Bargains in the energy patch?

Yes, says Trimark Canadian's ever contrarian Ian Hardacre.

Sonita Horvitch 4 March, 2015 | 6:00PM
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Ian Hardacre, head of Canadian equities at Trimark Investments, says he is bullish on Canadian energy stocks.

A value manager and ever the contrarian, Hardacre reports that he has been selectively adding to names in the Canadian energy sector. "There is money to be made in energy stocks, which have come under considerable selling pressure and offer good value."

In addition to energy, Hardacre likes select stocks in the Canadian materials sector. Stocks of both basic-materials producers and gold-mining companies have also come under selling pressure, he says, and there is value to be had. "A rebound in both energy and materials stocks will be positive for the Canadian equity market, as they represent substantial weights in the benchmark S&P/TSX Composite Index."

Turning to the heavily weighted Canadian banks, Hardacre says that their valuations are still reasonable, "though their earnings growth is likely to be limited this year." He is looking to add opportunistically to his weight in bank stocks over the course of the year. "They are good long-term investments."

At Trimark Investments, a division of Toronto-based Invesco Canada Ltd., Hardacre has a wide range of mandates, including the flagship Trimark Canadian.

At the end of January, Trimark Canadian, with 45 names, held 22.4% in energy equities and 18.9% in materials for a total of 41.3% in the natural-resources sectors. Financials had a weighting of 16.8% of the fund and consumer-discretionary stocks were 16.4%. Foreign content continues to be around 20%.

Hardacre has been adding to the fund's holdings in two Canadian energy producers: Bonavista Energy Corp. BNP and Crew Energy Inc. CR. The two stocks remain among the top-10 holdings.

Bonavista is an intermediate producer in Western Canada with some 70% of its production in natural gas. "A former income trust, this is a high-dividend-paying energy company," says Hardacre.

Bonavista produces 83,000 barrel of oil equivalent per day and its properties include key holdings in the Deep Basin core in Western Canada. A plus, says Hardacre, is that Bonavista management and the board have a significant stake in the company at almost 10%. The stock currently trades at a price to forward cash flow per share of 3.5 times, which is low by energy-producer standards, he says.

When energy prices improve, says Hardacre, both the company's cash flow and the multiple on the stock will increase. He and his colleagues collectively hold 15% of Bonavista in the funds they manage. "In all, Bonavista is a solid, well-managed company."

Crew Energy is a "small-cap producer with a big land position" in the Montney natural-gas reservoir situated in the northeast corner of B.C. "The Montney has huge potential," Hardacre says. Some 65% of Crew's production is in natural gas. He adds that the company stands to benefit from the development of liquefied-natural-gas terminals in B.C.

Crew management, led by Dale Shwed, "is capable and owns a significant amount of the company," Hardacre says. The stock trades at some four times forward cash flow per share. "The market is giving Crew minimal credit for its Montney holdings." Hardacre and his colleagues collectively hold more than 15% of the company in Trimark Canadian and other funds they manage.

Bonavista Energy Corp. Crew Energy Inc.
Feb. 27 close $7.16 $5.72
52-week high/low $17.85-$5.62 $12.74-$4.73
Market cap $1.46 billion $706 million
Total % return 1Y* -50.2 -28.2
Total % return 3Y* -24.0 -24.4
Total % return 5Y* -11.2 -17.1
*As of Feb. 27, 2015
Source: Morningstar

Of the large-cap Canadian energy producers, Trimark Canadian has holdings in both Suncor Energy Inc. SU and Canadian Natural Resources Ltd. CNQ. Suncor, says Hardacre, has an "excellent balance sheet and is good at managing its growth and its dividends." The company is in a strong position even if the oil price stays at these low levels, he adds. CNQ "has a strong and diversified asset base and is one of the best managed energy producers in Canada."

In the materials sector, Trimark Canadian's biggest holding is Teck Resources Ltd. TCK.B, a diversified natural-resource company. "This stock is another contrarian call," says Hardacre, "as the prices of the commodities that Teck has specialized in are depressed." Teck produces metallurgical coal, which is used in steel-making. It also produces copper. In the energy sector, Teck has a 20% stake in the Fort Hills oil-sands project, with Suncor holding 40.8% and France's Total SA with 39.2%. "There is a significant capital investment involved in the Fort Hills project for all the joint venture partners," says Hardacre.

Ian Hardacre

On metallurgical coal, Hardacre points out that "there is currently a lot of supply and it takes time to reduce production." What has helped Teck in this situation, he says, is the low Canadian dollar versus the U.S. dollar. "Teck produces this coal in Canada and the commodity price is expressed in U.S. dollars."

In all, Hardacre says, any strengthening of the price of metallurgical coal, copper or oil will have a significant and positive impact on Teck stock. Also in the materials sector, Trimark Canadian holds gold-mining companies. "Even though the price of gold has held up quite well at between US$1,200 and US$1,300 per ounce, the stocks have experienced a compression in their multiples."

Two gold holdings in Trimark Canadian are Yamana Gold Inc. YRI and Kinross Gold Corp. K. The latter is one of the largest Canadian investors in Russia, with two "highly profitable mines," says Hardacre. "The stock is being particularly penalized because of this Russian exposure." Hardacre reports that he has sold the fund's holding in Goldcorp Inc. G. "The stock hit our target and there was better relative value in other gold-mining company names."

Among the Canadian banks, Trimark Canadian continues to have significant holdings in Toronto-Dominion Bank TD, the biggest weight in the fund at 5.7%. Bank of Nova Scotia BNS at 4.1%, is also a top-10 holding. Another 2.5% of the fund is held in Royal Bank of Canada RY.

Of these banks' exposure to energy, Hardacre says that there could be some write-offs, "but it is not a huge negative." Their exposure to the Canadian consumer and housing market could also result in some write-offs, he says, "but the banks can deal with this."

Add to these challenges the low-interest-rate environment, and it is likely that growth in bank earnings will be modest this year, Hardacre says. "The banks are facing headwinds, but not a storm," he concludes. "I will be looking to add to the fund's holdings in Canadian banks on pullbacks during this year."

Hardacre has added a new name to the portfolio in the Canadian consumer-discretionary sector: BRP Inc. DOO, which makes the Ski-Doo snowmobile. "The company has had challenges meeting its targets and has disappointed investors," he says. "This provided an entry opportunity, as the company is a market leader in these recreational vehicles, is highly innovative and is doing more of its assembly in Mexico, which should improve its profit margins."

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Sonita Horvitch

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