Small-caps with solid results

Beutel's Stephen Arpin cites financial-services firms that took the 2008 crisis in stride.

Sonita Horvitch 23 October, 2013 | 6:00PM
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Stephen Arpin, vice-president and portfolio manager at Beutel, Goodman & Co. Ltd., says that while many Canadian small-cap financial-services stocks have gone up substantially since the beginning of the year, some still represent reasonably good value.

A specialist in small-caps at Beutel Goodman, Arpin notes that the total return on Canadian small caps, as measured by both the S&P/TSX Small Cap Index and the BMO Blended (Weighted) Small Cap Index, was essentially flat from the beginning of the year to recent close. Against this lacklustre performance, the financial-services sector put up solid, not spectacular results, he says.

Other sectors, such as consumer discretionary and industrials, produced much stronger performance, says Arpin. Like the financials, these two sectors represent good weightings in both leading small-cap indexes.

Investors in small caps are, he says, favouring those companies that are exposed to the developed rather than the developing economies. This, he says, accounts in part for the considerable weakness in the materials sector, which represents a hefty weighting in both leading small-cap indexes.

Of the financial small-caps, Arpin says that investors, while appreciating their North American exposure, "have long memories about the problems at a range of financial institutions during the severe global financial crisis of some five years ago." He emphasizes that there needs to be a stock-by-stock assessment. "We are essentially bottom-up stock pickers."

Within the small-cap financial-services sector, there are, Arpin says, some Canadian companies that managed to grow their book value per share during the financial crisis. They were also, he says, able "to raise external capital in a non-dilutive manner," at or above book value per share, to shore up their balance sheets.

A prime example of this, he says, is Industrial Alliance Insurance and Financial Services Inc. IAG. This stock is a long-time holding in Beutel Goodman Small Cap, (assets $550.4 million), which Arpin and colleague William Otton co-manage. The mandate defines small-caps as stocks with a market float of up to $1.5 billion at the time of purchase.

 
Stephen Arpin

In all, Arpin and Otton manage $1.5 billion in small caps at Beutel Goodman, which applies a value approach to stock selection. The small-cap managers target stocks that they consider can produce a 100% total return over a three- to four-year period.

Beutel Goodman Small Cap, which has 42 names, has significant overweight positions in financial services at 23.5% and in consumer-discretionary stocks at 19.5%.

Industrial Alliance (some 6% of the fund and a top-10 holding) is predominantly a Canadian life insurer and a wealth-management company, says Arpin. With its base in Quebec, the company, he says, is gaining market share in the insurance business. Its wealth-management business is also expanding, he says.

Industrial Alliance recently completed the acquisition of Jovian Capital Corp., which serves the private-wealth-management market through a number of entities. In all, says Arpin, Industrial Alliance's president and CEO Yvon Charest is "an excellent manager." Although the stock has done well this year, "we continue to hold it," he says. "The company is capable of growing its book value at a low-double-digit percentage each year, and the stock has a dividend yield of around 2.2%."

A property and casualty insurer that is also among the top-10 holdings and represents about 6% of the fund is Intact Financial Corp. IFC . This company, says Arpin, "is a market leader and successful consolidator in this business." The stock, he says, has come under some pressure because of concerns about the Ontario government's move to reduce auto-insurance rates.

Furthermore, the company faced an "elevated level of claims" from the adverse weather conditions in parts of the country. But Arpin points out that "P&C insurance rates tend to firm up after a rise in claims."

Industrial Alliance Insurance and Financial Services Inc. Intact Financial Corp.
Oct.21 close $46.38 $64.44
52-week high/low $46.65-$26.50 $66.82-$56.44
Market cap $8.5 billion $4.6 billion
Total % return 1Y* 74.1 9.3
Total % return 3Y* 17.1 14.4
Total % return 5Y* 12.2 15.7
*As of Oct. 21, 2013
Source: Morningstar

Arpin continues to be enthusiastic about the sub-prime-mortgage provider Equitable Group Inc. EQB, which represents about 5% of the fund. The stock has done well this year, he says, but remains inexpensive. Equitable trades at eight times 2014 earnings-per-share estimates and 1.5 times book value per share.

Also classified as financial services, a trust specializing in hotels that Arpin says has "improved the strength of its balance sheet and is judiciously pruning its property portfolio at good prices" is InnVest Real Estate Investment Trust INN.UN.

This REIT holds one of Canada's largest hotel portfolios with around 131 properties operated under major brands. Arpin says the hotel business is recovering significantly and pricing is improving. "In the past, InnVest's distributions were too high relative to its cash flow, but it has pared these back to a more sustainable level." The distribution yield is currently around 10%.

In the consumer-discretionary sector "an auto-parts manufacturer that continues to benefit from automakers outsourcing" is Linamar Corp. LNR, another top-10 holding in the fund.

The company provides core engine components and transmission systems to automakers around the world, says Arpin. The demand for its products is growing, he says. "Linamar is winning significant Japanese contracts and generally benefitting from the recovery in the auto cycle." On valuation, Linamar trades at 12 times earnings-per-share estimates for the current year and 10 times forward estimates.

A new addition to the portfolio via participation in an initial public offering in late May is BRP Inc. DOO, says Arpin. The IPO price was $21.50 a share. BRP, or Bombardier Recreational Products, makes recreational vehicles under such brands as Ski-Doo and Sea-Doo, for sale globally. "The industry is recovering from its plummet during the financial-services crisis," says Arpin. BRP is "an industry leader and innovator."

When it comes to sells, the Beutel Goodman small-cap team's discipline is to reduce a holding by 25% if the stock reaches the target price, and then to reassess the prospects for the stock. Accordingly, the team recently reduced its holding in WestJet Airlines Ltd. WJA by 25%.

"We would add to the stock on weakness; its decision to introduce a regional airline gives WestJet a long runway to grow," says Arpin. The stock, he notes, trades at 12 times current earnings-per-share estimates and 11.5 times forward estimates.

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Sonita Horvitch

Sonita Horvitch  

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