Full episode: Market Call for Tuesday, July 7, 2020
Brian Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities
As we said in March, the economy was placed into something akin to an induced coma to ensure the best possible health outcomes for citizens. Markets have recovered mightily from their mid-March lows largely due to unprecedented monetary and fiscal stimulus. These measures softened the blow of harsh lockdown restrictions and ensured continued functioning of markets and banking.
As leading indicators, stock prices are now signalling a belief that the strategy worked. This may or may not be true, as all prior pandemics have seen secondary outbreaks. Our belief is that investors should always have a primary position in stocks, as timing markets has been repeatedly proven to be sucker’s game.
We have taken a barbell approach, with the cornerstones of our portfolios being long-established, high-quality, profitable and financially strong companies with leadership positions within their industries. The periphery of the portfolio consists of cyclicals leveraged to economic recovery, but nevertheless financially resilient enough to survive a prolonged recession from a second wave. The frenzied speculation in stocks like Hertz, air and cruise lines likely driven by novices and day traders is the antithesis of our approach.
We have weeded stocks with damaged longer-term prospects related to the pandemic and the resultant societal changes out of portfolios. The proceeds from these sales we will redeploy selectively as opportunities arise. Potentially, we may redeploy more aggressively and broadly should a COVID-19 resurgence unfold or if second thoughts about the longer-term consequences of the measures enacted prompt a more sober assessment of companies’ earnings power.
TD Bank (TD TSX) - Latest purchase: June at $59.76.
TD is Canada’s second largest bank and is also increasingly a force to be reckoned with in U.S. banking and brokerage services. TD earns a mid-cycle return on shareholder’s equity of about 15 per cent, a figure currently depressed by the recession. They have grown earnings per share at a 7 per cent rate over the last decade, with a commensurate increase in its dividend as the firm has remained well capitalized through the cycle. With nearly 40 per cent of revenues originating in the U.S., TD benefits from geographic diversification and has a leading banking franchise along the U.S. East Coast. We expect them to opportunistically expand via acquisition should the current downturn present synergistic and accretive targets within the eastern U.S. Trading at 1.3 time book value versus a long-term average multiple of 1.8 times, TD looks well poised to continue outperforming the TSX.
Parex Resources (PXT TSX) - Latest purchase: June at $15.91.
Parex is a mid-sized company producing approximately 43,000 barrels of oil per day in Colombia. Parex enjoys some of the highest netbacks (operating profits) of any mid-to-large sized Canadian energy producer. The company had grown production by 135 per cent since 2014 until recently curtailing exploration and production amidst low oil prices. Crucially (and refreshingly, for a resource company) the management team is very focused on profitability, such that earnings grew more than eight-fold between 2014 and 2019 and the return on shareholders’ equity in 2019 topped 27 per cent. With no debt and $360 million in cash on their books, Parex is well positioned to weather even a prolonged period of low oil prices. Encouragingly, in June they announced a modest increase to their planned exploration program, signalling that oil prices have recovered enough for them to generate compelling economics on new well development.
Restaurant Brands International (QSR TSX) - Latest purchase: June at $72.02.
With $34 billion in system-wide sales across 27,000 restaurants in over 100 countries, Restaurant Brands International is an established leader in their industry. With 99 per cent of their stores owned by franchisees, the growth algorithm is very capital-light. This allows for rapid growth in store count, system-wide sales, royalties and profits with limited need for shareholder capital. The company enjoys a very high return on shareholder’s equity. Although Tim Horton’s is struggling amidst the COVID-19 pandemic as the breakfast daypart has been impacted, Burger King has recovered with same-store sales matching last year levels as of last week, and Popeye’s same-store sales in the U.S. are now up 20 per cent versus year ago levels. The rapid pace of new store openings is likely stalled for this year, but unit economics for new franchisees remain very compelling at all three banners so it will likely reassert itself next year. The likelihood of additional acquisitions further bolstering organic growth is high.
Past Picks: July 11 , 2019
Nutrien (NTR TSX)
- Then: $65.30
- Now: $44.85
- Return: -31%
- Total Return: -28%
Manulife Financial (MFC TSX)
- Then: $23.99
- Now: $18.57
- Return: -23%
- Total Return: -19%
TD Bank (TD TSX)
- Then: $76.67
- Now: $60.63
- Return: -21%
- Total Return: -18%
Total return average: -22%