Now’s the time to buy

The current market conditions are creating tremendous dislocations between share prices and intrinsic values, says Sionna’s Marian Hoffmann

Ruth Saldanha 1 April, 2020 | 1:08AM

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Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.

What should Canadian investors do in the midst of the volatility? We asked Marian Hoffmann, Senior Vice President and Research Director at Sionna Investment Managers. She is the lead portfolio manager for the firm’s Canadian large cap strategy and all cap strategy and co-lead portfolio manager for the firm’s focused dividend strategy, including the silver-rated Sionna Canadian Equity. Here are her thoughts:

Some answers have been edited.

After falling almost 30% since the start of the year, the S&P/TSX Composite index began a short rally. However, markets continue to be extremely volatile. Is this the beginning of the end? Or perhaps the end of the beginning?

The recent volatility has been staggering in many cases; however, as value investors focused on the longer term, we are excited. The current market conditions are creating tremendous dislocations between share prices and intrinsic values. As long-term value investors, we are active in periods of high volatility. The dislocations have presented opportunities to add to our higher quality holdings and to initiate positions in companies which were previously out of reach due to excessive valuations. With low oil prices, we believe the energy sector is fundamentally attractive at these valuation levels and we have used the price decline to reposition our portfolio into high quality holdings that will thrive over the long run. We seek to find resilient companies trading at large discounts to their intrinsic value.

While most people could not have predicted the COVID-19 situation, there have been murmurs of a potential downturn since as far back as mid-2019. Now that the slide has begun, is the pain likely to continue?

The market, and the situation itself, is changing on a daily basis. It’s not possible for anyone to say with certainty how the market will react over the next coming weeks or months. The virus has caused a slowdown in economic activity globally, so there will be implications for businesses and industries, some will experience more challenges than others, for example travel, hospitality, restaurants. We focus on identifying quality businesses that are well capitalized and make an investment when we believe it is trading at an attractive discount to our estimate of intrinsic value. Investing in companies when they are undervalued is a way to manage risk and preserve our clients’ capital.

From Canada’s point of view, are there any systemic risks that could threaten us long-term? What are some of the main Canadian risks you’re watching

The energy sector has been hit particularly hard following a failed attempt by OPEC to finalize a deal with Russia for new production cuts. There are significant concerns that a combination of reduced demand from the coronavirus and increased supply from Saudi Arabia will have negative implications for oil prices and have long-term impacts on some Canadian energy companies.

Many Canadian energy companies are unprofitable at this price level. As a result, capital expenditure budgets are being reduced, dividends suspended, and workers laid off. In response to the deteriorating economic situation, the Bank of Canada initially reduced interest rates from 1.75% to 1.25%. Rates were then further cut to 0.75%, which was the first time the bank had moved its rate outside of a scheduled meeting since 2009. The federal government also announced an economic stimulus package, which will provide up to $27 billion to Canadian workers and businesses. Then, last week, the Bank of Canada cut rates a third time, reducing to 0.25%.

Despite the current volatility within the sector, we do believe there are still quality energy names out there. We are invested in companies that we believe are well positioned to withstand periods of low commodity prices, given they have low cost structures, solid balance sheets and reasonable management teams.

What kind of impact will this have on dividends? Do you expect dividend growth to slow significantly this year? Do you expect dividend cuts?

Over the last few weeks, we have already seen many companies cut their dividends, especially within the energy space. It is likely that we will see more dividend cuts down the line. Companies will be reluctant to raise dividends now given the uncertainty in the economy with COVID-19 and the current oil prices. Instead, many companies are more focused on managing balance sheets and meeting their debt commitments. The strongest companies will likely be the ones that are able to maintain their dividends, and take advantage of price declines to opportunistically buy back their own shares.

What are some of your top dividend picks for the long term? Where should income investors seek yield in these volatile times?

Prior to this period of market volatility, we were underweight banks but are now about equal weight given drops in share prices. While prices have fallen significantly, the long-term value of these businesses have not, and therein lies the opportunity. We own three banks within our portfolios: Royal Bank of Canada (RY), Bank of Nova Scotia (BNS) and The Toronto-Dominion Bank (TD).

Sionna was underweight the sector because we felt we were entering a period of revenue compression and increasing provisions for credit losses. That remains a concern, along with additional strain from this current environment. From a risk/reward perspective, our outlook is now considerably different given where valuations sit. PE multiples and dividend yields are highly attractive. While we can’t speak to how they will perform in the coming months, we are buying quality institutions at a steep discount to our estimate of intrinsic values and focused on the longer term.

We have been confidently adding value to our portfolios in recent weeks. This confidence is rooted in the fact that our portfolios today are offering historically wide discounts to our fundamental assessments of intrinsic value. We are very comfortable with current positioning and confident in the long-term prospects for our invested companies.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Bank of Nova Scotia39.84 USD-4.23
Royal Bank of Canada89.38 CAD-2.14
The Toronto-Dominion Bank58.94 CAD-2.24

About Author

Ruth Saldanha

Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca

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