Value manager Mark Thomson, managing director and head of research at Beutel Goodman & Co. Ltd., considers that the Canadian natural-resources sector is fully priced, but the rest of the market is not.
Less cyclical companies such as financial institutions and telecom-services providers are "reasonably valued," says Thomson, who heads the Canadian-equity team at the Toronto-based firm.
These companies, he says, have "the virtue of being strong free-cash-flow generators." They can therefore offer investors both high dividend yields and the prospect of increasing dividends. "At Beutel Goodman, we favour such companies."
A specialist in the financial-services sector, Thomson says that a key factor in evaluating the merits of each of Canada's major chartered banks "is the strength of their domestic retail franchise and what you pay for this." Retail banking is their core business, he says, and there are substantial economies of scale to be had. "The greater the market share, the greater the operating leverage of the bank."
In Thomson's view, the big banks offer solid growth prospects and high dividend yields relative to 10-year Government of Canada bonds. "Those banks, with good capital bases and reasonable payout ratios, are likely to raise their dividends."
In the case of the Canadian telecom-services providers, Thomson says that investors' concerns about new entrants into the Canadian wireless business "are overblown." The newcomers are "significantly undercapitalized and will have difficulty competing against the incumbents over the long term." In addition, he says, wireless penetration in Canada is low by global standards and "as such the established players have decent growth prospects."
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| Mark Thomson | |
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Beutel Goodman manages assets of $22 billion. Of that total, Thomson and his team manage $6.8 billion in large-caps in portfolios that include Beutel Goodman Canadian Equity 
. Thomson is also co-manager of Beutel Goodman Balanced .
The $1.45-billion Beutel Goodman Canadian Equity, with 35 names, has 37.4% in financial services including 26.6% in banks. The two biggest holdings are Toronto Dominion Bank TD at 8.6% and Canadian Imperial Bank of Commerce CM at 7.7%.
Thomson recently doubled the holding in Royal Bank of Canada RY to 5.5%. The opportunity presented itself, he says, when RBC reported disappointing third-quarter earnings to July 31, and the stock retreated. (The banks' fiscal year ends in October.)
Trading revenue from RBC Capital Markets fell to $188 million in the third quarter compared with $1.7 billion for the same quarter in fiscal 2009. "The equity market thought that higher trading numbers were sustainable and they were not," Thomson says.
RBC and TD "are the two biggest domestic retail banks," says Thomson. RBC has 23% of domestic retail deposits versus TD's 25%. When it comes to credit cards and personal loans, RBC's market share is 23% and TD's is 29%. Where RBC shines most, he says, is in the Canadian wealth-management business, with more than one third of this important market.
On its profitability, RBC has a return on equity of 17% to 18%. The stock trades at 12 times fiscal 2011 earnings-per-share estimates and has a dividend yield of 3.7%. "RBC's dividend-payout ratio, based on the current dividend and next year's EPS estimate, is about 44%. This is about mid-way in RBC's target range of 40% to 50%." There is scope for a dividend increase, Thomson says.
| CIBC | Royal Bank of Canada |
Toronto Dominion Bank |
S&P/TSX Financial Services Index |
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| Nov. 9 close | $77.62 | $54.40 | $73.65 | NA | |
| 52-week high/low | $62.60-$79.63 | $48.85-$62.89 | $61.25-$77.37 | NA | |
| Market cap | $29.9 billion | $76.3 billion | $63.7 billion | NA | |
| Total % return 1Y* | 23.9 | -0.1 | 14.3 | 11.6 | |
| Total % return 3Y* | -2.9 | 6.1 | 6.9 | 0.2 | |
| Total % return 5Y* | 5.0 | 8.3 | 8.1 | 4.6 | |
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| *As of Nov. 9, 2010 Source: Morningstar |
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Beutel Goodman Canadian Equity has 12.9% of its portfolio in telecom-services companies. Here, Thomson favours Telus Corp. T as a play on the growth in the wireless business in Canada.
Telus, which represents 5.6% of the portfolio, earns 55% of its net income from wireless, he says. "The decline in its legacy wire-line platform is being more than offset by its growing wireless business." The company is generating double-digit free-cash-flow growth, says Thomson, "and we expect Telus management to be more disciplined in its deployment of capital than it has been in the past."
The stock is "cheap" and has a dividend yield of 4.4%, which is "double that of the S&P/TSX Composite Index." The expectation is that Telus will raise its dividend next year, says Thomson.
A company that Thomson likes for its cable franchise is Quebecor Inc. QBR.B. This stock has a 3.3% weighting in the portfolio. "Quebecor's cable business accounts for 80% of its operating cash flow, it has the dominant franchise in Quebec and it is one of the best run cable companies in North America." The company is spending money on building out its wireless business, he says, and will be able to offer its customers "a complete telecom bundle."
The capital expenditures and handset subsidies will affect Quebecor's free cash flow in the short term, but "it is an appropriate use of its capital and a viable alternative to paying it back to shareholders," Thomson says. Over the longer term, Quebecor's free-cash-flow growth should be "in the high single-digit range." The stock is "inexpensive."
In the materials sector, Thomson reduced his holding in Potash Corp. of Saskatchewan Inc. POT, "given our sell discipline of selling one third (of our position) when a stock hits our original target." It is now 1% of the portfolio.
He also reduced his holding in Enbridge Inc. ENB by one third as "the stock hit our target price." Enbridge currently represents 1.8% of the portfolio.
A major North American energy distributor, Enbridge is therefore classified in the energy sector. "The company has an excellent business and great management;" says Thomson. "In fact I like everything about this company except the valuation."
