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About six months after the price of oil started falling, the effects are rippling out beyond the energy sector. .
As capital markets activity slows and deal flow dries up, a new Bank of Nova Scotia report suggests independent broker-dealers Canaccord Genuity Corp. and GMP Capital Inc. appear to be taking it especially hard.
Independents have recently been feeling the pressure, particularly from the big banks competing even for smaller deals. In the past three years, 15 per cent of Canaccord's investment banking revenue was directly tied to the energy sector. GMP's share has been even greater at 30 per cent exposure. Moreover, the fortunes of both companies are highly sensitive to the performance of the wider equity markets, which have been helter skelter in recent months. The S&P/TSX Composite Index is down 10 per cent since Sept. 2014.
"This is not exactly the type of environment that has either companies or their investors thinking 'bought deal,' and the deterioration in the capital markets environment has had a clear negative impact on activity levels and operating conditions for the broker/dealer sector," wrote Bank of Nova Scotia analyst Sumit Malhotra in a note to clients.
Mr. Malhotra predicts Canaccord will post an operating loss of $0.06 a share in the fourth quarter of 2014, and that GMP will post a loss of $0.03 a share . These would be the first operating losses for the brokerages in two and a half years. Canaccord and GMP report their calendar fourth quarter results on February 4 and March 6 respectively.
"Things have changed so quickly. Earlier in 2014 you had a very good revenue environment for these guys. It has changed in a pretty big way," he said in a telephone interview.
GMP's revenue will fall 16 per cent compared to the third quarter, Mr. Malhotra said, while Canaccord should see a 28 per cent plunge in revenue. "Canaccord has been benefiting a lot from their non-Canadian exposure. This quarter it didn't matter. Whatever geography you're in, it wasn't good."
Both brokerages will see "sharply reduced deal flow" and higher facilitation [trading] losses, he said.
A lot of the negative sentiment appears to be already priced into to the share prices of the two brokerages. Shares in Canaccord have lost 43 per cent over their value over the past six months. GMP's stock is down 30 per cent over the same time period.
If the oil price stays low and deal flow remains moribund, both brokerages could take a cue from Bank of Nova Scotia and Royal Bank of Canada who have been aggressively cutting costs, Mr. Malhotra says.
Of the two brokerages, Canaccord has the higher fixed cost base, because of its recent global expansion, so it may be harder for it to trim fat.
GMP has been adding bodies over the past year or so (its head count is up 14 per cent since December 2013).
What about the possibility of layoffs? "It's reasonable to believe that in this environment that the companies are going to consider whether they are appropriately staffed for the level of revenue they see in the interim." said Mr. Malhotra.
The silver lining for both companies is that their balance sheets are in decent shape with capital levels "well above the levels at which adequacy was previously an issue," he said.
He has a sector outperform rating on Canaccord versus a sector perform rating on GMP. On reason Mr. Malhotra prefers Canaccord over GMP is because of its greater geographic diversification i.e. less exposure to Canada.
Niall McGee