IT’S TIME TO BEAR DOWN
Good idea to seek out areas that have been overlooked
JONATHAN RATNER
In a prolonged bull market like the one currently in place, investors are often tempted to move down the quality scale as they search for stocks with lower valuations amid markets that are generally expensive. This approach stems from the fact that many quality businesses are priced higher than they’ve been in the past.
But in a difficult economic environment, the negative attributes of lower-quality businesses really come home to roost. That’s why Ian Cooke, head of Canadian equities at Calgary-based QV Investors, doesn’t want to downgrade the quality aspects of his holdings.
“You get to understand why they are cheap or lower quality when you go through a bear market,” the portfolio manager of the IA Clarington Canadian Small Cap Fund said.
QV Investors is a sub-advisor to IA Clarington, and QV stands for “quality” and “value.” The firm is focused on protecting capital, companies with prudent capital allocation, and investing with management teams that have significant ownership stakes in their respective companies. Unlike many other small cap funds, more than 80 per cent of the portfolio’s 30 to 40 holdings pay a dividend.
The IA Clarington Canadian Small Cap Fund, which has roughly $1 billion in assets, has generated an annualized return of 12.2 per cent in the past five years, and 7.3 per cent in the past 10 years, as of March 31, 2017.
Investors may think their portfolios have better downside support in challenging markets if the stocks they hold have lower valuations, but a better approach might be to seek out areas that have been overlooked.
That’s what Cooke is finding in the energy sector — home to both high and low-quality businesses, but an area that’s had a challenging few years to say the least.
“Generally, sentiment toward the energy sector is negative,” he said. “However, there are still businesses that have terrific assets and have demonstrated their abilities in difficult periods.”
One such company he highlighted is AltaGas Ltd. (ALA/TSX), a company QV Investors has owned since its IPO more than a decade-and-a-half ago, but increased its weighting in over the past 12 months to make it one of the largest fund holdings.
“They’ve been able to generate record levels of cash flow, grow the dividend from below $1.70 two years ago to more than $2 per share today, and they have a very attractive runway of opportunities going forward,” Cooke said.
While AltaGas is classified as an energy company, the portfolio manager highlighted several of its alternative energy activities, including the largest run-of-river hydro project in B.C. over the past 50 years, the first battery storage utility assets in California, and the first wind project in B.C. nearly a decade ago.
Cooke noted that AltaGas is also on the cusp of becoming the first company to develop propane export capabilities on the west coast of Canada, which will provide much needed tidewater access to relieve the region’s propane glut.
“Projects such as this make meaningful contributions to Canada’s trade dynamics,” he said, noting that the propane project could boost the country’s exports to Japan by five per cent.
“These are the types of businesses we want to get our hands on when the general malaise is creating attractive opportunities to own them,” he added.
Even if there is no rebound in energy, or a continuous expansion in market multiples, which Cooke believes a lot of investors have be lulled into over the past eight years, he is confident AltaGas can generate a reasonable rate of return because of its attractive and rising dividend.
The portfolio manager also highlighted the high level of fund flows into ETFs and other indexrelated products, and how that is causing some companies to be overlooked.
E-L Financial Corp. Ltd. fits the bill as being under investors’ radars, as it’s not in the S&P/TSX Composite Index and is followed by few, if any, sell-side analysts.
Its corporate investment portfolio is primarily outside of Canada, but does include Empire Life, one of the country’s Top 10 life insurers.
“It’s got profitability measures that are as attractive as the other public life insurers,” Cooke said, noting that those names trades at roughly 1.5x book value, while E-L trades closer to 0.7x.
Netting out what he thinks the insurance business is worth, Cooke believes E-L’s collection of corporate investments is trading at about 50 or 60 cents on the dollar.
“We think it is a wonderful way to get exposure to markets without paying a steep price, in an environment where value is harder and harder to come by,” he said. “It’s also a nice way to be aligned with shrewd billionaire investors (the Jackman family is the company’s largest shareholder).”
A more recent addition to the portfolio (in 2016) is Canfor Pulp Products Inc. (CFX/TSX).
Cooke believes it too offers investors high-quality assets on the cheap, noting that Canfor Pulp operates in the lower-cost segment of the pulp industry.
He also pointed out that the company’s relationship with Canfor Corp. gives it better access to fibre than other western Canadian pulp producers.
“It trades at a steep discount to industry peers, and they’ve also increased their stability and cash flow,” Cooke said. “The company is exploring more green energy opportunities, has no debt, and has bought back about five per cent of the shares outstanding in the past two years.”
These are the types of businesses we want to get our hands on.