Encounter

Managers favour producers over service providers in the energy sector.
By Sonita Horvitch | 13/05/16

Editor's note: This week's coverage of our Canadian small-cap roundtable concludes today with the managers discussing their holdings in the energy, financial-services and industrials sectors.

About the Author
Sonita Horvitch is a Morningstar columnist who specializes in reporting on money managers and their strategies. A veteran financial journalist, she was formerly with the National Post and its predecessor, the Financial Post. At the Post she was best known as the author of the popular Buy & Sell column, which she wrote from its inception in 1994 to December 2008. She holds a master's degree in business economics from the University of the Witwatersrand in Johannesburg, South Africa.

The panellists:

Stephen Arpin, vice-president and portfolio manager, Beutel, Goodman & Co. Ltd. A value manager, his responsibilities include Beutel Goodman Small Cap.

Michael Chan, vice-president and senior portfolio manager, Fiera Capital Corp. A growth manager, his responsibilities include Fiera Capital Equity Growth.

Scott Carscallen, vice-president and portfolio manager, Mackenzie Investments. A value manager, his responsibilities include Mackenzie Canadian Small Cap Value and Mackenzie Canadian Small Cap Value Class.

The roundtable was convened and moderated by Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and continued on Wednesday.


Q: All three of you consider that the energy sector, which represents 16% of the S&P/TSX Small Cap Index, is improving. Can we discuss your stock selections?

Chan: The portfolio has 12% in energy. We're focused on the producers versus the service companies. The top two positions are Torc Oil and Gas Ltd. (TOG) and Spartan Energy Corp. (SPE).

Scott Carscallen
Scott Carscallen

Carscallen: We own both stocks.

Chan: Torc is a light-oil company led by Brett Erman, president and CEO. This is his third public oil company. We have invested in his previous two companies successfully. Spartan is another light-oil company. It has assets in Saskatchewan. This is the second public company for the CEO, Rick McHardy. We also successfully invested with him in his predecessor company.

Carscallen: I also own Raging River Exploration Inc. (RRX), which is another oil play. Raging River and Spartan provide exposure to Saskatchewan. The exposure is toward the producers. We are underweight the service companies. Our energy weight is 14%.

Chan: What's also attractive about Torc and Spartan is that both companies have the ability and the balance sheet to acquire attractively valued assets. They're hunters looking for assets. In the case of Torc and Spartan, the CEOs have large ownership in the companies.

Carscallen: Raging River is also in a position to make acquisitions.

Arpin: We have 7% in energy. Our largest energy holding is NuVista Energy Ltd. (NVA). The company is in the Montney formation, and the area within this formation that NuVista is focused on is called Bilbo. The economics there are exceptional.

NuVista
Energy Ltd.
Raging River
Exploration Inc.
Spartan
Energy Corp.
Torc Oil and
Gas Ltd.
May 11 close$5.97$10.15$2.98$8.21
52-week high/low$8.49-$2.72$10.42-$6.50$3.46-$1.80$10.17-$3.71
Market cap$959 million$2.3 billion$787.3 million$1.3 billion
Total % return 1Y*-27.510.7-9.4-11.9
Total % return 3Y*-3.637.348.03.4
Total % return 5Y*-8.8n/a18.4-18.0
*As of May 11, 2016
Source: Morningstar

Carscallen: I also own NuVista. It's a good-quality name. It has a more mixed production profile. But it's growing production and has decent operating costs. It's a survivor company and is not necessarily in acquisition mode.

Q: Let us discuss the financial sector, which is 14% of the S&P/TSX Small Cap Index and includes real-estate companies.

Chan: We have 22% in financials in Fiera Capital Equity Growth. This includes names such as Canadian Western Bank (CWB).

Carscallen: I have 19% in financials in Mackenzie Canadian Small Cap. One of my biggest holdings is Canadian Western Bank.

Arpin: I also own the stock. It came under extreme pressure because of its perceived exposure to the oil patch and traded at its lowest valuation that it has ever traded as a public company. Beutel Goodman Small Cap has 27% in financials. The biggest position in this sector is Equitable Group Inc. (EQB).

Q: This is the sub-prime mortgage market.

Chan: We own both Equitable and Home Capital Inc. (HCG).

Carscallen: We own Equitable.

Arpin: Equitable is generating a return on equity of 17% and its price/earnings multiple on 2016 earnings-per-share estimates is 6.5 times. The stock is exceptionally inexpensive.

Chan: We consider that Equitable has the potential to appreciate by more than 50% over three years. The company has a higher exposure to Alberta than Home Capital. Given our confidence that the oil price is in the bottoming phase, we consider that a serious downturn in Alberta housing will hopefully not occur.

Q: There were some governance issues at Home Capital in 2015.

Michael Chan
Michael Chan

Chan: In mid-2015, Home Capital reported that it had ascertained that there was a falsification of income levels accompanying loan applications submitted by certain mortgage brokers. The company suspended its relationship with some 45 individual mortgage brokers. Home Capital has taken steps to ensure that this does not happen again.

Carscallen: A global commercial real-estate brokerage company that I own in Mackenzie Canadian Small Cap Value is Colliers International Inc. (CIG).

Arpin: We own it.

Chan: So do we.

Carscallen: Colliers was a spinoff from FirstService Corp. (FSV) in early 2015. We inherited Colliers. It's one of the top companies in its field globally. The company is gaining market share and is an active acquirer. The management team is excellent. The fundamentals are looking good for commercial real estate.

Chan: We like its global brand.

Arpin: There's big insider ownership in Colliers. We still own FirstService. It's in the property-management business and has a significant presence in North America. The business is stable and a big free-cash-flow generator. Although the United States recently went through a severe real-estate downturn, FirstService came right through it with virtually no impact.

Carscallen: I also own FirstService.

Chan: So do I.

Carscallen: In summary, there are certainly opportunities in the financial space that have been hit by the fears over Alberta. The recovery in the oil price has helped to allay those fears.

Q: What about industrials? They represent 10.9% of the S&P/TSX Small Cap Index. Some of these stocks were penalized because of the companies' exposure to energy.

Carscallen: We have 20% in this sector and Badger Daylighting Ltd. (BAD) is a case in point. It provides excavating services to a range of industries. A big portion of its work is energy-related. This is a company that will participate in the oil rebound. It has an aggressive growth plan, particularly in the United States.

Arpin: I own it. The company is an innovator. It's well managed and well capitalized.

Chan: I also own Badger.

Carscallen: The largest industrial holding in Mackenzie Canadian Small Cap Value is Richelieu Hardware Ltd. (RCH). It has been a long-term holding.

Chan: We hold Richelieu, but we think that it's fairly valued.

Carscallen: It's not a cheap stock. It never has been a cheap stock. Operationally, it's a strong performer. It's consistent in generating revenue and profit growth. The fundamentals for its business, home renovation, are strong in both Canada and the United States. It's also successful in making acquisitions in regions where it is underexposed.

Stephen Arpin
Stephen Arpin

Arpin: Beutel Goodman Small Cap has 9% in industrials. The largest holding in this sector is  WestJet Airlines Ltd. (WJA). We've been adding to it. The stock traded near book value because of concerns about its exposure to Alberta. The reality is that jets can be moved anywhere. WestJet is the low-cost provider in Canada and it continues to take share from  Air Canada (AC). WestJet's stock is cheap.

Chan: Fiera Capital Equity Growth has 23% in industrials. Our one-two punch in this sector over the last three-plus years is New Flyer Industries Inc. (NFI) and Boyd Group Income Fund (BYD.UN).

Carscallen: We own Boyd too.

Q: Michael, New Flyer Industries is the biggest holding in Fiera Capital Equity Growth. Boyd Group is a top-10 holding.

Chan: Yes. New Flyer is a major player in transit buses and a major player in motor coaches in North America. The company is a successful acquirer and is also adding new services. Boyd Group is one of the largest players in the collision-repair business in North America. In a fragmented industry, Boyd Group is a consolidator.

Carscallen: The low oil price has encouraged increased driving and there is an increase in accidents, which is good for Boyd Group's business. Traditionally, the industrial sector is where we've found some of our most interesting value opportunities. We mentioned Badger, but there are others that have been hit by the downturn in energy, but stand to show good upside with the improving oil price.

Q: Scott, why the panel's bullish outlook for small-caps?

Carscallen: With the improving environment for resources, it's good for Canada and Canadian stocks. Traditionally, when we come out of troughs or rough patches, small-caps outperform.

Q: Standing back, what could upset the bullish apple cart?

Carscallen: You have to keep the macro factors, such as China's economy, in the back of your mind. If something goes wrong with one of them, you can expect risk aversion to come back into play and with it pressure on stocks. You'll probably see added pressure on small-cap stocks.

Arpin: China is a huge factor. It's a significant source of growth in demand for base metals and oil.

Chan: China is transitioning from a manufacturing economy to a service one. It's going to be bumpy. That's where the risk is.

Photos: Paul Lawrence Photography

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