Robert McWhirter, president of Selective Asset Management
Focus: Canadian equities and technology stocks

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MARKET OUTLOOK

U.S. 10-year bond yields broke above 2.5 per cent in the first week of January and quickly rose to 2.94 per cent on Feb. 20. They’ve been in a narrow range since. In response to strong economic growth and concerns about rising inflation, the U.S. Federal Reserve is expected to raise the Fed funds rate three or four times in 2018. 

Wolfe Research’s quantitative strategist Yin Luo’s recent report, Positioning Your Portfolio For Rate Hikes, suggested that rising rates may not be a near-term problem: “the (stock) market shrugs off the rate hikes and continues the rally.”

He noted that stock selection becomes very important as “utilities, real estate, food, beverage and tobacco stocks plummet in a rising interest rate environment (Phillip Morris and Altrius Group hit 52-week lows yesterday), while energy, banks and transportation tend to react positively.”

Our Canadian Dividend Strategy to Feb. 28, 2018 has outperformed the S&P/TSX Total return index by 753 and 2,136 basis points on a one and three year basis. The strategy is well positioned for the current market outlook as we seek stocks that are less expensive than the market with above-average growth in earnings, free cash flow and return on equity.

TOP PICKS

NORBORD (OSB.TO)
$46.86. $4.2 billion market cap.

Norbord is a leading global manufacturer of wood-based panels and the world's largest producer of oriented strand board (OSB). It has 17 plants in the U.S., Canada and Europe.

It has a 5.1 per cent yield, 19 per cent payout ratio of four-quarter-trailing cash flow. Norbord reported on Feb. 2 that year-over-year (YOY) sales per share were up 17 per cent, and YOY earnings per share grew 110 per cent. Free cash flow yield is 6.4 per cent (B+) with $256 million of free cash flow generated in the past year. Year over year, total debt declined 32 per cent to $686 million; debt to equity is 0.54 times (C-). Return on equity (ROE) 12-months-trailing of 39 per cent is attractive. Price-to-book (P/B) to ROE is 0.08 times (A+) (available at CapitalCube.com). Norbord’s shares appear attractive, with a 1.6-times enterprise value (EV) to trailing sales versus 17 per cent YOY sales growth: an EV/sales to sales growth ratio of 0.09 (C+). Norbord is expected to report earnings on May 3.

Forecast: $1.37 versus $0.73, an 87 per cent increase. Earnings estimates have increased 15 per cent in the past 90 days. Norbord is held in the Canadian Dividend Fund.

EXCHANGE INCOME CORP (EIF.TO)
$33.51. $1.0 billion market cap.

Exchange Income operates in two sectors: Aviation and equipment and manufacturing. 6.5 per cent yield, 34 per cent payout ratio of four-quarter-trailing cash flow. The company reported on Feb. 21 that sales earnings per share were up 8 per cent, and YOY earnings per share grew 19 per cent, with an 18 per cent earnings surprise.

Earnings estimates have increased 2.3 per cent in the past 90 days. On May 6, the company is expected to report a 32 per cent increase in YOY EPS ($.33 vs. $.25). Exchange Income trades at a modest 2.1 times EV to four-quarter-trailing sales. Sales per share grew 8 per cent YOY, which gives attractive EV/SALES to sales growth ratio of 0.28 times. With a 14.9 per cent forecast ROE and a price-to-book to ROE of 0.14 times (available at CapitalCube.com). Exchange Income’s shares appear attractive.

METHANEX (MX.TO)
$73.61. $6.2 billion market cap.

Methanex is engaged in the production and marketing of methanol. It has a 2.2 per cent yield ,12 per cent payout ratio of four-quarter-trailing cash flow.

The company reported on Jan. 31: YOY sales per share were up 45 per cent, and YOY earnings per share grew 252 per cent. Free cash flow of $795 million on a four-quarter-trailing basis is a free flow yield of 12.9 per cent  (A+). ROE 12-months-trailing of 26.9 per cent is forecasted to rise to 31.1 per cent for the 2018 fiscal year. P/B to ROE is 0.12 times (available at CapitalCube.com). 7.2 time EV to trailing EBITDA  versus 93 per cent YOY EBITDA growth: an EV/EBITDA to EBITDA growth of 0.08 times (A-).

Methanex is expected to report earnings on April 25. Forecast: $2.78 versus $2.06, a 35 per cent increase. The forecast P/E multiple of 10.4 times divided by the 16 per cent forecast EPS growth is a P/E to growth (PEG) ratio of 0.64 times (C+). Combined with earnings estimates that have increased 45 per cent in the past 90 days, we believe Methanex’s shares appear attractive.

Tony Popowich, technical analyst at Velocity Trade Capital notes that Methanex “has broken out above the down-sloping neckline of a four-year basing formation and is probing the Jan. high just below $81.00. A sustained breakout above $81.00 would target further technical upside in excess of $100.00,” implying 23 per cent potential upside.

PAST PICKS:  JULY 14, 2017

COGECO COMMUNICATIONS (CCA.TO)           

• Then: $83.71
• Now: $70.60
• Return: -15.65%
• Total return: -14.26%

WASTE CONNECTIONS (WCN.TO)                      

• Then: $81.62
• Now: $95.56
• Return: 17.07%
• Total return: 17.76%

WSP GLOBAL (WSP.TO)                              

• Then: $52.71
• Now: $60.45
• Return: 14.68%
• Total return: 16.23%

Total return average: 6.57%

FUND PROFILE

Canadian Dividend fund
Performance as of: Feb. 28, 2018

• 1 Month: -2.18% fund, -3.02% index
• 1 Year: 10.76% fund, 3.23% index
• 3 Year: 32.14% fund, 10.78% index

* Index: S&P/TSX Total Return Index .
* Fund returns include re-invested dividends.

TOP 5 HOLDINGS AND WEIGHTINGS

1. Waste Connections: 4.9%
2. CAE Inc: 4.7%
3. Martinrea: 4.6%
4. Linamar: 4.5%
5. Premium Brands: 4.4%

WEBSITE: Selectiveasset.com