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Canadian-equity roundtable: Part 3

Where managers are finding good values in the energy sector

Sonita Horvitch 31 October, 2014 | 5:00PM
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Coverage of our exclusive Canadian-equity roundtable concludes today with discussion of large-cap strategies in non-bank financials, energy, industrials and telecommunications. Our panellists:

Daniel Bubis, president and CEO of Winnipeg-based Tetrem Capital Management Ltd. Bubis manages a range of mutual funds for CI Investments Inc., including CI Canadian Investment and CI Canadian Investment Corporate Class.

Michael O'Brien, managing director and head of the core Canadian- equity team at TD Asset Management Inc. His responsibilities include serving as lead manager of TD Canadian Equity, TD Canadian Blue Chip Equity and TD Balanced Income.

Mark Thomson, managing director and head of research at Beutel, Goodman & Co. Ltd. Thomson and his team are responsible for a range of mandates including Beutel Goodman Canadian Equity, Beutel Goodman Canadian Dividend and Beutel Goodman Balanced.

The roundtable was convened and moderated by Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and continued on Wednesday.


Q: What about insurers? All three of you have Manulife Financial Corp. MFC in your top-10 holdings. Manulife is acquiring the Canadian operations of Standard Life PLC for $4 billion.

O'Brien: Most financial-services acquisitions within Canada have gone pretty well.

Thomson: Donald Guloien has done a good job at Manulife since taking over as CEO. The acquisition within Canada is not going to work out badly, but Manulife paid a full price and with stock. I would rather it paid with cash or debt. Stock is really expensive over time. There is dilution.

Michael O'Brien and Mark Thomson

Bubis: We did see a dividend increase by Manulife this summer for the first time in five years.

Thomson: Great-West Lifeco Inc. GWO is an interesting core holding. It's an exceptionally stable business and is well managed.

Bubis: Power Corp. of Canada POW, a holding company in this group, is among the top-10 weights in CI Canadian Investment. We also own some IGM Financial Inc. IGM. Lately, the stock is getting pressured from question marks related to some of the regulatory reform focusing on the advisory business.

O'Brien: The dividend yield on IGM is up over 5%. TD Canadian Equity has modest holdings in both Power Corp. and Power Financial Corp. PWF. Great-West and Power Financial are in the Canadian Blue Chip mandates. All three companies are a similar story. The only other name that we own in this area of any size is Brookfield Asset Management Inc. BAM.A.

Thomson: We recently bought it and have a decent position in it. Management is among the best in Canada. This has been one of the few opportunities, totally outside of this correction, that we have seen in Canada in the last year.

Q: Time to talk energy, which is about 26% of the index?

Thomson: Beutel Goodman Canadian Equity is underweight energy at 16%. Canada is a high-cost producer on a global basis. There are some decent Canadian companies. It is a question of valuations. Only one of the majors trades at net asset value and that is Cenovus Energy Inc. CVE. Cenovus and Canadian Natural Resources Ltd. CNQ are well positioned over time. (These two stocks are in the fund's top-10 holdings.)  Energy accounts for some 26% of the composite index and 13% of its earnings. This is a group with pretty high expectations built in.

O'Brien: TD Canadian Equity is slightly overweight energy. We are assuming long-term oil prices in the range of US$90 to US$95 per barrel long-term. We are seeing some discounts to net asset value. Suncor Energy Inc. SU, which is a top-10 holding, is trading at a 10% discount to our version of net asset value. CNQ is closer to 15% or 20%. Cenovus, to Mark's point, has a big discount. Markets have not been prepared to pay for longer-term value. They are more focused on shorter-term cash flow.

Q: Mike, Cenovus and CNQ are also top-10 holdings. What is the outlook for bigger-cap Canadian oil stocks?

O' Brien: For some time, I have felt that oil presents an opportunity. My perspective was that when investors recognized that we will still be driving gas-fuelled cars in five or 10 years' time, it would be good for those companies with inherent long-term value. This thesis played out early this year both in terms of the commodity and the stocks. We have given some of that back with the correction in both. From a longer-term perspective, I still see a lot of value in names like Suncor, CNQ and Cenovus. These senior names are being run in a much more shareholder-friendly manner. This is showing through in the dividends. Cenovus's dividend yield is about 4% and Suncor's is about 3%. CNQ's is about 2.5% and that is going to continue to grow very rapidly. These are the next generation of dividend-payers. They are getting to a point that they have enough of a base cash- flow level that they can afford to pay this out.

Canadian Natural Resources Ltd. Cenovus Energy Inc. Suncor Energy Inc.
Oct. 29 close $38.68 $27.86 $38.85
52-week high/low $49.57-$31.92 $34.79-$25.79 $47.18-$34.70
Market cap $42.1 billion $20.7 billion 57.4 billion
Total % return 1Y* 17.7 -7.6 4.7
Total % return 3Y* 3.4 -5.2 7.4
Total % return 5Y* 2.5 n/a 2.5
*As of Oct. 29, 2014
Source: Morningstar

Bubis: They are continuing to grow their dividends. We see tremendous value in the oil sector, right now. It's a great opportunity to be investing in the oil patch for anyone who has an outlook beyond six months, given where the valuations are and the potential for sustainably higher oil prices going forward. The oil-sands are bringing down their costs. Suncor is doing this. It has long-life reserves with no exploration risks. Obviously, its Fort Hills oil-sands project would be better with higher oil prices. Suncor is able to cover its capital expenditure through internally generated cash flow while doing share buybacks and increasing its dividend. These companies are cash-flow generating machines in a reasonable oil-price environment. I have a mid-20s weighting in energy.

Q: Danny, Suncor and CNQ are in the top-10 holdings in CI Canadian Investment, as is Tourmaline Oil Corp. TOU.

Bubis: Tourmaline has an excellent cost structure and a great management team.

O'Brien: We have a small position in Tourmaline.

Bubis: Since it has been a public company in late 2010, it has produced excellent cash-flow growth. It has invested in the future, in terms of building up its own infrastructure, which gives it a competitive advantage.

Q: As there is little enthusiasm round the table for the mining segment of the materials sector (which has shrunk to 11% of the index), let us press on to industrials, which are almost 9%. Mike and Danny have Canadian National Railway Co. CNR in the top-10 holdings in their respective funds.

Daniel Bubis

O'Brien: The rails are outstanding businesses; they are hitting on all cylinders. The difficult part is how much is too much to pay for these franchises. The stocks are not inexpensive.

Bubis: The companies have done very well operationally and the stocks are at historically high valuations. CNR is starting to get pretty fully valued. Over the last year, we've been reducing our weighting in it.

O'Brien: We have been trimming CNR throughout the summer.

Thomson: We had a huge weight in the rails, but we have a problem with the valuations. We've been through our third sell, when the stocks hit our revised targets on both CNR and Canadian Pacific Railway Ltd. CP.

Q: A brief discussion on telecommunications stocks?

Thomson: I really like them. If you want free cash flow, they fit the bill. We have a big weight in Telus Corp. T and Rogers Communications Inc. RCI.B, some 10% between the two. Both are about two-thirds wireless. Investors are worried about a new entrant, but new entrants have lost billions over time. Most out of favour is Rogers. It has had some management issues historically. We are positive on Guy Laurence, who became CEO in late 2013. Valuation is attractive. You're looking at dividend yields of 4% to 4.5% on businesses that have moats around them, largely.

O'Brien: This year, we were underweight the high-payout-ratio, dividend-paying stocks. But we wanted to keep some exposure there. I looked to identify a few companies that over the next three, five, seven years, had enough inherent dividend growth to outrun the headwind from rising rates compressing the valuation multiples. One of these stocks is Telus.

Bubis: I am a little more concerned about some of the competitive issues in the Canadian telecom industry, such as pricing. But the stocks are becoming interesting buy opportunities.

Q: Time to sum up regarding the stock-market correction.

Thomson: Valuations, being lower after the correction, provide opportunities.

O'Brien: The correction in the stock market is healthy. It's going to prolong the cycle and it prevents complacency.

Bubis: The correction is a warning that creates an opportunity, which is what markets do in normal market cycles.

Photos: paullawrencephotography.com

Daniel Bubis, Michael O'Brien and Mark Thomson

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Sonita Horvitch

Sonita Horvitch  

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