Full episode: Market Call for Friday, January 17, 2020
Jason Mann, chief investment officer at EdgeHill Partners
Focus: North American stocks
We’re seeing a rotation from defensive stocks to more cyclical “value” stocks. However, high-priced growth stocks in sectors like technology have led the market higher again. Even in the face of a steepening yield curve, investors remain in love with “growth-at-any-price” stocks.
The overall U.S. market is back to dot-com peak valuation on measures like EV/EBITDA and price-to-sales. Historically from these levels, returns over the next decade are in the single digits or even negative. Buying “beta” might not be the best approach.
The highest-risk stocks to own are the most expensive growth stocks, particularly U.S. tech stocks. If we have an economic growth recovery, these stocks are likely to lag more value-oriented sectors. If we roll into a recession (not our base case), growth stocks will get hammered.
We find the most defensive stocks like utilities to be expensive, as are high-priced growth stocks. The very cheapest cyclical sectors like energy and materials appear to be turning the corner and we’re adding to them here. Our highest conviction sectors are where we find decent valuation and decent price trends: financials, industrials and consumer discretionary.
WHITECAP RESOURCES (WCP TSX)
Like most energy companies, Whitecap has had a rough few years. With a bit of a cyclical rotation underway and with commodity prices overall a bit more supportive, we’re turning more of our attention to some of the more “deep value” stocks in the market.
Whitecap scores well on valuation not just against other energy stocks, but the whole market. They pay a 6.4-per-cent yield which we believe is sustainable and a balance sheet that isn’t stretched. Price momentum is still struggling on a relative basis to non-energy stocks, but it’s improving like for some other Canadian energy companies.
Whitecap’s historically conservative management team hasn’t tried to spend their way to growth, but stayed focused on sustainable cash flow and moderate capital spending. This pick is definitely a call on oil and on value rotation, but one that we think is worth it.
GREAT CANADIAN GAMING (GC TSX)
Great Canadian runs casinos in B.C. and Ontario. With strong employment and a strong consumer, the environment is good for a firm like this.
Over its history, the stock has been “lumpy,” tending to have periods of volatility around earning beats and misses. More recently, the concern has been whether they overpaid or not for their expansion into Ontario, in partnership with Brookfield Business Partners. This was highlighted recently as numbers for the division were soft and the company bought further interest from Clairvest, a minority partner who exited its stake. Great Canadian is also under scrutiny in B.C., where new money laundering regulations have the potential to crimp business.
We want to eliminate the emotionality around “story stocks” and just look at the numbers. Great Canadian is quite cheap, trading at 7.4 times EV/EBITDA and 16 times earnings and with a high return on equity of 27 per cent. The balance sheet is solid, with ample liquidity to draw on for development and acquisitions. Price momentum is turning the corner.
We also don’t see a lot of downside, as the above-stated worries are likely baked in. If they do show any strength in the face of these issues, the stock could have a meaningful re-valuation.
LINAMAR (LNR TSX)
In general, we like all the auto-parts companies. They’ve been left behind in the current rally and challenged by a global manufacturing and capital expenditure slowdown. While Linamar’s outlook for the near-term remains challenged, a lot of the negativity is already priced in. If there’s any concern on the fundamentals, it’s on the balance sheet, which is a little stretched following an acquisition in early 2018 that expanded their business into farm equipment.
Ultimately, Linamar is tied to an improving cyclical manufacturing and parts environment, which we believe we’re seeing the early signs of. A recent price momentum improvement is a reflection of that. Insiders also clearly believe in Linamar’s value at these levels, as they have bought about $20 million of stock in the last week. Historically, the family have been good buyers of the stock.
PAST PICKS: FEB. 14, 2019
HUDBAY MINERALS (HBM TSX)
- Then: $7.63
- Now: $4.88
- Return: -36%
- Total return: -36%
CHORUS AVIATION (CHR TSX)
- Then: $7.16
- Now: $8.44
- Return: 18%
- Total return: 25%
KINDER MORGAN CANADA (KML TSX)
Acquired by Pembina Pipeline (PPL TSX) on Dec. 19, 2019.
- Then: $14.75
- On acquisition date: $14.91
- Return: 1%
- Total return: 5%
Total return average: -2%