Full episode: Market Call for Tuesday, December 4, 2018
Brian Madden, senior vice president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities
As we look out towards 2019, macroeconomic and geopolitical risks are taking on greater prominence. Various trade spats weigh in on investors’ minds as the reality of a divided and likely combative U.S. government come into focus. Not surprisingly, with this backdrop and amidst the ongoing tightening of monetary policy via interest rate hikes by the Federal Reserve and the Bank of Canada, volatility has perked back up to more historically normal levels after being unusually suppressed last year. Obstacles to business competitiveness (carbon pricing, the inability to get pipelines built, high corporate tax rates compared to neighboring jurisdictions, minimum wage hikes, high hydro prices in the manufacturing heartland of Ontario) are an ongoing concern across Canada and will likely factor into federal and provincial elections next year.
So while seasonality is overwhelmingly favourable in December (the S&P TSX Composite is up an average of 1.4 per cent during the month over the last 30 years) and with gains remarkably consistent (83 per cent of the time), we can in all likelihood expect the traditional “Santa Claus” rally, but the subsequent twelve months may be more turbulent. The silver lining to this more challenging macroeconomic backdrop is that we enter it with supportive equity valuations. The S&P TSX Composite index price to trailing earnings ratio of 16.7 times and price to book ratio of 1.7 times are approximately 20 per cent below their long-term averages, and the current dividend yield of 3.2 per cent is a whopping 43 per cent above its long-term average. While earnings growth is moderating, consensus forecasts nevertheless call for corporate earnings to grow nearly 20 per cent over the upcoming twelve months.
These forecasts are virtually certain to be reduced, but even with the typical downward tweaking and fine-tuning of overly rosy analyst forecasts, Canadian stocks should still enjoy decent earnings growth in 2019. Our focus for much of 2018 has been de-risking portfolios in preparation for the late stages of the economic cycle. Accordingly, we’re now much more concentrated in sectors like real estate investment trusts, grocers, utilities and other defensive, stable business with good revenue and earnings visibility than we were a year ago. We believe this is the prudent stance to take at this juncture, just the opposite fashion to the stance we took in mid-2016 to increase portfolio beta and cyclicality as economic growth accelerated.
ROYAL BANK (RY.TO)
Latest purchase November 2018 at $98.06
Royal Bank is Canada’s largest company and one of the 10 largest banks in the world. It has a dominant domestic and commercial banking franchise, a top 10 global capital markets business and it’s the leading Canadian wealth management franchise rounded out with smaller insurance and investor services and treasury businesses. All of this provides RBC with a very solid and well diversified earnings stream. Royal is also well diversified by geography with large scale businesses in Canada, the U.S. and Europe as well as other global financial centers. The bank is a leader in digital banking as well as in artificial intelligence and is using its scale to invest heavily behind these drivers of long-term competitive advantage. This research and development is geared toward affinity program partners that would provide an additional 2.5 million new Canadian banking clients by 2023. Meanwhile, with a dividend yield of 4 per cent and with dividends growing at a 7 per cent compound annual rate over the last decade, we see a logical path towards double-digit returns in this stock over the course of a cycle.
ALIMENTATION COUCHE-TARD (ATDb.TO)
Latest purchase November 2018 at $68.01
Alimentation Couche-Tard is North America’s largest independent convenience store operator with nearly 10,000 stores and a further 2,700 locations in Europe. The company earns returns on equity in excess of 20 per cent, and has grown earnings per share at a 22 per cent compound rate over the last decade. Their business approach has been to use procurement scale to price sharply on fuel, thus drawing traffic to their sites and then luring shoppers into attractive, modern and well merchandised stores. The company has also been a very capable serial acquirer with a demonstrated pattern of realizing significant synergies from acquired businesses, in this still highly fragmented industry. Their largest deal to date, the $5.2 billion purchase of CST Brands closed last June and the acquisition of Holiday Station stores, another sizable deal which added 522 stores to their network, was completed in December. Both should be meaningfully accretive to earnings.
SUNCOR ENERGY INC (SU.TO)
Latest purchase November 2018 AT $43.09
Suncor is Canada’s largest integrated oil company and the longest-running operator of oil sands assets in the country. Their oil sands assets have a 36-year reserve life index, and with breakeven oil prices below $35, the company generates very healthy free cash flow at current oil prices. Downstream integration via their ownership of four world-class refineries and approximately 1,750 gas stations has been very effective in insulating Suncor from the steep discounts other Western Canadian oil producers have suffered when selling heavy crude oil into captive American refining markets while relying on often overcrowded pipelines. With their final two major expansion projects, Fort Hills and Hebron, now in production Suncor’s capital expenditures are set to fall 12 per cent this year and a further 3 per cent next year, allowing them to maintain their established pattern of dividend increases, which have grown at a 12 per cent compound rate the last five years also providing optionality to step up the pace of their share buyback program.
Merged with Agrium at 0.4 to 1 shares to form Nutrien (NTR.TO).
- Then: $25.32
- Now (as NTR): $69.02
- Total return: 12%
INTER PIPELINE (IPL.TO)
- Then: $27.10
- Now: $21.07
- Total return: -14%
ROYAL BANK (RY.TO)
- Then: $100.85
- Now: $97.21
- Total return: 0.1%
Total return average: -1%
Goodreid North American Balanced
Annualized Net Returns as of: November 30, 2018
- 1 Year:8.5% fund, 3.7% index
- 3 Year: 9.0% fund, 6.0% index
- 5 Year: 9.4% fund, 5.8% index
INDEX: Globe Canadian Equity Balanced Peer Index Average
Identify if your fund’s returns are based on reinvested dividends. Returns provided must be net of fees!
TOP 5 HOLDINGS AND WEIGHTINGS
- CDN Equities 31%
- U.S. Equities 40%
- CDN Fixed Income 18%
- Cash 11%