Martin Ferguson, director and portfolio manager at Mawer Investment Management Ltd., says that even though the performance of the Canadian small-cap market has been relatively flat in the year to date, there are stocks in some key sectors that have performed extremely well.
The benchmark BMO Small Cap Blended (Weighted) Total Return Index produced a total year-to-date return of 1.1% to mid-November. "The performance was hampered by the index's heavy weighting in natural-resource stocks at 52% -- 19% in energy and 33% in materials." These have been among the poorest performing sectors in the index so far this year," says Ferguson, a veteran small-cap specialist.
By contrast, he says, other key sectors in the BMO Small Cap Index, such as financials at 12% and industrial stocks at 11%, have done well. "Our portfolios are overweight these two sectors."
Of Canadian small-cap financials, Ferguson says there are a number of companies that focus on "smaller but important niches in the Canadian financial-services market and continue to do what they do well."
He cites as an example the alternative mortgage providers in Canada. "These companies generate a high return on invested capital, making them good wealth creators. This is our focus in stock selection."
The Canadian small-cap industrial sector offers "companies from a broad range of industries and specialty niches to choose from." A new addition to Ferguson's portfolios is Newalta Corp. NAL, which recycles industrial and oilfield waste. This company is a "major player in its industry and has good growth potential."
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| Martin Ferguson | |
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Ferguson's discipline is to "systematically create broadly diversified portfolios of wealth-creating companies that trade at discounts to their intrinsic values, as calculated using discounted-cash-flow analysis." The portfolios are fully invested and have low turnover rates.
Under his mandates, Canadian small caps are "companies with a market capitalization of up to 75% of the BMO Small Cap Index threshold." This currently imposes a market-cap ceiling on Ferguson's first-time purchases of approximately $1.2 billion versus the BMO threshold of about $1.6 billion.
At Calgary-based Mawer, (assets under management $12.8 billion), Ferguson's mandates include Mawer New Canada 
, which is closed to new investors, and BMO Guardian Enterprise , which is managed along similar lines. In all, he is responsible for $1.6 billion in assets.
BMO Guardian Enterprise, with 57 companies, is overweight in both financial services, at 25.8% of the portfolio, and industrials at 22.6%. These are its two biggest sector weightings. Its weight in energy is market-like at 18%, while its materials stake is substantially underweight at 9.4%.
"The portfolio has been perennially overweight financial services," says Ferguson. Two long-standing holdings in the portfolio that he continues to like are Equitable Group Inc. ETC and Home Capital Group Inc. HCG.
These two alternative mortgage providers continue to benefit from the substantially reduced competition in their niche following the departure of many foreign-owned and some Canadian-owned players after the financial crisis in 2008, says Ferguson.
Furthermore, he says, there will likely be additional demand for alternative mortgages, even though the Canadian housing market is showing signs of weakening. "Ottawa has tightened the rules on bank-prime mortgage lending in an effort to curb the rise of consumer debt, and this will drive more business the way of alternative lenders."
| Equitable Group Inc. | Home Capital Group Inc. | ||
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| Nov 20 close | $32.00 | $52.80 | |
| 52-week high/low | $32.50-$24.48 | $54.99-$42.00 | |
| Market cap | $483.1 million | $1.8 billion | |
| Total % return 1Y* | 23.6% | 10.0% | |
| Total % return 3Y* | 15.9% | 10.9% | |
| Total % return 5Y* | 3.1% | 7.7% | |
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| *As of Nov. 20, 2012 Source: Morningstar |
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Equitable Group, says Ferguson, has a high-quality loan portfolio and strong capital ratios. The company is a good wealth creator, with a return on equity of 19% in its most recent quarter. The stock is "attractively valued," he says. It trades at 6.6 times estimated earnings per share for 2012 and at 1.1 times book value per share.
Home Capital Group generates "an even higher return on equity in the 20s," says Ferguson. The stock is "slightly more expensive than that of Equitable Group as Home Capital is a bigger and relatively stronger company." Home Capital's stock trades at a multiple of eight times 2012 per-share earnings estimates, and at two times book value per share.
Turning to the industrial sector, Ferguson sees Newalta as a company with a strong growth profile trading at a reasonable valuation. The company, he says, has a network of 85 facilities across Canada that process industrial and oilfield-generated wastes. "This network provides recurring services to a diversified customer base," says Ferguson.
A growth part of the business, he says, is Newalta's Onsite division. The company, for example, has a $60-million contract from Syncrude Canada Ltd. to process tailings at Syncrude's oil-sands operation near Fort McMurray. Newalta has designed and built a plant on the Syncrude site for this purpose. The stock, he says, trades at an enterprise value to EBITDA (earnings before interest, tax, depreciation and amortization) of six times 2013 estimates and has a good dividend yield.
In addition to Newalta, another newcomer to Ferguson's portfolios is High Liner Foods Inc. HLF. The company "is a dominant player in the frozen-seafood business in both Canada and the United States." Its customers include food distributors/retailers and institutions -- restaurants, hotels, schools and hospitals.
High Liner, says Ferguson, "has successfully acquired companies that offer good synergies." For example, at the end of 2011, it completed the purchase of the U.S. and Asian operations of Icelandic Group, a major European seafood company.
As a result of acquisitions, High Liner has "a lot of debt on its balance sheet," says Ferguson. "It has the ability to reduce this quickly, given the synergies and cost reductions it is realizing and the resultant strong cash flow it is generating."
The stock, he says, has had a strong run this year, "but remains reasonably valued at less than 10 times estimated earnings per share for 2013."
Against the backdrop of weakness in commodity prices and junior resource stocks, Ferguson sold his holding in Sandstorm Metals & Energy Ltd. SND. This company provides upfront financing to smaller resource companies that are looking for capital.
"While its business model is innovative, the timings of the financings were poor," says Ferguson. "The capital was advanced before commodity prices fell," he says. "These weaker prices created significant hurdles for the smaller resource companies attempting to bring their projects on stream."
