Canadian small-cap roundtable: Part 3

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

 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. Ferguson was Morningstar Canada's Domestic Equity Fund Manager of the year in 2011.

Q: Let's discuss some industrials, consumer-discretionary and resource stocks in your portfolios.

Arpin: Beutel Goodman Small Cap is underweight industrials at 4%. Holdings include Toromont Industries Ltd. TIH. Its principal franchise is a Caterpillar dealership in Ontario. It is a well run company and has a superior return on equity.

Martin Ferguson and Stephen Arpin

Whitehead: I have 12% in industrials and the biggest weighting is Black Diamond Group Ltd. BDI. It makes portable homes, mainly for the energy sector. A name that has been in the portfolio for a long time and one that we recently added to is Richelieu Hardware Ltd. RCH, a manufacturer and distributor of specialty hardware.

Ferguson: I own it.

Whitehead: Another industrial name that I own is Russel Metals Inc. RUS.

Ferguson: I have a small weighting in it.

Q: Martin, it used to be one of your biggest weightings?

Ferguson: The valuation has kept us at a very small weight. It ran into an inventory problem, but this was not insurmountable.

Whitehead: It is a cyclical industry. You get hiccups here and there.

Ferguson: The portfolio has almost 20% in industrials. One of our stocks, Marsulex Environmental Technologies Inc., was taken over by Chemtrade Logistics Income Fund CHE.UN last year. Our largest holding in this sector is Stantec Inc. STN. The stock has done little in the last two years. This engineering-services company has been around for almost 50 years and it has never had a losing year. The stock looks attractive on a price/earnings basis at 11 times and also on a free-cash-flow basis.

Q: Consumer-discretionary stocks?

Arpin: These stocks are 16% of the portfolio. Our largest weighting in this sector is Quebecor Inc. QBR.B. It has a strong cable franchise in the Quebec market. Its investment in wireless is suppressing earnings and this is why the stock has been held back. But this investment is necessary. We also have a significant weighting in Uni-Select Inc. UNS.

Martin Ferguson and Stephen Arpin

Ferguson: Uni-Select is our biggest weighting in consumer discretionary, where we have a small weighting.

Arpin: This Quebec-based automotive-parts distributor has a lot of its business in the United States. Its return on equity has been going down a little in recent years, but this should improve. Valuation is reasonably attractive.

Ferguson: It has been a tough industry of late with auto sales down, but auto-parts sales should pick-up.

Arpin: We also own Linamar Corp. LNR, which manufactures auto parts, with a focus on engines and transmissions. It is a core holding in the portfolio.

		Linamar Corp.	Uni-Select Inc.
	Feb.9 close	$18.25	$26.94
	52-week high/low	$23.20-$12.55	$29.50-$24.35
	Market cap	$1.2 billion	$582.9 million
	Total % return 1Y*	-15.7%	-4.1%
	Total % return 3Y*	69.5%	2.4%
	Total % return 5Y*	6.1%	-0.4%
	*As of Feb. 9, 2012 Source: Morningstar

Whitehead: We own the stock. It is a core holding for us too.

Arpin: Linamar is investing heavily in its business, which is one of the reasons why the stock underperformed last year. This business has the ability to generate significant earnings and free cash flow.

Whitehead: If you have a four-year investment horizon, Linamar could be a double.

Q: Energy?

Ferguson: We have 21.4% in energy. Our largest energy weighting is Canadian Energy Services & Technology Corp. CEU. It has made two acquisitions in the United States and is starting to make headway there. It has very little capital requirements.

Our next largest holding is AltaGas Ltd. ALA. It is a mid-stream energy and electricity company and is extremely well run with lots of growth projects. It has a high dividend yield.

Ted Whitehead and Martin Ferguson

Arpin: I own it.

Ferguson: A junior natural-gas producer that we own is Delphi Energy Corp. DEE, which is smack in the middle of the big energy companies in the Montney play. This play is proving to be one of the prolific liquids-rich zones.

Whitehead: Manulife Growth Opportunities has 22% in energy. The emphasis is on international plays. I own Pacific Rubiales Energy Corp. PRE, an energy producer with interests in Colombia and Peru.

Arpin: I own it.

Whitehead: A big energy weight is Coastal Energy Co. CEN, which is offshore Thailand. Coastal has been ramping up production ahead of schedule and is building up its resource and reserves. I continue to own Baytex Energy Corp. BTE, which has a lot of growth potential and pays a decent dividend. I also continue to own Crew Energy Inc. CR.

Arpin: I own Crew.

Whitehead: It had a difficult 2011. It made an excellent acquisition last summer, which the market did not appreciate, but the stock is coming around.

Arpin: The primary driver of Crew's performance is light oil in the Pekisko region in Western Canada. Beutel Goodman Small Cap has almost 25% in energy. There is good value to be had among small-cap energy producers.

Q: Materials?

Whitehead: Manulife Growth Opportunities has some 30% in materials, with 15% of the portfolio in gold stocks. A significant gold weighting is B2Gold Corp. BTO. It is in Central America. It has been able to contain costs and is doing well in growing its production. Another gold name is Semafo Inc. SMF, which is in West Africa. It manages its costs well and has a good project.

A top-10 holding in materials is Neo Material Technologies Inc. NEM, which processes high-value niche metals, with production facilities around the world, including China.

Ferguson: I own it. It is one of the few rare-earth processors in China and this is beneficial because China has limited the export of unprocessed rare earth materials. Neo Material's Magnequench division produces powders used in high-technology magnets and it dominates this business.

Whitehead: The stock should have done better last year as its earnings were rising and it had positive surprises. But concerns about TSE-listed companies that operate in China overshadowed this. It was punished because of the problems at Sino-Forest Corp. TRE.

Ferguson: We had 12% in materials at the end of last year. We do not own any gold stocks. In this sector, we own Stella-Jones Inc. SJ, which is a leading manufacturer of treated wood products including railway ties and telephone poles. It dominates in Canada and has been a consolidator in this business in North America. Not a lot of new capital is needed in this business.

Arpin: We have 27.4% in materials in the portfolio and gold stocks represent 16% of the portfolio. We have been reducing our gold exposure over the last few years. The two biggest gold holdings are Minefinders Corp. MFL, which as I mentioned earlier, is being acquired, and Allied Nevada Gold Corp. ANV.

This is a low-cost producer in Nevada. It is in a safe jurisdiction and it has a producing asset. Its operating cost is around US$475 an ounce, which is attractive. It is making a lot of money. The longer-term prospects are also excellent. The company has a great balance sheet, with a lot of cash. Generally, valuations on gold stocks are attractive. A lot of these companies will be consolidated.

Additional coverage of Morningstar's Canadian small cap roundtable

•  Part 1: Managers encouraged by improved valuations and M&A activity.
•  Part 2: How smaller companies fit into the big picture.

Photos: paullawrencephotography.com