The case for cyclicals

Why Tetrem's Daniel Bubis is adding to his energy holdings.

Sonita Horvitch 13 October, 2010 | 6:00PM

 Daniel Bubis, president and CEO of Winnipeg-based Tetrem Capital Management Ltd., is bullish on equities, given the undertakings by governments in mature economies to do all it takes to stave off a double-dip recession.

Pessimism about the sustainability of the economic recovery in the United States and Europe has been "excessive," he says. "Investors have been fighting yesterday's war, by moving money out of equities into bonds." The result is that stocks are cheap relative to bonds.

Bubis points out that the developed world has experienced the worst recession since the 1930s. "While some of the recent economic data out of the United States has been disappointing, these aftershocks are to be expected." Bubis adds that policy-makers will "properly assist the recovery through appropriate monetary and fiscal policy."

There has been some recognition of this in the substantial third-quarter rally in the global equity market. In local-currency terms, both the Canadian equity market and the U.S. market were up sharply during that period. Bubis says it is to be expected that there could be modest profit-taking. "But I remain bullish longer-term."

Within the Canadian equity market, the rotation into more defensive areas, such as telecom-services stocks and food retailers, "has left these stocks expensive." There continues to be value among the cyclicals, he says.

Energy stocks in particular offer good upside, says Bubis. In mid-September, he added to his holdings across the board in Tetrem's Canadian equity portfolios. The firm manages $5.7 billion, of which $4.6 billion is for CI Financial Corp. The largest mandate is CI Canadian Investment  , which Bubis manages.

 
Daniel Bubis

At the end of September, this portfolio held roughly 75% in Canadian equities. Of the foreign content, U.S. equities comprised roughly half, at around 13% of the fund as a whole. In the economically sensitive industries, energy represented 25% of fund assets, materials 16% and industrials 10%.

Bubis and his team target stocks that trade below Tetrem's estimated intrinsic value of the business. A senior energy producer that Bubis believes offers good value is Talisman Energy Inc. TLM, which is in the fund's top 10 holdings.

Talisman trades at 4.5 times estimated cash flow per share for 2011, compared with a six-times multiple for its peers. "It is also cheaper on a price-to-book basis," Bubis says. The company operates both domestically and internationally. "It is doing well operationally."

Despite this progress, Talisman Energy "remains a show-me stock," says Bubis. John Manzoni, who was appointed CEO at Talisman three years ago, is redefining the company's strategy. "There is scope for the stock to trade at a multiple that is more in line with the peer group," Bubis says.

Bubis is also enthusiastic about energy-services providers. "There is, for example, strong demand for fracturing services used in shale gas plays." Here he likes Trican Well Service Ltd. TCW, which is a dominant player in this field domestically and is expanding its presence internationally.

Trican's stock has done well, says Bubis, but there is more upside. Trican trades at an enterprise value (equity plus debt) to EBITDA (earnings before interest, tax, depreciation and amortization) of seven times 2011 estimates, "which is around its historic average." The company has good earnings prospects over the near-term and this multiple could expand, Bubis adds.

At the same time, he provides a note of caution concerning Trican. "We are in a sweet spot in the cycle for fracturing services, where demand exceeds supply. But there is new capacity coming on stream and, at some stage, I will be looking to book some profits in the stock."

Talisman Energy Inc. Trican Well Service Ltd.
Oct. 12 close $18.29 $17.11
52-week high/low $15.71-$20.86 $10.43-$17.25
Market cap $18.8 billion $2.5 billion
Total % return 1Y* -5.6 22.9
Total % return 3Y* -1.2 -3.7
Total % return 5Y* 2.0 -3.4
*As of Oct. 12,2010
Source: Morningstar

Early this year, Bubis sold his holding in Canadian Oil Sands Trust COS.UN because it was "more expensive than other oil-sands plays." This turned out to be "a good move," he says, as the unit price has since declined.

Turning to the industrial sector, Bubis considers that "we are in the early stages of a positive commercial-aerospace cycle." There is also secular growth in infrastructure spending, which will benefit suppliers.

Bombardier Inc. BBD.B is a play on both, Bubis says. The stock trades at 12 times 2010 earnings-per-share estimates. "These are depressed earnings, reflecting a trough in the aerospace cycle."

The company has a transportation-order backlog of US$30.3 billion, notes Bubis. It has had recent wins in Latin America. If its new C Series aircraft is "moderately" successful, Bombardier shares will receive a big boost from investors, he says.

Also, the Quebec government is awarding a $1-billion contract to Bombardier to manufacture 500 subway cars for Montreal. "In all, it is a cheap stock and there are good growth prospects. The stock has a dividend yield of 2%, which is a further plus."

One of the portfolio's largest holdings in the materials sector is Potash Corp. of Saskatchewan POT at 4.3%. Bubis says he "built out his holding in 2009, when the company ran into some issues; in 2007-2008 it was too expensive for a value manager."

After BHP Billiton's announced hostile takeover bid for Potash in August, Bubis took some money off the table in the stock. "But I have held on to most of it, as there is a high probability of a bid greater than the US$130 a share currently on the table."

Also in materials, gold stocks constitute 8% of the portfolio. "The low-interest-rate environment and the ongoing quantitative easing by developed-country governments support bullion."

Bubis says large-cap Canadian gold producers are "inexpensive." The two biggest holdings in the fund are Barrick Gold Corp. ABX, which trades at 14 times 2011 earnings per share estimates, and Goldcorp Inc. G, which trades at 22 times 2011 EPS estimates.

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Sonita Horvitch

Sonita Horvitch