RETAIL STRATEGY VOLUME 23, N°5, MAY 2012 EDITORIAL ED SOLLBACH, CFA PORTFOLIO STRATEGY AND QUANTITATIVE RESEARCH ANALYST F CUS PLEASE SEE THE LAST PAGE OF THIS DOCUMENT FOR COMPANY SPECIFIC DISCLOSURES. CONTINUED ON PAGE 2 MESSAGE FROM THE GENERAL MANAGER BRUNO DESMARAIS VICE-PRESIDENT AND GENERAL MANAGER FULL SERVICE BROKERAGE The global financial markets are characterized by sharp regional differences—the US is recovering steadily but slowly from the worst recession in 70 years, Europe continues to struggle with sovereign debt problems in the PIIGS and China is slowing after two years of tightening. UNITED STATES In late April, the US Federal Reserve (Fed) revised upward its forecasts for 2012, increasing its GDP growth forecast to 2.4 – 2.9% (from 2.2 – 2.7%) and signifi- cantly lowering its unemployment forecast to 7.9 – 8% (from 8.2 – 8.5%); it also increased its inflation forecast to 1.9 – 2% (from 1.4 – 1.8%). However, the Fed is stubbornly sticking to its belief that rates will remain at zero until late 2014. CANADA Following a few weak months, Canada had a blockbuster jobs report in March with 82,000 jobs created—proportionately seven times more than in the US—while unemployment dropped to 7.2% (from 7.4%). The Bank of Canada raised its forecast for Canadian GDP growth to 2.4% in 2012, and expects the Canadian economy to return to full capacity by mid-2013. However, the Bank of Canada warned of a “withdrawal” of monetary stimulus—a statement that leads us to believe it will likely raise rates modestly in mid-2013, about a year ahead of the Fed. We believe the Canadian dollar can continue to appreciate toward US$1.05 as Canadian short rates are now 100bps higher (1% vs 0% in the US), with this spread likely increasing in 2013 as Canada raises rates ahead of the Fed. GLOBALLY Global GDP growth is expected to slow to a near-average 3.5% in 2012, from 4% in 2011, as Europe is dragged into a recession because of sovereign debt problems in peripheral countries. Recent worries centre on Spain and its banking system—the downward spiral due to severe austerity, job losses and a contracting economy has resulted in a depression-like record unemployment of 24.4%. In China, which has been tightening its monetary policy to combat inflation, growth slowed to 8.1% in 1Q12 (from a high of 11.9% in 2010); however, we note that spending and lending data in China has been more positive recently. Lastly, for the first time in over a year, the International Monetary Fund raised its global growth forecast in view of stronger US growth, and now expects global growth of 4.1% in 2013. “ Our models suggest that relative valuations continue to favour stocks vs the competing asset classes of government or corporate bonds.“ As investors, we are continually bombarded with all sorts of information: debt crisis in the euro zone, Barack Obama’s difficulties with the U.S. Congress or, closer to home, fluctuations in the price of gold and oil. All this data can influence our investment decisions, hence the importance of knowing your goals and having a plan. In addition to clearly defining your situation, a well-structured financial plan gives a direction to your decisions. Your Investment Advisor can help you in this regard, because he or she can understand your situation and support you in achieving your financial goals. Your Advisor’s experience, knowledge and judgment are just some of the elements that make him or her a financial partner of choice, provided, however, that you enable your Advisor to correctly assess your situation. It is therefore essential that there be open lines of communication between you and your Advisor. I encourage you to contact your Investment Advisor for any change that may have an impact on your situation. The more transparent you are in your discussions with your Advisor, the better your relationship will be with him or her, which could be very beneficial for you. “The only route that offers any hope of a better future for all humanity is that of cooperation and partnership.” — Kofi Annan
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retail strategy
Volume 23, N°5, may 2012
eDIToRIal ed sollbach, CFAPortFolio StrAtegy And QuAntitAtive reSeArCh AnAlySt
F CuS
Please see The lasT Page of ThIs DocumeNT foR comPaNy sPecIfIc DIsclosuRes.
Continued on PAge 2
message fRom The geNeRal maNageRbruno desmaraisviCe-PreSident And generAl MAnAger Full ServiCe BrokerAge The global financial markets are characterized
by sharp regional differences—the US is
recovering steadily but slowly from the worst
recession in 70 years, Europe continues to
struggle with sovereign debt problems in
the PIIGS and China is slowing after two
years of tightening.
United StateSIn late April, the US Federal Reserve (Fed)
revised upward its forecasts for 2012,
increasing its GDP growth forecast to
2.4 – 2.9% (from 2.2 – 2.7%) and signifi-
cantly lowering its unemployment forecast
to 7.9 – 8% (from 8.2 – 8.5%); it also
increased its inflation forecast to 1.9 – 2%
(from 1.4 – 1.8%). However, the Fed is
stubbornly sticking to its belief that rates
will remain at zero until late 2014.
CanadaFollowing a few weak months, Canada had a
blockbuster jobs report in March with 82,000
jobs created—proportionately seven times
more than in the US—while unemployment
dropped to 7.2% (from 7.4%). The Bank
of Canada raised its forecast for Canadian
GDP growth to 2.4% in 2012, and expects
the Canadian economy to return to full
capacity by mid-2013. However, the Bank
of Canada warned of a “withdrawal” of
monetary stimulus—a statement that leads
us to believe it will likely raise rates modestly
in mid-2013, about a year ahead of the
Fed. We believe the Canadian dollar can
continue to appreciate toward US$1.05 as
Canadian short rates are now 100bps higher
(1% vs 0% in the US), with this spread likely
increasing in 2013 as Canada raises rates
ahead of the Fed.
GloballyGlobal GDP growth is expected to slow
to a near-average 3.5% in 2012, from
4% in 2011, as Europe is dragged into
a recession because of sovereign debt
problems in peripheral countries. Recent
worries centre on Spain and its banking
system—the downward spiral due to severe
austerity, job losses and a contracting
economy has resulted in a depression-like
record unemployment of 24.4%. In China,
which has been tightening its monetary
policy to combat inflation, growth slowed
to 8.1% in 1Q12 (from a high of 11.9%
in 2010); however, we note that spending
and lending data in China has been more
positive recently. Lastly, for the first time in
over a year, the International Monetary Fund
raised its global growth forecast in view of
stronger US growth, and now expects global
growth of 4.1% in 2013.
“ Our models suggest that relative valuations continue to favour stocks vs the
competing asset classes of government or corporate bonds.“
As investors, we are continually bombarded with all sorts of information: debt crisis in the euro zone, Barack Obama’s difficulties with the U.S. Congress or, closer to home, fluctuations in the price of gold and oil. All this data can influence our investment decisions, hence the importance of knowing your goals and having a plan.
In addition to clearly defining your situation, a well-structured financial plan gives a direction to your decisions. Your Investment Advisor can help you in this regard, because he or she can understand your situation and support you in achieving your financial goals. Your Advisor’s experience, knowledge and judgment are just some of the elements that make him or her a financial partner of choice, provided, however, that you enable your Advisor to correctly assess your situation. It is therefore essential that there be open lines of communication between you and your Advisor.
I encourage you to contact your Investment Advisor for any change that may have an impact on your situation. The more transparent you are in your discussions with your Advisor, the better your relationship will be with him or her, which could be very beneficial for you.
“The only route that offers any hope of a better future for all humanity is that of cooperation and partnership.”
— Kofi annan
EDITORIAL (continued) REcOmmEnDATIOns
PRIC
E ($
)PR
ICE
($)
Volu
mE
(m)
Volu
mE
(m)
Algonquin Power & utilities CorP
CAnAdiAn nAtionAl rAilwAy ComPAny
05
10154
5
6
7
Apr-11 Jul-11 Oct-11 Jan-12 Apr-12
RiSKSThe main risks to our positive outlook for
North America are the elections on May 6 in
Greece and France, which could jeopardize
the recent political consensus of more
austerity in Europe. Longer term, with rising
unemployment in the European peripheral
countries and uneven distribution of the
benefits of a common currency, we are
concerned that politics will tear apart the
fragile European consensus.
Oil prices have climbed to US$110/bbl this
year. Political unrest in Syria or growing
tensions concerning Iran’s nuclear program
could push oil prices higher, hurting the US
consumer.
StoCKSThe S&P 500 hit our original 2012 price
target of 1420 in early April and then had
a much needed correction after rallying
for 105 days—the longest run since 2007.
Similar to the seven previous corrections,
the US dollar and bonds rose, while investors
sold stocks and commodities. A fall in bond
yields and commodity prices is an important
reset for longer term economic recovery as
falling bond yields mean lower mortgage
rates for US homebuyers.
Our models suggest that relative valuations
continue to favour stocks over the
competing asset classes of government or
corporate bonds. As yields are at historically
low levels and below inflation, the price of
bonds in Canada and the US continues to be
high. With 2.7% inflation, bond investors
are losing 80bps per annum to inflation.
Currently, both the S&P 500 and the TSX
yield more than government bonds (currently
around 2%), a situation not seen in 54 years.
The TSX yields almost 3%, and its 100bps
premium over Canadian government bonds
is the highest since World War II. Moreover,
dividends are increasing rapidly while the
return on government bonds is, of course,
fixed. TSX dividends are up 8.9% over the
last year and have tripled over the last
10 years.
We continue to believe that investors are
best served by holding equities. Normally at
this time of the year, a good switch is to sell
low-yielding stocks and buy high-yielding
bonds. However, this May, for the first
time since 1958, stocks are yielding more
than bonds (+22bps); stocks yielded at least
140bps less than bonds the previous two
times when stocks corrected in May.
Our portfolio strategy has not changed
this year, as we continue to recommend a
core portfolio consisting of high-yielding
REITs, utilities, telecoms and pipelines, with
a riskier component comprised of growing
companies (preferably with yield protection)
in the financial, technology, industrial,
consumer discretionary, transportation,
gold, oil and oil services sectors. n0246
60
70
80
90
Apr-11 Jul-11 Oct-11 Jan-12 Apr-12
RATING TOP PICK–AVERAGE RISKTarget $7.75
Symbol AQN
Sector Utility & Power
Recent price $6.34 Total potential return 26.7%52-week range $4.90–6.59
Market cap $930m
Year-end Dec-31
EBITDA 2012E $140.8m
2013E $201.1m
CFPS 2012E $0.77
2013E $0.90
Adjusted debt/total capital 31.6%
Dividend yield* 4.4%
* Most recently announced dividend (annualized) Sources: Desjardins Securities, company reports, Bloomberg
RATING BUY–AVERAGE RISKTarget $88.00
Symbol CNR
Recent price $84.39
Total potential return 6%
52-week range 63.72–81.79
Market cap 37,216m
Year-end Dec-31
Revenue 2011A $9,028m
2012E $9,796m
2013E $10,477m
Adjusted EPS 2011A $4.59
2012E $5.49
2013E $6.19
Last quarter ROE 28.2%
Dividend yield 1.8%
Sources: Desjardins Securities, company reports, Bloomberg
3
Recommendations
Volume 23, n°5, may 2012 2-3
Sources: Desjardins Securities, company reports, Bloomberg
Algonquin Power & utilities CorP
CAnAdiAn nAtionAl rAilwAy ComPAny
n Stable earnings and cash flow from a diversified portfolio
of ~424MW of renewable and thermal power capacity in
Canada and the US, as well as regulated water, gas and
electricity distribution utilities in the US
n exceptional near-term growth from investments in
~$1b of power projects under construction and ~$550m
of utility acquisitions in progress
n attractive relative valuation and ~5% dividend yield
Algonquin Power & Utilities Corp. (AQN) is a diversified power and
utility infrastructure company, with ownership interests in a portfolio
of ~424MW of net installed hydro, wind and thermal capacity, as
well as regulated water, gas and electricity distribution utilities.
The company’s power portfolio is supported by long-term power
contracts for ~70% of installed capacity, while its utility operations
are underpinned by healthy regulated equity returns in the
8–10% range.
We expect strong near-term growth for AQN over the next five
years based on utility acquisitions in progress, including expansions
into the electricity and gas distribution sectors, as well as upcoming
investments totalling ~$1b in contracted power projects in Ontario,
Québec and the US.
Our Top Pick recommendation for AQN is primarily based on its:
• Very strong near-term growth outlook, which is expected to
generate five-year EBITDA and cash flow growth in excess of
~20% per year;
• Inexpensive relative valuation of only ~5x estimated 2012
EV/EBITDA and P/CF (vs ~9x average for its peers);
• Healthy ~5% dividend yield, ~40% forward cash payout ratio
and low ~33% debt-to-total capitalization ratio.
The risks to our recommendation include fluctuations in the
foreign exchange rate and commodity price risk associated with
the company’s current operations, as well as political, regulatory,
financing and execution risks associated with its growth projects.
n Cn reported solid 1Q results, driven by a record
operating ratio
n Several growth opportunities on the horizon should
boost future earnings
n Cn’s premium valuation is justified
CN recently reported solid 1Q12 results that handily beat our
expectations on the back of a record operating ratio (operating
expenses/revenues), of 66.2%, the lowest among North American
railroads. Following these results, the company raised its 2012
outlook, calling for EPS growth of “a full 10%” (previously “up to
10%”), which we view as conservative.
We expect CN to continue to increase its profitability as it generates
additional volumes at low incremental cost and sustains above-
inflation pricing gains. CN has several growth avenues:
• Markedly higher potash shipments through Canpotex;
• Stronger export coal and intermodal shipments out
of Prince Rupert, BC;
• Growth in frac sand shipments;
• Opportunities in Mexico with Kansas City Southern;
• Plan Nord;
• The Contrecoeur, Québec, intermodal expansion.
Trading at 15.4x our estimated 2012 EPS, in line with its historical
average of 15.6x (last-12-month basis), CN shares are still worth a
look despite their premium valuation vs US peers, which are trading
at an average (ex KCS) of 12.9x consensus 2012 EPS. In our view,
this premium valuation is justified given CN’s limited exposure
(~2% of revenue) to further expected declines in thermal coal
shipments, which are severely impacting US railroads.
Moreover, we prefer CN over CP in Canada (CP is trading at 17.1x
our estimated 2012 EPS) as we believe significant profitability
improvement has been largely factored into CP’s current price.
Our $88 target for CN is based on the average of three valuation
methods.
Jeremy rosenfield, CFA, ANALYST
Benoit Poirier, CFA, ANALYST
DesjarDins securities top 25
Volume 23, n°5, may 2012 4
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COMPANY TICKER RATING & RISK TARGET PRICE ($) MARKET CAP (M$)
Toronto-Dominion Bank (The) TD Top Pick–Average 95.00 75,150Bank of Nova Scotia (The) BNS Top Pick–Average 65.00 61,953Brookfield Asset Management Inc. BAM Top Pick–Average US$40.00 US$20,515TransForce Inc. TFI Top Pick–Average 22.00 1,721Algonquin Power & Utilities Corp. AQN Top Pick–Average 7.75 930Whitecap Resources Inc. WCP Top Pick–Average 15.00 797Royal Bank of Canada RY Buy–Average 66.50 82,241Canadian National Railway Company CNR Buy–Average 88.00 37,216Potash Corporation of Saskatchewan Inc. POT Buy–Average 58.00 35,946Enbridge Inc. ENB Buy–Average 42.00 31,685BCE Inc. BCE Buy–Average 43.20 30,969Manulife Financial Corporation MFC Buy–Average 18.00 24,567Teck Resources Limited TCK.B Buy–Average 64.40 21,615Agrium Inc. AGU Buy–Average 106.30 13,756Yamana Gold Inc. AUY Buy–Above-average US$22.25 US$11,033Tim Hortons Inc. THI Buy–Average 58.00 8,932Penn West Petroleum Ltd. PWT Buy–Average 30.50 8,068Bombardier Inc. BBD.B Buy–Above-average 7.00 7,175Baytex Energy Corp. BTE Buy–Average 68.00 6,191Metro Inc. MRU Buy–Average 59.00 5,341Finning International Inc. FTT Buy–Average 34.00 4,805Vermilion Energy Inc. VET Buy–Average 59.00 4,598Dollarama Inc. DOL Buy–Average 58.00 4,040Inmet Mining Corporation IMN Buy–Average 80.10 3,815Cogeco Cable Inc. CCA Buy–Above-average 55.00 2,361Source: Desjardins Securities Portfolio Advisory Group in collaboration with Research analysts.