline, AltaGas, Keyera and Veresen. Tidewater’s EV/EBITDA multiple of 6.2 times compares to a peer average of 11.2 times EV/EBITDA. As a relatively new company, Tidewater also has a much healthier and still underutilized balance sheet (0.8 net debt/EBITDA 2018E versus peer average of 4.8 times). Tidewater’s debt/total capital is 12 per cent compared to the peer average of 50 per cent. Tidewater also has the lowest dividend payout ratio among its peer group, yet it still offers a dividend yield of 3.1 per cent. Management is retaining more of its cash to fund its double-digit growth plans. The lower valuation, lower debt levels and lower payout ratio all contribute to share price upside for this early stage mid-stream company. Last purchased on August 8, 2017 at $1.30.
AMC ENTERTAINMENT (AMC.N)
Through recent acquisitions and an increased debt load, AMC has become the largest movie theatre exhibitor in the U.S. and Europe with over 10,000 screens across 900 theatres. Movie theatre stocks have been hit hard due to a weak Q2 and Q3 box office. The falling share prices have spurred many in the media to wonder: “Is the movie theatre dead?” It is very common for investors to extrapolate events of the most recent past into the future. However, in this case, such extrapolation seems unfounded. The box office in 2017 has suffered for two main reasons: a low number of major releases and a poor reception to those released. For example, the past Labour Day long weekend was the first in 17 years that no major film was released. However, the number of major releases planned for 2018 is noticeably higher than in 2017. An April 2017 article from Forbes.com has gone as far as stating “2018 will be our first taste of year-round blockbusters.” And with respect to the poor reception to major films released in 2017 - movies are in the creative content business. The quality of creative content will always fluctuate. Just because this year’s movies did not resonate well with viewers, it does not mean next year’s slate of films will share the same fate. As the movie theatre company with the most debt, which makes it riskier among its peers, AMC’s stock is down the most – 60 percent year to date. However, upon a turnaround at the box office, AMC also offers great upside from its current level. Last purchased on July 26, 2017 at $21.15.
PAST PICKS: SEPTEMBER 19, 2016
Every quarter, Google sells more online ads, or ad impressions. But the price received for each impression falls slightly each quarter. Last quarter, Andy and I noted that Facebook increased its first quarter ad impression by 35 per cent year over year. But its price per ad impression was up 14 per cent: increased supply and increased prices, which is not what you would typically expect. In Facebook’s second quarter, supply continued to increase, yet prices jumped even more than in the first quarter. This all bodes well for the second half of 2017.
- Then: $128.65
- Now: $173.01
- Return: 34.48%
- Total return: 34.48%
PAINTED PONY ENERGY (PONY.TO)
On the plus side, Painted Pony has the third-largest natural gas proven and probable (2P) reserve behind Canadian Natural Resources and Tourmaline. It has 12 of the 13 top performing wells among the nearly 1100 wells in the North Montney. Its operating costs are among the lowest in industry at 62 cents in 2017 and expected to be 52 cents in 2018. It is expected to grow average annual production from 23,000 BOED (barrel of oil equivalent) in 2016 to ~45,000 in 2017, and to ~70,000 BOED in 2018. It is able to show positive earnings where most companies are struggling to show positive cashflow.
Stock is down though for the following reasons:
(1) Started out the year with good gas prices, did a deal with UGR and got pushback from some shareholders, but got 75 per cent support.
(2) Concerns over pushing too close to bank line, but issued term debt to reduce reliance on bank line.
(3) Reduced production guidance as gas price weakened through the year.
Best remedy for PONY’s stock is higher natural gas prices so that it can earn greater excess cashflow to exploit is massive 6.4 trillion cubic feet resource and accelerate increased production and cashflow per share. Higher price could happen from increasing exports of natural gas. In this regard, a tipping point has been reached. For the first time, the U.S. is exporting the same amount of natural gas as it is importing from Canada, and exports are expected to increase further. This year, Cheniere is exporting 2 Bcfd of LNG and 4 Bcf is going to Mexico via pipelines. LNG and Mexican exports are expected to climb to 10 Bcfd over next 2 to 3 years, exceeding the 6 Bcfd annual import from Canada.
- Then: $7.74
- Now: $3.06
- Return: -60.44%
- Total return: -60.46%
The New Home Company (NWHM.N)
This Southern California-based company started out as a builder of $2 million+ luxury homes in Orange County, primarily around the Newport Coast. It is now a builder of homes in the $1.3 million range, on average, in Southern California, the Bay Area/Sacramento and Phoenix. With a market cap of US$210 million, New Home was identified last year as an opportunity to own a new and early stage homebuilder with an experienced management team with ambitions to create a mid-sized publicly traded homebuilder. The stock has had a sideways year, mostly due to a joint-venture project in Phoenix being pushed out from 2017 to 2018. With EPS of $1.25 expected in 2018, the stock is trading at an average of 8 times next year’s earnings. Toronto-based Tricon Capital (TCN.TO) was an early investor in New Home, at which point Tricon’s Chairman, David Berman, (and New Home board member) touted Tricon’s investment in New Home’s “blue chip” management team.
- Then: $10.03
- Now: $10.24
- Return: 2.09%
- Total return: 2.09%
TOTAL RETURN AVERAGE: -7.96%