Canada's corporate elite have emerged from the dark shadows of recession into a sunnier landscape awash in higher profits and restored performance bonuses. But most CEOs won't be throwing lavish parties to celebrate their deliverance from the epic financial and economic horrors that laid waste to large swaths of the economy during the Great Meltdown of 2008 and 2009. They still have a lot of ground to make up. And every new gloomy report on Chinese manufacturing, European debt, the U.S. housing market or inflation in the emerging world serves as a reminder of the ever-present risks to the still-fragile global recovery on which they have become increasingly dependent.
The country's 1,000 largest publicly listed companies racked up an impressive $100.5 billion in total earnings in 2010, nearly double the dismal tally of the previous year and the highest since 2007, when the U.S. housing bubble burst, triggering massive derivatives writedowns, an unprecedented global credit crunch and the worst economic slump since the Great Depression. But the score still falls well short of the record $109.9 billion chalked up in 2006. Looking at the entire universe of public and privately held corporations (including data beyond the Top 1000), total Canadian profits still languish 24% below their pre-recession level, while cash flow remains about 15% lower.
Still, after you survive a fall off a steep cliff-profits plunged about 45% in less than a year-even a modest climb back toward the high ground starts looking good. Firms across a broad economic spectrum posted gains in double and sometimes triple digits. No fewer than 27 companies in our annual Top 1000 ranking scored four-digit increases. It could be that they hired better accountants. But the more likely reason was an ability to capitalize, either directly or indirectly, on surging world resource prices, a historically low cost of capital and the determined efforts of Canadian consumers, who apparently didn't get the message that they were supposed to be reducing household debt and steering clear of homes they couldn't afford. "The real story this year is a rising tide lifts all boats," says Arthur Heinmaa, managing partner with Toron Investment Management in Toronto. "Everybody has done really well."
Well, not quite everybody. More than 40% of companies on our list brought home lower profits last year, in some cases dramatically lower. The Biggest Losers club includes such corporate icons as Manulife Financial, which plummeted all the way to 997th from 18th (don't mention U.S. variable annuities if you're visiting their offices), and Onex Corp., which slid to 953rd from 113th (don't worry, they won't need any tag days). Bell Aliant, which does a big chunk of its telecom-related business in the troubled eastern part of the country, had the dubious distinction of finishing dead last, a precipitous drop from 59th the previous year.
But let's leave the intensive-care ward and get back to where the money is once again pouring in. As our latest ranking underscores, Canada's traditional spinners of wealth-the big financial players and major resource producers-continue to rule. Indeed, these powerhouses have become more dominant than ever, thanks to healthier margins, an abundance of cheap financing and China's insatiable demand for base metals, crude oil and just about everything else we can dig or pump out of the ground. Mining and oil and gas producers accounted for more than a quarter of total profit chalked up by all the companies on our list, and about a fifth of total revenue. Oil and gas alone delivered a 16.5% slice of Canada's profit pie, up from just under 13% in 2009. And a sustained rise in prices, whether through actual global shortages or fears of supply disruptions elsewhere in the world, could result in a substantially better showing this year.
Even with the travails of Manulife, providers of financial services bounced back strongly in 2010. Banks (21.1%) and insurers (7.1%) combined to capture 28.2% of total profit. That compares with about 39% of a considerably smaller pie in 2009, a year filled with misery for some of them and many of their clients. The Big Five banks, the envy of oligopolists the world over, occupy half of the top 10 spots on our list, led by perennial front-runner Royal Bank of Canada. Toronto-Dominion Bank leapfrogged ahead of Bank of Nova Scotia to claim second spot, while Bank of Montreal moved up a notch to seventh place. Laggard CIBC joined the party in eighth, after clawing its way back from 21st a year earlier. Among other profit drivers, bank bottom lines have been fattened by the juicy fees emanating from the wave of merger activity in the resource world. It didn't hurt that the Canadian housing and mortgage market enjoyed good health, defying the naysayers who predicted its imminent implosion.
On the resource side, energy producers Suncor Energy (No. 4) and Imperial Oil (10) cracked the top 10, along with mining giant Barrick Gold, which jumped all the way to sixth place from dead last in 2009. It's remarkable what getting rid of a dreadful hedging program can accomplish. So far, though, Barrick's investors haven't had nearly as much joy from the paper turnaround. Its stock closed out the year at about $47, the same level it reached in pre-crisis 2007.
Behind the impressive gains lurks an unpleasant truth about the Canadian economy: its continuing transformation into a two-trick act, which does not bode well for our long-term prospects. The only corporations in the top 10 outside the financial services or commodities businesses are regulars Research In Motion (5) and BCE (9). The next 10 include five resource players and three financials, along with Canadian National Railway, which derives a big chunk of its revenue from carting resources, and Brookfield Office Properties, which houses many of the profit-churners.
"Banks and resources are the two plays we have here," says Phillip Colmar, a partner with MRB Partners, a Montreal-based investment research firm. Fortunately, this story likely still has several years to run. "Canada has benefited over the last year from the global recovery, the strength in China and a healthy financial system," Colmar says. "There's a great policy backdrop. Liquidity trends are great."
That policy backdrop has several key facets. Environment cleanup costs haven't yet become much of an issue for resource producers. Meanwhile, there is still no sign of any significant monetary tightening by the Bank of Canada or a higher tax take by government. "So it [the outlook]is pretty favourable and we have had a pretty good commodity tailwind so far," says Colmar.
But once the current resource boom ends-as all cycles eventually must-the profit picture is bound to become muddier. The overvalued loonie will almost certainly stumble, wages will fall and complacent policy makers will find out what happens when there isn't enough growth to compensate for a lack of effective fiscal or industrial policies. MRB issued just such a warning this spring, laying out the growing risks of a skewed economy. The firm is bullish "about the prospects for the economy and maintains a positive cyclical outlook on Canadian risk assets," the report says innocuously, before getting to the good stuff. "Nonetheless, the euphoria needs to be kept in check. Oil and rocks have masked substantial and rapidly growing imbalances that will prove devastating if not corrected before the next global economic recession."
The outcome could be a made-in-Canada version of dreaded Dutch disease, which Colmar, the report's author, believes is already infecting the corporate sector. The economy-crushing syndrome gets its name from what befell the Netherlands after a major gas find in the 1960s. The resulting resource boom overwhelmed the little economy. The guilder shot up too fast for industry to adjust. Manufacturers could no longer compete in export markets and the business sector shrivelled.
Canada's non-resource manufacturers were already looking less competitive than other nations' before the resource boom, but a cheap dollar helped mask their problems. With soaring commodities and a strong currency, their plight has worsened. For now, the operators in the winning sectors are too busy raking in the bucks to pay much heed to such a gloomy assessment of the future. Just about every key resource Canada produces-with the notable exception of natural gas-has reaped the enormous benefits of surging global demand and skyrocketing prices. The smarter, more agile manufacturers and service providers are tying their futures to the same track. Everything related to the complex business of extracting and shipping resources, from fabricated metals, equipment and technology to transportation and finance, is cleaning up.
Colmar sees more of this in his crystal ball, citing a global economy that is even stronger than it was last year, and monetary policies that remain loose enough to encourage further expansion. Sure, the Americans are ending their experiments with quantitative easing; the Chinese will impose further restrictions on bank lending to ease inflationary pressures; and central banks everywhere will slowly raise interest rates. But as Colmar observes, "nobody is looking to really slam on the liquidity brakes here and cause the recovery to derail. Right now, we don't see any red flags on the horizon."
But all bets are off if the Chinese cool their commodity spending binge while turning their attention to worrisome domestic price inflation and the threat of bubbles in real estate and other assets. And it's anyone's guess what a planned shift in focus to increased domestic consumption and development of the nascent service economy will do to Chinese demand for raw materials.
"We're expecting everything to sort of pull back in the next couple of years," says Francis Fong, an economist with TD Bank. Still, growing demand for Canada's resources will remain a bulwark for the economy, helping to cushion it from the dangers posed by further trouble in the still-critical U.S. market or falling consumption at home, as Canadians stop spending like shopaholics, in the face of higher fuel and food prices and rising interest costs on their growing piles of debt. "Fundamental demand for commodities will still benefit Canada in future," Fong says. "But probably not to the same degree that they have been over the past nine months."
TD predicts profit growth will moderate, in line with a slowing economy, to about an average of 2%, quarter over quarter, between now and the end of next year. This points to a corporate take of about 13% for this year, dipping to 8% in 2012. That would still place Canada comfortably ahead of its larger industrial competitors on the profitability scale. British firm Consensus Economics puts U.S. earnings growth this year at 6.1%, and Germany's at only 5.3%, year over year.
But quite apart from what happens to China's celebrated growth story, other potential storm clouds are gathering that could rain all over Corporate Canada's profit parade. "It's going to become more of a challenge for the North American economy to grind out growth," says Doug Porter, deputy chief economist at BMO Capital Markets. "The [Canadian]economy faces all kinds of challenges at this point. There's very little pent-up demand on the consumer side. If anything, we've got almost the reverse. So we're going to be relying on a stronger global economy over the next year, which is still a reasonable assumption. But it's not a foregone conclusion."
If China and the other high-growth parts of the emerging world let us down, if the two-trick act folds its tent and Canadian consumers tighten their belts, those sighs of relief in corporate boardrooms across the land could once again be replaced by heart-wrenching cries of despair.