Alan Wicks finds sweet spot in mid caps

Manager sees good value in consumer stocks RONA and Dorel; Transcontinental shows promise with new U.S. assets; BMO's dividend too generous.

Sonita Horvitch 2 September, 2009 | 6:00PM
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Value manager Alan Wicks, vice-president and senior portfolio manager of Canadian equities at Toronto-based MFC Global Investment Management, is finding some of his best opportunities among mid-capitalization stocks.

Canadian large caps, he says, have benefitted from the flow of funds back into equities, since the market bottomed this March. "Big caps offer liquidity and are a natural re-entry point for investors."

At the other end of the spectrum, Canadian small caps, he says, have been boosted by the fact that many are natural resource juniors, which have participated in the general surge in base metal stocks as well as the rebound in energy stocks over the past six months.

This leaves mid caps, he says, with consumer discretionary stocks in particular offering a good risk/reward profile. "There has been investor concern about the health of the consumer, and we consider that these stocks do not reflect the fact that this health is improving," says Wicks.

At MFC, Wicks and his team are responsible for managing $8 billion in a wide range of value mandates includingManulife Canadian Value , which has $300 million in assets and 45 names.

Of late, this team has been raising cash by selling down names that have "increased substantially and reached our sell target." Cash is currently 7%.

 
Alan Wicks

Manulife Canadian Value is, says Wicks, predominantly a large cap fund. "It would be rare to have a holding with a market capitalization of less than $500 million."

The fund's sector weightings are a reflection of the individual stocks in which Wicks and his team have been finding value. At the moment it has substantially overweight positions in both consumer discretionary stocks, at 10% versus 4% in the S&P/TSX Composite Index, and consumer staple stocks at 5% versus 2.7%.

But the fund has underweights in both financial services (28%) and energy (20%) compared with their weightings in the index of 32% and 28%, respectively. These are the two largest sector weights in the index.

Another underweight is materials stocks at 12% of the portfolio versus 17% of the index. This, he says, is a reflection of the fact that the fund only has a modest position in gold stocks. "I find them to be expensive."

The MFC team uses a comprehensive proprietary quantitative model that screens for value based on metrics that are appropriate for a particular company. It then subjects its targets to both quantitative and fundamental analysis. As part of this process, the team looks at a wide range of characteristics of the business such as market dominance, barriers to entry, government policy risk, exposure to fluctuations in input costs and strength of management. A key financial metric is the calculation of a book value for the business.

A stock that he considers offers good value at this stage is RONA Inc. ( RON/TSX). The company, which has a market capitalization of $1.7 billion, retails and distributes home improvement hardware and gardening supplies in Canada. "The stock was badly beaten up because of the general concerns about the consumer and the housing sector." It currently trades at MFC's estimated book value per share. Its price-earnings (P/E) multiple is 12 times earnings-per-share (EPS) estimates for 2009 and 11 times for 2010.

Another consumer discretionary stock in the portfolio that he highlights is Dorel Industries Inc. ( DII.B/TSX), which has a market capitalization of $1 billion. Dorel has three business segments: products aimed at the children's market including infant seats, strollers and high chairs; recreational products such as bicycles "where it is building a global business in leading brands"; and home furnishings, including ready-to-assemble products. Dorel, says Wicks, has been making strategic acquisitions in these three segments. The stock trades at 0.9 times MFC's estimated book value per share, and its P/E multiple is 8.5 times the EPS estimates for 2010.

A name that has seen its stock come under pressure but offers promise, according to Wicks, is Transcontinental Inc. ( TCL.A/TSX). This is a major North American printing, publishing and marketing services company with a market capitalization of $800 million. Transcontinental has seen its printing and direct mail business decrease in this economic downturn, says Wicks. It has reduced costs in many of its divisions, he says, and is starting to see the fruits of its capital expenditure in the United States on a state-of-the-art printing press in the San Francisco Bay area.

Under a 15-year contract with Hearst Corporation, Transcontinental has started to print the San Francisco Chronicle daily newspaper and its related products, as well as to provide complete post-press services. There is enough extra capacity in this plant, he notes, and this can be used to print other publications. The stock trades at 0.75 times MFC's estimated book value per share and at a P/E multiple of 6.5 times the EPS estimate for the fiscal year to October 2009.

Stocks of the major Canadian banks have had a considerable run this year, says Wicks, and he considers that the risk/reward ratio is better for Canadian insurers than for the banks. "A mid-cap Canadian insurance company has shown up on our radar screen," he says.

Still, Toronto-Dominion Bank ( TD/TSX) was his largest holding in the fund and Bank of Montreal ( BMO/TSX) featured in the top 10 holdings at the end of July. Wicks notes that he has been reducing his holding in Bank of Montreal. The stock trades at 1.7 times MFC's estimated book value per share. "Bank of Montreal has a higher dividend payout ratio than its Canadian peers, which will make it more challenging for it to build book value," Wicks says.

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Sonita Horvitch

Sonita Horvitch  

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