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Corporate Canada Is at a Crucial Juncture

By Ari Charney on February 26, 2016

If Canadian corporate profits are down, it must be because of the energy sector, right? Well, yes and no.

Statistics Canada’s (StatCan) latest financial numbers for Canadian enterprises show that the country’s corporations saw operating profits drop 3.4% year over year, to C$77.4 billion.

Although the energy sector accounted for nearly 60% of the decline, most of the balance came from the financial sector. In particular, insurers recorded a C$1.2 billion drop in operating profits due to fair-value adjustments to actuarial liabilities.

To be sure, energy and financials weren’t the only weak spots during the fourth quarter: StatCan notes that operating profits declined in 13 out of 22 industries.

Overall, operating profits were down about 12.2% from the cycle high in the third quarter of 2014. At the same time, they’re only off by about 2.4% from their trailing five-year average.

So while the recent trend is decidedly not a friend—operating income has declined sequentially in four of the past five quarters—the latest figure is hardly a disaster.

It also should be noted that the fourth quarter wasn’t even the trough—that actually occurred during the first quarter of last year, when operating profits were nearly 7% lower than the latest number.

That period encompassed what some economists have referred to as a technical recession—gross domestic product (GDP) declined during the first half of the year before a sharp rebound in the third quarter. Naturally, that rebound helped give a substantial boost to operating profits.

We could be at a similar juncture. Economists estimate that GDP essentially flatlined during the fourth quarter, with growth expected to come in at around 0.1% (StatCan doesn’t release the official number until next week).

Fortunately, the economy is expected to reaccelerate sharply during the next three quarters. No doubt that the energy sector will continue to be a drag, at least until supply and demand appear to be coming back into balance. But clearly that won’t be enough to offset growth in other areas.

Meanwhile, it’s worth noting which sectors of the economy actually produced meaningful growth during what was a challenging fourth quarter.

On that score, the two sectors that saw the biggest jump in operating profits were motor vehicle and parts manufacturing (up 5.3%) and food and soft drink manufacturers (up 5.7%).

Of course, StatCan’s data reflect a broad swath of Canadian enterprises, of which the publicly traded companies that comprise the country’s stock market are merely a subset.

Nearly 60% of the 239 companies on the benchmark S&P/TSX Composite Index have now reported fourth-quarter earnings. Thus far, sales are down 7.8% year over year, while earnings fell 5.1%.

As might be expected, the resource sector has been the biggest contributor to these declines.

However, there are a couple pockets of noteworthy growth. For the 10 out of 13 firms in the information technology sector that have reported earnings, sales rose 3.0%, while earnings jumped 10.1%.

Of greater note for income investors is the performance of the country’s telecom sector, which includes the Big Three, BCE Inc. (TSX: BCE, NYSE: BCE), Telus Corp. (TSX: T, NYSE: TU) and Rogers Communications Inc. (TSX: RCI/B, NYSE: RCI), our favorite oligopoly. Sales eked out a gain of 0.9%, while earnings climbed 3.6%.

This performance underscores why companies that provide essential services make great investments during uncertain times: Stable demand sustains steady dividends.

Now, it’s time for the rest of the market to catch up.

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