Robert McWhirter, president of Selective Asset Management
Focus: Canadian dividend and small-cap stocks

MARKET OUTLOOK

National Bank Financial Markets expects an unemployment rate in the neighborhood of 9 per cent in the coming year and a 13 per cent decline in Toronto house prices. However, investors are viewing the impact of COVID-19 as causing a temporary economic slowdown. Long-term challenges of escalating U.S.-China conflict and supply chain shortening leading to reduced world trade have also been factored in to the rising stock prices.

RBC Capital Markets’ Lori Calvasina recently noted the price-to-earnings multiples for the S&P 500 are 24 and 20 times respectively for 2020 and 2021. While high by historical standards, the equivalent earnings yield of 4.2 and 5 per cent respectively appear attractive compared to the 0.67 per cent yield on U.S. 10-year Treasury bonds.

We said last month that gold stocks were attractive. The current low level of real interest rates and significant free cash flow generation continue to make the sector attractive.

Tina Normann, principal and technical researcher at Eight Capital, noted that the rise in German bond yields is increasing the yield spread versus U.S. bonds. This is expected to weaken the U.S. dollar and “confirms the shift in money flow favouring cyclicals and gold stocks.” We expect equity prices to continue to rise over the coming year.

TOP PICKS

OPEN TEXT (OTEX TSX)

Open Text provides software to archive, aggregate, retrieve and search documents, e-mails and presentations. It has a 1.7 per cent yield and a modest 21 per cent payout of trailing four-quarter cash flow. On April 30, it reported a 13.5 per cent year- over-year (YOY) sales increase. Open Text has a 5.5 per cent free cash flow yield and has generated $1.1 billion in free cash flow over the past four quarters. June 2020 earnings of $3.77 are forecast to grow 13.8 per cent in 2021, giving a price-to-earnings (P/E) multiple of 12.2 times. Open Text’s trailing return on equity is an attractive 19.2 per cent (A-). The consensus $62.92 target by nine analysts implies 13 per cent upside potential.

PROTECH HOME MEDICAL (PTQ TSXV)

Protech provides in-home monitoring and respiratory disease management in the U.S. On May 19^, reported a 13.6 per cent YOY increase in sales per share and 13.7 per cent YOY cash flow growth. Free cash flow was $11.4 million on a trailing 12-month (TTM) basis, giving a significant 18 per cent (A+) free cash flow yield.While it has $29 million of debt, the net debt to EBITDA is 1.34 times (B-). September 2021 earnings of $0.06 are forecast to grow 133 per cent in 2022 giving P/E multiples of 17.7 times and 7.6 times respectively. Protech’s TTM return on invested capital is an attractive 31.9 per cent (A+) The consensus $2.50 target by five analysts implies 97 per cent upside potential.

TOURMALINE OIL (TOU TSX)

Tourmaline is a crude oil and natural gas exploration and production company operating in the Western Canadian Sedimentary Basin. It has a multi-year drilling inventory and operating control of natural gas processing and transportation infrastructure. On May 6, National Bank Financial Capital Markets forecast a massive natural gas inventory deficit We expect this deficit will lead to much higher natural gas pricing. 2020 cash flow estimated at $3.47 is forecast to grow 41 per cent to $4.90 per share in 2021, giving a 2021 price to cash flow of 4.2 times. The $19 consensus price target by 13 analysts implies 39 per cent upside potential.

PAST PICKS: MAY 17, 2019

EXCHANGE INCOME CORP (EIF TSX)

• Then: $36.05
• Now: $24.92
• Return: -31%
• Total return: -26%

GILDAN ACTIVEWEAR (GIL TSX)

• Then: $50.63
• Now: $18.99
• Return: -63%
• Total return: -63%

MICROBIX BIOSYSTEMS (MBX TSX)

• Then: $0.35
• Now: $0.33
• Return: -7%
• Total return: -7%

Total return average: -32%

WEBSITE: selectiveasset.com