Despite an unusually harsh winter, the Canadian economy has been performing far stronger than expected during the first quarter. And that appears to have translated into upbeat sentiment among the executives running Canada’s largest firms.

Each quarter, the Bank of Canada (BOC) interviews the senior management teams of about 100 firms that are considered most representative of the composition of Canada’s gross domestic product (GDP). The spring 2014 survey was conducted from Feb. 18 to March 13. The results of these meetings are summarized in the central bank’s latest Business Outlook Survey.

The broad findings were that the effect of a lower exchange rate coupled with firms’ growth initiatives have bolstered expectations of better growth ahead.

In particular, businesses have noted an improvement in recent sales activity and anticipate further growth in sales over the next 12 months. Export-oriented firms expect sales to gradually strengthen, while firms that are more dependent on the domestic economy are optimistic about their efforts to enter new markets or develop new products.

For the trailing 12-month period, 44 percent of firms reported that sales volumes had grown at a greater rate than during the previous period. That result was an improvement of 10 percentage points from what companies said during the winter survey.

Equally important, 51 percent of firms expect even stronger sales in the year ahead. That’s essentially the same figure that was reported in the last survey, though at least now there’s greater evidence of rising sales to support such optimism.

Plans to increase investment in machinery and equipment (M&E) are similar to those in the winter survey, but have improved somewhat among manufacturers, which offset declines in other sectors.

Over the next 12 months, 46 percent of the firms surveyed expect to spend more on M&E than they did during the prior period, while 30 percent of firms say they’ll spend about the same. That’s an improvement of 4 percentage points for the former, while the latter figure declined by the same amount.

Canada’s manufacturing sector was hit hard during the downturn, particularly exporters, so the fact that companies are starting to invest for growth again is reassuring. The bank says intentions to increase M&E investment are somewhat more prominent among small- and medium-sized firms and among export-oriented firms.

Hiring plans are also positive, with 53 percent of firms surveyed anticipating higher levels of employment over the next 12 months, which was consistent with what was reported in the winter survey.

Although more firms indicated that they’re operating close to capacity, the economy still has plenty of excess capacity. The percentage of firms reporting that they would experience “some difficulty” meeting an unexpected increase in demand rose 5 percentage points, to 39 percent. And firms that said a sudden jump in demand would pose a “significant difficulty” ticked up 1 percentage point, to 6 percent.

While the BOC hopes the depreciation of the Canadian dollar will help support a resurgence among exporters, there is some concern that this could hurt companies’ bottom lines in the near term.

Firms say they’re already paying higher prices for necessary inputs, particularly for imports, though also among some materials from domestic sources. Indeed, 47 percent of firms expect input prices will rise at a greater rate over the next 12 months, a sharp increase of 18 percentage points from the winter survey.

At the same time, competition has kept a lid on how much of this inflation can be passed along to customers. While 37 percent of companies expect to charge higher prices for their products in the coming year, that’s up by just 8 percentage points from the winter survey. Of course, this situation can only persist for so long, and prices will eventually have to rise accordingly.

For now, most businesses expect inflation will remain within the central bank’s 1 percent to 3 percent target range. While the vast majority of respondents still expect inflation to remain concentrated toward the lower end of that range, there was a slight improvement in these numbers, which suggests the BoC’s fears about Canada’s persistent disinflation could soon be put to rest.

Overall, with survey results showing the strongest intentions for investment and hiring in nearly two years, Canada’s rebound appears likely to continue apace.

Portfolio Update

On April 7, energy and industrial waste-management firm Newalta Corp (TSX: NAL, OTC: NWLTF) announced that the company has retained RBC Capital Markets to conduct a strategic review of its Industrial Division, with an eye toward a potential sale, initial public offering (IPO) or spinoff of the division, in whole or in parts.

National Bank Financial believes the Industrial unit could be sold for CAD200 million to CAD315 million. And CIBC World Markets says the segment could fetch as much as CAD450 million, while TD Securities puts the possible range at CAD300 million to CAD350 million. To put those figures in context, Newalta’s current market capitalization is CAD1.1 billion.

In response to the announcement, Newalta’s shares rose as much as 7.2 percent, to CAD21.43, the stock’s highest intraday price since late 2007. The shares have since settled down somewhat, trading at CAD20.56 more recently.

This latest initiative is being undertaken in the context of the more comprehensive review, announced in mid-December, that aims to improve Newalta’s productivity and profitability, particularly in the Industrial Division as well as for Selling, General and Administrative (SG&A) expenses. As part of this broader strategic review, the company intends to focus its operations on low-risk growth investments that provide high returns and stable cash flow.

Meanwhile, Newalta has already initiated a program to achieve approximately $10 million in annual savings from the Industrial Division’s operations. To that end, the company undertook a number of actions during the first quarter, including the closure of three facilities in eastern Canada and overhead reductions in associated support functions.

Although the Industrial segment delivers the bulk of Newalta’s revenue–in 2013, for example, the division’s sales totaled CAD371.2 million, or 47.4 percent of the company total–it has much lower margins than the firm’s energy sector-focused New Markets and Oilfield segments.

Last year, for instance, the Industrial Division generated CAD65.3 million in EBITDA (earnings before interest, taxation, depreciation and amortization), equivalent to about 18 percent of the segment’s revenue, while the Oilfield division produced CAD82.1 million in EBITDA, which accounted for about 44 percent of the segment’s revenue. 

As such, management is keen to devote its attention to Newalta’s two high-margin divisions, while still finding a way to unlock shareholder value for its Industrial segment.

The Industrial Division provides a broad range of environmental waste-management services to a number of industries, including automotive, construction, pulp and paper, mining, manufacturing, refining, steel and transportation.

Among this segment’s operations are Canada’s largest lead-acid battery recycling facility, located at Ville Ste-Catherine, Québec, an engineered non-hazardous solid waste landfill, located at Stoney Creek, Ontario, and a used oil re-refining facility in North Vancouver.

The Industrial Division employs 900 people (nearly 41 percent of the firm’s total) and operates a network of over 35 locations across Canada.

While the strategic review is underway, management is also implementing plans to further develop the Industrial segment’s onsite services, which have helped drive growth at its two other divisions. In 2013, the division doubled its profit from onsite services compared to the prior year. Onsite services provide an opportunity for the firm to win longer-term contracts and generate more stable revenue.

Though analysts seem to take a positive view of a potential spinoff of the Industrial Division, prior to the announcement the stock had suffered an erosion in sentiment, with three analysts over the past month downgrading the shares to “hold” from “buy.”

And in the wake of this latest development, Canaccord Genuity Corp lowered its rating to “hold” from “buy,” while maintaining its 12-month target price at CAD20.00. However, the analyst attributed the downgrade to the stock’s strong rally, as the shares currently trade above her 12-month target price.

With five “buys,” four “holds,” and one “sell,” Newalta’s mix of analyst sentiment is still slightly bullish, though now with a strong neutral component. The consensus 12-month target price is CAD22.28, which suggests potential appreciation of 8.4 percent above the current share price. Newalta is a buy below CAD17.50 in the Aggressive Portfolio.