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A High-Quality Stock Hits a Rough Patch

Every investor thinks they’re a contrarian.

But buying stocks after they’ve fallen out of favor with the market is a lot easier in theory than in practice. After all, it’s hard not to be plagued by doubt when your own money is on the line.

That’s why it’s important for bargain hunters to focus on quality–because a high-quality company that’s hit a rough patch is more likely to turn things around.

Income investors interested in Canadian stocks may have just such an opportunity. Mid-cap asset manager CI Financial Corp. (TSX: CIX, OTC: CIFAF) boasts a consensus “Buy” rating among Wall Street and Bay Street analysts. And it also has as an above-average Canadian Edge Quality Score, which is our proprietary system for gauging dividend safety.

Nevertheless, over the past year, CI’s shares have dropped 17.6% on a price basis in Canadian dollar terms, while the overall Canadian market has risen 8.9%, a gulf in performance of more than 26 percentage points.

Over the long term, however, the story is quite different: CI has been among the top performers on the Toronto Stock Exchange since its debut in 1994, with a total return of 4,470%, or roughly nine times the Canadian stock market’s performance over that same period. Read that last sentence one more time.

Equally important, CI has delivered growth AND income to its shareholders. Over the past five years, the company has grown its monthly (yes, monthly) dividend 9.3% annually, for an annualized payout of C$1.38 and a forward yield of 5.5%. Salivating yet?

As an independent asset manager, CI makes most of its money by managing mutual funds and exchange-traded funds. With the right people running the show, asset management is a high-margin business that generates strong free cash flows and high returns on equity.

To that end, CI’s free cash flow per share regularly exceeds earnings per share, while its returns on equity have averaged 25.3% over the past five calendar years.

Credit for this performance is largely due to CI’s fund managers, who over the long term have done a superb job of beating their benchmarks and attracting new assets. The firm even had positive net inflows during the Global Financial Crisis, when most of its peers were suffering massive outflows.

Managing the Managers

More recently, however, performance has begun to lag, and that’s led to some attrition in assets under management as well as lower overall management fees. At the end of the second quarter, CI reported $109.6 billion in assets under management, down 1.4% from their peak in the first quarter, while the firm’s average management fee declined 7.9 basis points year over year, to 1.575%.

Management noted that redemptions were higher than average during the quarter due to the departure of two large institutional clients.

The second quarter’s performance is emblematic of what’s been happening over the past several quarters. CI’s typically strong earnings growth began to flag during the second half of last year, while this year analysts expect an outright decline in earnings per share of 5%.

The company has also done a poor job of managing investor expectations during this time, with both sales and earnings per share falling short of analyst estimates in each of the past five quarters.

Certainly, the Canadian market deserves some of the blame. The country’s stock market performed poorly last year, while the beginning of 2016 saw last year’s decline deepen to worrisome levels.

But the Canadian market has since reversed course and is now up 12.8% year to date on a price basis in Canadian dollar terms. And the majority of the firm’s assets are invested in non-Canadian securities, so there is a limit to blaming Canada.

That means lackluster fund management is likely the culprit behind the firm’s recent financial performance. Fortunately, CI’s senior executives have acknowledged the concerns about investment performance and accordingly have made changes among the company’s fund managers in recent months.

Another part of the story could be greater competition from cheaper, passively managed investment vehicles, such as exchange-traded funds. Here, too, CI’s management is working to stem the tide.

Last year, the firm acquired Toronto-based First Asset Capital Corp., which is a market leader in Canadian ETFs. Since the deal’s close, CI has already launched three actively managed ETFs and has plans to launch a new family of ETFs later this year, with more to come.

Perhaps these initiatives are already starting to bear fruit. In its latest monthly financial report, CI announced that assets under management have grown to $112.4 billion, with average assets during the third quarter up 2.9% from the second quarter and up 0.7% from last year’s average.

Looking ahead, analysts expect adjusted earnings per share to rebound by 10% next year, to C$2.10, a post-downturn high. The consensus 12-month target price is C$29.11, which suggests potential appreciation of 16.3% above the current share price.

Meanwhile, the Canadian dollar is down about 4.3% from its trailing-year high, thus affording value-conscious U.S. income investors a further discount on a high-quality stock that’s already been beaten down.


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