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Canadian small-cap equities roundtable: Part 3

Managers take the wraps off packaging stocks and other best bets

Sonita Horvitch 8 March, 2013 | 7:15PM
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Coverage of our exclusive Morningstar equities roundtable on Canadian small-cap stocks concludes today with picks from the managers in various non-resources sectors. This week's three-part series was produced by Morningstar columnist Sonita Horvitch, who moderated the discussion.

Our panellists:

 Ted Whitehead, senior managing director and senior portfolio manager at Manulife Asset Management. A growth manager, Whitehead uses both quantitative and fundamental analysis. His responsibilities include Manulife Canadian Opportunities and Manulife Growth Opportunities.

 Stephen Arpin, vice-president at Beutel, Goodman & Co. Ltd. A value manager, Arpin is the lead manager of Beutel Goodman Small Cap.

 Martin Ferguson, director and portfolio manager at Calgary-based Mawer Investment Management Ltd. His mandates include Mawer New Canada, which is closed to new investors, and BMO Guardian Enterprise. His discipline is to buy wealth-creating companies at a discount to their intrinsic value.

  •  Canadian small-cap equities roundtable: Part 1
  •  Canadian small-cap equities roundtable: Part 2


Q: Let's focus on packaging companies, which you all favour.

 
"The industrial sector of the BMO Small Cap Index had a total return of 18.8% in 2012," says Whitehead.

Arpin: Our biggest holdings are CCL Industries Inc. CCL.B and Winpak Ltd. WPK. We've owned both these companies for years.

Ferguson: We own Winpak.

Whitehead: We own CCL.

Arpin: CCL develops labels for global producers of consumer brands. Winpak specializes in food packaging. These are relatively slow growers, but the business generates good returns above the companies' cost of capital. The two stocks are inexpensive both by historic standards and compared to the valuations at which these types of businesses have been acquired.

Ferguson: I've held Winpak for a long time. It focuses on plastics, which is gaining market share against other forms of food packaging. Food is basically a non-cyclical business. Winpak has good corporate governance. Its majority shareholder is Wihuri Oy of Finland. Winpak is financially strong, operationally strong and attractively valued.

CCL Industries Inc. Winpak Ltd.
March 7 close $62.26 $18.50
52-week high/low $64.91-$34.42 $19.45-$13.98
Market cap $2.1 billion $1.2 billion
Total % return 1Y* 72.2% 23.6%
Total % return 3Y*  32.3% 29.6%
Total % return 5Y*  18.7% 27.3%
*As of March. 7, 2013 Note: All figures for Range Resources are reported in US$ Source: Morningstar

Whitehead: We've owned CCL for a long time. It's in the throes of making an acquisition. This is accretive and earnings estimates are being guided up.

Arpin: CCL is buying the label business of Avery Dennison. The acquisition price is attractive. CCL's end market is more economically sensitive than that of Winpak.

Whitehead: We've added some U.S. packaging-related names. They are Owens-Illinois Inc. OI and Rock-Tenn Co. RKT.

Q: Let's turn to industrials, which represented 10.9% of the BMO Small Cap Index at the end of January.

Whitehead: We have a little over 15% in this sector. We have names in the aerospace area. We own Bombardier Inc. BBD.B, which is more of a mid-cap. We also own Triumph Group Inc. TGI, a U.S.-based supplier to the aerospace industry. Black Diamond Group Ltd. BDI continues to be our biggest holding in the fund. It makes portable homes, camps, for the energy and mining industries. It recently expanded into Australia with an acquisition.

Ferguson: We are overweight industrials at 22%, which is double that of the index. The three largest weightings are Stantec Inc. STN, Nu Flyer Industries Inc. NFI and Newalta Corp. NAL. The latter is a fairly recent addition to the portfolio. The company has facilities across Canada that process industrial and oilfield-generated wastes. Its growth area is Newalta's Onsite division. We like these companies, as they are wealth creators and there are high barriers to entry.

Arpin: We're underweight industrial stocks. The largest holding is WestJet Airlines Ltd. WJA. We've owned the stock for a long time.

 
"We are overweight industrials at 22%, which is double that of the index," says Ferguson.

Whitehead: I own the stock.

Q: The stock has done well.

Arpin: Airlines are notorious for destroying value. The only way that they don't is if they are low-cost. WestJet is low-cost. It has about a 30% cost advantage versus Air Canada. WestJet is starting a regional airline, which is a big opportunity for the company. It's good at stimulating demand in new areas. The stock's valuation has increased, but we haven't trimmed it. The company generates a high return on capital.

Whitehead: Going back to what we look for, WestJet has been able to beat analysts' expectations.

Ferguson: In summary, the Canadian small-cap industrial sector has a lot of niche wealth-creating companies that are generally more tied to the North American economy than the world economy. These stocks did well in 2012, with the U.S. economy showing signs of recovery.

Whitehead: The industrial sector of the BMO Small Cap Index had a total return of 18.8% in 2012.

Q: Time to look at the consumer-discretionary sector, which represented 11.8% of the BMO Small Cap Index at the end of January. This sector had a total return of 17.3% in 2012.

Arpin: Beutel Goodman Small Cap has 18% in the sector. Our largest weighting continues to be Quebecor Inc. QBR.B. It's among the best cable operators anywhere in North America. Linamar Corp. LNR also continues to be another top 10 weighting. This automotive-parts manufacturer will benefit from the improved health of the Big Three automakers. This is a long-standing holding.

Whitehead: We've owned Linamar for a long time too. We have just over 6% in this sector and half of that is Linamar.

Arpin: Automotive-parts distributor Uni-Select Inc. UNS is also a top 10 holding in Beutel Goodman Small Cap.

Ferguson: I have reduced my holding in Uni-Select. The company hasn't been performing up to our expectations. It's been losing a little market share and its fundamentals are deteriorating. It's still a wealth-creating company, but we've found better opportunities elsewhere.

Arpin: Uni-Select has historically been a well-run company. We haven't reduced our position. We have concerns about its competitive position too. But, we're looking to the company to deliver on cost improvements.

Ferguson: We have a 4.4% weighting in consumer-discretionary stocks. Our largest holding is MTY Food Group Inc. MTY. This is a franchisor and operator of quick-service restaurants under some 30 banners. It's an excellent business model. MTY is earning fees on every dollar of revenue that goes through the restaurants.

Q: Finally, we should talk about your holdings in the financial sector. It produced a total return of 17.9% in 2012 and represented 12.8% of the BMO Small Cap Index at the end of January. The three of you have held onto your major holdings in this sector for some time and are all overweight financials.

Whitehead: We are a little overweight. Our biggest holding is Morguard Corp. MRC, a real-estate company with properties in Canada and the United States. This stock has been a winner for us. We bought it many years ago. We also own Morguard Real Estate Investment Trust MRT.UN. Other holdings are Intact Financial Corp. ITC, a property and casualty company, and Home Capital Group Inc. HCG, an alternative mortgage provider.

 
"We have 16.8% in financials. Our largest holdings are Intact, Industrial Alliance Insurance and Financial Services Inc. IAG and Equitable. Intact is the leader in Canada," says Arpin.

Ferguson: The financial sector is our largest sector weighting in the portfolio, at almost 27%. Our biggest holding is Home Capital Group, followed by Canadian Western Bank CWB and Equitable Group Inc. ETC, another alternative mortgage lender.

Arpin: We have 16.8% in financials. Our largest holdings are Intact, Industrial Alliance Insurance and Financial Services Inc. IAG and Equitable. Intact is the leader in Canada. It's a well-run P&C company and has been successful in making acquisitions and consolidating the business. Industrial Alliance, a Quebec-based life insurer, has been under huge pressure because of low interest rates. The company operates in Canada only and it has been able to grow the business and take market share.

Ferguson: The Canadian alternative mortgage lenders operate in an area that the big banks have largely left alone. These lenders are attractive because they have good capital ratios, stringent lending criteria, high returns on equity, and they trade at low price-earnings multiples. They are wealth-creating companies.

Arpin: They're also benefiting from the fact that a number of their competitors exited the business after the financial crisis in 2008.

 Photos: paullawrencephotography.com

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Sonita Horvitch

Sonita Horvitch  

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