Low-cost leaders in resources

Efficient natural-gas producers are among Mackenzie strategist Fred Sturm's favourites.

Sonita Horvitch 12 May, 2010 | 6:00PM

 Fred Sturm, executive vice-president and chief investment strategist at Toronto-based Mackenzie Financial Corp., is bullish on the price of natural gas and is steadily building up his holdings from previously low levels in both producers and pipeline companies.

His call: The natural-gas price, which has been weak for some time, should improve in 2011 and 2012, "but it will likely take until 2014 or 2015 for it to more substantially close the gap relative to the oil price."

A leading natural-resource specialist in Canada, Sturm's responsibilities at Mackenzie includeMackenzie Universal Canadian Resource, with assets of $1.6 billion, which he has managed for 24 years. Sturm and his team are responsible for managing $9 billion. Other mandates includeMackenzie Growth,Mackenzie Universal World Resource Class  andMackenzie Universal Precious Metals.

Sturm's strategy in managing Mackenzie Universal Canadian Resource is to overweight or underweight industries, depending on the inventory outlook for the relevant commodity and the stock valuations. Any commodity that China has needed, such as copper, iron ore and metallurgical coal, has had a big run in China's economic recovery and the stocks have followed suit, he says.

Sturm and his team have been "harvesting gains" in these stocks and, in the main, "progressively building up" positions in natural-gas producers and natural-gas pipeline companies.

He is also seeing opportunities among forest-products companies. After being in the doldrums for some time, these commodity prices are rebounding and the stocks are responding, he says.

Here, Sturm and his team are emphasizing "those companies with tree farms in emerging economies." The focus is on sustainable cash-flow producers. A major holding in the fund is Canada's Sino-Forest Corp. TRE, which has commercial forest plantations in China.

 
Fred Sturm

On agriculture, Sturm notes that he has reduced his exposure to companies serving this industry. "While their profits and prospects are solid, the stocks are fairly priced, given the companies' prospective rates of growth."

Looking at the big natural-resource picture, Sturm says that there is currently sufficient supply of most commodities to meet global demand, and that "the commodity prices at present reflect skepticism about the sustainability of that demand."

His strategy against this backdrop is to target the most efficient producers in their industries with high-quality assets and strong technical skill sets. Sturm's extensive analysis of the future demand/supply equation for major commodities calls for a scarcity of supply in five years.

On the demand side, global growth will continue to strengthen, he says. But the supply remains constrained by a raft of factors such as "growing" political interference (for example in Australia), smaller discoveries, technological challenges, environmental issues, capital-investment requirements and a lack of new talent entering the natural-resource industry.

"There could well be a rationing of key commodities in five years," Sturm says. This will naturally boost commodity prices, perhaps benefiting the marginal players most, he says. "But until we position accordingly, we will continue to focus on low-cost leaders."

Sturm underscores that the team's strategy for managing Mackenzie Universal Canadian Resource is decidedly global. The fund currently has roughly half of its holdings in companies with their head offices outside Canada, with the United States the largest foreign weighting at 27% of the portfolio.

"There are better valuations elsewhere," Sturm notes. Also, the pool of major global natural-resource players based in Canada is limited and these "steady wealth creators" are the "anchors" in the fund.

A Canadian example in the portfolio is the gold producer Barrick Gold Corp. ABX, with its global reach, which Sturm says is "an attractively priced slow grower." Added to these core holdings, he says, are the exploration companies that tend to have higher growth rates.

Mackenzie Universal Canadian Resource's major sector weightings are in energy at 53% (mainly producers and services companies) and materials at 26%. A substantial portion of the materials weighting consists of precious-metals equities. As for other sectors, pipelines and other utilities constitute 9%, forest products 7% and agriculture a modest 4%.

As part of the team's "contrarian" stance on natural-gas producers, it has added to holdings in two Canadian companies: Progress Energy Resources Corp. PRQ and Advantage Oil & Gas Ltd. AAV. Progress Energy, says Sturm, has high-quality assets focused on a prime part of the Western Sedimentary Basin. It has a low cost structure and strong technical skills.

How two natural gas producers have fared YTD 1Y 3Y 5Y
Progress Energy Resources Corp. 0.4 0.1 -9.3 3.6
Advantage Oil & Gas Ltd. -5.7 55.0 -10.0 -13.1
Returns as of May 10,2010
Source: Morningstar

Recently converted from an oil and gas royalty trust, Advantage is focusing on developing its significant Montney natural-gas resource play at Glacier, Alta. "The valuation on these two stocks is reasonable, they are both efficient producers and sustainable free-cash-flow generators," says Sturm.

Two U.S.-based companies that Sturm believes offer good value are El Paso Corp. EP and Williams Cos. Inc. WMB. Both of these companies are natural-gas producers that own pipeline utilities.

El Paso owns North America's largest natural-gas pipeline system and is a large natural-gas producer. Williams is an integrated natural-gas company that produces, processes and transports natural gas in the United States. "The market is not fully valuing the underlying businesses of these companies," Sturm says. "We are big proponents of infrastructure assets."

Both stocks are significant holdings in Mackenzie Universal Canadian Resource. Sturm and his team have taken profits in the oil-sands giant Athabasca Oil Sands Corp. ATH, which was a $1.35-billion initial public offering in April at $18 a share. The price declined after the stock was listed. But Sturm notes that he was an early investor in this company when it was still private and "we have done well in this stock."

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Sonita Horvitch

Sonita Horvitch