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PH&N managers find insurers alluring

Manulife and Sun Life among firms expected to emerge from industry's current malaise with strong earnings rebound.

Sonita Horvitch 25 November, 2009 | 7:00PM
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Dale Harrison and Andrew Sweeney, co-managers ofPH&N Dividend Income , have been taking profits in Canadian bank holdings this year and increasing their exposure to Canadian insurance companies, telecom services providers and select industrial companies. "We considered that the banks were fairly valued and there were better opportunities elsewhere," says Harrison.

Sweeney notes that the bank weighting was reduced during the first half of this year in favour of life insurance companies. "This was a switch within the financial services sector," he says.

In the three months to the end of September, the two managers further lightened up their bank holdings, "this time in favour of other sectors such as telecom services and select industrial stocks," says Sweeney.

Nonetheless, bank stocks remain core holdings of PH&N Dividend Income, which is managed using a growth at a reasonable price (GARP) style. At latest count, banks represented 24% of this fund, which has a total weighting in the financial services sector of 45%. The top three holdings as of the end of October -- Canadian Imperial Bank of Commerce ( CM), Toronto-Dominion Bank ( TD) and Royal Bank of Canada ( RY) -- are Big Five banks.

At Vancouver-based Phillips, Hager & North Investment Management Ltd., part of RBC Global Asset Management Inc., Harrison and Sweeney have a number of mandates including PH&N Dividend Income, which has assets of $2.5 billion. The fund has a foreign-content component, currently 13% in U.S. stocks. This foreign-currency exposure is 50% hedged.

Dale Harrison

A long-time specialist in the financial services sector, Harrison says that the move to boost insurance company exposure reflects the expectation that their earnings growth will rebound strongly over the next couple of years. Short-term earnings might be lacklustre, he says. "The current malaise in the insurance stocks reflects an investor focus on short-term earnings prospects."

Harrison argues that major Canadian insurance companies such as Manulife Financial Corp. ( MFC), which the duo added to this year, and Sun Life Financial Corp. ( SLF), a new position in the fund this year, will emerge from the financial meltdown, "with enhanced long-term earnings growth prospects." They will, he says, have stronger balance sheets and "be in a position to acquire weaker competitors globally." Manulife and Sun Life were both in the top 10 holdings of PH&N Dividend Income at the end of October.

Manulife (MFC) Sun Life (SLF)
Nov. 24 close $18.50 $29.27
52-week high/low $26.50-$9.02 $38.50-$14.97
Market cap $30.3 billion $16.4 billion
Total % return 3Y* (17.8) (11.9)
Total % return 5Y* (3.7) (1.7)
Total % return 10Y* 9.8 NA**
*As of Nov. 24, 2009
**Sun Life became a publicly traded company in March 2000
Source: Morningstar

The fund has a total of 52 names and its average dividend yield is 3.2%. "We look at total returns, not just the dividend yield," says Sweeney. "Key is that the company has the ability to grow its cash flow and dividends." Qualitatively, there is an evaluation of the sustainability of the target's business model including an analysis of its competitive strength.

Sweeney, who has been following telecom stocks for many years, says that two companies that are strong cash-flow generators, are well capitalized and have attractive growth prospects are Rogers Communications Inc. ( RCI.B) and Shaw Communications Inc. ( SJR.B).

The duo added to the existing position in Rogers, which now constitutes 2.5% of the PH&N fund. Some two-thirds of Rogers's business is wireless and one third is cable, says Sweeney. "Investors are concerned about the impact on Rogers from competition by new entrants into the Canadian wireless business," he notes. "They are underestimating the resiliency of the current players."

Rogers trades at an enterprise value (equity plus debt) to EBITDA (earnings before interest, depreciation, taxes and amortization) based on 2010 estimates of 5.7 times. "This valuation is low by historic standards."

The two managers established a new position in Shaw Communications Inc. This cable company, says Sweeney, is facing competition from TELUS TV, which is being rolled out in western Canada. "We consider that the cable companies are better placed to compete for customers than the telephone companies," says Sweeney, "as they have greater capacity to launch new services through their networks."

  Andrew Sweeney

Shaw's valuation of EV/EBITDA, based on 2010 estimates, is seven times. The company has traditionally traded at a premium to the group, he says, but this premium is currently lower than it has been historically.

Two companies in the industrial sector that Harrison and Sweeney consider will benefit from the global economic recovery are Toromont Industries Ltd. ( TIH) and Finning International Inc. ( FTT). "It is hard to find quality cyclical companies that trade at reasonable valuations," says Sweeney. The two stocks combined represent 2.5% of the portfolio.

Harrison and Sweeney added to their holding in Finning, which has Caterpillar heavy-equipment dealerships in Western Canada, parts of South America and the UK. "Its excellent Canadian and South American dealerships, which are geared to the natural resource industry, will do well with the rebound in their customers' capital expenditure," says Sweeney.

Toromont holds a major Caterpillar dealership in Canada and has, he says, been successfully building its compression group, which specializes in designing, making and installing compression systems, mainly for the energy industry.

The company has been expanding this business in the United States, and its recent bid to take over Enerflex Systems Income Fund ( EFX.UN), if successful, "will make Toromont a global player."

As part of their profit-taking in Canadian bank stocks, the two managers eliminated a "sizeable" holding in National Bank of Canada ( NA), says Harrison. "Investors were overly focused on National's exposure to the troubled asset-backed commercial paper market and took the stock down," he says. "The stock recovered as we had hoped and we sold it, as we considered that there is unlikely to be a large rebound in National's earnings over the remainder of the cycle."

In general, says Harrison, Canadian bank earnings "were more resilient during the financial meltdown and economic downturn than the equity market had anticipated, so there is unlikely to be material acceleration in earnings over the next few years."

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Sonita Horvitch

Sonita Horvitch  

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