Our Canadian equities roundtable, focusing on non-resources sectors, concludes today with a discussion of the managers' favourite consumer stocks and their value picks in several other industries.
The participants: Kim Shannon, president and CEO of Toronto-based Sionna Investment Managers Inc.; Mark Thomson, managing director and head of research at Beutel Goodman & Co. Ltd.; and Ian Hardacre, vice-president and head of Canadian equities at Invesco Trimark Ltd. The trio of value managers spoke with Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and continued on Wednesday.
Q: Let's talk about consumer-related stocks. Consumer staple stocks are a 2.4% weighting in the S&P/TSX Composite Index and consumer discretionary stocks are 4% of the index.
Shannon: On the staples side, we own Shoppers Drug Mart Corp. SC. It is a cash-flow story. It has had challenges from the changes in drug regulations, so the pharmacy side is less profitable. It is also a convenience store and has been expanding in the high-end cosmetics area. It trades at a trailing price/earnings ratio of 15 times. Its chief executive officer recently left, so that is a hiccup. Shoppers is good at hiring new management.
Hardacre: We have owned Shoppers for the past two years. It is a relatively new position for us. We bought a half-weight (versus the index) when the issue came up with the Ontario government regarding generic drugs and the pharmacists. Thereafter, the stock went down and we bought more. The company has great real estate. It is a good business. The negative is (uncertainty over) who the new CEO will be. The valuation is good at 13 times forward earnings estimates.
Shannon: We also own the Quebec-based pharmacy company, Jean Coutu Group (PJC) Inc. PJC.A. It has strong cash flow. It learned from its mistakes going into the United States. The stock is particularly weak right now, because the squeeze on pharmacies is spreading. The company may or may not be for sale. It is family controlled and the founder, Jean Coutu, is getting on.
Thomson: Our biggest weight in consumer staples is Molson Coors Canada Inc. TPX.B. It trades at 12 times forward earnings, with huge cash-flow generation. It is well positioned in its market and has consistently gained market share. It pays a dividend and its payout ratio is going up. It has an excellent balance sheet, lots of free cash flow, and we hope that they utilize that correctly. It should continue to raise its payout ratio and buy back its stock. This is one of the cheapest brewers in the world, based on its private market value.
We bought Metro Inc. MRU.A in the past three months. The company has exceptional management and lots of free cash flow. It is an excellent operator in Ontario and Quebec. It trades at 10 times forward earnings.
Shannon: Metro's dividend yield is 1.7%. I own Loblaw Cos. Inc. L and Empire Co. Ltd. EMP.A, as my food retailers. Food retailers are great stabilizers in an equity portfolio. They are not as strong performers and they get inexpensive when the stock market is hot, frothy and speculative, like it has been recently. But when the market gets ugly, as in 2008, they outperform. The market has been strong and these stocks are inexpensive. It is not a bad time to be looking at a Metro, Loblaw and Empire.
Thomson: I also own Loblaw.
Shannon: Loblaw is interesting because it is in a turnaround situation. What concerns us with Loblaw is that it needs to build a new distribution centre, and that is never pretty for food retailers. It usually means a hiccup or two in inventory management.
Q: What about consumer discretionary stocks?
Shannon: Probably our most controversial holding in this sector is Yellow Media Inc. YLO. Yellow Pages' business has challenges and the stock price reflects this. Print is still declining and the company is moving its information online. The stock price reflects these challenges. It is cheap. Yellow has a management team that wants to acquire its way into a growth business. Its capital-allocation story can be told in its buying Auto Trader five years ago for $1.2 billion and selling it recently for $745 million. It has a good yield, which we are reasonably confident is sustainable at this stage, after being cut a few times. It is one of those cigar-butt value stocks.
Hardacre: There are still a couple of puffs left in it.
Q: Ian, you have exposure to the technology sector, which represents 2% of the S&P/TSX Composite Index.
Hardacre: The largest holding in Trimark Canadian is MacDonald Dettwiler and Associates Ltd. MDA, which is almost 7% of the fund. A more controversial name is Research in Motion Ltd. RIM, which is also in our top 10 holdings. There are a lot of moving parts to this company. It is in the top three players in its space and it is not going the way of Finland's Nokia Corp., which has had its share of problems. RIM is a strong free-cash-flow generator. It is not without its risks. But the company has a good private market value.
Thomson: We have a zero weighting in information technology. In the case of RIM, we don't know what the franchise is worth. Given our focus on margin of safety in buying a stock, we can't buy this stock even though it looks cheap.
Shannon: The stock is cheap by historical standards. The industry is highly competitive.
Q: Industrials, which represent over 5% of the S&P/TSX Composite Index?
Thomson: Most stocks in the industrial sector are as expensive as they have ever been by historical standards. They are chicken cyclical stocks as investors, who are nervous about resource stocks, use industrials as a lower-beta proxy. Looking, for example, at the rails, we view Canadian National Railway Co. CNR as a hold. We recently added Canadian Pacific Railway Ltd. CP, which has excellent return potential. The stock declined recently due to the impact on its business of adverse weather conditions in the West. This is irrelevant in determining the long-term valuation of the business.
Hardacre: We have a big weighting in Toromont Industries Ltd. TIH, a diversified high-quality industrial company. It is also in our top 10 holdings in Trimark Canadian. The company is proposing to spin off its natural-gas compression business as a separate, publicly traded company. I have confidence in the management team of Toromont. It has been a good creator of shareholder value in the past.
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| Ian Hardacre, Kim Shannon and Mark Thomson |
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