Three undervalued Canadian stocks

As the less than cheery economic data continues to roil global markets, now may be a good time for Canadian investors to look for opportunities closer to home. It helps that Canadian stocks are trading at far more attractive valuations relative to their peers south of the border despite the fact that the S&P/TSX Composite Index has racked up 17% gains, matching the 18% return for the S&P 500, for the year to date, as of Oct 10.

While Canadian companies are not entirely immune from short-term macroeconomic events, quite often their undeniable growth prospects are drowned out by short-term noise. Prudent investors may want to scour their own backyard for long-term investment opportunities that offer value and portfolio stability.

Morningstar’s Canadian coverage universe has some names with sizeable price mismatch between their market price and fair value, underscoring their potential for price appreciation. These companies with stable cash flows, healthy balance sheets and generous dividend payouts could be the perfect vehicle to ride out market’s yo-yo swings. 

The merged entity of PotashCorp and Agrium, Nutrien (NTR) is the world’s largest fertilizer producer. Although the firm produces three main crop nutrients – nitrogen, potash, and phosphate – its main focus is potash, where it is the global leader with roughly 20% market share.

“In the highly fragmented farm retail industry, Nutrien is pursuing an acquisition strategy to expand its retail store base, which should improve bargaining power with suppliers,” says a Morningstar equity report, adding that the company also benefits from selling proprietary and private-label products at its newly acquired stores.


The firm’s Canadian mines are most cost efficient and therefore generate profits even when prices are below the marginal cost of production. “Nutrien possesses a narrow economic moat due to its cost advantage in potash and nitrogen,” says Morningstar stock analyst, Seth Goldstein, whose $90 fair value for the stock indicates significant unrealized upside. Prompted by this cost efficiency, he forecasts potash and nitrogen businesses to account for 30% and 20% of profits, respectively.

One of the largest oil and natural gas producers in western Canada, Canadian Natural Resources (CNQ) focuses on the acquisition, development, production, marketing, and sale of crude oil, natural gas, and natural gas liquids. The company, whose portfolio includes light and medium oil, heavy oil, bitumen, synthetic oil, and natural gas, also has operations in the U.K. sector of the North Sea and Offshore Africa.

“Canadian Natural Resources is an independent energy company engaged in upstream operations coupled with the ownership of midstream pipeline assets,” says a Morningstar equity report, adding the firm’s midstream pipeline assets allows it to control the transport of a significant portion of its own production, which helps lower its transportation expenses and overall costs.

While its cost structure compares favourably with peers, the company has struggled in recent times due to depressed prices forcing it to curb capital spending, thus stalling the growth potential of its oil sands assets. “Proposed expansion projects still require high levels of capital spending, and growth is at a standstill,” says Morningstar equity analyst, Joe Gemino, who pegs the stock’s worth to be $41, implying enterprise value/EBITDA multiples of 7 times and 8.5 times for 2019 and 2020, respectively.

With growth stalled, Canadian Natural has turned its focus to returning capital to shareholders in the form of dividends. “Its yield around 4% is at the head of the class among oil sands producers,” says Gemino, adding that “the market is overlooking the company’s ability to generate cash flow amid low Canadian commodity prices.”

Canadian auto parts supplier Magna International (MG) manufactures a wide range of products including exteriors, interiors, body and chassis, powertrain, vision and electronic systems, electric vehicle systems, tooling and engineering, and contracted vehicle assembly. North America accounts for roughly half of Magna's revenue, while 40% comes from Europe. The company counts nearly all major automakers across the globe among its customers.

Magna has grown rapidly through acquisition over the years to become one of the largest, most diversified auto-parts suppliers in the world. “The company generates innovations, benefits from high customer switching costs, possesses long-term highly integrated customer relationships, and has wide product breadth,” says a Morningstar equity report.

The firm’s decentralized organization strategy encourages and rewards entrepreneurialism. However, this also means that any competitive advantage developed in individual segment gets diluted in the consolidated results, the report says, while assuring that “the company's healthy liquidity and balance sheet are able to support operations through severe industry downturns.”

Also noteworthy is the fact that Magna's capabilities are diversified into many areas, which prevents the firm from developing expertise in any one area. “We would be more confident in Magna's ability to generate long-term excess returns on invested capital if its products were more focused but its customer base and geographical manufacturing footprint were better diversified,” says Morningstar equity analyst Richard Hilgert, who appraises the stock to be worth $81.

Significant reliance on the Detroit Three (43% of total 2018 revenue) and limited exposure in developing markets could threaten Magna’s success, he adds.