More Northern Exposure
The Canadian dollar ended trading at USD1.0704 Nov. 2, its highest close on record. The loonie’s rise gained momentum after a government report showed the economy added five times more jobs than forecast in October, and the unemployment rate fell to a 33-year low.
The Canada-US trade relationship is the largest ever to exist between two nations. Two-way trade in goods and services during 2000 was estimated at approximately CAD700 billion, or almost CAD2 billion per day. Eighty-six percent of Canada’s total exports were shipped to the US. The volume of Canada-US trade that year was greater than the total amount of Canada’s trade with all of its other trading partners combined.
“Decoupled”–or broken up with–is a strong term; Canada’s economy is tied like no other to the US. But in 2006, the share of Canada’s total exports to the US was down to 79 percent.
And Canada should be able to avoid the sharpest impacts of a mortgage meltdown. From 2004-06, subprime lending grew to account for 22 percent of new mortgages in the US. In Canada, subprime loans account for 5 percent of new loans.
Canada Finance Minister Jim Flaherty announced a couple tax cuts in late October, a demonstration of the flexibility government officials up there have to provide fiscal stimulus during a period of global economic slowdown. The flexibility is based on the federal government’s strong financial position, evidenced by a budget surplus of more than CAD13 billion.
Canada’s manufacturing sector has had to adjust to the rising loonie, and the auto and forest firms are struggling because of weakness in the US economy.
But the appreciation of the Canadian dollar has also helped to boost the volume of capital investment, which has increased 48 percent since early 2002, mirroring the increase during the high-tech investment boom.
Rising middle classes in China, India and other emerging markets have increased demand for natural resources, leading to a structural change in the economics of commodity markets worldwide. Asia’s emergence has blunted the impact of a slowing US economy on Canada’s fortunes.
Demand for resources should only intensify as consumption patterns evolve along with rising Asian household income. And resources are the most important part of Canada’s economy.
The Bank of Canada’s commodity price index is near its record high amid surging prices for the nation’s commodity exports. The index represents the spot prices of 23 commodities produced in Canada and sold worldwide. Commodities account for about half of Canada’s exports.
In April, we introduced five non-trust plays on the broader Canada story, four dividend-paying stocks and one speculative recommendation. Given the rapid rise of the loonie, we’ve done well with positions that serve also as long bets on the Canadian currency.
Given the changing global resource supply/demand profile and Canada’s ability to prosper from it, the loonie should enjoy a long stay above parity. And the wealth generated by Canada’s resources should filter down to support a broadening of the domestic economy.
New Ways Forward
First Quantum Minerals (TSX: FM, OTC: FQVLF) shares came under attack Nov. 5 after a draft version of a Democratic Republic of Congo (DRC) review of mining contracts suggested companies operating in the DRC could lose their assets or have license terms changed. A government panel indicated that, of the 61 mining contracts under review, 38 should be amended and 23 could be cancelled.
DRC Mines Minister Martin Kabwelulu said in a Nov. 6 statement that most mining companies operating in the country would remain for the long term, despite government review. “The speculation is not based on any official document but on a leak of an early draft from within the commission,” the statement said. “The government deplores the leaking of this draft and the uncertainty that it has understandably created.”
The government set up a mining commission in the DRC earlier this year to bring contracts, most of which were negotiated during a 1998-2003 war and a subsequent three-year transition period, up to international standards. The government expects most companies currently operating in the DRC to continue working there, and their continued presence can only help further the economic progress that’s been made since hostilities ceased.
First Quantum’s Kolwezi mining project in the DRC represents 13 percent of its net asset value, according to UBS. Its Frontier mine accounts for 20 percent of estimated net asset value.
First Quantum now has a total of seven projects. Its 2006 revenue topped CAD1 billion, and it’s also enjoyed meteoric share-price growth.
In 2002, First Quantum was producing 12,000 ton of copper and its stock was below CAD3. Last year, it produced 183,000 ton and shares topped CAD110. The company expects to produce 400,000 ton in 2010.
CEO Phillip Pascall has built a Central Africa mining operation without peer–in an extremely difficult day-to-day environment. First Quantum, which reports third quarter results Nov. 12, could draw interest from bigger miners seeking exposure to Central Africa and DCR, such as Rio Tinto and Anglo American. Buy First Quantum Minerals up to USD103.
Talisman Energy (NYSE: TLM), Canada’s No. 3 independent exploration and production (E&P) firm, has operations in North America, the North Sea, Southeast Asia and Trinidad. The company has struggled in recent quarters to meet production and earnings guidance, but aggressive new CEO John Manzoni, late of BP, pledged in his first quarterly conference call to break the habit.
Talisman produced 441,000 barrels of oil equivalent a day in the third quarter, down 4 percent from a year earlier. The company suffered some operational problems in the North Sea but should bring several new projects online in the next several months. As new capital projects progress, Talisman’s longer-term growth potential should become evident.
It’s trading at a substantial discount to its peers, and some analysts have suggested a breakup of assets along geographic lines.
“One of the most blatant gaps in current valuation in the equity market is the premium trading multiples of the Canadian-based junior international E&P companies (due to the high growth outlook) compared to the seniors such as Talisman,” Raymond James analyst Stephen Calderwood said in a note to clients. Calderwood forecast a breakup would create more than CAD45 in value for each Talisman share.
The bottom line: The value of Talisman’s asset base exceeds its current share price. A great value relative to other E&P firms, Talisman Energy is a buy up to USD24.
Shaw Communications (TSX: SJR-B, NYSE: SJR) boosted its annual dividend 9 percent to 72 cents Canadian per share, making it the highest-paying North American cable company. Shaw has been rumored as a possible entrant to the Canadian wireless market and could do it without harming its dividend. But absent clarity on the rules for the early 2008 spectrum auction, the costs may be prohibitive.
Shaw continues to focus on its core cable business, paying down debt and returning capital to shareholders. If the auction rules are favorable for new entrants, Shaw has the flexibility to compete. A spectrum set-aside or mandated tower-sharing and roaming may mean a strategic shift.
Another potential catalyst: The CAD30 billion in funds currently invested in BCE will soon be looking for a new home, and Shaw’s operating results suggest it as a viable candidate.
Shaw reported a drop in net profit for its fourth quarter, but year-ago results were bolstered by one-time items. Earnings excluding nonoperating items were up 66 percent.
Shaw earned CAD136 million (31 cents Canadian per share) in the three months ended Aug. 31. Revenue increased 13 percent to CAD715 million, and free cash flow increased 38 percent to CAD76 million. Buy Shaw Communications up to USD32.
Catching Up
The logic on the Norbord (TSX: NBD, OTC: NBDFF) recommendation has been stretched on the rack of the US real estate market, but the company hasn’t broken. In fact, it’s made a couple dividend payments and geographic diversification means the wood panel maker will be able to sustain the distribution for the long-term.
Norbord beat expectations for the third quarter as its European operation delivered strong numbers. Management expects the current US price cycle to continue through 2008, but prices across the Atlantic are up 15 percent this year.
Norbord reported a third quarter loss of USD1 million, down from a year-earlier profit of USD7 million, or 5 cents a share. Sales rose slightly to USD292 million from USD291 million. Norbord benefited from overall higher prices in the quarter, but the impact was limited by regional price variations. And prices backed off with the end of the peak summer building season.
The company doesn’t expect any near-term relief from the recent downturn in the US housing market, but its work in Europe should ease the path–and sustain the dividend–to better fundamentals in 2009 and 2010.
You never want to include the phrase “it’s hard to see much more downside” when updating the status of a buy. And never has “it’s a marathon, not a sprint” seemed more appropriate. Stress-tested Norbord is a buy up to USD8.50.
What sets Bank of Nova Scotia (TSX: BNS, NYSE: BNS) apart from its peers is its international exposure. More than any of the remaining Big Five of Canadian banking, Scotiabank is making money on emerging economies.
Scotiabank is focusing on Latin American and Caribbean countries where its market share remains below 10 percent and on Asian countries where it’s currently operating. The bank is looking to grow market share in countries where it already has a retail presence and hopes to expand into complementary businesses such as insurance and wealth management.
Bank of Nova Scotia recently doubled its presence in Chile with the acquisition of Banco del Desarrollo for USD1.03 billion, boosting its market share there to 6 percent. In Asia, Bank of Nova Scotia is targeting China, Thailand, Malaysia and India for growth. It has a minority stake in Dalian Bank in China and is in ongoing discussions to increase its ownership. The bank also recently purchased a minority stake in Thailand-based Thanachart Bank.
Bank of Nova Scotia is a buy up to USD58.
Canadian Hydro Developers (TSX: KHD) is one of the few publicly listed alternative energy generation pure plays. Its growth potential is attracting the attention of more and more investors, and it’s seen as a potential takeover target as well.
Canadian Hydro also has a lot of exposure to efforts by Canadian provincial governments to boost wind generation capacity. Buy Canadian Hydro Developers up to CD6.75 or USD5.95.
Russel Metals (TSX: RUS, OTC: RUSMF) reported a 37 percent drop in third quarter profit on lower demand for its steel products. Russel earned CAD27.9 million (44 cents Canadian per share), down from CAD44.6 million (72 cents Canadian per share) a year ago.
Revenue for the quarter was CAD624.3 million, down 7.1 percent from CAD672.3 million. The energy tubular products division had revenue of CAD175 million, and its steel distributors segment reported revenue of CAD108 million.
The company has generated a 25 percent total return in US dollar terms since we initially recommended it in the April 2007 CE. Yielding 6.4 percent, Russel Metals remains a buy up to USD33.
Manitoba Telecom Services (TXS: MBT) remains hopeful of establishing a fourth national wireless carrier in Canada, but the company won’t make a decision about entering the market until federal officials releases rules for the early 2008 spectrum auction.
The company has discussed with potential financial and strategic backers who could contribute capital and expertise to such a venture. The rules are expected later this fall.
Manitoba Telecom Services earned CAD45.5 million (70 cents Canadian per share) in the three months ended Sept. 30, up from a profit of CAD40.5 million (59 cents Canadian per share) a year ago. Earnings from continuing operations rose 18 percent to 73 cents Canadian a share from 62 cents Canadian. Operating revenue dipped to CAD475.9 million from CAD477.9 million, but revenue from wireless, Internet and digital TV operations rose 13.2 percent.
The growth revenues also contributed 41 percent of the total, compared with 36 percent last year.
Manitoba Telecom Services is a buy up to USD50.