Economic woes cast cloud on sunny earnings results

Production growth key in evaluating energy stocks, Manulife's Ted Whitehead says

Sonita Horvitch 5 October, 2011 | 6:00PM
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 Ted Whitehead, senior portfolio manager at Manulife Asset Management, cautions that uncertainty about the health of the global economy could translate into further weakness in the equity market.

While the macroeconomic picture is clouded, he says, the good news is that growth in North American corporate earnings in the second quarter was strong across the board. Also, company balance sheets are in good shape.

"Still, investor sentiment remains bearish about stocks and the volatility in key commodities, such as gold and oil, is exacerbating this," says Whitehead, who manages a growth portfolio with a Canadian smaller-cap focus.

His call is that the world economy is likely to avoid falling back into negative territory. The current malaise, he says, is being caused by "the indecisiveness of politicians in Europe and the United States and differs from the global liquidity crisis in the fall of 2008, after the collapse of Lehman Brothers."

It is imperative, he says, that the key decision makers who are dealing with the present crisis of confidence "recognize that they are skating on thin ice and take the necessary steps to reduce the uncertainty."

Given this challenging environment, it is important, says Whitehead, for investors to decide on an asset-allocation model that they are comfortable with. "Stocks are cheaper than bonds, and Canadian stocks are cheap by historical standards." There will, therefore, be good opportunities in the equity market, "once there is better clarity about the economic outlook."

At Manulife Asset Management, Whitehead is responsible for managing $1.5 billion in assets, of which some $744 million is in his flagship Manulife Growth Opportunities. This fund's mandate requires that it hold at least 40% in small caps.

Ted Whitehead

Currently the portfolio, which has 93 names, has some 50% in small caps and 50% in medium- and larger-cap companies, says Whitehead. Foreign content is modest, but he has been increasing this lately by adding to holdings in the U.S. technology sector.

In stock selection, Whitehead uses proprietary quantitative models that rank stocks, as well as fundamental analysis. The portfolio is overweight in energy relative to the BMO Small Cap Index, its benchmark.

Whitehead points out that "oil demand and oil prices rebounded quickly after their sharp decline in 2008." Emerging economies, with their superior economic growth rates, will continue to fuel the demand for oil, he says.

In analyzing energy producers, Whitehead says it is important to assess their ability to grow production efficiently. A recent addition to the portfolio, Angle Energy Inc. NGL, "has an excellent production-growth profile," says Whitehead.

He says that in contrast to many peers, Angle was able to maintain its drilling activity this spring, despite wet weather conditions in Western Canada. "At the end of its second quarter, it was able to raise its 2011 production guidance, when many other Canadian energy producers had to reduce theirs."

Whitehead says Angle is expected to grow its BOE/D (barrels of oil equivalent per day) to 17,000 in 2012 from 13,500 in 2010, an increase of 26%. The company, which produces natural-gas liquids (NGL) and light oil in Western Canada, is generating strong production growth, he adds. "It is one of the most NGL-leveraged listed companies in the industry."

Angle Energy's present strategy, he says, is to reduce gas production and add to its light-oil-drilling inventory to take advantage of the relative strength in the oil price. A junior that Whitehead has been establishing a position in is Pinecrest Energy Inc. PRY. He participated in a bought-deal financing in August at $2.40 per share and in another bought deal last November at $1.55 a share.

"This junior energy producer has proven management from Crescent Point and Peerless Energy." The company is a light-oil producer in Western Canada. It is expected to end the year with production of 3,000 BOE/D. "Wells in its Slave Point area in Alberta are coming on stream at higher rates than forecast by reserve engineers."

Angle Energy Inc.

Pinecrest Energy Inc.
Oct.4 close $5.50 $1.75
52-week high/low $10.54-$5.27 $3.19-$1.36
Market cap $472.4 million $324.2 million
Total % return 1Y* -27.2% 25.9%
Total % return 2Y* 4.1% 139.5%
Total % return 3Y* 5.0% 62.7%
*As of Oct. 4, 2011
Source: Morningstar

In the materials sector, Whitehead increased his stake in the global agricultural company Viterra Inc. VT this September. The company, which has a market capitalization of more than $4 billion, operates in three distinct businesses: grain handling and marketing, agricultural products (fertilizers) and processing. "It is a core holding in the fund; we have owned it since March 2008."

Viterra's prospects for 2012 are promising, he says. Volumes in its grain handling operations should be robust, "given the favourable weather conditions in the Prairies and Australia." Also, its agricultural products segment should do well, "with expected high fertilizer volumes and high prices." In all, "the theme of investing in agricultural stocks continues to have legs."

A mid-cap U.S. technology company that Whitehead added to the portfolio is Amtel Corp. ATML. This company is a global leader in the design and manufacture of microcontrollers (58% of revenues) and touch-screen products.

The latter are used in smartphones and tablets and Amtel has a "leading position in both these markets," says Whitehead. "Its touch-screen products are used in eight out of 10 of the best selling smartphones made by manufacturers such as Samsung, Nokia and Motorola."

This segment of Amtel's business will be a key driver of the company's growth, says Whitehead. Another plus, he says, was Amtel's sale of its less profitable European-based smart-card business last year to refocus on its microcontrollers. "In all, we consider that Amtel has the potential to achieve a 50% or more gross-margin level from the present 40%, earlier than the management's target of the end of 2012."

The largest technology holding in Manulife Growth Opportunities is the Canadian content-management company Open Text Corp. OTC. "Although the company missed analysts' earnings estimates in its past quarter, this is likely to be a one-off situation and its earnings should rebound in the third quarter."

This summer, Whitehead sold his holding in RONA Inc. RON, a distributor and retailer of home-improvement products. The company, he says, is experiencing a squeeze in its margins from higher promotional and higher transportation costs. It is also having to deal with lower consumer spending and increased competition from the expansion of the U.S. home-improvement chain, Lowe's Cos Inc. LOW, into Canada.

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Sonita Horvitch

Sonita Horvitch  

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