Canadian small-cap manager roundtable: Part 3

Value picks, growth picks, and some that are both

Sonita Horvitch 18 February, 2011 | 7:00PM
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Editor's note: Small-capitalization stocks are less followed and less widely held than the large-caps, and portfolio managers use that lack of familiarity to their advantage. As we learned at Morningstar's Canadian small-cap manager roundtable, however, their respective investment disciplines will sometimes lead them to the same names.

Our panellists:

 Stephen Arpin, vice-president at Beutel, Goodman & Co. Ltd. and lead manager of Beutel Goodman Small Cap  .

 Ted Whitehead, senior managing director and senior portfolio manager at Manulife Asset Management, who manages Manulife Growth Opportunities  .

 Martin Ferguson, director and portfolio manager at Calgary-based Mawer Investment Management Ltd. He manages Mawer New Canada, which is closed to new investors, and BMO Guardian Enterprise  .

William Aldridge, associate portfolio manager at Mackenzie Financial Corp., who is co-manager of Mackenzie Saxon Small Cap and Mackenzie Saxon Mircocap.

Today's instalment concludes this week's three-part series by Morningstar columnist Sonita Horvitch, who convened the manager roundtable and served as its moderator.

Q: Time to discuss your stock selections.

Ferguson: We have just less than 60 names in BMO Guardian Enterprise and Mawer New Canada. The range is 40 to 60. Our definition of small-caps is $500 million or less at the time of first purchase. We have a low turnover. In all, I manage assets of $1.3 billion.

Montreal-based Paladin Labs Inc. PLB is a pick for the roundtable. Paladin is a specialty pharmaceutical sales and marketing company. Jonathan Ross Goodman is president and CEO. The company is currently doing a $35-million bought deal of common shares.

William Aldridge

Whitehead: We own it. Management is conservative. The company continues to deliver on earnings and growth.

Ferguson: Recently, Paladin announced an acquisition of the Tempra line of products in Canada, aimed at kids, from Bristol Myers Squibb. Paladin did not pay much for the acquisition.

Whitehead: Paladin has no debt.

Aldridge: We own Paladin. With an established base in Canada, Goodman is now successfully branching into overseas operations.

Ferguson: Another pick is Equitable Group Inc. ETC. It's in a duopoly position with Home Capital Group Inc. HCG, which is my largest holding.

Arpin: We own Equitable Group.

Aldridge: So do I.

Equitable Group
Home Capital
Group Inc.
Feb. 17 close $29.15 $59.04
52-week high/low $29.38-$19.86 $59.23-$38.21
Market cap $435 million $2.05 billion
Total % return 1Y* 44.2 37.6
Total % return 3Y* 7.5 15.6
Total % return 5Y* 3.7 7.7

*As of Feb. 17, 2011
Source: Morningstar

Ferguson: These are mortgage-finance companies, focusing on non-prime mortgage lending. It is a good niche. Equitable earns a decent return on equity and this ROE will be increasing. The stock trades at slightly above book value and still well below 10 times earnings per share.

Arpin: We expect Equitable's ROE to be north of 15% over time, and the stock is trading at book value. It is substantially undervalued relative to other financial stocks.

Aldridge: Its ROE has been lower than that of Home Capital's for some time, as Equitable has been lending on condominiums. But its strategy is to focus more on single-family homes. The regulators require lower back-up capital on the balance sheet of these mortgage lenders when they lend for single-family homes.

Q: Martin, any other selections?

Ferguson: Fortress Paper Ltd. FTP.

Stephen Arpin and Martin Ferguson

Whitehead: We own it.

Ferguson: CEO Chad Wasilenkoff has put Fortress together. He started off by buying two undervalued specialty-paper mills in Europe in 2006. The one in Germany is a wallpaper producer and the mill in Switzerland is a bank-note-paper producer. The game changer was Wasilenkoff's recent purchase of a paper mill in Thurso, Quebec, which he bought for a song. Fortress will produce cellulose-based rayon fabric from this mill. There is a shortage of rayon globally. Wasilenkoff is a wealth creator for shareholders.

Whitehead: The stock demonstrates everything that we look for in our initial quantitative analysis. It has rising earnings estimates, positive earnings surprises and positive price momentum. The stock had a huge run in 2010. We bought it on the IPO (initial public offering) in 2007 at $8. It is now around $60.

Q: Ted, your portfolio?

Whitehead: We currently have 91 names in Manulife Growth Opportunities. This mandate has $1.5 billion in assets. We use the BMO definition of small-caps, currently companies with market caps under $1.7 billion.

North American Palladium Ltd. PDL. It's a play on a recovery in the auto sector. The main producer of this commodity is South Africa, which has power and labour challenges. Palladium's primary assets are in Ontario and Quebec. The commodity has gone up with the other precious metals.

I have two other commodity-related names and the message here is that they have their financing behind them. Northland Resources Inc. NAU is a development-stage mining company with iron-ore projects in northern Sweden and Finland. The stock is currently at half of Northland's NAV (net asset value). Production should begin in about two years.

Baja Mining Corp. BAJ is a copper play and I am bullish on this metal. The company is the operator and 70% owner of the Boleo mine project in Baja, Mexico. Production is expected to start up in early 2013. The stock trades at a little less than half Baja's NAV.

My final pick is Twin Butte Energy Ltd. TBE. The stock had a bit of a run recently. It's a heavy-oil producer in Alberta. The president and CEO is James Saunders, who has typically built up companies and then sold them. It's the third company of his that we have invested in.

Q: William?

Ted Whitehead

Aldridge: We are value managers. We manage about $600 million in Mackenzie Saxon small-cap mandates. We have about 55 names in Mackenzie Saxon Small Cap and have a low turnover. We use the BMO definition of small-caps.

Besides Canaccord, another stock that I am selecting for the roundtable is Major Drilling Group International Inc. MDI. It has a $1-billion market capitalization. This is a drilling contractor to the mining industry and a leading player in this field globally. It is an indirect way for us to play metals and mining. The production companies and explorers have access to capital and are spending a lot of money on drilling. The company's balance sheet is super clean and the stock has a nice dividend. It has had a great run and is not as cheap as it was.

Arpin: I own it.

Aldridge: My final pick is a specialist retailer of cell phones, Glentel Inc. GLN, which has a market cap of $330 million. It recently bought into the U.S. market. Consumers view Glentel as an unbiased advisor on cell phones and cell-phone plans. Management has a history of building and selling companies. Glentel has a history of increasing its dividends and buying back shares. Its return on equity has been strong.

Q: Stephen, you -- like William -- are a value manager. Time to discuss your buys.

Arpin: Beutel Goodman Small Cap has 45 names. In all, the small-cap team manages $1.45 billion. We target companies with a market float of $100 million to $1.5 billion. We are overweight financials and our two biggest holdings in the portfolio are Intact Financial Corp. IFC, a property and casualty company, and Industrial Alliance Insurance and Financial Services Inc. IAG, a life insurer.

Whitehead: We own Intact.

Arpin: Intact is not one of the names that I am going to pick. Right up there with Ted's pick, Twin Butte Energy, is Emerge Oil and Gas Inc. EME, a heavy-oil producer. It has a market cap of $300 million and is a recent addition to the portfolio. Emerge has been public for about a year. It is under-followed. The stock trades at 1.2 times price to net asset value and five times forward cash flow per share. My next pick is automotive-parts distributor Uni-Select Inc. UNS.

Ferguson: I own it.

Arpin: A substantial portion of its business is in the United States. It trades at nine times forward earnings. The stock is super cheap. Uni-Select just completed an acquisition of FinishMaster Inc., a major auto-parts distributor in the United States. This acquisition should be accretive. The company has historically grown through acquisitions. Uni-Select's debt is about three times its EBITDA (earnings before interest, taxation, depreciation and amortization). That is something you have to pay attention to.

Ferguson: We have owned it for quite a while. It's a steady business model with lots of barriers to entry and the stock is inexpensive.

Arpin: My final pick is Allied Nevada Gold Corp. ANV. It's already a producing company. It trades around its NAV for its existing operation, but there is a substantial resource upside. It's my biggest holding of eight gold names in the portfolio.

Additional coverage of the Canadian small-cap manager roundtable

 Part 1: Two consecutive years of stellar returns is a hard act to follow.

 Part 2: Merger activity will help drive stock prices, panellists say.

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Sonita Horvitch

Sonita Horvitch  

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