Canadian equities manager roundtable: Part III

Senior gold stocks appeal to both growth and value managers

Sonita Horvitch 21 January, 2011 | 7:00PM

Editor's note: Materials stocks are the main theme of today's concluding part three of Morningstar's manager roundtable on Canadian equities. There is also a brief discussion on the outlook for the Canadian banks. Our four panellists: Ted Macklin, managing director, Canadian equities, at Guardian Capital LP; Martin Hubbes, executive vice-president and chief investment officer at AGF Investments Inc.; Daniel Bubis, president, chief investment officer and founder of Winnipeg-based Tetrem Capital Management Ltd., and manager of CI Canadian Investment  ; and Suzann Pennington, senior vice-president and leader of the Saxon Group's all-cap Canadian equity and balanced team at Mackenzie Investments. The roundtable was organized and led by Morningstar columnist Sonita Horvitch. The first instalment, a discussion of the market outlook, ran on Monday, followed by Wednesday's part two, which was devoted to energy stocks.

Q: Time to talk about the materials sector, which is 24% of the S&P/TSX Composite Index. Let's start with coal.

Pennington: There is no pure play on thermal coal in Canada.

Macklin: A way to play metallurgical coal is through Teck Resources Ltd. TCK/B. I reinitiated a position in the stock in September. I sold Teck when the company concluded the acquisition of the remainder of Fording Canadian Coal Trust in 2008. I was concerned about balance-sheet risk. Teck has since addressed its balance sheet. I like the outlook for metallurgical coal and copper. Zinc has a less favourable outlook, but it is less material to Teck, if you will pardon the pun. From a large-cap manager's perspective, Teck is the obvious way to play this area.

Hubbes: There is not a lot left in the large-cap Canadian base-metals space.

Pennington: Teck has a couple of the best commodities with its metallurgical coal and copper. The Fort Hills oil-sands project is coming on steam in 2012. Teck's energy component is not material now, but it could be in the future. We trimmed Teck a little, as the stock moved a lot.

Bubis: We own it too. It still trades at a discount to some of its global peers. The stock has had a spike recently. This is due to the flooding of the mines in Australia, so you have to be a little cautious right now. I have been trimming Teck.

Macklin: I don't have a big enough position to trim.

 
Martin Hubbes

Hubbes: Neither do I.

Q: Gold stocks? They are close to 13% of the index.

Macklin: They add ballast to a portfolio. I am staying with the seniors. My two long-standing holdings are Goldcorp Inc. G and Barrick Gold Corp. ABX. Barrick is one of the biggest gold producers in the world. It doesn't have the growth profile of some of the juniors or Goldcorp, but Barrick does have some attractive growth opportunities. I like Barrick's new management team. There will be continued dividend increases out of Barrick and Goldcorp. Bullion is vulnerable to a pullback at this stage, but long term, I am constructive on gold.

Hubbes: I have owned gold stocks for some time now. A lot of the better gold companies are starting to make money and in a more significant way than they historically have. I have focused on the companies that have some production growth and have better operating metrics. The big positions that I have are Agnico-Eagle Mines Ltd. AEM, Goldcorp and Barrick. The value managers might say that Agnico is expensive, but it has tremendous growth.

Bubis: Agnico-Eagle is not that expensive. Barrick is a big holding. The juniors are not our cup of tea. Barrick is nicely diversified across mines and geographies. It has had a strong earnings-growth profile over the last four or five years. It's easier now to value gold companies than it has been as long as I've been in this business. The large-cap gold companies have become real companies. Again, it's the large-cap theme that is coming out of this roundtable. The valuation multiples on the large-cap Canadian gold producers have been contracting. In a bubble, you typically see a multiple expansion. The positive secular move on bullion is intact.

 
Daniel Bubis

Pennington: Gold stocks are a must-own because they behave significantly differently from anything else in the portfolio. I also own a silver stock, Pan American Silver Corp. PAA. Silver lagged gold coming out of the financial crisis. It started to play catch-up in mid-2010 and silver prices have moved up substantially. Platinum also offers a store of value and has industrial and investment demand. A Canadian way to play this is Eastern Platinum Ltd. ELR.

Hubbes: I own it. We bought it on the last issue.

Pennington: So did we. It is a way to play the huge auto-sales growth in the developing world as platinum is used in emission controls. The price of platinum is well below its previous high.

Hubbes: In addition to developing-country demand, platinum will benefit from a rebound in the U.S. auto market.

Q: Briefly, agricultural stocks.

Bubis: We own Potash Corp. of Saskatchewan Inc. POT.

Pennington: I own Potash and Agrium Inc. AGU.

Macklin: I own both.

Hubbes: I own only Potash.

Bubis: The commodity is an essential resource and Potash Corp. of Saskatchewan is the best producer of it, with long-life reserves.

Macklin: It has growth in its reserves.

Bubis: It is a good diversifier in a portfolio.

Macklin: Agrium has a retail business.

Pennington: This is growing and its production of fertilizers is growing.

Q: Our emphasis at this roundtable has been on natural resources. We should briefly discuss financial services, at almost 28% of the index.

 
Suzann Pennington

Macklin: Banks are 18% of the composite. The growth in the banks' earnings going forward is going to be restrained. You are going to see dividend increases. I favour Toronto-Dominion Bank TD and Bank of Nova Scotia BNS. But all the banks in Canada are high quality. I am in a holding pattern with the banks. The insurance companies (6% of the index) continue to face headwinds near term. Longer term, they can develop markets in emerging economies.

Pennington: The banks' loan growth will be moderate in 2011, net interest margins will probably be relatively stable and there will be modest dividend growth in line with the earnings. You will probably have rates of return in line with those of the Composite. Banks could produce high single-digit returns, with dividends a big component of that. The dividend yield on bank stocks is 3.5% to 4.5% depending on the bank. Like Ted, I like the TD, which is by far my biggest weighting in the banks.

Bubis: It is all about risk/reward. There is limited downside on these stocks. There will be reasonable returns going forward. By contrast, I think that we all agree that there is more upside in the commodity stocks for the next year or two. But, you also have more immediate downside risk that you do not see in the banks. TD is my biggest holding in the banks. We bought more on the Chrysler Financial transaction at the end of last year. Our second largest position is Royal Bank of Canada RY. We were building our Royal holding all of last year, as it had continued to disappoint. The stock usually trades at a premium valuation to its peers, but now it is arguably at a discount or in line. This presents an opportunity. The stock was actually down in 2010.

Hubbes: My largest bank position is TD, which it has been for years, and the second largest position is Scotiabank. Six or eight months ago, I initiated a position in Canadian Imperial Bank of Commerce CM, for the first time in many years. It is trading at a significant discount to the group. I am betting that it will focus on its core business. I am still not fully there yet. It is a 2.5%, not a 5% position. Its jewel is its Canadian banking business.

Photos: paullawrencephotography.com

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Sonita Horvitch

Sonita Horvitch