A contrarian on resource stocks

Juniors "substantially undervalued," Manulife's Chris Arbuthnot says

Sonita Horvitch 27 February, 2013 | 7:00PM
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Chris Arbuthnot, senior managing director at Manulife Asset Management (US) LLC, is optimistic about the prospects for select junior energy and materials companies, even though the equity market has shunned these stocks over the past two years.

A global manager with no sector or market-capitalization constraints, Arbuthnot says that in the energy and materials sectors his focus has been on advanced "project" or junior companies. These do not, as yet, have any production or generate cash flow, but have good assets and good growth prospects, he says. He acknowledges that these companies do carry a higher risk.

Investors have been emphasizing companies that generate strong cash flow and pay high dividends, says Arbuthnot. "At some point, market sentiment will change, as the defensive pendulum has swung too far."

Arbuthnot considers that quality junior natural-resource companies "are now substantially undervalued by our analysis, even based on the most conservative assumptions about production prospects and commodity prices."

A key question, says Arbuthnot, is how close the juniors are to commercializing their resources? There are "two main milestones" -- permits and financing. "Many of the long-standing small-cap resource holdings in my global portfolio are in the final stages of obtaining the necessary approvals and permits." News about this progress should, he says, be a catalyst for boosting valuations.

Based in Boston, Arbuthnot is the lead portfolio manager for the global opportunities strategy and a co-manager for the emerging-markets strategy at the U.S. division of Manulife Asset Management. His mandates include Manulife Global Opportunities Balanced and Manulife Global Opportunities Class.

Arbuthnot's approach to stock selection is two-pronged. He adopts a value style in developed markets and more of a GARP (growth at a reasonable price) style in emerging markets.

"Colgate-Palmolive (India) is a direct play on the increasing affluence of the emerging-market consumer," says Chris Arbuthnot.

Manulife Global Opportunities has 66 holdings, with the top 10 names accounting for 33% of the fund. The biggest geographic weightings include its 31% in U.S.-based companies and 15.4% in Canada, mainly natural-resource companies.

Europe constitutes 20%, with France at 6.2% and Italy at 5.5%, as the largest individual country weightings. Arbuthnot's European focus is on well placed media companies. "They are reducing their costs, given the weak economy and the dramatic fall-off in advertising and should do well as Europe recovers." An example is France's Societé Télévision Française 1, a top-10 holding.

Emerging markets represent 27% of Manulife Global Opportunities. The biggest weightings are India at 8.2% and Brazil at 6.2%.

Arbuthnot continues to champion India. "The government is introducing far-reaching reforms to attract more foreign investment. As well, the productivity of its work force is increasing." By contrast, he has been selling down his holdings in Brazil. "I am cautious, given the structural challenges facing the country and the question mark over its productivity."

A long-standing Brazilian holding that remains in Arbuthnot's top 10 holdings is OGX Petróleo e Gás Participações SA. "The market has excessively punished this stock for a short-term problem," he says. This major offshore oil and gas producer missed its 2012 production targets for its first two wells, Arbuthnot adds.

This fall, OGX will be receiving two tailor-made floating production, storage and offloading vessels to facilitate its offshore operations, Arbuthnot says. "This should ramp up its production fairly quickly."

Another significant and long-standing energy holding that Arbuthnot says has been unfairly treated by the market is Ivanhoe Energy Inc. IE. The company has two heavy-oil projects, one in Alberta and the other in Ecuador. "Ivanhoe is close to receiving regulatory approval from the Alberta government for its Tamarack project."

The review process for Tamarack began in the fourth quarter of 2010, so this is an important step forward, says Arbuthnot. "This approval will allow Ivanhoe to bring in a joint-venture partner and begin construction."

The company, he says, will be installing its proprietary Heavy-to-Light (HTL) oil technology as part of the Tamarack project to improve the project's economics by avoiding the heavy-oil discount.

Ivanhoe is looking to "commercialize" this HTL technology and will be moving forward on its project in Ecuador by mid-year. "In all, the company has a solid balance sheet and is about to cross the finish line." This, he adds, should help with market recognition of its value.

In the energy sector, Arbuthnot sold two stocks, "which had done well." They are Canada's Progress Energy Resources Corp., which was taken out by Malaysian national oil company PETRONAS, and Denbury Resources Inc. DNR. "The risk-reward on Denbury was no longer that attractive, when compared to other companies in our portfolio and potential investments."

In the materials sector, Arbuthnot points to his holding in Canadian potash-project developer Karnalyte Resources Inc. KRN as yet another example of a junior natural-resources company that is "close to the finish line." The company has received the nod for its project from the Saskatchewan government. It has also obtained a $45-million investment plus a 20-year purchasing agreement from an Indian fertilizer company.

Ivanhoe Energy Inc. Karnalyte Resources Inc.
Feb. 25 close $0.68 $7.72
52-week high/low $1.15-$0.41 $10.50-$4.85
Market cap $234 million $169 million
Total % return 1Y* -22.7 -19.0
Total % return 3Y* -41.0 N/A
Total % return 5Y* -15.9 N/A
*As of Feb. 25, 2013
Source: Morningstar

In India, Arbuthnot's focus is on financial and consumer companies. A "leading diversified banking and financial-services group" in the portfolio is ICICI Bank Ltd., which trades on New York under the ticker IBN. "This stock is performing well."

A consumer-products stock in the fund that is a dominant brand in India and that exemplifies his consumer holdings is Colgate-Palmolive (India) Ltd. This company, listed in India, is part of the U.S.-based multinational, Colgate-Palmolive Co. "Colgate-Palmolive (India) is a direct play on the increasing affluence of the emerging-market consumer," says Arbuthnot.

An "indirect play" in the portfolio is the Anglo-Dutch consumer staples giant Unilever PLC. This global company, he says, has an exceptionally high exposure to emerging markets. The parent's stock "trades at a discount" to the company's listed affiliate in Indonesia, PT Unilever Indonesia, and to its listed Indian subsidiary, Hindustan Unilever Ltd., "which trade at higher multiples."

A recent addition to the portfolio as a play on the health-conscious U.S. and Canadian consumer is Annie's Inc. BNNY. This is a natural and organic food company with products ranging from packaged macaroni and cheese to frozen pizzas.

Arbuthnot bought the stock on a pullback after Annie's initiated a voluntary recall of its organic pizzas, earlier this year in the United States. There is, says Arbuthnot, a rising demand for natural and organic foods on both sides of the border; "an important development is that regular supermarkets are incorporating more of these products into their offerings."

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Sonita Horvitch

Sonita Horvitch  

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