Value and Stability up North

Editor's note: Read the latest on how the coronavirus is rattling the markets and what you can do to navigate it.

Stock markets continue to be on edge and the uncertainty south of the border may be a stay-at-home signal for Canadian investors. 

The June 11 stock market rout in the U.S., the biggest since March, was a sign things are far from normal yet. Fears of a resurgence in coronavirus cases, reopening of the economy without a vaccine, elevated levels of unemployment and forecast of GDP contraction was a cocktail of negative headlines that triggered a steep selloff that saw Dow plunge nearly 7%, while the S&P 500 and the Nasdaq dropped more than 5% each.

No doubt, the Canadian market isn’t immune from the fallout of the coronavirus crisis, but the volatility over the past few months has created attractive openings for some quality Canadian stocks that are now trading at a sizeable discount to their intrinsic value.

Select names in the Morningstar’s Canadian coverage universe represent value and stability for those looking to ride out the storm. Investors with some cash to deploy longer term may want to keep the following companies on their screen. These stocks offer both upside potential and a margin of safety, coupled with considerable dividend yields.

Canadian energy behemoth, Enbridge (ENB) has operations in the U.S. and Canada. Its pipeline network consists of the Canadian Mainline system, Canada’s largest pipeline, as well as regional oil sands and natural gas pipelines. The company is also Canada’s largest natural gas distribution company and generates renewable and alternative energy.

Enbridge is well-positioned to benefit from growing oil sands supply dynamics with its Mainline system, which “generates attractive tolls and represents approximately 70% of Canada’s pipeline takeaway capacity,” says a Morningstar equity report, adding that the system’s attractiveness is further enhanced by refinery access it offers to various markets.

Directly tied into the Mainline are various regional pipelines, each of which originates from existing oil sands projects and is secured on long-term contracts.

While crude pipelines are the crown jewel of Enbridge, the company operates a diverse energy portfolio, including gas distribution operations providing regulated returns and reliable cash flows. “Enbridge also operates natural gas pipelines that supplement its crude pipeline network and are underpinned by long-term take-or-pay contracts,” says Morningstar equity analyst Joe Gemino, who puts the stock’s fair value at $57, and sees “significant upside coupled with the top-end dividend yield.”

Gemino refers to the wide-moat stock as “one of our top picks in the energy sector,” and argues “the market is mistaken to price Enbridge as if oil prices will remain weak forever.”

Magna International (MG) is one of the largest, most diversified auto-parts suppliers in the world. The company makes exteriors, interiors, seating, roof systems, body and chassis, powertrain, vision and electronic systems, closure systems, electric vehicle systems, among other auto parts. North America accounts for nearly half of Magna's revenue while approximately 44% comes from Europe.

Unlike its peers that focus on a particular area of the vehicle, the Canadian auto parts supplier’s “capabilities are so broad that the company could nearly design, develop, supply, and assemble vehicles all on its own,” says a Morningstar equity report.

However, such broad diversification could spread resources thinly and prevent optimal allocation of capital, thereby restricting the firm’s ability to develop 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 product offering was more focused but its customer base and geographical manufacturing footprint were better diversified,” says Morningstar equity analyst Richard Hilgert.

Pointing to Magna’s overreliance on the Detroit Three (43% of total 2018 revenue) and limited exposure in developing markets, Hilgert says “we would like to see the company diversify its customer base with additional business from Asian manufacturers.”

Magna’s push for developing product and process technology has received industry recognition, says Hilgert, who recently raised the stock’s fair value from $82 to $89.

Nutrien (NTR) is the world’s largest crop nutrient company that produces nitrogen, potash, and phosphate. While the company is the global leader in potash with roughly 20% share, it is also the largest agricultural retailer in the U.S., selling fertilizers, crop chemicals, seeds, and supplies directly to farmers through physical and online stores.

Nutrien has been expanding its retail store bases through acquisitions, which has boosted its bargaining power with suppliers. “The company benefits from selling proprietary and private-label products at its newly acquired stores,” says a Morningstar equity report, noting that Nutrien’s online retail platform positions it well for higher sales growth as more farm retail sales move online.

The online pivot should allow Nutrien to better showcase its proprietary products, improving margins over the long-term. “We expect the retail segment, which accounted for roughly 60% of gross profit in 2019, to generate relatively steady cash flows,” says Morningstar equity analyst Seth Goldstein, whose $85 fair value for the stock underscores significant upside potential.  

Nutrien is also the world’s largest producer of potash which is projected by Goldstein to account for about 30% of midcycle profits. “Nutrien’s potash mines are located in Canada and sit on the low end of the global cost curve due to favourable geological [setting],” he says, pointing out that these mines have “generated profits even when prices are below the marginal cost of production.”

Canadian Natural Resources (CNQ) develops, produces, and sells crude oil, natural gas, and natural gas liquids. The company’s portfolio comprises light and medium oil, heavy oil, bitumen, synthetic oil, and natural gas. One of the largest oil and natural gas producers in western Canada, it also has operations in the U.K. sector of the North Sea and Offshore Africa.

The Canadian energy giant is engaged in upstream operations coupled with the ownership of midstream pipeline assets, which “allows it to control the transport of a significant portion of its own production and lowers its transportation expenses and overall cost structure,” says a Morningstar equity report.

Prompted by the firm’s first-quarter results, Goldstein raised the stock’s fair value from $33 to $34. “The market is overlooking the company’s long-term ability to generate cash flow amid low global commodity prices,” he argues. While Goldstein concedes the near-term outlook for energy companies remains bleak due to supply shock and lower demand but assures “these issues only affect cash flows in the next one to two years.”

Weaker realized prices have stalled the near-term growth potential of the company's oil sands assets. Beyond 2021, though, the company’s expected to see robust demand growth as disruptive forces like electric vehicles could take much longer to impact global crude consumption. “Once the dust clears, we expect Canadian Natural to return to its cash-generating ways,” assures Goldstein.