Steve Belisle is Senior Portfolio Manager & Managing Director at Manulife Asset Management. His focus is North American Dividend Stocks
Element Financial (EFN-T)
The split of the company will officially happen in early October. This will allow small-cap fund managers to buy the ECN stock. Using a 2017 EPS estimate of $1.20 and putting a 13x multiple on it, you get $15.60 of value for the fleet side. It would imply a negative value for ECN, which makes no sense.
This stock has lagged the market and its peers recently. They reported bad second quarter results, however most of the issues were temporary, and we should see an improvement next quarter. This company’s top line was seriously impacted by weaker energy activity in the past 18 months, but this headwind is becoming much less meaningful now. We like the acquisition of MWH, giving them more exposure to the water utility business, and it will be a driver of earnings growth in 2017. The stock is now trading around 9x enterprise value to EBITDA, based on 2017 consensus.
Cott Corp (BCB-T)
This is a soft drink company in transition to become a more diversified company mostly through tuck-in acquisitions. Cott recently announced the acquisition of S&D Coffee for $355-million. It is expected to be mid-teens free cash flow accretive in 2018, taking into account cost synergies but not revenue synergies, which is the big opportunity. Cott has been talking about acquiring a coffee service provider in North America in order to take advantage of the large cross-selling opportunity they have with their current home and office water customers. Given the mid-teens accretiveness to cash flows and 20-per-cent increase in net debt, it should only take them slightly off course of their target to reduce net debt/EBITDA down to 3x by 2018. The sale of the legacy carbonated soft drinks (CSD) business is still very much on the table, which could help instantly reduce debt by 1.5x. The stock is only trading at 8x EV/EBITDA in 2017. COT trades at a significant discount to its peer group. This not only includes large beverage peers like Coke and Pepsi, but also similarly sized small-cap private-label beverage stocks listed in the UK and Europe and the North American consumer staples group as a whole.
Previous picks: May 18, 2016
Milestone REIT (MST.UN-T)
Then: $18.35 Now: $19.77 +7.44% Total return: +9.08%
Boyd Group Income Fund (BYD.UN-T)
Then: $72.61 Now: $85.63 +17.93% Total return: +18.19%
Element Financial (EFN-T)
Then: $14.75 Now: $14.23 -3.53% Total return: -3.34%
Total Return Average: +7.98%
This year’s market performance is somewhat puzzling as both resources and defensive sectors have outperformed. The significant decline in long-term interest rates has brought yield-sensitive sectors, such as real estate, telecoms and utilities, to new highs. For example, real estate investment trusts are now trading at a premium to their private market values, after trading at a discount for a long period of time.
The premium for defensiveness is now quite high. If you compare the price/earnings ratio of high- and low-beta stocks for the S&P 500, you realize that the premium of low-beta stocks is reaching new highs in 2016. The reason is that in this very low interest rate environment, fixed-income investors are increasingly turning to defensive dividend-paying equities as a substitute to bonds to generate steady income. The rally in bonds has thus brought dividend stock valuations to a very expensive level.
On the other hand, the rally in resource stocks has essentially been caused by a recovery in the oil price and an increase in the price of gold. When I was on the show back in May, I expressed my near-term concerns about the oil price. It indeed declined by about 12 per cent since, but energy stocks are nevertheless up 6.5 per cent nevertheless. As a result, most stocks are already pricing-in much higher oil prices. So we will need to see further production declines before seeing the oil price go materially above $50. Longer-term (1 to 2 years), we expect the oil price to reach the $60-65 range, where it makes sense again to invest in production growth. Indeed, a large portion of Canadian Natural Resources growth projects would not go ahead below $60. As a result, we are currently not inclined to increase our positions in energy stocks in general.
The gold rally is a reflection of our broader concerns about the global economy, with sluggish growth around the world, debt levels on the high side, ineffective monetary policy and very little capacity in terms of fiscal stimulus. Moreover, the U.S. economy, which used to be the brightest spot on the globe, now seems to be weakening, judging by the latest ISM survey. Hopefully, this leading indicator will not trend further down. Despite that, the Federal Reserve’s rhetoric about near-term rate increases is still there, and the U.S. election could create uncertainty.
In that context, we are inclined to maintain relatively high cash balances as we believe that further deterioration in the economic environment and/or a surprise Fed rate hike could send North American markets in a correction. Now, more than ever, the soundness of our investment process will be very important, which means focusing on companies with a strong business model for the long term and strong cash flow generation. We want companies that have visible growth not fully recognized by the market. Indeed, before pulling the trigger on new purchases, we believe that a greater margin of safety is necessary in terms of valuation to avoid overpaying.Report Typo/Error
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