These nine Canadian stocks are poised to absorb excess consumer savings.
What are we looking for?
Canadian equities that generate plenty of free cash flow.
Canadian consumers are now saving 13.1 per cent of their income, compared with a savings rate of 3.6 per cent at the beginning of 2020. After jumping early in the COVID-19 pandemic, the savings rate began to decline last year, but it is still significantly higher than before the outbreak. The consumer discretionary sector is well positioned to receive this spare cash.
We screened Canadian stocks in the sector focusing on the following criteria:
- Market capitalization greater than $500-million;
- Free-cash-flow-to-capital ratio higher than 10 per cent. We want a company that generates a large amount of free cash flow as a percentage of capital. A high ratio shows the company has plenty of cash to invest or distribute to shareholders;
- Economic performance index (EPI) change higher than 0.10. The EPI is the return on capital divided by the cost of capital. A positive change in this value shows an improvement in the company’s risk-return profile;
- A StockPointer (SP) risk score lower than 35. Developed by Inovestor, the SP risk score is scaled from 0 to 100, where 100 is a high-risk company and 35 is considered low to medium risk. The score uses many criteria such as valuation risk perceived by our software, leverage and stability of company profits.
For informational purposes, we have also included the EPI, P/E ratio, price-to-book ratio, one-year price return and dividend yield. Please note that some ratios may be reported as of end of the previous quarter.
What we found
Children’s entertainment company Spin Master Corp. has the highest free-cash-flow-to-capital ratio on our list, at 26 per cent. The company has a strong portfolio of brands ranging from good old Etch A Sketch, to the well-established Paw Patrol and DC Universe figurines.
Spin Master faced difficulties before the pandemic with its supply management in Asia, and COVID-19 exacerbated fears of a supply crunch. Fortunately, the company now seems to be moving in the right direction. Spin Master reported second-quarter earnings on Aug. 4 and raised its forecast for 2021 sales growth from the low teens to the mid-teens.
Automotive original equipment manufacturer Linamar Corp. has a risk score of 21.1, the lowest of our screen, which reflect a low valuation risk, also shown by its low price-to-book ratio of 1.1 and P/E of 13.4. The microchip shortage is having an impact on the auto sector and it is still uncertain when the shortage will end.
On the bright side, used car prices are up 22.6 per cent year to date according to the CarGurus price index, largely owing to strong demand. High used car prices stimulate new car sales and dealers’ inventories are low. This could lead to robust sales for Linamar as dealers need to replenish their inventories of new cars. Linamar is scheduled to report second-quarter earnings on Aug. 11.
Mattress retailer Sleep Country Canada Holdings Inc. reported solid second-quarter earnings on Aug. 3, and appreciative investors bid up the share price by 15.5 per cent the next day. The company has benefited from a pandemic shift in consumer spending. This second quarter demonstrated the shift does not appear to be over. The company plans to invest in software to enhance inventory management and in the customer experience to maintain its growth.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
Anthony Ménard is an investment analyst at Inovestor Asset Management. Inovestor for Advisors is a fundamental analysis research platform specializing in the economic value-added (EVA) approach.
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