Out-of-favour stocks and sectors create opportunities

The Canadian market is currently out of favour, but that could be good news for discerning investors, says Mary Crowe, vice-president, Canadian equities, with Beutel Goodman Investment Counsel.

Crowe said out-of-favour markets are the perfect hiding place for undervalued sectors and stocks.

“Out-of-favour markets can create opportunities in individual names,” she said. “Focusing on individual stock attributes can lead you to find some gems, and that is when we get excited.”

Crowe said markets hate uncertainty, but value investing is all about being patient through periods of uncertainty and focusing on the fundamentals.

“The Canadian market is currently out of favour, but we don’t invest in markets, we invest in stocks,” she said. “We look for dislocations in the market that provide opportunities for prospective returns.”

She offered the example of Toronto-Dominion Bank, which has been out of favour for the past two years, under the shadow of two issues: its CEO succession plans and fallout from its failure to prevent money laundering at its U.S. branches.

“TD has lost billions in market capitalization driven by these issues, with its valuation multiple compressed to a discounted level relative to peers,” she said. “We believe the market is pricing in a Draconian outcome and represents an opportunity.”

She expects uncertainty around TD to lift soon, which should be viewed positively by the market, leading to stronger stock performance.

“TD remains a very strong franchise and generates substantial capital,” she said. “Over the long term, TD’s high-quality franchise will produce good prospective returns.”

Another example, she said, is Calgary-based Tourmaline Oil, a well-capitalized, large-scale, low-cost producer of natural gas that should benefit from further liquified natural gas (LNG) development in Canada.

“Gas is currently oversupplied and is out of favour, but supply and demand and pricing should improve with growing LNG offtake in Canada and the U.S. over the next three years,” she said. “Tourmaline should benefit from improving natural gas prices. The company has a better-than-average balance sheet, is trading at a discount valuation, and we believe it represents an opportunity.”

She also sees opportunities in consumer discretionary and industrials, as well as in certain pockets of out-of-favour commodity sectors like real estate. In fact, her team was able to take advantage of uncertainty around commercial real estate last year, picking up Toronto-based Colliers International Group Inc. at a very attractive valuation.

On the consumer discretionary front, she likes Valcourt, Que.–based BRP Inc.

“The larger the discount to business value, the more margin of safety the investment provides,” she said. “This, combined with quality companies with strong balance sheets, should mitigate the potential loss of capital.”

She said while Canada is currently out of favour with international investors, it remains an attractive market with a stable political and legal system, and abundant natural resources.

“We believe Canadian stocks remain an important component of many investment portfolios,” she said. “There are many leading Canadian companies that provide global exposure and diversification through their business activities.”

She pointed out that a Beutel Goodman review found that a range between 9% to 31% in Canadian equities is optimal in a world-focused portfolio, depending on specific investor risk tolerance.

“This is a greater allocation than Canada represents in the MSCI World Index, at about 3%,” she said. “In our view, Canadian equities have demonstrated solid risk-adjusted returns over the long term.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.