Undervalued Canadian Stocks

U.S. stocks have picked up in 2021 exactly where they left off in 2020. The Dow and the S&P 500 have been consistently hitting new highs as the market’s bull run continues unabated. Are there any underappreciated opportunities left?

Coming as it does close on the heels of over 18% return for the S&P 500 in 2020, the upward march of equities, and the attendant euphoria, have made it difficult to find entry points for value investors looking to shuffle their portfolios. Luckily, there are still stocks some attractive names Canadian investors can find in their own backyard.

The following domestic players are rare islands of opportunities in Morningstar’s Canadian equity coverage universe. Reflecting a disconnect between their current price and their long-term growth prospects, these underappreciated stocks offer some margin of safety and represent durable businesses. While it’s hard to foretell equity market moves in the short term, Morningstar analysts argue these stocks have the potential for value appreciation over the long haul.

Canadian legacy wireless and internet service provider, BCE (BCE) is one of the big three national players. It boasts nearly 10 million customers constituting about 30% of the market. The telecom operator also has a media segment, which holds television, radio, and digital media assets. BCE licenses the Canadian rights to movie channels including HBO, Showtime, and Starz. In 2019, the wireline segment accounted for just over half of total EBITDA, while wireless composed 38% and media made up the rest.

BCE maintains a leading position in a three-player oligopoly comprising Rogers and Telus, together controlling 90% of Canada's total wireless market, a scale no rival can hope to match. “BCE has been investing heavily to upgrade its wireline network by extending fibre to the home (FTTH), which positions the firm to take share over its footprint,” says a Morningstar equity report.

With more than 3.5 million customers, BCE is the biggest Canadian broadband provider with a footprint that reaches three-quarters of the nation’s population. “As a legacy phone provider, BCE has historically competed with an inferior network, contributing to better penetration rates for Rogers and Videotron,” notes Morningstar equity analyst Matthew Dolgin, adding that FTTH will shrink operating costs and allow BCE to “offer speeds comparable to or better than competitors, and charge higher prices.”

While BCE’s revenue and profits were depressed throughout the pandemic, “we expect substantial business improvement throughout the Canadian telecom industry when the pandemic ends, and BCE continues to position itself to outperform its peers,” says Dolgin, who puts the stock’s fair value at $65.

Canadian supermarket operator, George Weston (WN) owns three subsidiaries: retail (Loblaw), real estate (Choice Properties), and consumer goods (Western Foods). The firm has a 52% controlling stake in Loblaw, the largest grocer in Canada. George Weston’s ownership of is Choice Properties, an open-ended real estate investment trust, sits close to 63%. The firm wholly owns Weston Foods, a North American bakery.

While all three are separate entities, they operate under a contractual framework of strategic business partnerships. This is exemplified by Loblaw being Choice’s largest tenant. Consolidated sales come almost entirely from Canada, with Weston Foods being the only operator that generates revenue (more than 50% of its mix) from the U.S.

George Weston has a meaningful presence across Canadian retail, consumer goods, and real estate. “The businesses tout varying degrees of scale and, while we don’t believe any of them boast moatworthy competitive advantages, we see some semblance of a symbiotic relationship among them,” says a Morningstar equity report.

Loblaw, the company’s largest business segment, “is centred around leading food and drugstore banners, with its assortment across segments bolstered by a prolific private label program, including brands like Presidents Choice,” notes Morningstar equity analyst Nicholas Johnson.

Further, Loblaw boasts a robust digital engagement strategy, based on its PC Optimum loyalty program and e-commerce capabilities. “These assets are core to the firm's value proposition across a retail landscape that is constantly in flux,” says Johnson who appraises the stock’s fair value to be $117, indicative of adequate margin of safety in the shares at current levels.

One of the largest oil and natural gas producers in western Canada, Canadian Natural Resources (CNQ) also has operations in the U.K. sector of the North Sea and Offshore Africa. The company’s portfolio includes light and medium oil, heavy oil, bitumen, synthetic oil, natural gas liquids, and natural gas. In addition to upstream operations, the independent energy company also owns midstream pipeline assets.

With the permit for the Keystone XL project revoked, declining imports from Venezuela and Mexico, and oil prices on the upswing, oil sand producers like Canadian Natural may find rail transportation attractive as a supplement market option. A Morningstar equity report projects Canadian supply to grow 6.3 million barrels of oil per day by 2030, increasing by 1 mmbbl/d over the next decade. “We think the market is underestimating the growth prospects and the cash flow potential of the oil sands producers along with the midstream pipeline operators,” the report notes.

Like its peers, Canadian Natural has been executing major spending cuts forced by depressed oil prices due to the pandemic and a price war between leading oil-producing nations and stalled growth. “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 fair value at $42.

With growth stymied, Canadian Natural has shifted its focus to returning capital to shareholders in the form of dividends. The company’s yield of nearly 6% is “at the head of the class among oil sands producers,” Gemino notes.