Brian Madden, chief investment officer, First Avenue Investment Counsel
FOCUS: Canadian equities
With the first quarter drawing to a close, the breathtaking and virtually uninterrupted bull run in US stocks off the pandemic lows two years ago has been broken, with US major market indices poised for a down quarter. The Canadian S&P/TSX Composite index is set to eke out a modest gain for the quarter, bolstered by its concentration in energy and other commodities as inflation runs rampant and as geopolitical risk holds at multi-decade highs.
Tragic as the war in Ukraine is, and as much as it has captured investor attention and media headlines, it is not the primary reason for weakness in stocks this quarter. That’s because geopolitical events rarely end economic cycles. We are positioning portfolios for slowing economic growth in the coming quarters as the economy laps a COVID re-opening and fiscal and monetary stimulus fueled 12 per cent growth rate in Q2 2021 – the fastest pace of growth since at least 1950.
We expect disinflation in the back half of the year as demand for durable goods is in many cases satiated, household finances are less flush than they were a year ago and as supply chain bottlenecks in many categories of manufactured goods are expected to be alleviated. Last but not least, disinflation will also emerge as the effect of gradually rising interest rates sets in. Under the circumstances we favor staple companies, utilities, rate sensitive banks, and other defensive businesses. Over the past few months, we have been reducing “long duration” equities like the high growth tech giants, as higher discount rates weigh upon their valuations in the marketplace, and as rising volatility curtails investor appetite for risk-taking and speculation.
Parex Resources (PXT TSX)
Parex is a mid-sized company producing approximately 53,000 barrels of oil per day in Columbia. Parex enjoys some of the highest netbacks (operating margins) of any mid-to-large sized Canadian energy producer. The company is poised to grow production 12 per cent this year and has grown production at a 9 per cent compound rate over the last 5 years.
Crucially (and refreshingly, for a resource company) the management team is very focused on profitability, such that cash flow per share grew 365 per cent over the last five years, and rare among oil producers, it remained profitable during 2020.
With no debt and $378M of cash on their books, Parex is well positioned to continue their pattern of returning cash to shareholders, something they have done prolifically the last four years, deploying over $640M to retire 23 per cent of their outstanding shares in the process accreting value to remaining shareholders.
Live Nation Entertainment Inc (LYV NYSE)
Live Nation, parent company of Ticketmaster, is the largest live entertainment firm in the world. The firm controls 235 venues either owning, operating or holding exclusive booking rights for events. The firm is poised for a multi-year cycle of growth, as post-COVID pent up demand for concerts and sporting events unfolds.
Both price and volume are supportive of strong revenue growth this year, with 2022 sales expected to surpass 2019 levels by 20 per cent, bolstered by double digit ticket price increases and a deep pipeline of 45 major concert tours vs. 25 in a more typical year. Major concert tours typically span more than one calendar year, affording good revenue visibility looking out several years.
An internal cost cutting initiative undertaken during the pandemic realized $200M of structural cost savings that will benefit operating margins as activity picks back up this sector in 2022 and beyond.
TD Bank (TD TSX)
TD is Canada’s second largest bank and is on the verge of becoming America’s sixth largest bank as well. TD earns a 16 per cent return on shareholder’s equity and has grown earnings per share at an 8 per cent rate over the last decade, with a more than commensurate increase in its dividend as the firm has remained well capitalized through the cycle and remains the best capitalized major Canadian bank today.
The strength of their balance sheet affords them the flexibility to pursue the recently announced $13.4B acquisition of US southeastern regional bank, First Horizon in an all cash deal expected to be 10 per cent accretive to earnings post realization of an anticipated US$610M in synergies .
Currently offering a 3.5 per cent yield, and with dividends likely to continue growing at a high single digit pace, we see a logical and visible path to continued low double digit total returns over a cycle, a pattern that has allowed TD and other Canadian banks to outperform the S&P TSX Composite in 18 of the last 25 years.
PAST PICKS: March 5, 2021
NFI GROUP (NFI TSX)
- Then: $28.12
- Now: $16.71
- Return: -40%
- Total return: -38%
FRANCO NEVADA (TSX FNV)
- Then: $138.65
- Now: $195.63
- Return: 41%
- Total Return: 42%
INTACT FINANCIAL (IFC TSX)
- Then: $149.85
- Now: $184.79
- Return: 23%
- Total Return: 29%
Total Return Average: 11%