Canada’s Cheapest Consumer Cyclical Stocks Right Now

To the relief of many Canadian investors, Canada’s stock market has been inching back from last year’s lows. But is it too late for buyers to get in on the upswing?

The S&P/TSX Composite Index, Canada’s benchmark stock index, has risen 6.15% in the past twelve months, recovering a substantial portion of 2022’s dreadful losses. Meanwhile, the Morningstar Canada Index, our collection of stocks from across the Canadian market, has grown 10.35% in the same period.

Cyclical Stocks Lead the Recovery

As Canadian shareholders have emerged from the depths of last year’s bear market, consumer cyclical stocks have far outpaced other sectors. Shares of companies in this sector, which includes industries such as retail, hospitality, and entertainment, tend to reflect swings in the broader market. The sector often rises during periods of economic growth and optimism, and typically retreats during periods of uncertainty and pessimism. Consumers tend to spend more money on things like restaurants, hotels, and new cars if they feel confident about their own finances and the economy.  

Thus, it may be no surprise to investors that consumer cyclical stocks have climbed this year, in line with the broader Canadian stock market. What may come as a surprise, however, especially given inflation’s stubborn grasp on Canadians’ pocketbooks and the BOC’s tight monetary policy, is the extent of the sector’s outperformance. While the Morningstar Developed Markets Index, a pool of stocks from around the developed world, has risen 11.09% YTD, the Morningstar Developed Markets Consumer Cyclical Index, a sub-section that includes only consumer cyclical stocks, has gained 21.04% in the same period. Clearly, a rebound in consumer demand is driving growth in market-sensitive industries.

In her mid-year outlook for the sector, Morningstar’s Director of Consumer Sector Equity Research Erin Lash notes that despite poor savings rates and elevated prices, consumer demand for discretionary goods and services is likely to hold up in the long run. She sees plenty of buying opportunities in the consumer cyclical sector, especially as restaurant sales remain strong and our innate desire to travel persists. According to Lash, tailwinds like more work flexibility and an easing of COVID restrictions will also help to offset headwinds like elevated inflation and high interest rates, factors that she sees as disproportionately reflected in the sector’s share prices. “Near-term challenges should abate over a longer horizon,” Lash posits, “rendering meaningful discounts unwarranted.”

How Can Canadians Ride the Upswing?

Luckily for Canadian investors, there are a few domestic companies in the consumer cyclical sector whose shares are currently undervalued. Despite the sector’s impressive growth so far this year, the share prices of these four companies have yet to reach what we consider them to be worth. Below is our list of Canada’s most undervalued consumer cyclical stocks right now, which Canadians may want to consider adding to their portfolios as the sector continues to shine. 

These four companies, which span the leisure, recreational vehicles, auto parts, and specialty retail industries, all earn a Morningstar Rating of four stars, meaning that their shares are currently trading below our fair value estimates.

• Spin Master Corp (TOY)   
  • Industry: Leisure
  • Price/Fair Value: 0.68%
  • Star Rating: ★ ★ ★ ★
    
    

“With more than two decades since its inception, Spin Master has developed and acquired a plethora of well-known brands like Paw Patrol and Hatchimals, amassing 2% share in a fragmented, more than $100 billion global toy industry (Circana). Utilizing a multifaceted plan for growth focusing on innovation in toys and digital games, higher penetration of overseas markets (which composed around 40% of 2022 sales), the pursuit of strategic acquisitions, and the development of evergreen global entertainment properties, we believe Spin Master has the ability to grow into nascent product and geographies. 

We posit now-completed supply chain optimization, with warehouses consolidated and sourcing better diversified, should support solid operating metrics (we forecast a low-teens average operating margin over the next decade). Spin Master is set to generate average free cash flow to equity of around $225 million over the next five years, facilitating investment in its operations while maintaining the flexibility to strategically add assets to its mix.”

-Senior Analyst Jaime M. Katz

• BRP Inc (DOO)
  • Industry: Recreational Vehicles
  • Price/Fair Value: 0.74%
  • Star Rating: ★ ★ ★ ★
    
    

“Fiscal 2024 (ending January) should be another solid year for BRP's sales thanks to resilient consumer demand across its year-round segment (48% of fiscal 2023 revenue). With a team that remains focused on its long-term product and operational priorities, we believe BRP should continue to maintain strong competitive positioning. 

We recently raised our economic moat rating for BRP to wide from narrow, as we think performance at the business signals an enhanced brand intangible asset and the acquisition of a cost advantage. On the brand side, innovation has consistently won with consumers, thanks to healthy research and development spending, resulting in impressive market share metrics, which we don’t believe will recede.

As BRP’s sales and manufacturing processes have scaled, we think the firm has captured a cost advantage. BRP now has the ability to spread fixed costs over higher volumes, negotiate better with vendors, and manufacture more efficiently, with a factory footprint that is more competitive than in the past and a more favorable product mix (boats rather than marine engines). These factors have led to structurally higher operating margins and improving ROICs, which we don’t expect to recede.”

-Senior Analyst Jaime M. Katz

• Magna International Inc (MG)
  • Industry: Auto Parts
  • Price/Fair Value: 0.77%
  • Star Rating: ★ ★ ★ ★
    
    

“Magna International is one of the largest, most diversified auto parts suppliers in the world. Many suppliers focus on a particular area of the vehicle. In sharp contrast, Magna's capabilities are so broad that the firm could nearly design, develop, supply, and assemble vehicles all on its own. In 2022, the firm contract manufactured roughly 107,500 vehicles, generating $5.2 billion in revenue and $235 million in adjusted EBIT for a margin of 4.5%.

We assign Magna a Standard capital allocation rating, which reflects our assessment of a sound balance sheet, fair investment, and mixed shareholder distributions. We think reinvestment in the business is the most likely key driver of total shareholder returns.”

-Senior Equity Analyst Richard Hilgert

• Canadian Tire Corp (CTC.A)
  • Industry: Specialty Retail
  • Price/Fair Value: 0.85%
  • Star Rating: ★ ★ ★ ★
    
    

“Canadian Tire’s sound balance sheet has given it the financial flexibility to bolster its omnichannel capabilities, weather the pandemic, and improve its own-brand portfolio. Near-term debt maturities are manageable (at around CAD 760 million annually for the next three years), and with net debt less than twice adjusted EBITDA, we do not believe leverage is excessive.

We believe Canadian Tire’s approach to investments has been fair, with accelerating expenditures to boost its omnichannel abilities and own-brand portfolio pursued prudently. Although we believe the firm’s omnichannel evolution started late, we have a favorable view of investments made during the pandemic and the company’s use of its stores as key fulfillment nodes for pickup and delivery orders. Canadian Tire faces a difficult competitive landscape, leaving little room for returns growth, but recent investments have, in our view, aided its ability to protect its current standing.”

-Senior Equity Analyst David Swartz