BMO Capital Markets chief strategist Brian Belski believes 2024 Canadian equities offer “asymmetric upside” – it is far more likely that performance exceeds expectations than disappoint – as pessimism turns to optimism in the second half of the year.
The combination of inflation, rising interest rates and heavily indebted households has seen the TSX underperform the S&P 500 by the widest margin since 2015 so far this year. Mr. Belski thinks the economic risks are “more than priced in” at current levels (valuations sit near recessionary levels), and Canadian stocks should offer downside protection in periods of global market volatility.
The strategist expects that valuations will expand as sentiment improves in 2024, helping push the S&P/TSX Composite Index to 23,500 by the end of the year. This is approximately 17 per cent above current levels.
A year ago, Mr. Belski set a year-end 2023 target of 22,500. That proved overly optimistic but he believes a market recovery has been merely delayed.
BMO believes that domestic technology stocks will continue to perform well and that a recovery in telecommunications, financials, and consumer discretionary stocks will push the index to new highs.
Telecom stocks saw the biggest year-over-year loss in index weighting and are now excessively oversold and poised for a comeback next year, he says. Consumer stocks are also unloved and Mr. Belski forecasts that well-managed companies in the sector will enjoy outsized returns as the economy improves in the second half of 2024.
For financial stocks, the strategist notes the sector is enduring pessimistic sentiment at historic extremes, particularly the major bank stocks.
Mr. Belski maintains the Large Cap Canadian Plus Equity Portfolio, a list of largely domestic stocks combining timeliness and fundamental value. Royal Bank, TD Bank, Canadian National Railway and Enbridge are the largest Canadian positions in the portfolio. Suncor Energy and Canadian Natural Resources were the top performers in the third quarter. The worst performers, potentially candidates for a rebound in the second half of 2024, have been Aritzia Inc., BCE Inc., Open Text Corp and Shopify Inc.
-- Scott Barlow, Globe and Mail market strategist
More outlooks for 2024
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Ask Globe Investor
Question: I am puzzled why Brookfield Infrastructure Partners LP (BIP-UN-T) would be a good investment when it has a price-to-earnings multiple of 50. Please advise. Thank you.
Answer: Before I answer the question, a request to readers: If you’d like me to explain valuation or other financial figures for a particular company, please include the source of your data. Better yet, e-mail me a screenshot. There are myriad sources of financial ratios online, and readers often send me numbers without indicating where they got them. The more information I have, the easier it will be to answer your question.
Now, since I don’t know the source of the P/E multiple of 50, I can’t tell you how it was calculated. What I can tell you is that it’s often dangerous to rely on data published by financial websites. These numbers are typically crunched by a machine, often with little regard for the nuances that apply to specific companies and industries.
That’s why we still need the input and expertise of human beings.
In Brookfield Infrastructure Partners’ case, most analysts pay attention to a cash flow measure called funds from operations (FFO). The company defines FFO as net income excluding non-cash items such as depreciation and amortization, deferred income taxes and other items “that are not related to the revenue earning activities and are not normal, recurring cash operating expenses necessary for business operations.”
The advantage of using FFO is that it focuses on the cash generated by the business, as opposed to accounting earnings that include non-cash items that don’t affect the company’s ability to pay distributions. Certainly, the Brookfield empire has come under plenty of criticism for its complex structure and accounting, but suffice to say that most analysts accept FFO as a legitimate measure to evaluate the business.
Now, back to the P/E ratio. Analysts expect Brookfield Infrastructure Partners – which reports in U.S. dollars – to generate FFO of about US$2.95 per unit in 2023, rising to about US$3.25 in 2024. On Friday, the units traded at about US$27 on the New York Stock Exchange (where the ticker symbol is BIP). If we plug the NYSE market price into the P/E’s numerator, and substitute FFO estimates for the “E” in the denominator, we get P/FFO values of 9.2 and 8.3, respectively, for 2023 and 2024.
In other words, investors are willing to pay about eight or nine times cash flow, as measured by FFO. That’s actually a pretty reasonable multiple.
Generally, companies with strong expected earnings and cash flow growth command high P/E (or P/FFO) multiples, while those with slower expected growth trade at lower multiples. The most attractive companies, from an investing standpoint, offer the best of both worlds: strong earnings growth and a low or modest multiple.
Brookfield Infrastructure Partners ticks both those boxes, according to many analysts.
The partnership’s current valuation is “a drastic discount to its 5-year average P/FFO multiple” of 12.5, said Frederic Bastien, an analyst with Raymond James, in a recent note. In light of the discount, Mr. Bastien rates the units a “strong buy,” with a price target of US$40 ($54.50). That compares with the average price target of US$37.50 ($51.10), according to Refinitiv, representing a premium of about 39 per cent to the current market price. Analysts’ price targets are often overly optimistic, but even if the units were to get halfway to the target it would represent a very attractive return.
The lesson here: If you had taken the P/E of 50 at face value, you wouldn’t know the units are trading at an attractive valuation.
One final note: When calculating a P/E, P/FFO or any other financial ratio, be careful not to mix currencies. If I had used Brookfield Infrastructure Partners’ price on the Toronto Stock Exchange, I would have had to convert it to U.S. dollars to match the currency in which Brookfield Infrastructure reports results. If the currencies don’t match, the ratio will be meaningless. I’ve seen some financial websites, and even discount brokers, make this mistake, which is another reason to double-check any numbers you find online.
--John Heinzl (E-mail your questions to email@example.com)
What’s up in the days ahead
Earnings preview: Canadian banks looking at weak profits as fiscal year wraps up
Advisor lookahead: Q3 GDP to show whether Canada is in a technical recession
More Globe Investor coverage
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Compiled by Globe Investor Staff