3 Growth Drivers for Canada’s Economy

Editor’s Note: Please see our analysis of the latest news from our Dividend Champions in the Portfolio Update section following the article below.

It’s taken more than a year, but a crucial shift is taking hold north of the border.

That would be the shift from the beaten-down resource sector, which had been the dominant player in Canada’s economy before oil prices collapsed, to other sectors, such as retail and auto manufacturing.

In the past seven days, we’ve seen two key reports back that up—plus an assist from the country’s just-released federal budget.

Retail Therapy

No sooner had we clicked “publish” on last week’s Maple Leaf Memo, on Canada’s volatile retail sector, than Statistics Canada (StatCan) came out with the latest round of retail sales, and they were, as one analyst called them, “fireworks.”

Overall sales surged 2.1% in January, easily topping the 0.6% analysts expected. Sales slipped 0.2% in oil-dependent Alberta, but shoppers in Ontario and Quebec picked up the slack, notching 2.8% and 2.9% increases, respectively.

We’ve written before about how important handoffs are in changing investor sentiment, and this handoff was dramatic: In December, it was as if Christmas never came—Canadian retail sales fell 2.2% from November, on a seasonally adjusted basis.

The uptick also bodes well for Canada’s first-quarter GDP, after growth slowed to 0.8% annualized in the fourth quarter from 2.4% in Q3. (We’ll have to wait until the end of May for StatCan to come up with the official Q1 numbers).

Factories: Working Overtime

One place where a reversal wasn’t in the cards was in Canadian factory sales. That’s because they’re already on a growth spree, rising 1.2% in November and 1.4% in December. In January, they jumped 2.3%, far exceeding the 0.5% forecast.

When you add in strong export data in January, first-quarter GDP growth should easily exceed the 1% the Bank of Canada (BoC) is forecasting, CIBC economist Nick Exarhos wrote in a note quoted in the Financial Post.

Again, the shift from the resource-producing west to the manufacturing-oriented east was evident: Vehicle manufacturing represented 12.5% of all sales, the highest since 2003, while oil and coal slumped to just 7.5%, a low not seen in 12 years.

A key driver of the manufacturing rebound has been the Canadian dollar, which dropped from around US$0.85 in January 2015, when BoC governor Stephen Poloz brought in the first of two interest rate cuts last year, to US$0.69 in January 2016.

But relying too heavily on monetary policy has risks, including the risk of a sharp currency rebound: In the last two months, the loonie has snapped back to around US$0.753 (more on that below).

Business Investment Wanted

To be sure, the recovery is still tepid, with the central bank calling for GDP growth of just 1.4% this year and 2.4% in 2017, which is still below the 2.5% the bank feels is needed to get the economy firing on all cylinders.

And with household debt levels hitting a record 164.5% of income in Q4, consumers can’t be counted on to carry the load much further. Now would be a great time for business to step up and fill the gap, but corporate Canada’s spending remains “very weak,” according to the BoC. (Canada isn’t alone here: U.S. capital spending has also been a missing ingredient in the recovery.)

That brings us back to the loonie, which, if it rises further, could pinch exports. At this point, the BoC seems unconcerned; earlier in March, the bank said the loonie is on the flight path it more or less expected when it released its last monetary policy report in January.

Budget Delivers Expected Stimulus

Finally, the long-awaited federal budget—the first under Prime Minister Justin Trudeau—was released March 22. As promised, it contained C$11.9 billion in infrastructure spending, though it also drove the federal books firmly into the red, to the tune of C$29.4 billion.

The government’s finance department expects the infrastructure cash and other measures to boost Canada’s GDP by 0.5% this fiscal year. That could prompt the BoC to raise its growth forecasts at its April 13 policy meeting, making it even more likely that the bank will leave rates untouched this year.

Our Super-Secret Stock Pick

In May, we’re holding our annual Wealth Summit–this year in Las Vegas. It’s a great way for us to meet you, our subscribers, one-on-one, and there are still spaces open if you’re interested.

Also this year, we’ll be making a special recommendation to those who attend the Summit, and to those who are part of our Wealth Society, whose members receive all the Investing Daily newsletters and other premium services.

It’s a fun exercise for us because there are no rules. We don’t have to pick a Canadian stock. In fact, our pick doesn’t even need to be a stock: It could be an alternative investment that isn’t traded on a public market.

Our publisher says we can’t reveal the pick in Canadian Edge, or even to him before the Summit. But in the weeks ahead, we’ll let you in on some of the research we’re doing to identify this exclusive pick.

The Dividend Champions: Portfolio Update

By Deon Vernooy

North West Company’s (TSX: NWC, OTC: NWTUF) results for the last quarter of the 2015 financial year (ended Jan. 31, 2016) disappointed some investors. Earnings per share were unchanged compared to the prior-year period, while full-year profit was up by 11%.

The quarterly dividend was 7% higher than a year ago and 5.2% higher for the full year.

Lackluster earnings were ascribed to a 19% increase in employment costs–mainly stock-based compensation and incentive pay. Business operations generally performed well, with revenues up by 10% in the quarter and same-store food sales up 3.6% in Canada and 2.4% outside of Canada.

Management intends to accelerate its capital expenditure program over the next three years to improve stores in its 42 strongest markets. The store upgrades are expected to improve productivity per square foot by de-emphasizing less productive categories, such as apparel and toys, and redeploying resources to more profitable categories, such as convenience food, perishables and pharmacy services.

The balance sheet remains sound, with a debt-to-capital ratio of 41%, while full-year free cash flow (that is operating cash flow minus capital expenditures) just about covered the dividend payments.

Consensus estimates indicate earnings per share growth of 17% for 2016. The stock currently trades at a forward price-to-earnings ratio of 17, while offering a dividend yield of 4.3%.

Given the fairly heavy capital expenditure program ahead, dividend growth may be limited for some time to come, although the current yield remains attractive. We estimate the fair value for the stock at C$33/US$25, suggesting reasonable upside potential.

Brookfield Infrastructure Partners LP (TSX: BIP-U, NYSE: BIP) is hoping the third time’s the charm, as it teamed up with rival bidder, Qube Holdings, to make a revised offer to acquire Asciano, the Australian port and rail operator.

The revised all-cash offer amounts to A$9.28 per share, or A$9.1bn (US$6.6bn), and has been recommended by the Asciano board. The deal is expected to close by the end of the second quarter, although it is subject to various regulatory approvals.

The original cash-plus-equity bid from Brookfield last August was valued at A$8.6 billion, implying a relatively small premium for the latest offer. However, Brookfield will no longer end up with 100% of the Asciano business, as the rail operations will be acquired by the institutional partners of Qube and Brookfield, including the Canadian Pension Plan Investment Board and the China Investment Corporation.

Brookfield and Qube will be 50/50 partners in the ownership of the Patrick port terminals for which the cash price tag is A$2.9 billion. In addition, Brookfield will pay a further A$925 million for other port and terminal operations owned by Asciano.

Brookfield will also receive around $900 million for the sale of the toehold position in Asciano that the company acquired earlier in the deal process, as well as a break-up fee of A$350 million to compensate the firm for when the Asciano Board removed their support for the initial Brookfield offer.

Although the deal looks rather diluted (and different) from when the process started, this was probably the best possible outcome for Brookfield given the rival bidder and the regulatory objections.

We maintain a C$55/US$42 fair-value estimate for Brookfield.

TransCanada Corp. (TSX:TRP, NYSE: TRP) has bounced back from the Obama administration’s rejection of the Keystone XL pipeline by announcing a major acquisition.

The company plans to acquire Columbia Pipeline Group for US$25.50 per share in an all-cash deal that represents a 32% premium over the average share price of the preceding month. The deal is valued at US$13 billion, including US$2.75 billion of debt, is subject to shareholder and regulatory approvals and expected to close by the second half of 2016.

U.S.-based Columbia operates extensive natural gas pipelines and storage facilities in the Northeast, with extensions into the fast-growing Marcellus and Utica shale fields, as well as a connecting line to the Gulf Coast.

TransCanada indicates that the transaction could be accretive to earnings per share in the first year following the deal’s close, and the firm expects to realize synergies of $250 million per year from the acquisition. Other key attractions for TransCanada are the low-risk nature of the regulated or contracted Columbia pipelines, as well as US$7.3 billion worth of near-term expansion projects.

To finance the transaction, TransCanada plans to issue new shares worth US$3.2 billion and sell higher-risk power generating assets valued at around US$7 billion.

Assuming that TransCanada succeeds in selling the assets as indicated, we estimate the firm’s debt-to-capital ratio will increase to around 66%, which is on the higher side our comfort zone. However, the company will further de-risk its business operations by increasing the contribution of regulated and long-term contracted assets to around 92% of total EBITDA (earnings before interest, taxation, depreciation and amortization).

We are not overly enthusiastic about Canadian companies acquiring U.S. firms with limited obvious synergies, especially at the current exchange rate. We also note that the deal may run into trouble with several law firms announcing their intentions to “investigate” whether the Columbia board has acted in the best interest of shareholders in accepting the TransCanada proposal.

Nevertheless, TransCanada owns an enviable asset base that provides critical North American energy infrastructure. We estimate the fair value of the stock at C$52/US$39, with a current dividend yield of 4.6%.

Stock Talk

Add New Comments

You must be logged in to post to Stock Talk OR create an account