Globe editors have posted this research report with permission of Dundee Securities. This should not be construed as an endorsement of the report's recommendations. For more on The Globe's disclaimers please read here. The following is excerpted from the report:
We tend to like the antithesis of the "this time is different" argument. It never is. Using this logic, overweight industrials is a must at this point of the economic recovery.
The key trends which are supportive of our "go long" E&Cs investment thesis include: 1) E&Cs are late cycle performers; we are already running ahead of the market at this point, however, we believe this is just the beginning (E&Cs are now up 236% from the Feb 2009 trough vs. +91% for the broader market, if we were to overlay the prior share price momentum peak, we still have another 160% ahead of us);
2) Y/Y Backlog metrics are starting to rebound in the U.S. (up 8% y/y in the latest reporting period vs. a 5% decline for the Canadian peers), and Canada is bound to follow suit (historically it always has) which should translate to multiple expansion for the Canadian peers given the directional correlation between backlogs and trading multiples;
3) Europe is on the mend (well at least the fear of disintegration is behind us at this point); a more positive EU vibe should also help China which exports ~20% of its production to that geography. Add to that a growing U.S. economy, and the backdrop appears conducive for cyclically sensitive names to continue climbing higher;
4) Canadian LNG build-out should provide a sizeable market opportunity for most of the companies under coverage (there are currently 10 proposals with combined export potential of 156mtpa; Figure 10), although this will likely be a 24-36 month out prospect;
5) Industrials as a group are now a bigger part of the S&P/TSX index (~10% vs. 6.7% in early 2007), with a weighting comparable to materials (currently at 14%), investors have no choice but to pay attention to the former;
6) U.S. investors have been spoiled by a huge industrial recovery, some of the fund flow will end up in Canada due to relative undervaluation (Figures 12, 13; weaker C$ should also help);
7) Cyclicals still have room to run, if the previous cycle is used as a blueprint for peak valuation levels in the E&C space. An examination of Bloomberg's Americas E&C index reveals that during the prior cycle, the index peaked at 4.5x P/Book (in Oct 2007; Figure 14), implying a material upside from the current 2.3x level; and
8) We are nearing the bottom of the negative earnings revisions cycle which should help set the stage for positive surprises in 2014, over the last 90 days, 2014E EPS estimates for Canadian E&Cs were revised downward by 4%, contrast this with -26% revision we witnessed over the last 12 months.
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