Daniel Bubis, president and CEO of Winnipeg-based Tetrem Capital Management Ltd., says that the Canadian equity market needs the adrenaline of stronger global economic growth to propel it higher.
"There are concerns that the recent sharp drop in China's equity market will spill over into the underlying Chinese economy and delay a return to more robust global economic growth," he says. China has emerged as a key driver of global growth and an important buyer of commodities, he notes. It is not surprising, he says, that China's stock market has corrected. "The market displayed some distinct casino-like characteristics in its sharp run-up."
From a Canadian perspective, the economy still remains significantly resource-dependent, says Bubis, and has been impacted by weakness in a range of important commodities. "The halving of the oil price, for example, affects not only Canadian energy producers, but feeds into other sectors such as the financials and the industrials."
The good news, says Bubis, is that the U.S. economy is expected to gather steam in the second half of this year. Also, the outlook for the European economy "is a little brighter, despite the recent high-profile problems of Greece."
The U.S. equity market was undoubtedly the place to be over the past 12 months to the end of June, says Bubis. "The U.S. market handily outperformed the Canadian market [when] comparing local currency performance to local currency performance, and Canadian investors in U.S equities obtained a huge win from the drop in the Canadian dollar."
Foreign investors have been eschewing the Canadian equity market, says Bubis. Compounding the country's widely recognized macroeconomic challenges are the political uncertainties that result from both the change of government in Alberta and the federal elections in October.
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| Daniel Bubis | |
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Bubis, a value manager, acknowledges the Canadian equity market's shorter-term headwinds but says that there is value to be had in a wide range of sectors, provided investors are patient. "The challenge is that many Canadian non-resource stocks are no longer cheap, and the resource-sensitive stocks, which are cheap, could remain so for some time until global economic growth picks up."
Both the Canadian and U.S. equity market are trading at fairly reasonable valuations, he says, although they are not cheap. Looking at forward 12-month earnings estimates, the S&P/TSX Composite Index and the S&P 500 Index are both trading at price/earnings multiples of around 16.5 times, says Bubis. On a trailing 12-month basis, the Composite's P/E multiple is 20 times versus 18 times for the S&P 500.
Tetrem Capital Management manages a range of mutual funds for CI Investments Inc., including CI Canadian Investment (assets $2 billion) and CI Canadian Investment Corporate Class (assets $919 million). At the end of June, this portfolio had 56% of its holdings in Canadian names, 34% in U.S. stocks and the remaining 10% in international names.
The Canadian component has 40 holdings, and 14 of the top-15 names in the overall portfolio are Canadian. The foreign content is managed in separate portfolios. The U.S. portfolio has 39 names. Bubis and his team target stocks that trade below Tetrem's estimated fair value. Their investment horizon is three-to-five years.
Focusing on the Canadian content of CI Canadian Investment, Bubis reports that he has been selectively adding to long-standing names in the portfolio in such sectors as consumer discretionary and industrials.
The Tetrem team has added to the portfolio's holding in 
Magna International Inc. (MG), which is in the consumer discretionary sector. "This global auto-parts giant has significant exposure to Europe and only modest exposure to Canada." The company, says Bubis, recently announced that it is buying Germany's Getrag for $2.5 billion. Getrag, a major independent maker of automotive transmissions, has a global presence, including joint-venture relationships with Chinese automakers. Magna, which has a "pristine balance sheet," is also growing internally, says Bubis. The company has also been increasing its dividend to shareholders at a high rate and this is expected to continue, he adds. The stock trades at around 11.5 times current earnings per share estimates, he says, and "remains inexpensive relative to its competitors."
A long-standing industrial holding in the portfolio that Bubis and his team added to in the second quarter is Canadian National Railway Co. (CNR), which is in the industrial sector. The stock experienced some weakness and "its valuation relative to that of the S&P/TSX Composite Index, was at a five-year low." Railway stocks, on both sides of the border, came under selling pressure as a result of concerns about low volumes related to commodities, particularly coal. "CNR was tagged with this, though it is less exposed to coal and some other commodities, than its peers." Also, he notes that the company is strong on North-South intermodal transport, which involves different modes of transportation, and is benefitting from a more robust U.S. economy.
| Canadian National Railway Co. |
Magna International Inc. |
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| July 31 close | $81.59 | $71.06 |
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| 52-week high/low | $88.89-$68.81 | $74.50-$46.44 |
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| Market cap | $65.1 billion | $29.2 billion |
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| Total % return 1Y* | 13.5 | 23.0 |
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| Total % return 3Y* | 24.0 | 54.0 |
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| Total % return 5Y* | 21.5 | 31.2 |
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| *As of July 31, 2015 Source: Morningstar |
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In all, he says, Canadian National Railway is an exceptionally well-managed company. "It has high returns on its capital, good cost controls and continued pricing power." The company has a moat, he says. "There are high barriers to entry in this business."
In financial services, Bubis says he currently prefers the insurers to the banks, "though the bank stocks do have strong dividend support and they remain an important part of the portfolios that we manage."
Following the recent reduction in the Bank of Canada rate, the Canadian banks lowered some of their lending rates, says Bubis. This put some pressure on domestic margins, he says, although the banks' prime lending rates did not decline to the same extent as the reduction in the Bank of Canada rate. "This demonstrates the Canadian banks' ability to protect their profitability." But there are challenges to the banks' domestic business, he says, and "there are, at present, better growth prospects among the insurers."
Bubis reports that he has been adding to the fund's holding in life-insurer Manulife Financial Corp. (MFC), which is a top-10 weighting in the fund. Manulife is doing well on many fronts, he says. It is growing its Asian business, and its insurance business is generally strong. Its capital ratios are healthy, he adds, and the company has resumed its dividend growth. "Manulife has raised its dividend twice in roughly one year." The stock trades at more than 12 times forward earnings per share estimates, "which is still reasonable given the company's growth prospects."
In energy, "there is great value to be had in this sector for investors with a three-year time horizon," says Bubis. His strategy has been to "focus on the stronger names that offer good, fundamental value." The better producers, he notes, are cutting costs and becoming more efficient and will thus be in good shape to benefit from a rebound in the oil price.
Here he is highlighting two oil-weighted companies that he considers can continue to grow, despite the weak commodity price environment: Vermilion Energy Inc. (VET) and Whitecap Resources Inc. (WCP). Bubis and his team have sold the portfolio's holding in Crescent Point Energy Corp. (CPG). The company is on a "dividend-paying treadmill and it currently has insufficient cash flow to support this." Also, Crescent Point had good hedges on the commodity price coming into the year, he says, and "these hedges are rolling over at lower prices." Despite these issues, the stock had held up reasonably well until recently, he says. "We decided to exit the position in the second quarter."
