Leaner times expected for financial services

Property and casualty insurers are a bright spot, Guardian's Ted Macklin says.

Sonita Horvitch 29 September, 2010 | 6:00PM
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 Ted Macklin, managing director of Toronto-based Guardian Capital LP, says that while Canada's leading financial institutions are of high quality, their future earnings growth is likely to be restrained.

The Canadian banks are, he says, experiencing more moderate loan growth. "There appears to be reluctance by both individuals and companies, in particular, to borrow." Also, in the wake of the financial meltdown, the banks have reduced their off-balance-sheet business, which included controversial structured financial products. "This reduction has resulted in a loss of what was an important source of revenue and earnings growth for them," says Macklin.

Turning to the major life-insurance companies, Macklin says that some are "facing significant headwinds when it comes to earnings growth." He notes that the life companies may be operating in a tougher regulatory environment, and that they are sensitive to stock-market fluctuations and remain vulnerable to a severe market downturn. Also, "they are feeling the pinch from low interest rates, which are adversely affecting their profitability, due to required reserve increases."

Conversely, Macklin says there is considerable upside in these life-insurance stocks "if the stock market rallies strongly and interest rates move up markedly." He says one existing bright spot in the Canadian financial-services industry, from an earnings-growth perspective, is the property and casualty industry.

A member of Guardian Capital's eight-person Canadian equity team, Macklin is a growth-at-a-reasonable-price (GARP) manager and is focused on big-cap Canadian equity portfolios. At Guardian, which has a total of $13.4 billion under management, he is directly responsible for managing a total of $1.4 billion in both institutional and retail mandates. This includes his role as lead manager of BMO Guardian Canadian Large Cap Equity, which has assets of $286 million.

Benchmarked against the S&P/TSX 60 Index, the fund currently has 38 names. It has been attracting money, says Macklin, and "I have selectively added to existing names in what is a low-turnover portfolio."

Ted Macklin

Macklin has "consistently" been underweight in the three biggest sectors in the S&P/TSX 60 Index, which collectively account for 78% of the index. The portfolio holds 25% in financial services (32% of the index), 22% in energy (25%) and 15% in materials (21%). "This underweighting is in the interest of prudence,'' he says, in explaining his preference for broader diversification by sector.

In financial services, a recent addition is Intact Financial Corp. IFC, which constitutes 1.8% of the portfolio. The company is the largest provider of property and casualty insurance in Canada. "The management team, under the leadership of CEO Charles Brindamour, is strong and the company has achieved a high level of efficiency and profitability." Macklin says.

He cites, as an example, Intact's successful harnessing of the Internet as a means of distributing its products. This is in addition to the company's more than 1,800 broker relationships across Canada. The consensus earnings-per-share (EPS) estimate is $3.68 for this year and $4.48 for 2011.

Macklin notes that he is keeping his weightings in the major life insurers Manulife Financial Corp. MFC and Sun Life Financial Inc. SLF at 1.5% and 1.8% respectively. "They are world-class financial institutions, but they do face near-term challenges." The consensus EPS estimate for Manulife Financial is nine cents for 2010 and $1.82 for 2011, and for Sun Life $2.46 and $3 respectively.

Of the banks, Royal Bank of Canada RY, Bank of Nova Scotia BNS and Toronto Dominion Bank TD are in the top five holdings of the fund. The consensus EPS estimate for Royal is $3.75 for the fiscal year to October 2010, and $4.41 for the fiscal year to October 2011.

Royal Bank of Canada Bank of Nova Scotia Toronto Dominion Bank
Sept.28 close $53.04 $53.56 $73.85
52-week high/low $48.85-$62.89 $43.49-$54.20 $61.17-$77.37
Market cap $76.0 billion $56.8 billion $65.1 billion
Total % return 1Y* -4.8 15.8 11.1
Total % return 3Y* 2.5 4.4 2.1
Total % return 5Y* 8.0 7.7 8.0
*As of Sept. 28,2010
Source: Morningstar

For Scotiabank, the estimate is $3.89 for fiscal 2010 and $4.41 for fiscal 2011 and for TD the estimates are $5.53 and $6.23, respectively. Macklin notes that TD and Royal, which both have significant operations south of the border, could benefit from any pick-up in the U.S. economy.

Scotiabank "is well positioned to grow internationally. For example, it is increasing its footprint in Latin America," Macklin says. This bank is also likely to continue to enhance its wealth-management offerings by, for example, "leveraging its relationships" with CI Financial Corp. CIX and DundeeWealth Inc. DW. Scotiabank owns 36% of CI and 18% of DundeeWealth.

Turning to energy, Macklin says that he is more enthusiastic about oil producers versus natural-gas producers. But he did recently add to his holding in the major Canadian natural-gas producer EnCana Corp. ECA. "EnCana's attraction is its participation in the emerging, unconventional natural gas plays in both Canada and the United States," he says.

EnCana's resource plays include the Montney Formation and Horn River Basin in Western Canada and its key plays in the United States, namely Barnett, Piceance and Haynesville. "Both Horn River and Haynesville offer attractive near-term growth opportunities for EnCana," Macklin says. The consensus cash-flow-per-share estimate is $6.13 for 2010 and $6.20 for 2011.

Of his holdings in the materials sector, Macklin has almost 9% in gold stocks, "which is a high weighting for this fund." This weighting is equally split between the senior producers Barrick Gold Corp. ABX and Goldcorp Inc. G. "I am not a gold bug, but gold stocks do add ballast to a diversified Canadian equity portfolio."

The BMO Guardian fund also holds the two leading Canadian fertilizer stocks: Potash Corp. of Saskatchewan POT at 3.8% of the portfolio and Agrium Inc. AGU at 2.8%. Macklin is keeping his holding in Potash as is. The company is the target of a takeover bid by BHP Billiton.

"Potash has long-life assets which are strategic and worth a lot of money." Macklin says. But he has taken some profits in Agrium, "representing one of my few trims in the portfolio in recent months."

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Sonita Horvitch

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