Canadian equities in a “tough spot”

The lack of global demand for oil, and for commodities in general, is likely to keep Canada’s resources stock prospects, along with economic growth, muted in 2016. “[The resources sector is] a part of the market that we think remains in a tough spot,” says Matt Barasch, vice president, equity advisory group, with RBC Dominion Securities Inc. in Toronto. “And, as a result, the Canadian stock market, widely speaking, remains in a fairly tough spot.”

Lower oil prices should keep Canadian consumers’ spending on other goods and services growing, and the low value of the loonie relative to the U.S. dollar will benefit manufacturing and service companies that export to the U.S. However, with relatively few non-resources and non financial-services stocks to choose from in Canada, clients will have to look closely to ensure the stocks being considered haven’t become overvalued, having been pushed up by other investors seeking these investments.

“The opportunities are becoming fewer and further between,” says Brandon Snow, principal and co-chief investment officer with Cambridge Global Asset Management, a unit of CI Financial Corp. in Toronto.

Here are some stock picks in sectors outside of resources and financials that are catching the eyes of portfolio managers:

– Consumer staples. Portfolio managers, including Alex Lane, vice president and portfolio manager with Dynamic Funds, a division of 1832 Asset Management LP in Toronto, are overweighted in consumer staples because of the steady demand for these products even in a sluggish economic environment. Canada’s grocers are of particular interest.

“No matter what’s happening out there, people need to eat,” says Lane. “So, grocery stocks for that reason are great stability names.”

These stocks won’t come cheap, however, as valuations are up this past year. However, portfolio managers, including Graham Meagher, associate portfolio manager with Mackenzie Financial Corp. in Toronto, believe that there are still many good finds, with Loblaw Cos. Ltd. being a particular favourite.

Meagher likes Loblaw because of its successful integration of Shoppers Drug Mart, Loblaw’s resulting diversification of its businesses and the support of the Weston family, its largest shareholder. “It’s a high-quality company,” says Meagher.

Other favoured names in this sector include Saputo Inc. and Alimentation Couche-Tard Inc.

– Consumer discretionary. This sector also is given an overweight ranking by portfolio managers, including Darren Lekkerkerker, portfolio manager at Fidelity Canada Asset Management ULC in Toronto, although relatively high valuations and market challenges mean portfolio managers are being choosy.

One company that Lekkerkerker sees potential value in for 2016 is Gilden Active Wear Inc. He says this stock is a “buy” because of its low manufacturing costs and the potential for increased volumes and margins.

An industry in this sector that is falling out of favour is autoparts manufacturing. For example, James Morrison, senior investment analyst with Mackenzie, believes that Magna International Inc. is a solid company, but the timing for an investment in autoparts may not be right.

Morrison likes Magna’s strong balance sheet and leadership. However, factors such as longer lease contracts and a growing number of subprime auto loans in the industry suggest that autoparts companies are harvesting auto sales today at the risk of seeing sales decline in future.

– Telecommunications. Portfolio managers, including Snow, are looking a little more favourably upon this sector, but high stock prices and interest rate sensitivity mean telecoms remain underweighted.

“[The sector] is pretty expensive,” says Snow. “[Telcos have] pulled a lot of levers to improve cash flow in the short term. But, from a secular basis, it’s a very competitive business and there’s still pricing pressure.”

Of the big names in this sector, Rogers Communications Inc., Bell Canada Enterprises (BCE) and Telus Corp., the last is preferred by Justin Flowerday, vice president and director with TD Asset Management Inc. in Toronto, because of its strong corporate culture and commitment to clients in a sector not known for customer service.

“Telus is in a position in which as long as it keeps its customers happy and as long as it maintains low levels of churn,” says Flowerday, “[it] should be able to generate better operating leverage and better earnings growth relative to [a company] like a Rogers.”

– Information technology. This sector received mixed reviews. Companies that tend to grab attention include CGI Group Inc., McDonald-Dettwiler and Associates Ltd., and DH Corp.

– Health care. Portfolio managers, including Lane, are staying clear of this tiny sector, given the recent volatility of the dominant company in the Canadian market – Valeant Pharmaceuticals Inc.

Valeant’s stock price began to drop in 2015 due to questions of drug price increases and alleged accounting irregularities. Nonetheless, Lane believes Valeant could see gains over the long term if it takes steps to restore investor confidence. Says Lane: “We have to see some results.”

In the meantime, U.S. health-care stocks are preferred.

– Utilities. This sector tends to be underweighted because of its high valuations, interest rate sensitivity and exposure to Canada’s flagging energy sector. Individual companies of interest include Emera Inc., Fortis Inc. and Northland Power.

– Industrials. This sector also received mixed reviews, particularly for the railways, the sector’s heavyweights. Both Canadian Pacific Railway Ltd. (CP) and Canadian National Railway Co. (CN) had a tough 2015 due to falling productivity and volume, says Lekkerkerker, but these firms are poised to rebound in 2016. Of the two, Lekkerkerker prefers CP because of its potential purchase of U.S.-based Norfolk Southern Corp.

Morrison, on the other hand, believes CN is the more attractive buy: “It’s a world-class business that we think can make money through a cycle.”

A FOOT IN NON-CANADIAN MARKETS

Finding Canada-based companies with exposure to foreign economies will be key to uncovering opportunities in Canada’s small- capitalization stocks in 2016 as the Canadian economy is likely to hit a few more bumps in the road.

The drop in commodities prices has driven clients to look for opportunities in other parts of the small- and mid-cap space, says Brandon Snow, principal and co-chief investment officer with Cambridge Global Asset Management, a unit of CI Financial Corp., in Toronto. Valuations for many companies in these sectors are uncomfortably high.

Ted Whitehead, senior managing director and senior portfolio manager with Manulife Asset Management Ltd. in Toronto, is hopeful that 2016 might mark the bottom of the rout of small-caps. Says Whitehead: “I do think 2016 is starting to look better.”

Here are a few small-cap stocks that portfolio managers, including Whitehead and Jack Hall, senior research analyst with Sentry Investments Inc. in Toronto, are optimistic about for 2016:

– AGT Food and Ingredients Inc. is a “buy” because of the food processor’s large market share in Canada and its global exposure, says Whitehead. As well, AGT recently started creating ready-made packaged ingredients, which is having a positive impact on earnings.

– AltaGas Ltd. is known for its gas-processing business. But the company’s power generation and utility divisions are of interest to Hall. “We think that part of the business should be able to withstand lower energy prices,” Hall says, “but the market has kind of sold this [company] off as if it were an energy stock.”

– DIRTT Environmental Solutions Ltd. is a software company and “the IKEA of builders,” says Whitehead. DIRTT provides a solution for businesses, primarily in the U.S., to create wall and cubicle panels for office floor plans. Whitehead likes DIRTT’s business model, and notes that the company has beaten market expectations in three of the past four quarters.

– Chemtrade Logistics Inc., which provides industrial chemicals and services, has caught the eye of Aubrey Hearn, vice president and senior portfolio manager with Sentry. He likes Chemtrade’s exposure to the U.S., its high dividend, free cash flow and its take-or-pay contracts, which give the company some distance from the turmoil in commodity prices.

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