Jason Mann, chief investment officer at EdgeHill Partners
Focus: North American equities

MARKET OUTLOOK

Markets are approaching all-time highs in the United States. Surprising as it is, it would be hard to argue against this being a new “bull” market. While its certainly surprising to witness a rally of this magnitude alongside some of the worst economic numbers in history, the big factor that might explain it better than any other is the extreme level of central bank easing and money supply increase. Money has to go somewhere, and that somewhere has been bond markets, equity markets, real estate and discretionary purchases. In expensive tech stocks, there is a speculative atmosphere, especially in younger retail investors who are new to the market. For the first time in a while, investors are talking about the risk of inflation as a result of the money supply increase. The inflationary outlook may be partially responsible for the rally in gold, along with the falling U.S. dollar. There are really two markets: the “work-from-home” beneficiaries that are concentrated in a handful of mega-cap tech growth stocks, and “everything else”.  For those who feel like they’ve missed the rally, there are still opportunities in the “have-nots” of smaller, more cyclically-oriented stocks. These “return-to-work” stocks in industrial, consumer discretionary and financial sectors have plenty of catching up to do. There is a real risk of mean reversion from “growth” to “value”, which would be typical after emerging from a recessionary bear market. We’re rotating from more defensive stocks to cyclical ones, as we get further evidence that the value rally can take hold.  We see value in industrials, consumer discretionary, and communications services. We’re avoiding expensive utilities and REITs. For the first time in a while, we are buyers of energy and materials sectors, which represent some of the “deepest” value in the market today.

Top Picks

Labrador Iron Ore (LIF TSX)

Labrador Iron Ore has a 7 per cent overriding royalty on the production of Iron Ore Company of Canada (IOC), one of Canada’s largest iron ore producers. We’ve seen a stealth rally in the price of iron ore, which is up 65 per cent since the end of March (as high as $130/ton) on the back of Chinese steel demand and limited supply additions. This fits the theme of “reflation” and ultimately “inflation”. We may be in a bit of a run on many of these commodities, especially as the U.S. Dollar remains under pressure and supply is tight. Definitely a value pick: trades at 8.2 times earnings, with high ROE of 37.8 per cent, no net debt, and a yield of 3.7 per cent.  They tend to pay special dividends, so “real” yield has been closer to 10 per cent over the last year, and they are expected to pay ~2.60/share in dividends over the next 12 months, or around a 9 per cent yield. Price momentum is improving quickly as a result.

Canfor (CFP TSX)

Canfor is an integrated forest products company that produces SPF lumber, oriented strand board (OSB), plywood, craft pulp and paper. The stock has had quite a ride over the last year, first with a bid from Pattison to buy in the rest of the company at $16 which sent the stock as low as $6, and now with a huge rally in lumber prices to all-time highs. Lumber prices have been incredibly strong (up 155 per cent since March) as U.S. homebuilding has taken off, despite (or perhaps because of) COVID.  With the lowest mortgage rates ever and the desire to be in less crowded living environments, the housing market and the renovation market are driving demand for lumber. Lumber inventories are tight, and demand is outstripping production. CFP is still ~50 per cent, well below its former highs, despite lumber prices at all-time highs. Forestry companies are tricky, because it can be feast or famine, and it doesn’t look cheap on past year returns, but forward looking earnings look very strong. Trading at 5.5 times 2020 EBITDA, and likely at ~4 times price to free cash flow. Price momentum is strong as analysts move to catch up to the reality of the strong underlying market. They reported a big beat in their recent quarter.

North American Construction Group (NOA NYSE)

North American Construction Group, established in 1953, is a construction and mining company, with services in oil (particularly oil sands), natural gas, and resource companies. A smallcap stock, definitely not a household name, and a pick with more risk due to their balance sheet with more debt than we’d like to see. It trades very cheaply otherwise and would definitely be a “deep value” pick. This was a US$16 stock at the start of the year and now trades at US$9. This is play on improving economics in the energy and materials sectors, and we’ve started to see for the first time since probably 2016. Scores well on valuation for us, at 4 times EV/EBITDA, 5.5 times price to earnings, and an ROE of 30.4 per cent. The balance sheet is a bit debt heavy, and hopefully increasing cash flow will be used to work that lower; price momentum has been challenged, but appears to be turning up.  Like the energy service companies, the producers tend to move higher first, with service companies following. Trades right around hard book value of US$9.00/share.  Small dividend at 1.7 per cent, but very low payout ratio means room to improve it as they balance out their debt with paying a dividend.
 

Past Picks: June 26, 2019

Westshore Terminals (WTE TSX)

• Then: $22.23
• Now: $18.16
• Return: -18%
• Total Return: -15%

Northland Power (NPI TSX)

• Then: $25.49
• Now: $37.00
• Return: 45%
• Total Return: 53%

IA Financial (IAG TSX)

• Then: $53.52
• Now: $49.93
• Return: -7%
• Total Return: -3%

Total Return Average: 12%