Low oil prices create buying opportunities for veteran value manager Kim Shannon, president and chief investment officer of Sionna Investment Managers Inc.
"A couple of years ago, when oil prices dipped below US$40," says Shannon, "we started seeing a lot of value in commodities and in the stocks. We began as sector- neutral, so when oil prices and high-quality names dipped below intrinsic value, we started to add to the stocks."
Shannon's investment thesis is that the price of oil will eventually rebound to its marginal cost of production, and that the laws of supply and demand will prevail. The energy sector currently represents 25% of the portfolio of Sionna Canadian Equity Class, which Shannon manages. That's about as high as she'll go, since for risk-management purposes she restricts the fund to a maximum overweight position of five percentage points relative to the sector's S&P/TSX Composite Index weighting.
Shannon says the resource companies she holds tend to have more stable businesses relative to their peers. These characteristics include low costs of production, conservative balance sheets and quality management. "Over a longer time horizon," says Shannon, "we have the utmost confidence that our energy holdings will outperform their peers and do so with more stability.”
Patience is the hallmark of Shannon's value approach. The investment team is "relentlessly at peace with trailing the market" when the upswing is led by lower-quality stocks. Resources overall will always have higher highs than the individual investments in the related sectors in the mandate, adds Shannon.
PrairieSky Royalty Ltd. (PSK), among the top holdings, is an example of Shannon's bargain-hunting in the energy sector. "Without the energy downturn, we wouldn't have a chance to buy PrairieSky," she says. "This is a company that in normal times would trade at a significant premium. It's a business that has very little operating expenses and risks related to drilling the land because they simply collect royalties." Shannon also likes PrairieSky's debt-free balance sheet. "They have the ability to ride out this downturn for a long time at a very attractive valuation."
The second-largest holding in the fund, Suncor Energy Inc. (SU), wins applause from Shannon for its superior on return on equity in its peer group, and its willingness to take advantage of the downturn in energy prices to make acquisitions. "Their recent acquisition of Canadian Oil Sands Ltd. at bargain-basement prices was quite astute," she says.
Imperial Oil Ltd. (IMO), also among the Sionna fund's top holdings, is an example of a long-term hold. "We like Imperial Oil because it's an integrated producer," says Shannon, noting that the company has operations in exploration, production and refining. "In the downturn that we've seen recently, the downstream business (of buying oil and refining it) really shines." Shannon says the downstream operations provide far more stable earnings and cash-flow streams. "As a result, Imperial Oil has generated the best return on investment capital over the long term than any other energy company in the industry."
Along with energy, a lot of interesting non-bank financial names started showing up in value in the last couple of years, says Shannon. Financial services represents 31% of the mandate.
For example, Boardwalk Real Estate InvestmentTrust (BEI.UN), which has exposure to real estate in Alberta, was added to the portfolio. "It's a company with a management team that we always really admired and we thought the valuation was very attractive," Shannon says.
The Sionna investment team blends stringent quantitative and qualitative stock analysis with a macroeconomic perspective. According to Shannon, historically the market has two distinct phases: bull-market runs where equity markets experience positive returns in the range of 9% to 11%, and sideways markets where returns are closer to 6%.
"We've been in the current sideways market for 15 years now," says Shannon, "and there's probably between three and five more years of sideways markets to go. So hang on to your horses for now on this front."
In the meantime, "what's absolutely really interesting," says Shannon, "is that from time to time value becomes a dirty word, and it's become a dirty word again. Value globally hasn't done well for quite some time and in Canada has been suffering of late."
As a result, says Shannon, people are turning away from value in favour of other investment disciplines. "We think that we're in a current environment that's a particularly good value opportunity because financial numbers are always interest-rate sensitive. It's a good time to enter a value strategy after it's underperformed significantly for a period of time and it's where we're at now."