Something strange is afoot in the way investors look at Canada's two biggest independent brokerage firms.
On one hand, there's a consistently profitable firm we'll call Firm A, with a bigger presence in global markets where there is more going on when it comes to making money in investment banking and brokerage. The firm has $380-million of cash on its balance sheet. On the other hand, there's a firm we'll call Firm B that has struggled to stay profitable and whose business is largely concentrated in Canadian resources, which are in the dumps. Firm A's earnings per share on an operating basis are twice Firm B's in the past three quarters.
Yet, investors are willing to pay a lot more for Firm B. What gives?
Firm A is Canaccord Financial. The firm on Tuesday reported another profitable quarter, booking net income of 4 cents a share, or 9 cents if special items are excluded. That was in line with analysts' estimates. Two thirds of revenue and 96 per cent of adjusted net income came from outside Canada where the firm has been focused on growing. The company reports book value of $7.87 a share, and the stock trades at about $6.50.
The latter firm is GMP Capital. It has yet to report its most recent quarter, but it lost money in the first quarter on an adjusted basis and barely broke even once special items were excluded. Analyst Sumit Malhotra of Macquarie does not expect the coming earnings report from GMP to be much better. GMP shares are trading at $6.35, on a book value that Mr. Malhotra estimates at $3.56 a share this year.
The valuation disparity is similar when it comes to price-earnings ratios, with GMP's almost twice Canaccord's. If people are betting on a resource rebound, and therefore choosing GMP, it's worth remembering that Canaccord has a solid resource business as well.
Mr. Malhotra forecasts GMP will do just better than break even when it reports its most recent quarter, and "our forecast of $50.1-million in revenue would make it nine consecutive quarters in which GMP has come in below the $100-million threshold we view as representing a peak level of profitability, indicative of the tough backdrop for Canadian-centric brokers."
So no surprise then that he prefers Canaccord shares. One reason is Canaccord's more global business model. But the second is valuation, with Canaccord trading at less than 1 times book value and GMP trading close to 2 times.
Given the performance difference between the two firms, it's odd more investors don't feel the same way as Mr. Malhotra.
(Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)
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