Full episode: Market Call for Thursday, February 14, 2019
Jason Mann, chief investment officer at EdgeHill Partners
Focus: North American equities
We were quite concerned in the fall that U.S. market strength, which had been holding up versus the rest of world, had the potential for a “catch-down” to the downside. Like a broken record, we’ve been warning about the overvaluation of growth stocks (like the FAANGs or cannabis). Up until the summer, this growth-at-any-price trade had led to underperformance of more profitable stocks while was deployed there, in many cases without any earnings.
Q4 was the end of this cycle’s growth outperformance. We’re now seeing sector and style rotation to quality, dividend-paying and reasonably-priced stocks. We think this rotation will continue for many months ahead. The drop from growth to value for a stock can be a long way down.
Global growth appears to have peaked. U.S. earnings remain strong, but the rate of change is slowing and we expect margins to get pressured. It’s too early to tell whether this is a growth pause or a rollover. The market, however, over-discounted the probability of a near-term recession in December. “Hard” data in the U.S. remains well above levels that historically predict recessions.
Critically, the Fed blinked during the December plunge. They’ve turned dovish and hikes appear to be on hold. China also appears to be readying more stimulus and Trump seems to strongly desire a trade war resolution.
After playing defence from September to mid-January, our tactical risk indicators have shifted positive, with cyclical markets like Canada and Australia leading the way. While we’re somewhat skeptical on the durability of the bounce (it has been led by junkier stocks), overall sentiment remains bearish and there are large cash allocations. Skepticism and excess cash fuel future rallies and we respect our process of adding risk when conditions warrant.
HUDBAY MINERALS (HBM.TO)
It’s been a while since we recommended a mining stock, but valuations and price momentum are lining up for the sector. HudBay ranks in the top 5 percentile for us on valuation, at 3.2 times enterprise value to earnings before interest, tax, depreciation and amortization (EV/EBITDA), 0.7 times book value, and 7.7 times price to earnings. Cash flow and return on equity (ROE) have struggled with lower base metals prices, but that might change if we get a trade war resolution. Importantly, the balance sheet isn’t stressed like some others in the space.
- Their flagship Peruvian mine is performing well.
- It’s a volatile stock, but price momentum is turning the corner.
- A proxy battle with a private-equity firm who owns 12 per cent of the company is potentially looming. But if anything, this could lead to value-surfacing initiatives since the CEO the firm is proposing just finished selling Nevsun to the Chinese.
CHORUS AVIATION (CHR.TO)
An airline stock without the typical sensitivities to fuel costs, traffic and currencies, Chorus is tied to the sector’s health in terms of volumes and specifically tied to Air Canada’s health, which itself is a cheap stock with a strong business.
This recommendation is timely because Chorus recently eliminated two major risks to their business: 1) they signed an amendment to their contract with Air Canada, now extending out to end of 2035; and 2) the collective agreement with their pilots also extended out to 2035, which is almost unheard of in the industry.
That the show “no growth” isn’t true anymore now that they have a growing leasing business. We liken Chorus to a REIT or a utility in many ways: a stable, cash-flowing business with limited risks on operations.
KINDER MORGAN (KML.TO)
With Kinder Morgan, we think you’re buying a reasonably-priced pipeline and infrastructure company with a near-term catalyst.
The company originally IPO’d in Canada to raise funds for the Trans Mountain project, which would have helped move trapped bitumen overseas. B.C. ultimately blocked the pipeline and the federal government lost the court case to move it forward. In January, the company distributed their excess cash back out to shareholders and consolidated the shares, so what you are left with is the “stub” business. Two main businesses remain: pipelines and terminals. These are good assets that throw off cash flow. The stub has no net debt although it does have preferred shares outstanding.
On a stand-alone basis, it’s reasonably priced at around 10.5 times EV/EBITDA, and pays a dividend of around 4.5 per cent that’s well supported by cash flow. The company, however, is in a strategic review with three likely outcomes: 1) they do nothing and run the business, 2) the parent company takes in their shares, or 3) they sell the entire business to a third-party like Brookfield or a private equity. The sum of the parts suggests a $16.50 to $17 value in a takeout, and we think this is the mostly likely outcome. Expect a decision in April, but in the meantime you get paid to wait, with a good chance of a 15 per cent return in the short term.
PAST PICKS: JAN. 18, 2018
MAGNA INTERNATIONAL (MG.TO)
- Then: $73.90
- Now: $68.13
- Return: -8%
- Total return: -6%
PAREX RESOURCES (PXT.TO)
- Then: $19.05
- Now: $19.32
- Return: 1%
- Total return: 1%
CENOVUS ENERGY (CVE.TO)
- Then: $13.04
- Now: $11.28
- Return: -13%
- Total return: -12%
Total return average: -6%
EHP Select Fund
Performance as of: Jan. 31, 2019
- 1 month: 3.8% fund, 8.7% index
- 1 year: -6.6% fund, 0.5% index
- 3 years: 9.0% fund, 9.8% index
INDEX: TSX Total Return.
Returns are net of fees, distributions and annualized.
TOP 5 HOLDINGS AND WEIGHTINGS
- Quebecor: 5.7%
- Aritzia: 5.3%
- CGI: 5.1%
- Hudbay Minerals: 5.0%
- Air Canada: 4.8%