Small-cap roundtable: Growth and value strategies in non-financial sectors

Scott Carscallen, vice-president and portfolio manager at Mackenzie Investments. A value manager, Carscallen is responsible for Mackenzie Canadian Small Cap Value and Mackenzie Canadian Small Cap Value Class.

Martin Ferguson, director and portfolio manager at Calgary-based Mawer Investment Management Ltd. His mandates include Mawer New Canada and BMO Enterprise, both of which are closed to new investors. Ferguson’s discipline is to buy wealth-creating companies at discounts to their intrinsic value.

Ted Whitehead, senior managing director and senior portfolio manager at Manulife Asset Management. A growth manager, Whitehead’s responsibilities include Manulife Growth Opportunities.

Q: What about industrials, which represented 10.6% of the BMO Small Cap Index at the end of February?

Whitehead: I am overweight this sector. Black Diamond Group Ltd. (TSX:BDI) continues to be our largest holding in industrials. The company provides housing for workers offsite, encampments and ancillary services such as catering. There is room for the dividend to go up. The company has a very low payout ratio.

Carscallen: I own it too. The fundamentals are good. It’s similar to an energy-services company. It has a lot of potential in the oil-sands and could also do well with the liquefied-natural-gas build-out. The latter is a potentially big positive catalyst.

Arpin: We are underweight in industrials. Our largest holding there continues to be WestJet Airlines Ltd. (TSX:WJA). It has been a long-standing holding. We recently trimmed some because it hit our target price. Our discipline is to sell one quarter of our holding when a stock reaches our target. We still hold a substantial amount of WestJet. We still think it’s attractive. In small-caps, our goal is to obtain a 100% return on a stock over three or four years.

Whitehead: I own Air Canada (TSX:AC.B). The buyers of Air Canada stock have been from south of the border. Compared to U.S. carriers, the stock is cheap. Also, Air Canada generates a lot of additional fees such as for luggage.

Ferguson: Industrials are 17.8% of the portfolio. My biggest industrial holding is Stantec Inc. (TSX:STN). I inherited the stock when I took over the portfolio 17 and a half years ago. We have, during that time, trimmed and added to it and trimmed and added to it. It has been a core holding. It’s a professional-services company focusing on engineering. CEO Bob Gomes took over from Tony Franceschini and continues the machine-like progress of Stantec. It’s a growth-by-acquisition company. It pays a dividend. It has a low payout ratio. Stantec is a high-cash-flow-generating company.

Q: Consumer discretionary stocks, which make up 9.4% of the BMO Small Cap Index?

Whitehead: We are overweight the discretionary sector. The biggest weighting in the overall portfolio is auto-parts manufacturer Linamar Corp. (TSX:LNR). It’s a long-standing holding in this sector. We’ve been trimming it to keep the weight at 4%. It’s a play on the recovery in the auto sector. It’s a well-run company. One of the things we look for is management ownership, and Linamar’s CEO Linda Hasenfratz owns a fair bit of the company. Linamar has delivered and the stock was up 81% in 2013.

Arpin: We are also overweight this sector. Linamar is also one of our biggest holdings. We have owned it for more than 10 years. It makes power-train products, one of the last areas where there is still substantial outsourcing by auto manufacturers. We’ve been trimming it. The stock has had a huge move and it hit our initial target price. It’s still a substantial position at around 5% of the portfolio.

Carscallen: We have Linamar too. I also own AutoCanada Inc. (TSX:ACQ), the only publicly traded auto dealership in Canada. Similar to Linamar, its fundamentals are strong. The stock has had a huge run and is not cheap. AutoCanada is a growth-through-consolidation story.

Ferguson: I am underweight the consumer-discretionary sector.

Q: Materials, at 27.1% of the index?

Ferguson: I am underweight materials and have zero weight in gold stocks. I have no direct exposure to mining stocks. One of my largest holdings in this sector is Stella-Jones Inc. (TSX:SJ). It’s a producer and marketer of industrial pressure-treated wood products. It has a leadership position in railway ties and utility poles. It has grown through acquisition. It announced another one recently. CEO Brian McManus runs a good business.

Whitehead: I own Stella-Jones too.

Carscallen: I am underweight the materials sector. A gold-mining stock that I own is Dundee Precious Metals Inc. (TSX:DPM). It’s a small weight.

Arpin: We are also underweight materials. In terms of mining exposure, our largest position is Major Drilling Group International Inc. (TSX:MDI). It can generate free cash flow through the cycle and has a good balance sheet. It has a relatively low business risk and offers leverage to an improvement in drilling demand from the mining industry. It’s fairly dependent on gold because roughly half of its drilling is gold-related. This area is challenged and the stock price has come down to reflect this. It’s attractive versus its intrinsic value.

Whitehead: I am also underweight the materials sector. The only gold-mining stock that I own is B2Gold Corp. (TSX:BTO). The company has operating mines in Central America and the Philippines. It is constructing a mine in Namibia. It’s a low-cost gold story. The company is well capitalized with more than $250 million in cash.

Arpin: We have a holding in Pan American Silver Corp. (TSX:PAA), a major silver producer.

Q: Energy, at 21.6% of the BMO Small Cap Index?
Whitehead: My biggest energy weighting is Gran Tierra Energy Inc. (TSX:GTE), which has substantial energy exploration and production interests in Colombia. Its big growth area is Peru. Gran Tierra has no debt and generates free cash flow.

Carscallen: I am overweight energy-services companies and underweight the producers. The service companies have strong cash flows. Their equipment is being well utilized. The outlook for this area is positive. Valuations are not too bad in the energy-services space. My biggest weight is Akita Drilling Ltd. (TSX:AKT.A). It tends to produce a more consistent performance compared to many other drillers. It specializes in pad drilling, which is a popular technique used in tight-space wells. These are a feature of unconventional plays. There is high utilization on pad rigs and favourable pricing. A caveat is that the stock is fairly illiquid. Akita trades at a very low multiple whereas another energy-services stock that I own, Canadian Energy Services & Technology Corp. (TSX:CEU), has a much higher multiple. Both stocks have performed well.

Q: Martin, Canadian Energy Services was your biggest holding in BMO Enterprise at the end of February.

Ferguson: The stock has gone up over 100% over the last year, so that this has raised its weighting in the portfolio. I have trimmed it. Energy constitutes 22% of the portfolio. My emphasis is on energy-services companies, but I also have exposure to exploration and development companies. An example is Delphi Energy Corp. (TSX:DEE), which is a natural-gas-weighted company that has interests in the Montney formation. It has a significant land position there for a company of its size, and its holdings are next to those of larger players. The Montney is an area that has liquids-rich natural gas.

Arpin: My biggest energy holding is Paramount Resources Ltd. (TSX:POU), with operations focused in Western Canada. The Riddell family has a substantial ownership in Paramount. Clay Riddell is CEO and his son Jim is president.

Ferguson: I own Paramount too.

	Cdn Energy Serv & Tech Corp.	Delphi Energy Corp.	Gran Tierra Energy Inc.	Paramount Resources Ltd.
April 2 close	$29.70	$2.89	$8.31	$48.50
52-week high/low	$29.81-$11.52	$2.90-$1.06	$8.66-$5.30	$48.58-$31.68
Market cap	$2.0 billion	$442 million	$2.3 billion	$4.7 billion
Total % return 1Y*	151.6	151.3	39.7	32.7
Total % return 3Y*	39.8	5.5	2.0	13.2
Total % return 5Y*	77.4	26.8	19.0	49.3
*As of April 2, 2014 Source: Morningstar

Arpin: Paramount also has a significant holding in the Montney. The wells are so condensate-rich or liquids-rich, like those of Delphi, that you get the natural gas for free. These wells can operate at extremely low natural-gas prices. Paramount is making a major investment in a deep-cut gas plant, which will allow it to strip more of these liquids and create more value.

Carscallen: I own Raging River Exploration Inc. RRX . It’s big in the Viking play. It has been able to drill consistent wells and it has a big inventory, which should propel continued production growth for the next several years. At some point, it will start paying a dividend.

This concludes the Canadian small-cap roundtable.