Mark Thomson boosts bank holdings

Beutel Goodman is a traditional value manager. Thomson, who heads the Canadian equity team, has extensive responsibilities including managingBeutel Goodman Canadian Equity . He is also co-manager ofBeutel Goodman Balanced , as well asHartford Canadian Dividend andHartford Canadian Value.

Beutel Goodman Canadian Equity "is fully invested, with only 1% in cash, which is low by historic standards and indicates my optimism about the equity market," Thomson says. He and his team look for stocks that they believe can deliver a minimum of 50% total return over three years. "When the stocks hit their target price, we do a minimum one-third sale."

Mark Thomson

The fund, which has 32 names, holds a 35% weighting in the financial services sector, consisting of 22% in banks and 13% in insurance companies.

Thomson notes that before March 2008 the portfolio had a significantly underweight to the banks because of the managers' concerns about the negative impact of the expected economic downturn and the already apparent cracks in the financial system. "But the U.S. Federal Reserve Board's rescue of troubled investment dealer Bear Stearns in late March and early April indicated that there would be government support for the financial services sector."

This, combined with "compelling valuations," encouraged Thomson and his team to boost their holdings in Canadian banks. Since then, the team has continued to increase its weighting in the Canadian financial services sector.

"The short-term environment will be difficult for banks with both their corporate and individual clients under some pressure, but the investor's challenge is to choose those banks that are best placed to deal with this," Thomson says.

The fund's largest holding is Toronto-Dominion Bank ( TD/TSX), which has a 7.8% weighting. "This bank has an excellent Canadian retail banking franchise and is growing a significant retail banking platform in the northeastern United States, building on its purchase of two well-managed U.S. retail banks," Thomson says.

He adds that Canada is a mature retail banking market and there is good growth potential in the "prime" northeastern U.S. market. "The decimation of some of TD's competition in this market is a distinct plus."

In addition, Thomson noted that TD has a substantial stake in TD Ameritrade Holding Corp. ( AMTD/NASDAQ), a major discount broker. In all, some 25% of TD's earnings stem from its non-Canadian operations, he says. Finally, in contrast to many of its peers, both in Canada and elsewhere, "TD has an exceptional risk management culture."

For example, says Thomson, "it largely avoided the meltdown in structured financial products such as asset-backed commercial paper." He says TD generates a return on equity of 15%. The stock trades at 1.4 times book value per share and has a "healthy dividend" which is "well supported" by its earnings.

Thomson and his team recently sold their entire holding in Bank of Montreal ( BMO/TSX). The stock, he says, is "not cheap and despite positive efforts to boost its Canadian retail banking system, it is generally poorly positioned in this market." BMO also has a "high" dividend payout ratio (the ratio of dividends paid to its earnings). Thomson says that as a result of its high level of dividend payouts, BMO is less able to build its capital base through retained earnings than many of its peers.

Beutel's Canadian equity team used the proceeds of its sale of BMO stock and previously held cash to increase the portfolio's weighting in Canadian Imperial Bank of Commerce ( CM/TSX) to 7% during the past seven weeks or so.

CIBC "has significantly written off its troubled off-balance-sheet exposure," says Thomson. Furthermore, "CIBC has one of the largest Canadian branch networks, which it could effectively use to aggressively grow its business." The stock, he says, has a high dividend yield and the dividend is "well supported by CIBC's earnings."

Based on its price-to-book ratio, CIBC stock appears to be expensive at 1.8 times, "but when you take into account its return on equity of 19%, an indication of its ability to build its book value, its attractiveness becomes more evident." Furthermore, CIBC trades at less than 10 times its earnings-per-share estimates for fiscal 2009, "which is at a discount to its peers."

In the energy sector, Thomson has bought EnCana Corp. ( ECA/TSX), another major holding in the fund. This senior oil and gas producer "is disciplined in its use of capital and generates high returns on invested capital." It is also, he says, one of the few energy producers to pay a reasonable dividend to shareholders, and "this dividend is sustainable."

Encana, he says, has low finding and development costs for natural gas. The stock trades at around the net asset value per share of the company, based on a "conservative natural gas price assumption." Beutel Goodman is bullish on the natural gas price over the longer term, "as the level of drilling activity has slowed dramatically, which will reduce supply."

However, Thomson and his team sold their holding in Nexen Inc. ( NXY/TSX). "It was a matter of valuation," says Thomson. "We consider that the equity market is not pricing in the potential risks attached to its stake in the Long Lake project in the Athabasca oil sands region."