Full episode: Market Call for Friday, August 10, 2018
Mike Archibald, associate portfolio manager at AGF Investments
Focus: Canadian small and midcap stocks
It’s likely the ongoing volatility surrounding many macro-related events will continue over the next six months. The most significant drivers continue to be the trade disputes, principally the U.S.-China discord that seems to creep up every few weeks. Along with this, NAFTA continues to be top of mind for many Canadian companies, although we feel there’s a clearer path to settlement on that issue over the coming months. All of these trade disputes continue to center around the mid-term elections in the U.S. and Trump’s desire to show he is tough on trade and protecting the rights of American workers and farmers. He and his administration are taking a win-at-all-costs approach to this dispute. As long as the stock market continues to hover near all-time highs, Trump will view that as a signal that his current approach can be maintained and he will continue to press on the tariff angle.
From a broader market perspective, we continue to hold elevated levels of cash in anticipation of the typical summer volatility that usually sets in around the August-September timeframe. Despite all of the noise on trade and tariffs, the earnings and fundamental backdrop in both the U.S. and Canada is quite attractive over the coming quarters. Earnings growth in both Canada (up 14 per cent) and the US (up 18 per cent) continues to track to mid-teens growth for 2018, followed by another year of solid growth in 2019 (Canada up 12 per cent, the U.S. up 10 per cent). After a strong first half, Q3 and Q4 earnings estimates have continued to hold in well, pointing to a strong back half in 2018. Our view is that 2018 has been driven by tax reform and capital repatriation, and 2019 is likely to be driven by ongoing global strength, a capital expenditure resurgence and the possibility for fiscal stimulus in the U.S.
As far as Canada goes, we continue to like the setup for a catchup trade to the U.S. as later-stage cyclical sectors look attractive to us and the macro drivers of these look poised to trend higher. Notably, interest rates look like they will continue to trend in a gradual upward direction over the coming 12 months, which should be a source of strength for financials as margins improve and the economic strength continues to result in decent loan growth. We believe the oil outlook points to higher prices over the coming months as the supply/demand situation is fairly tight, U.S. production is unlikely to grow at the same rate moving forward and the discipline shown by OPEC continues to support prices. We think Street expectations for the oil commodity price are too low, and will result in another positive estimate revision cycle in the coming months. Finally, there’s a strong probability that the U.S. dollar rally is nearing an end, which should be beneficial for commodity prices moving forward. World growth is improving, and the outlook for higher U.S. interest rates is now largely priced into the market. All of this suggests a flat-to-lower greenback, which is a tailwind for commodities as well as industrials on the prospects for higher inflation.
Finally, small caps have been challenged versus large caps in Canada for many quarters as money has focused south of the border and some investors worry the stock market cycle is nearing an end, preferring to focus on larger, more liquid names. We think there continues to be attractive opportunities in many mid and small cap names, albeit having to accept higher volatility and slightly less liquidity.
PRECISION DRILLING (PD.TO)
Last purchase on June 2018 at $4.35.
Precision is the largest drilling company in Canada, with operations in this country, the U.S. and Kuwait. As I mentioned earlier, we quite like the fundamentals in the oil space right now, and this stock has been a huge laggard to the price moves we’ve seen in both the oil price and the exploration companies. If you look at when oil bottomed at $26 on Feb. 11, 2016, you can see it’s up more than 150 per cent since; Precision bottomed on the same day at $3.70 and has only moved up to $4.70 over that same period: a 33 per cent move higher. We think there is a good opportunity for catchup as the market becomes more confident in the oil price.
The fundamentals for this company are really improving now, with more rigs at work, better day rates and more bidding opportunity over the next few quarters. The last two quarters they’ve reported have shown continued margin improvement as the company is doing a great job of controlling costs and have also been able to grab further market share in both Canada and the U.S. The company is currently operating 80 rigs in the U.S. and 60 in Canada, with the expectation that they will continue to grow their rig count with a focus on profitability over the next several quarters. Drilling day rates have moved up nicely to around $25,000 per day, and should continue to drift higher in the back half of 2018. This should result in EBITDA increasing 25 per cent this year, and another 25 per cent next year. I think it has a really strong management team and the company has been focused on using excess cash flow to pay down debt, which should continue to make it more of a full-cycle investment. We think that, as sentiment continues to improve on energy, this company is ripe for a major catchup – you could see this stock at $7 under the right set of circumstances.
- Company size: $1.4 billion market cap
- 2019 price to cash flow (P/CF): 4 times
- EBITDA margins: 25%
- Dividend yield: 0%
STORAGEVAULT CANADA (SVI.V)
Last purchase on August 2018 at $2.45.
This is a great high growth, high cash flow business that offers good upside from current levels. StorageVault is the largest storage operator in Canada, renting all across the country under many different banners. They’ve done a tremendous job of buying up both small and large storage facilities across Canada and then integrating them into their revenue management system. The storage industry remains highly fragmented, so many M&A opportunities continue to exist. This is a great way to play the long-term demographic changes in Canada as the population grows, people acquire more things they need to store and the average size of condos and apartments continues to shrink. Many customers rent a storage facility, thinking they will use it only for a short period of time, and then end up with the unit for more than a year. Also, there are many barriers to entry in this industry, given the significant capital requirements and the many municipalities across Canada that are limiting the amount of new storage facilities, so this should continue to give StorageVault access to higher rents over time. Steven Scott and his team know the storage business better than anyone in Canada and get a look at almost every asset that comes for sale. The current management team has grown fund from operations more than 350 per cent since taking over a few years ago.
The stock really moved up in 2017 as the company executed on a few large acquisitions. They now have more than 100 owned locations and over 50,000 storage units. It’s lagged the larger and more mature U.S. storage companies in the past year, despite having significantly better growth. The beauty of this company versus some of the other private companies operating in this space in Canada is that it can offer the seller stock in the company, so they can continue to participate in the growth of the business and avoid paying taxes when they sell. The stock has been range-bound over the past 12 months as the market digests the large acquisitions. We think with all the M&A they’ve done, the upcoming quarters look like they are poised to be very strong. There are a couple large storage portfolios still out there in Canada, and I think if SVI can acquire one of those, the stock will move up sharply again. We think they can grow same-store operating income at around 10 per cent moving forward.
- Company size: $860 million market cap
- 2019 P/FFO: 20 times
- Dividend yield: 0.4%
Last purchase on August 2018 at $16.55.
Savaria manufactures and distributes chair lifts and other mobility and accessibility devices, primarily in Canada and the U.S. The company has demonstrated significant growth over the past four years, improving margins every year as well as growing earnings by more than 20 per cent in each year since 2015, which has been a combination of organic growth through market share gains and new product introductions as well as acquisition growth to target new products and markets that complement their existing business. The company just recently made a large acquisition of a company called Garaventa, a Swiss-based mobility company which now gives them a large platform to grow in Europe, China and on the west coast in the U.S., markets that they were previously fairly limited in. The company has done a tremendous job of integrating previous acquisitions (Span-America), realizing significant cost-savings and cross-selling synergies, so we expect this will continue in a much larger way with this latest acquisition. We think the company should earn around 85 cents in 2019, so it trades around 20 per cent price-to-earnings and pays a 2.2 per cent dividend yield. I really like the founder Marcel Bourassa and he currently owns almost 30 per cent of the company, so very aligned to shareholder interests. We entered the stock in the middle of 2016 at $7.80 and think there remains a lot of upside both organically and through further M&A in the future as the population continues to age and look for mobility solutions like stair lifts, home elevators, wheelchair lifts and ceiling lifts. I believe given the growth and new market opportunities, this stock could trade to $21 or $22 in the next 12 months.
- Company size: $775 million market cap
- 2019 P/E: 20 times
- EBITDA margins: 16%
- Dividend yield: 2.2%
- Brands include: Savaria, Vuelift
AGF Canadian Growth Equity Class
Performance as of: July 31, 2018
- 1 Month: 0.2% fund, -1.0% index*
- 1 Year: 5.3% fund, 4.3% index
- 2 Year: 3.4 fund, 1.3% index
* Index: S&P/TSX Small Cap Index.
* Returns are based on reinvested dividends.
TOP 5 HOLDINGS AND WEIGHTINGS
- RY – 5.6%
- BNS – 5.1%
- PXT – 4.1%
- GIBa – 3.4%
- BYD_u – 3.3%