Two investment banks worth a look

The core business for both Canaccord and GMP is capital markets services for mid-sized and small companies. This is a niche that’s usually below the radar of bank-owned competitors and which was very lucrative during the resources boom. An issue for the independents is that bigger competitors have been looking to smaller companies in search of more business.

Both Canaccord and GMP have been racking up losses since oil prices plunged in late 2014, but the firms’ income statements are now close to breaking even and both should start reporting positive net income later this year.

Both firms have sufficient capital to survive an extended period of low commodity prices, as each has suspended its dividend, says Sumit Malhotra, managing director of Canadian financial services in the global equities division of Bank of Nova Scotia.

Canaccord and GMP also implemented significant restructuring and cost-cutting. Malhotra estimates that Canaccord is about 40% of the way toward achieving its target of $30 million in fixed cost savings, while GMP is at 75% of its goal of cutting $40 million.

GMP’s more severe cost-cutting is due to the firm’s focus on capital markets services for Canadian small- and mid-cap firms. Canaccord has other sources of income – U.S. investment banking (IB) focused on the technology, life sciences and consumer sectors; and the strong U.K. WM business.

Here’s a look at the two firms:

– Canaccord genuity group inc. In fiscal 2016, ended March 31, Canaccord received 45.2% of its revenue from the U.S., 31.4% from Canada, 18.7% from the U.K. and Europe, and 4.8% from Asia-Pacific. Two-thirds of revenue came from capital markets activity and 30% from WM.

Malhotra believes Canaccord shares are undervalued because markets are not putting sufficient value on the firm’s U.K. operations. He values those at $4.29 a share. Add in $3.50 a share for working capital and subtract $1.76 for the preferred shares, and the result is $6.03 – hence, his $6 a share one-year price target, well above the $4.79 the 104 million outstanding shares closed at on June 7.

However, Malhotra admits, the share price is unlikely to rise until underwriting results improve. In Q4 2016, ended March 31, IB revenue was only $16.9 million, the lowest level in almost 10 years. He’s forecasting a 10% increase in IB revenue in fiscal 2017.

A recent report from Toronto-based CIBC World Markets Inc. also points out concerns about Canaccord’s underwriting, noting that there has been “some slippage in market share in Canada and the U.K.” The report rates the stock as “sector perform,” with a 12 to 18 month price target of $4.50 a share.

David Tuttle, portfolio manager at Franklin Templeton Investments Corp. in Toronto, says that Canaccord is a core holding in the Templeton Global Smaller Companies Fund; he takes a longer-term view and considers the current share price attractive: “Markets are fixated on the near term and are not factoring in the cyclical recovery in commodities that is likely to occur eventually.”

Canaccord had a loss of $358.6 million in the 12 months ended March 3, but that included $321 million in impairment charges, as well as restructuring and development costs. Without non-recurring items, the loss was $6 million vs positive net income of $39.3 million in the previous 12-month period. Revenue was $787.8 million vs $880.8 million.

– GMP capital inc. With higher commodity prices, the bounce in the TSX Venture Index and costs trending lower, “the worst of the losses [at GMP] is likely behind us,” a recent CIBC World Markets report states. However, a better equities underwriting market is the key to positive earnings.

As investors wait for GMP’s return to profitability, the focus will be on the expected sale of the firm’s 31% stake in Toronto-based Richardson GMP Ltd. (RGMP), which was formed in 2009 with the merger of GMP Private Client LP and Richardson Partners Financial Ltd. RGMP hasn’t been a strong performer, even after the acquisition of Macquarie Private Wealth Inc. in 2013.

A sale of RGMP can be triggered after Nov. 15 by any of the three owners: GMP, the Richardson family and RGMP’s advisors. Malhotra doesn’t expect any buyouts, but notes they would be attractive for competitors who could bring costs down. He thinks proceeds of a sale could be around $500 million, with GMP’s share being $160 million. The stock price already assumes RGMP will be sold.

Both Malhotra and a CIBC World Markets report have a “sector perform” rating on GMP, with a target price of $5 a share. The 68 million outstanding shares closed at $5.21 on June 7.

GMP had a loss of $24.9 million in the 12 months ended March 31 vs net income of $2.7 million in the corresponding period a year earlier. Without non-recurring items, the loss was $17 million vs positive net income of $5.5 million in the previous 12-month period. Revenue was $214.3 million vs $265.1 million.

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