Teal Linde, manager of Linde Equity Fund

FOCUS: North American Mid and Large Cap Stocks

MARKET OUTLOOK:

Canadian Dollar vs U.S. Dollar – impact on investment strategy

A relatively unnoticed development during the current equity bull market, which began on March 23, 2020, is the strength of the Canadian dollar, which has risen from 69 cents to 80 cents (16 per cent) against the U.S. dollar.

Since March 2020, the U.S. dollar has weakened against all major world currencies as foreigners have become net sellers of U.S. treasuries on fears of U.S. dollar weakness amid an ever-expanding U.S. debt load and enormous Fed liquidity while enhanced risk appetites have lessened its desirability as a ‘safe haven’ currency.  During that time, the Canadian dollar has strengthened against most world currencies (the Australian dollar being the notable exception). The loonie is benefiting from commodity price strength, particularly for oil, and the Bank of Canada’s quick recognition of emerging inflationary pressures, causing it to be more hawkish that the U.S. Federal Reserve.

Over longer cycles, relative currency strength between the Canadian and U.S. dollars is quite well correlated with relative stock market performance. In periods of strong U.S. stock performance compared to Canada, the U.S. dollar has risen relative to the Canadian dollar and vice-versa. So, identifying the more attractive stock market can also benefit investors in terms of currency appreciation.

Over the last year we have seen better opportunities for new investments in Canada than we have seen in the U.S., increasing the Canadian bias in our portfolios, and having the added benefit of lower exposure to U.S.-dollar denominated names as the USD has weakened. With better relative valuations and the potential to benefit from improving fundamentals, Canadian stocks may be about to reverse their decade-long underperformance relative to U.S. stocks (the Canadian market is outperforming in 2021). We recommend a continued bias towards Canadian stocks compared to their U.S. counterparts.

TOP PICKS:

Bank of Nova Scotia (BNS TSX) - last purchased on April 29, 2021 at $78.65

Over many decades, the Canadian banks have generally moved long term upwards as a group.  However, in the short term, the banks tend to play a game of leapfrog, where certain banks will move ahead of the pack, then take a breather as other banks catch up. Over the last two years, CIBC, BMO and National Bank have raced ahead, jumping roughly 30 per cent in price from 2019 levels. They are due for a breather. The bank that is now lagging the most and due for a catch up move is Bank of Nova Scotia, which is only up about five per cent since 2019. From a fundamental perspective, Bank of Nova Scotia’s earnings growth is also due for catching up as this year’s earnings of its Big 5 peers are expected to increase an average of 20 per cent compared to 2019. Bank of Nova Scotia, due to its large exposure to Latin America, where economic reopening is behind Canada and U.S., is expected to increase earnings only seven per cent. However, as Latin America commences it own economic reopening as vaccinations expand beyond North America and Europe, Bank of Nova Scotia’s earnings and share price should benefit and catch up to its peers.

Facebook (FB NASD) – last purchased on May 7, 2021 at $319.85

Facebook continues to grow revenues and earnings more than three times faster than the S&P500, yet trades at only a ~15% premium to the S&P500 based on 2021 P/E valuations. Facebook revenues are expected to grow 35 per cent this year, on top of impressive revenue growth of 22 per cent last year. Thus, the 35 per cent growth rate is not a result of an easy year-over-year comparison like it has been for most other companies this year. In 2022, analysts’ consensus estimates are forecasting revenue growth of 19 per cent. With annual growth rates spanning from 19 per cent to 35 per cent, companies with these types of strong revenue growth rates typically trade at P/E multiples double their growth rates, which would mean 40x times earnings or higher for a company growing as quickly as Facebook. However, Facebook only trades at 25 times 2021 expected EPS, just a 15 per cent premium above the S&P 500 P/E of 22 based on 2021 overall S&P 500 earnings estimates, making Facebook attractive from a growth/value basis.

Linamar (LNR TSX) - last purchased on April 27, 2021 at $75.48

With 2019 impacted by a GM strike and weakness in its Skyjack and MacDon agriculture equipment business, and 2020 impacted by the coronavirus, 2021 is shaping up to be a full recovery for the company as each of its three businesses are coming back strong.  Insider buying activity further reinforces this outlook as CEO Linda Hazenfratz bought $3.4 million worth of shares at $68 in December, after the stock has already moved up 70 per cent from its lows. Insider buying of a rising stock is a more bullish signal than when insiders are buying a stock that is falling.  From a financial perspective, Linamar earned an average ROE of 20 per cent from 2013 to 2017.  With current book value around $67 per share, if the company can return to earning an ROE of 15 per cent, that would equate to EPS of $10 per share.  Apply a 10x P/E multiple to $10 of EPS results in a $100 share price.  If ROE returns to 20 per cent, EPS will become $13 per share.  At a 10x P/E multiple, the share price would be $130. Significant upside exists should the company’s three businesses continue to recover and return to prior profitability levels on an ROE basis.

PAST PICKS: June 22, 2020

Tidewater Midstream & Infrastructure (TWM TSX) – pursuing a Renewable Diesel Project at its Prince George refinery - attractive economics with the $215-235 million gross capital cost being reduced by roughly $100 million from B.C. government commitments and the company estimating $75 million of EBITDA in the first year of operations (as early as 2023). With B.C. government financial support, payback back period for investors could be as little as two years.

• Then: $0.83
• Now: $1.30
• Return: 57%
• Total Return: 64%

Western Forest Products (WEF TSX) – record revenues and earnings expected in 2021, yet stock is still 30 per cent lower than its previous cyclical high of $2.90 reached in 2018.

• Then: $0.85
• Now: $1.95
• Return: 129%
• Total Return: 132%

CIT Group (CIT NYSE) – pure play commercial banking lender that fell the most among all U.S. bank stocks last year, and has since recovered sharply. 

• Then: $22.95
• Now: $50.30
• Return: 119%
• Total Return: 129%

Total Return Average: 108%

Company Website: www.lindeequity.com