Full episode: Market Call for Thursday, June 4, 2020
Jason Mann, chief investment officer at EdgeHill Partners
Focus: North American equities
Markets have staged a surprising rally from the lows in March. It seems inconsistent with historic levels of unemployment, economic damage, and record-high valuations for stocks.
The headline indexes don’t give us the full picture. 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. While the S&P 500 is down only 5 per cent on the year now, the average stock is still down 11 per cent. Small caps are down 20 per cent.
For those who feel like they’ve “missed” the rally, there is still plenty of opportunity 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. That said, the work-from-home beneficiaries as well as the most defensive sectors like consumer staples are looking overpriced. 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 admittedly uncertain about this rally. There is no question the Fed moved aggressively to backstop the market and ensure that liquidity was ample. But we still have our doubts as to how quickly the real economy can return to normal and whether employers actually hire back all the displaced workers as quickly as the market is discounting.
While we took risk off in February and survived the plunge in March as a result, our process responds to changing markets. We have added back risk both in the credit markets and equity markets. For now, we remain balanced between defensive and cyclical stocks and sectors, waiting for further evidence that the value rally can take hold. We prefer higher quality, reasonably priced stocks with stronger balance sheets that can weather the storm if the recovery is slow, but have good upside if the economic recovery picks up steam. We see value in financials, industrials and communications services. We’re avoiding expensive utilities and are net short REITs, energy and materials sectors.
LINAMAR (LNR TSX)
We’re looking for picks that will be survivors of the current environment, aren’t priced for perfection in terms of valuation and can potentially thrive coming out of a recession. Linamar fits this narrative: it’s primarily in auto parts, but also farm equipment and its skyjack business. The stock is very cheap, scores in the top 1 per cent for us among all other stocks, at only 4.2 enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), 3.3 times price to free cash flow and 6.5 times price-to-earnings (P/E). The balance sheet could be stronger, but they have ample access to capital and so it’s not a concern if things get worse from here. Price momentum has been weak along with other industrials, but is playing catch-up recently and improving. They are going to have near-term losses and they recently cut the dividend which will have disappointed some holders, but they’re doing it for the right reasons and this was never really viewed as a yield stock. The bottom line is the near-term headwinds are more than reflected in the price you are paying today.
CORUS ENTERTAINMENT (CJR/B TSX)
Corus owns radio and specialty TV as well as digital content. We had been short the stock for quite a long time as they took on too much debt a few years back and then their traditional TV and radio ad business declined meaningfully as ad revenue shifted online. It’s been a deleveraging story since then as they try to right-size the balance sheet. Shaw exited their stake as well, which brought a lot of stock to the market, putting further pressure on the price. Interestingly though, Heather Shaw, who remains as chairwoman, has been an active insider buyer of the stock. For us, it has simply become too cheap, and it’s the valuation that is driving us to buy it for the first time in years. It trades at only 4.2 times EV/EBITDA, 3.5 times P/E and recently beat earnings estimates. They are making the tough choices on dividends, holding off on the June dividend. No question earnings will be tough near-term, but that is more than priced in at this point. Price momentum is turning higher and it has plenty of catching up to do if they can continue to generate a high level of free cash flow.
CASCADES (CAS TSX)
Cascades produces paper and packaging products. This one hits for us on both value and price momentum, which is a bit of a rare find in this bifurcated market. It scores in the top 3 per cent on both metrics, trading at 6.2 times EV/EBITDA, 5 times cash flow, with a recent earnings beat. The balance sheet is again a little more stretched than we’d like to see, but the smallish yield at 2.3 per cent is more than sustainable with a low payout ratio. They’ve been a beneficiary of COVID-19, as some demand has been pulled forward in the tissue and packaging divisions (everyone still fully stocked on toilet paper, right?), but unlike a lot of other COVID beneficiary stocks, this one isn’t overpriced. We think of this stock as a safer forestry products business that is less cyclical, but one that still has room to run on valuations as the market rotates away from expensive growth and towards value.
PAST PICKS: JULY 26, 2019
WESTSHORE TERMINALS (WTE TSX)
- Then: $21.19
- Now: $15.85
- Return: -25%
- Total return: -23%
NORTHLAND POWER (NPI TSX)
- Then: $25.63
- Now: $32.77
- Return: 28%
- Total return: 33%
IA FINANCIAL (IAG TSX)
- Then: $53.52
- Now: $46.53
- Return: -13%
- Total return: -10%
Total return average: 0%