Chris Damas, editor of The BCMI Report
Focus: Cannabis, agriculture and fertilizer stocks
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MARKET OUTLOOK

CANNABIS STOCK OUTLOOK
As is the case with any event that has affected many people, (Y2K, the Berlin Wall falling), investor expectations surrounding recreational cannabis will wax and wane and the producer equities will trade with volatility, but in a range. Common sense says the illicit market will not be replaced by a legal regime that easily, and only the strongest companies will survive if the medical marijuana market is the sole source of revenue. Recently, Canopy Growth, the leading cannabis company by sales, reported only an 8.25 per cent registered medical marijuana patient growth quarter over quarter, not 10 per cent a month as has been assumed for the industry. Individual company stock prices will eventually reflect relative market shares, as well as product quality and margins of what I believe will be a considerably smaller frequent-user group than what is being forecasted by most investment banking firm analysts. The export market for Canadian medical cannabis has somewhat better prospects than domestic recreational demand, but sales will experience lower margins after considering the regulatory complexity to achieve approvals in various jurisdictions.

AGRICULTURAL/FERTILIZER STOCK OUTLOOK
The ongoing devastation from Hurricane Harvey and subsequent floods in the Houston and surrounding areas will have some bearish impact on U.S. agriculture and fertilizer profits. Texas produces crops such as cotton, corn, sorghum, rice and forage lands for livestock, but not enough to move prices up, and port export operations have been suspended.

The storm and floods impacted areas closer to the U.S. Gulf, away from the northern and western highlands. Sixty-three per cent of Texas corn was mature as of August 27, and 91 per cent of cotton was setting bolls. Texas is a big rice producer and 87 per cent was harvested when the storm hit. The storm and floods could cause agricultural losses as Texas and Louisiana were in harvest time. Most of these losses are insured and could set farmers up for a better 2018. But companies that produce fertilizers for fall post-harvest application in the southern U.S. will see some drop in demand as these croplands have to dry out and farmers are going to see diesel prices rise sharply; Terra Nitrogen LP, CF Industries, Agrium, PotashCorp, LSB Industries and Intrepid Potash could see negative Q3 effects. Since these company stock prices did not correct, it is hard to be contrarian and buy them. Certain internationally-oriented agricultural and fertilizer stocks have had good rallies, such as AGCO and Soquimich (SQM) due to the low U.S. dollar and other factors. I panned Canadian AGI and AGT last time and they haven’t really done much.

We recommended Tractor Supply on July 17 at $52 and after a Q2 beat on July 26, TSCO has risen to $58.95. But many of their stores are in Texas, so we have sold it.

TOP PICKS

ALON USA PARTNERS (ALDW.N) – US$11.40
I continue to like this MLP, which we recommended on July 6 and May 12. The units pay a variable quarterly distribution. Alon paid US$0.38 cents for the first quarter and US$0.35 cents in the second quarter. The only refinery is in Big Spring, Texas and is benefiting from higher crack spreads due to a glut of WTI Midland oil caused by Hurricane Harvey. Alon’s common units are 81.6 per cent owned by Delek US Holdings, which is also the General Partner and operates four other refineries. We expect the minority position in Alon to be bought out by Delek for shares at some point. We have a US$15 target price. Canadian investors should note there is a 40 per cent withholding rate which can be recovered if they file with the IRS. American residents in Canada receive the distribution tax-free unless in a registered plan. U.S. MLPs can defer income taxes and calculate your portion of business income (through the K-1 form, which is available after the year’s end). Disclosure: We own Alon. Last bought at US$11.07-15 but also at US$10.29.

NORBORD (OSB.TO) – $43.08
Norbord is the leading oriented strand board (OSB) producer in North America and three quarters of production is geared towards North America, with the rest of OSB and MDF panel production in the U.K. and in Gerk, Belgium. About half the North American OSB is commodity priced and used for new home construction and R&R (repair and renovation). Norbord is doubling capacity at their Inverness, Scotland facility. OSB and other structural panels are not included in the softwood trade negotiations but would be affected if NAFTA were terminated. Norbord has seven mills in the U.S. and six in Canada. The Huguley, Alabama mill is coming out of care and maintenance this year. Harvey may cause some short-term disruption in panel distribution, but longer-term reconstruction should benefit Norbord. We have recommended Norbord consistently since May 2016 and expect the company to produce, annualized, at least US$5 in adjusted earnings per share at peak panel pricing, which we believe is still ahead of us. We had a US$36 price target on Norbord over a year ago and now have a US$40/CAD$50 price target. The company earned $165 million in adjusted EBITDA, $1.10 in adjusted EPS and raised the quarterly dividend to 50 cents, up from 30 cents in Q2. Brookfield Asset Management private equity funds and affiliates sold 3.55 million shares of Norbord at $42.35, which closed August 9, and continue to own 41.86 million shares or 48.6 per cent of Norbord. Immediate additional sales are unlikely.

DELEK US HOLDINGS (DK.N) – US$25.18
Delek is an oil refinery operator and operates the Alon refinery referred to above, but also Tyler, Texas (which benefits from strong Dallas pricing), El Dorado, Arkansas (which exports products on the Tepco pipeline to the Midwest), and Krotz Springs, Louisiana (which wholesales gasoline on the Colonial Pipeline).

Goldman Sachs recommended Delek today, a full week after we recommended it to our readers.

Since Delek closed down a losing oil hedge in Q2, we expect the company to benefit from upside on products as well as the $95 million in synergies following their July 1 acquisition of Alon Energy USA, the GP and ex-majority owner of Alon USA Partners. Delek pays a US$0.15 quarterly dividend. Our target price is US$40 and we recommended and bought the stock at $22.19 on August 22.
 

PAST PICKS: JULY 6, 2017

ALON USA PARTNERS (ALDW.N)
We sold some Alon at $12.68 on August 7 on valuation. Bought it back as low as $10.27 on August 22. Last buy at $11.07-15. We still like Alon and it is a Top Pick. We’ve also added other U.S. refinery operators to the portfolio we bought over a week ago when Harvey was a Tropical Depression: Delek US Holdings (DK) and recently, CVR Refining (CVRR).

• Then: $10.58
• Now: $11.77
• Return: 11.24%
• Total return: 14.98%

ICC INTERNATIONAL CANNABIS (ICC.V)
We sold at $1.13 on July 18. It was expected that other brokerages would pick up coverage of ICC, but this failed to happen. We still like it but think it is a 2018 story until CBD ramps up.

• Then: $1.12
• Now: $0.93
• Return: -16.96%
• Total return: -16.96%

CANACCORD GENUITY (CF.TO)
We sold some CG at $6.52-60 on July 12 for a maximum gain of 39 per cent since recommending the stock to readers on June 2. The company had a really great first quarter, but the second quarter was in line with previous quarters and capital markets revenues dropped 37 per cent Q1/Q4. Wealth management revenues were up two per cent and the company will have AUA of almost $50 billion when the purchase of Hargreave Hall closes at the end of calendar 2017. We continue to like and hold CF (at $4.80) as we expect capital markets in their target sectors to improve, and we like the U.K. business.

• Then: $5.58
• Now: $4.72
• Return: -15.41%
• Total return: -15.23%

TOTAL RETURN AVERAGE: -5.73%