Martin Hubbes, chief investment officer of AGF Investments Inc., says that while there is a long-term case for investing in natural-resources plays, not all natural-resource companies are created equally. "Investor enthusiasm for energy and materials stocks remains at a high level, but some of these stocks will disappoint," he says.
Hubbes's strategy is to focus on low-cost producers that have high-quality assets and are capable of strong production growth. "It is also important to assess the calibre and track record of management."
Global economic growth, in the main, drives the demand for natural resources, says Hubbes. But, he cautions, the hefty levels of both government and consumer debt could hamper this growth. A related issue, he says, is that central banks currently have their "feet on their monetary-policy accelerator, but what happens if they change their strategy?"
At AGF, Hubbes directly manages $4.5 billion includingAGF Canadian Stock, a Canadian Focused Equity fund, which has assets of $2.1 billion. The fund holds 85 names and the average market capitalization is $2.7 billion. The foreign content is 20%.
A conservative growth manager, Hubbes looks for companies that are producing sustainable growth in earnings and cash flow, and yet trade at reasonable valuations. AGF Canadian Stock has 22% in energy and 14% in materials -- the bulk in gold stocks -- making for a total of 36% in natural resources.
Financial services constitute 25%. The Canadian banks, says Hubbes, have been reporting strong earnings numbers and beating analysts' estimates. "They are generating good spreads on their Canadian intermediary business, their trading revenue is robust and non-performing loans are more modest than the Street anticipated."
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Hubbes's ongoing three favourites are Toronto-Dominion Bank TD, Bank of Nova Scotia BNS and Royal Bank of Canada RY. Besides natural resources and financial services, other significant sector weightings are health care at 8.6% and consumer staples at 8%.
On energy, Hubbes says that the oil price should remain "fairly firm" in the US$70 to US$80 per barrel range. There is, he says, a "slight surplus" of oil at present, but this should decline provided there is stability in demand from the mature economies and increasing demand from emerging economies. "On the long-term supply side, it is increasingly expensive to find oil."
By contrast, the natural gas price "will be challenged over the intermediate term and I am focusing on low-cost producers." On the supply side, he notes, shale plays have "opened up a whole new frontier with a resultant substantial addition to production."
Hubbes says gold "represents a good store of value at a time when governments around the world have resorted to the printing press to revive the global economy." Although the bullion price has risen sharply, "there are enough naysayers to indicate that this is not yet a bubble." In addition to a strong bullion price, gold producers are generally enjoying lower production costs, he says. For example, oil, an input, has seen its price slashed roughly in half from its peak.
The integrated energy company Suncor Energy Inc. SU is the largest holding in AGF Canadian Stock, at 6.2%. Suncor is strategically focused on developing oil sands, says Hubbes, and "oil-sands projects are out of favour at present."
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Resources sectors lag over past 12 months |
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Index |
1-yr return* |
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S&P/TSX Composite |
62.4 |
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S&P/TSX Capped Energy |
45.5 |
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S&P/TSX Capped Materials |
52.1 |
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* For the 12 months ended March 9 Source: Morningstar |
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Furthermore, he says, investor expectations after Suncor's merger with Petro-Canada in mid-2009 were too lofty. "It will take time for Suncor's strong management team under the leadership of CEO Richard George to extract value from the combined high-quality assets." Hubbes considers the stock to be cheap. "The valuation does not reflect the good long-term prospects of this company."
A natural-gas producer that "generates a high return on capital" is the oil and gas royalty trust Bonavista Energy Trust BNP.UN, which represents 1% of the portfolio. Bonavista operates in Alberta, Saskatchewan and north-eastern British Columbia. Natural gas constitutes 61% of its total production, and 39% is in oil and liquids. This trust, says Hubbes, is a low-cost producer with strong technical and operational expertise.
The Bonavista management team led by Keith MacPhail and Ronald Poelzer is strong and focused, Hubbes says. The trust is growing its production both internally and through acquisition of assets, and has a high distribution yield, he adds. "While the trust's valuation is fairly high, it is warranted given that this is a high-quality business, which should continue to do well over the long haul." Bonavista has yet to unveil its plans to convert to a conventional corporation.
A gold company that Hubbes considers is trading at a more reasonable valuation than many of its peers is IAMGOLD Corp. IMG, which focuses on West Africa, the Guiana Shield of South America, and Quebec. "The company has high-quality assets and is growing its production." Its flagship Rosebel mine located within the Guiana Shield in Suriname is "showing improved production," he says.
At the beginning of this year IAMGOLD's CEO Joseph Conway resigned and left the company in mid-January. The board, says Hubbes, has struck a committee to search for a new CEO, "so there is some uncertainty about this."
Hubbes has reduced his holding in another gold-mining company, Kinross Gold Corp. K. "The stock has done well," he says "and I have some concerns about its exposure in Russia." Kinross has a 75% interest in the Kupol project, a high-grade gold and silver mine. There could be some sovereign risk here, he says. "Russia has, at times, treated foreign natural resource companies poorly." Hubbes underscores that there is "nothing fundamentally wrong with Kinross," which is held in other AGF funds.
