Large-cap picks for turbulent times

Guardian Capital's Ted Macklin favours companies with financial ballast.

Sonita Horvitch 21 December, 2011 | 7:00PM

 Ted Macklin, managing director of Toronto-based Guardian Capital LP, has been taking advantage of the volatility in the equity market to boost exposure to Canadian resource stocks in the big-cap Canadian equity portfolios he manages.

"I have been adding to these stocks on weakness." His premise is that the U.S. economy will remain in positive territory and that emerging-markets demand for commodities will continue to be robust, despite a slowdown in these high-growth economies.

But the risks to the Canadian and global equity markets remain, says Macklin. At the top of the list is the sovereign-debt problem in Europe and its adverse impact on the European banking system. "It's all about the European banks," says Macklin. The good news for Canada, he says, is that the Canadian banks don't have much direct exposure to these troubled European sovereign borrowers.

In all, says Macklin, the weakness and high volatility in the Canadian and other equity markets reflect "investor recognition that the resolution to the European financial crisis is a complicated political process."

Politicians in the financially strong European countries, such as Germany, want to be re-elected and are reluctant to be seen to be bailing out the weaker countries, he says. The equity market, says Macklin, has "reasonably discounted the uncertainties in Europe, but it is difficult to predict how the market will react if there is a serious blow-up in one or more of the countries."

Given these uncertainties, Macklin says his investment strategy is to focus on senior companies with financial ballast. Their balance sheets must be structured to reflect the requirements of their industry, he says.

The companies must also not be reliant on external funding to finance their business plans. "In the 2007-2008 credit crisis, companies dependent on the capital markets for short-term financing got hurt."

Furthermore, Macklin is avoiding those companies that have not addressed their large, unfunded pension liabilities. "Low returns from equity markets and low interest on fixed-income products have made it difficult for pension funds to build assets." Investors recognize, he says, that the need to fund pension liabilities can be a significant drag on company performance.

 
Ted Macklin

A member of Guardian Capital's eight-person Canadian equity team, Macklin's investment style is growth at a reasonable price (GARP), and his focus is on big-cap Canadian equity portfolios.

At Guardian, which has a total of $13.3 billion under management, Macklin is directly responsible for managing a total of $1.7 billion in both institutional and retail mandates. This includes his role as lead manager of BMO Guardian Canadian Large Cap Equity. The fund, which has 36 holdings, is benchmarked against the S&P/TSX 60 Index and currently has a modest 4% cash reserve.

The portfolio has 21.9% in financial services, an underweight position compared to the sector's 30.5% weighting in the big-cap Canadian index. "The bulk of the fund's financial-services exposure is to the major Canadian banks; I have no holdings in Canadian life-insurance companies," says Macklin.

He has been modestly adding to his bank holdings. They currently represent 19.5% of the fund versus 25.4% of his benchmark. While the banks "are challenged to drive growth, they have shown stability in their earnings-per-share performance, are strong cash-flow generators and are growing their dividends."

Turning to natural resources, energy represents 23.9% of BMO Guardian Canadian Large Cap. This is close to the index weight at 25.4%. Materials stocks at 20.1% are also near the index weight of 22.4%.

Gold stocks are 10.7% of the fund (13.7% of the index). "Gold is a hedge against uncertainty and the possible resurgence of inflation," Macklin says. The fund currently has three gold names: Franco-Nevada Corp. FNV, Goldcorp Inc. G and Barrick Gold Corp. ABX.

Franco-Nevada is a gold-focused royalty company with the majority of its revenues generated in North America. "It is an attractive way of participating in the strength in the bullion price, without taking on the operational risks attached to gold mining."

Goldcorp is "the second largest gold company in the world," says Macklin, producing 2.5 million ounces annually and with reserves of 60 million ounces. "Its core production is being enhanced by attractive growth assets."

An example is its 40% stake in the Pueblo Viego Project in the Dominican Republic, with Barrick holding the majority 60%. Another important Goldcorp growth asset, says Macklin, is the Eleonore gold project in Quebec.

Barrick is the "world's largest gold-mining company," producing 7.5 million ounces annually and with a reserve base of 140 million ounces. Its growth assets, Macklin notes, include the Pascua-Lama Project on the border between Chile and Argentina.

Barrick Gold Cop. Franco-Nevada Corp. Goldcorp. Inc.
Dec.20 close $47.45 $39.31 $46.88
52-week high/low $55.36-$42.06 $47.24-$27.75 $55.93-$38.99
Market cap $47.5 billion $5.4 billion $38.0 billion
Total % return 1Y* -8.9 19.5 3.7
Total % return 3Y* 6.5 27.4 11.1
Total % return 5Y* 7.4 NA 8.6
*As of Dec. 20,2011
Source: Morningstar

Of Barrick's acquisition of the copper miner Equinox Minerals Ltd., Macklin says that while it increases its exposure to this base metal, Barrick "remains committed to gold."

Also in the materials sector, Macklin holds fertilizer stocks: Potash Corp. of Saskatchewan Inc. POT, which makes up 4% of the fund, and Agrium Inc. AGU, which has a 2.5% weighting. These stocks offer "a play on the growth in the emerging economies' middle class and the resultant rising demand for animal protein."

In energy, Macklin has been adding to some existing holdings on weakness in the stocks, with an emphasis on oil-sands companies. For example, he added to Suncor Energy Inc. SU, which is the biggest energy holding in the fund. He also added to his holding in MEG Energy Corp. MEG, an oil-sands producer with "an attractive production-growth profile, which came public last year."

MEG's flagship Christina Lake Project in Alberta's southern Athabasca region "continues to demonstrate favourable operating performance," says Macklin. The stock is not cheap, he cautions, reflecting MEG's strong growth prospects.

In the industrial sector, Macklin recently took profits in one of his two major railway holdings in the fund, Canadian Pacific Railway Ltd. CP. But he has maintained his position in Canadian National Railway CNR.

Macklin notes that he bought CP in the summer and the stock had a good run since then. Moreover, he says, CNR, which has superior operating performance to CP, has been trading at a modest discount to CP, "which has not traditionally been the case."

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Sonita Horvitch

Sonita Horvitch