Aug 9, 2016

James Rife's Top Picks: August 9, 2016

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James Rife - Top Picks

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James Rife, Head of Canadian Equities, Canalyst

FOCUS: Canadian Equities

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MARKET OUTLOOK:

Asking where the markets are going is (hopefully!) the hardest question I’ll have today on BNN.

I say this because we are in a unique time in financial history, where not only are the foreseeable outcomes very hard to predict, but the subsequent reactions are just as surprising. For example, if you had proclaimed on June 23, the day before Brexit, that a) Britain would surprise 90 per cent of pollsters and vote to Leave, and b) the markets would then rocket up 10 per cent within six weeks, that would have seemed laughable – but here we are.

The reasons behind this point solely to the market’s laser focus on central bank policy and stimulus. With global rates being pushed lower and lower, both bonds and stocks are soaring to new highs, a very rare occurrence in financial markets. As investors are forced into accepting lower rates of return closer and closer to zero, asset prices rise exponentially. If a stock with a 3 per cent dividend yield gets repriced to a 2 per cent dividend yield, it needs to go up 50 per cent.

Therefore, if the markets are willing to fully price in a lower-for-longer global rates scenario, there exists the possibility for a “blow-off top” where stocks, particularly dividend names, deliver great 1-2 years returns as valuation explode. This would result in both stocks and bonds being extraordinarily expensive, and the endgame would be another “Lost Decade” of flat markets similar to the 1970s.

To summarize, investors should a) continue to experience asset price inflation caused by our central bank overlords, b) realize the asymptotic math behind the final leg of the rates-driven bull market, and c) understand that it will result in an environment where it’s almost impossible to make money afterwards – so enjoy it now!

Top Picks:

Secure Energy Services (SES.TO)

This is a $1.4 billion market cap energy services name, and they own landfill and waste facilities where they handle the byproducts of upstream producers. It’s a great business because of significant barriers to entry – very hard to permit / build these disposal sites. Secure has done a good job protecting their balance sheet, recently raising equity in an oversubscribed deal, and they are in much better shape than either of their two main competitors. They are able to grow both organically and inorganically during the downturn, and you can see a path to over $1/share in free cash flow, at which point the current 3 per cent dividend would likely rise substantially.

American Hotel Income Properties REIT (HOT_u.TO)

This is a $500 million market cap REIT that owns railroad and branded hotels in the U.S. They have been quite aggressive in raising capital, issuing units 5 times in the last two years; however, all these transactions were accretive, and they are starting to get to the market cap where larger investors will notice them. The stock has an 8 per cent yield but just a 65 per cent payout ratio on next year’s numbers, and is quite cheap around 7-8x cash flow. As the company shows scale from acquisitions, the multiple should rise, and in the meantime you are paid to wait.

Tidewater Midstream (TWM.TO)

Tidewater is a $375 million market cap midstream company that has grown by acquiring assets at 5-6x EBITDA. With a net cash balance sheet of $25 million, Tidewater is starting to spend organically in order to tie together what they’ve bought and raise margins and cash flow. While larger-cap peers like Keyera and Pembina trade at 13x EBITDA, Tidewater is very cheap at 6x. They have some work to do in order to earn the re-rating, but mgmt. has a great track record at previous companies, so it seems like a smart bet, along with clipping a 3 per cent dividend.