May 18, 2018

Robert McWhirter's Top Picks: May 18, 2018

BNN Bloomberg

Robert McWhirter , BNN Bloomberg

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

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MARKET OUTLOOK

In mid-May 2018, the U.S. 10-year bond yield (3.10 per cent) broke above 3 per cent for the first time in seven years. This rise in yield has reversed the 36-year downtrend in interest rates. We expect 10-year bond yields to move to 4 per cent by early 2019.

The spread between U.S. 10-year bond yields and 10-year German bund yields is the widest it has been in 30 years. Higher U.S. interest rates have attracted foreign buyers, which is driving the U.S. dollar higher and gold lower.

Bond yields are rising due to growing concerns about inflation, as oil is trading at three and a half year highs and appears to be headed higher. JPMorgan head of oil strategy Abhishek Deshpande expects WTI to continue rising, saying oil will hit $80 to $90 in coming weeks and months. This is good news for the energy sector of the S&P/TSX.

On May 14, Joe Farrell, head of research at Velocity Trade Capital, noted that XEG, the iShares S&P/TSX Capped Energy Index ETF, is incurring an important technical breakout through the top of its trading range going back to the beginning of 2017 at the $12.85 zone. The breakout now targets further technical upside to resistance highlighted at the $14.50 zone, implying 8 per cent further upside.

We expect stocks to continue to rise for the rest of 2018. Our Canadian Dividend Strategy as of April 30 has outperformed the S&P/TSX Total return index by 280 and 2,310 basis points on a one and three year basis respectively. 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

CANADIAN NATURAL RESOURCES (CNQ.TO)

Canadian Natural Resources ($57 billion market cap) is an independent crude oil and natural gas exploration, development and production company. CNQ’s operations are focused in Western Canada, in the North Sea and in offshore Africa.

The company reported on May 3 that year-over-year (YOY) sales per share were up 40 per cent and YOY cash flow per share grew 32 per cent. Earnings estimates increased by 50 per cent in the past 90 days. Free cash flow (FCF) grew 332 per cent to a total of $1.4 billion on a trailing twelve months (TTM) basis. RBC Capital Markets recently noted that, with oil price at $70 per barrel, CNQ will generate more than $7 billion of FCF in 2019.

What to do with all that FCF? Crank up the 2.9 per cent yield on the dividend, currently at a modest 18 per cent payout ratio of four-quarter trailing cash flow. CNQ renewed its normal course issuer bid, allowing for the purchase of up to 61 million shares (5 per cent of the shares outstanding) over the next year at an estimated cost of $3 billion.

CNQ’s shares appear attractive with a 5.7-times price-to-cash-flow (P/CF), which is in-line with the energy industry multiple. Yet CNQ’s 32 per cent forecast for 2018 cash flow growth is 50 per cent above the energy industry’s 21 per cent forecast: a forecasted P/CF to forecasted 2018 cash flow growth ratio of 0.23.

CNQ is expected to report earnings on Aug. 2. The forecast: $0.68 versus $0.29, a 134 per cent increase.

On May 17, Velocity’s Farrell noted that CNQ is breaking out above the top of a 2-year high basing formation, targeting further technical upside to just under $60 and implying potential upside of 25 per cent. He says a sustained breakout would introduce further measured upside in excess of $70, implying potential upside of 45 per cent. CNQ is held in the Canadian Dividend Fund.

TFI INTERNATIONAL (TFII.TO)

TFI International ($3.3 billion market cap) is a North America leader in the transportation and logistics industry. TFI International companies service four segments: package and courier, less-than-truckload, truckload, and logistics. It has a 2.1 per cent yield, a modest 18 per cent payout ratio of four-quarter trailing cash flow.

TFI reported on April 25. Earnings per share grew 36 per cent. The company paid down $141 million in debt in the past year, a 9 per cent improvement.

The $2.61 per share earnings forecast for 2018 gives a price-to-earnings (P/E) of 14.6 times. When compared to the 20 per cent earnings growth forecast for 2018, it gives an attractive p/e to growth (PEG) ratio of 0.66 times. A PEG of less than 1.0 is believed to be attractive.

TFI is expected to report earnings on July 24. The forecast: $0.66 versus $0.61, an 8 per cent increase.

TFI is incurring a major technical breakout through the top of its bullish four-year secondary accumulation zone, targeting further technical upside in excess of $50 according to Farrell. This implies potential upside of 43 per cent. TFI is held in the Canadian Dividend Fund.

WASTE CONNECTIONS (WCN.TO)

Waste Connections ($25 billion market cap) is one of North America's largest waste services companies, providing solid waste collection, recycling and disposal services to commercial, industrial, municipal and residential customers in 39 states in the U.S. and six provinces in Canada. It currently has a 0.7 per cent yield, a modest 11 per cent payout ratio of four-quarter trailing cash flow.

The company reported on May 3. Free cash flow grew 16 per cent to a total of $855 million on a TTM basis. Waste connections paid down $300 million in debt in the past year.

Earnings are forecasted to grow by 17 per cent in 2018, with further earnings per share (EPS) growth of 14 per cent forecasted for 2019. The rising earnings drive a 24 per cent increase in return on equity (ROE) to 10.7 per cent in 2018 versus 8.6 per cent a year ago.

The company is expected to report earnings on July 24. The forecast: $0.81 versus $0.74, a 10 per cent increase.

Farrell said on May 16 the company is resolving its multi-quarter trading range to the upside. He said a sustained breakout above $95 targets further technical upside to just under $115. This implies a potential upside of 20 per cent. The stock is held in the Canadian Dividend Fund.