Kim Shannon, president and CEO of Toronto-based Sionna Investment Managers Inc., says big-cap Canadian energy companies are inexpensive and should provide attractive returns over the next few years.
"It has been a long time since Canadian energy stocks have made it to the front page of our analysis, which ranks stocks on the basis of their valuation," says Shannon, who is a relative value manager. "The front page of this analysis features the 50 cheapest stocks in Canada."
Canadian energy stocks, says Shannon, are "currently trading both below the companies' estimated intrinsic value and at trailing price-earnings ratios that are below that of the market as a whole." The firm's call is that the major energy players could produce a total return of close to 20% over the next two years, she says.
Shannon points out that some investors argue that over the long haul a solid blue-chip company's stock should do well, "but the price you initially pay for the stock has a significant impact on the long-term returns from the investment."
Of the Canadian equity market as a whole, Shannon considers that it is still going sideways. Her view is the same as in February. This type of market historically ends, she says, when the price-earnings multiple for the market as a whole declines to single-digit levels.
Shannon notes that the S&P/TSX Composite Index briefly touched single-digit P/E multiples during the trough in the market in March 2009. "The P/E multiple on the index expanded with the rebound in the market, and the index currently trades at about 19 times the trailing earnings per share."
There is a misconception, says Shannon, that low bond yields will result in high price-earnings multiples for the stock market. "Research, using the 10-year bond yield, shows that once this yield falls below 5%, as is currently the case, this correlation is much weaker."
Sionna Investment Managers, which specializes in Canadian equities, has $3 billion in assets under management. It offers mutual funds in conjunction with Brandes Investment Partners & Co., including Brandes Sionna Canadian Equity and Brandes Sionna Canadian Balanced .
Brandes Sionna Equity has assets of $665 million and holds 40 names. The fund has 85% in Canadian equities, 10% in foreign content and 5% in cash.
An analysis of the big picture shapes Sionna's shifts in sector emphasis. As of the end of September, the fund's two largest sector overweights relative to the S&P/TSX Composite Index were energy and consumer staples. Financial services continues to be an underweight position, says Shannon, as is the materials sector, which is the biggest underweight in the portfolio.
In the energy sector, a recent addition to the fund is Husky Energy Inc. HSE , an integrated player in the oil patch. The stock, says Shannon, offered good relative value and a prospective total return higher than the average for its peers. Furthermore, the stock has a 4.8% dividend yield versus 2.6% for the S&P/TSX Composite Index.
Dividend yields are important in a sideways market, Shannon says. "Husky's high dividend yield is atypical in the energy space." The quality of its assets "is of a lower calibre than some of its rivals and there are operational risks, but both are reflected in the price of the stock."
At the end of September, four of the top 10 holdings in Brandes Sionna Canadian Equity were energy stocks. Canadian Natural Resources Ltd. CNQ had a weighting of 5.2%, EnCana Corp. ECA and Suncor Energy Inc. SU were both at 4.3%, and Cenovus Energy Inc. CVE was at 3.3%. The top 10 holdings constituted 42.1% of the fund at the end of September, with these four stocks collectively making up 16.9%.
|EnCana Corp.||Husky Energy Inc.|
|Market cap||$41.4 billion||$20.6 billion||$21.3 billion|
|Total % return 1Y*||10.9||-1.7||-7.0|
|Total % return 3Y*||3.5||-3.0||-10.3|
|Total % return 5Y*||8.2||2.9||1.2|
|*As of Nov. 23,2010|
In the consumer-staples sector, Shoppers Drug Mart Corp. SC is still showing up on Sionna's front page, says Shannon, even though the stock has moved higher of late. "We bought the stock at the height of the concerns about the changes to the pricing of generic drugs in Ontario," she says. "We had not owned it before, but the stock became cheap enough."
Shoppers' management is "high quality." The company is more than a pharmacy chain, Shannon says. It has a convenience-store component and is one of the leading retailers of high-margin brand-name cosmetics in Canada. Its customer-loyalty program is also highly successful, she notes. The stock trades at 10 times trailing earnings per share and has a dividend yield above 2%.
Within the financial-services sector, says Shannon, the banks "continue to be expensive by our calculations and we remain underweight the stocks." Of the niche players in the financial sector, Shannon considers that TMX Group Inc. X offers good value. The company owns and operates the Toronto Stock Exchange and the TSX Venture Exchange.
The stock, says Shannon, was "overly punished" with the entry of the bank-owned Alpha Trading Systems Ltd. into its business. Even so, TMX recently raised its dividend to 40 cents a share from 38 cents, says Shannon. The stock carries a dividend yield of 4.8%.
In the materials sector, Brandes Sionna Canadian Equity's holding in Gerdau Ameristeel Corp. was taken out when parent Gerdau S.A., a major global steel producer, bought all the shares in Gerdau Ameristeel that it did not own at US$11 a share this summer. "We have not replaced our holding as we do not like any stocks in the metal space," Shannon says.
In the consumer-discretionary sector, Shannon sold the fund's holding in the global auto-parts maker Magna International Inc. MG . "Part of the holding was sold before the company eliminated its dual-class share structure this summer, and the remainder was sold after it did so."