Recessions leave no room for sentimentality. Already, someof Canada’s oldest and largest companies look to be in deep trouble. In thefollowing, we try to answer the hard questions about five one-time titans ofcorporate Canada: How did they get into this mess? How bad is it? And what ifthe worst happens — and they fail outright?
One way to consider thelikelihood of a company falling into bankruptcy is the Z score. Developed in1968 by New York University professor Edward Altman, it weighs five ratios —equity to debt, return on total assets, and sales, working capital and retainedearnings to total assets; any score below 1.8 is not good news for employees,investors and other stakeholders. The five companies we’re subjecting here tothe harsh spotlight all certainly fit that bill.
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Of course, there are winnersin any scenario, and in "The magnificent seven" you’ll find 10 companies whosebalance sheets and business strategies look solid enough not just to survive thedownturn, but to thrive.
The magnificent seven
by Sharda Prashad, Calvin Leung
Goldcorp (tsx: G)
Mining
Whengold prices topped US$1,000 in February, they didn’t stay there long, but it didserve investors notice that gold’s role as a safe haven in turbulent times isstill intact. Canada, of course, is home to some of the world’s largest goldcompanies in Barrick (tsx: ABX),Goldcorp and Kinross (tsx: K),all of which are in a good position to survive 2009.
Top marks go toGoldcorp, says Richard Gray, precious metals analyst at Blackmont Capital.Goldcorp has no debt, no hedges, and Gray calls it the go-to name in the sectorbecause of its longer-term growth profile, low costs, solid balance sheet andthe low political risk profile of its asset base. Indeed, 70 per cent of its netasset value comes from North American mines.
Goldcorp produced 2.3million ounces of gold last year at a cost of US$306 per ounce. By 2013, itexpects to produce 3.5 million ounces at US$300 per ounce. The compounded annualproduction growth rate of 8.8 per cent is the highest among the senior goldproducers, says Gray, and it is driven by two main projects, Peñasquito inMexico and Pueblo Viejo in the Dominican Republic.
Gray also notes thatGoldcorp’s balance sheet, which at the end of 2008 boasted US$262 million incash and no debt, provides the financial flexibility necessary to take advantageof any opportunities that may come its way.
SNC-Lavalin(tsx: SNC)
Infrastructure
Withgovernments around the world pumping billions into their respective economies,there’s one sector that’s an obvious winner: infrastructure. That puts Canada’slargest and highest-profile engineering design firm, SNC-Lavalin, in a prettygood spot. “It’s the Canadian champion internationally in the space,” says IanNakamoto, head of research at MacDougall, MacDougall & MacTier.
CoreyHammill, an analyst at Paradigm Capital, noted in a January report that SNC iswell-positioned to take advantage of a worldwide infrastructure debt that willcost billions to address. China alone has a stimulus plan worth approximatelyUS$600 billion, featuring a significant infrastructure component.
SNC hasa healthy balance sheet — about $800 million in cash and roughly $100 million inunsecured debt — and a track record of increasing its dividend by more than 20per cent in each of the past five years. It’s also been in business for 100years, giving it plenty of experience at taking on often complex coreinfrastructure projects in more than 100 countries.
Although there mightbe some exposure to risk because of the high spending levels required on theselarge-scale projects, Hammill counters that many governments have little or nochoice but to spend money on them. And while half of SNC’s contracts are sealedat a fixed price, which carries the risk of cost overruns, Hammill notes thatSNC has a good record of delivering projects on time and onbudget.
EnCana (tsx: ECA)
Oiland gas
Energy prices might be dropping, but there is still a lotof growth potential in the sector, says John Stephenson, senior vice-presidentand portfolio manager at First Asset Funds Inc. With the United States facing anunprecedented debt because of its massive bailouts and stimulus packages, moremoney will be in the system and that, in turn, sets the stage for inflation anda falling greenback. The beneficiary? None other than U.S.-denominatedcommodities, and its largest asset class is energy, says Stephenson. Energysupplies have been dropping for years, and while there has been slowing demandin Europe and North American, Stephenson expects emerging markets, such as Chinaand India, to pick up the slack as the barriers to entry for owningenergy-sucking devices like cars fall.
EnCana is widely viewed as thebenchmark company in the industry by national and international investors, andis the leader in the natural gas field in terms of technology, operationaleffectiveness and strategy, says Stephenson. The company has $383 million incash and a debt-to-capital ratio of 34.6 per cent, versus an average of 41.38per cent by Canada’s senior energy and petroleum producers.
RandyOllenberger, an analyst at BMO Capital Markets, in a February note to clients,also believes EnCana will do better than most, noting its ability to “deliverconsistent growth in production and free cash flow from its impressive assetbase given its positioning in almost every key and emerging resource play inNorth America.”
Royal Bank of Canada (tsx: RY)
Financialservices
In some ways, the Canadian banks have made a full360-degree turn in recent months, says Nakamoto at MacDougall, MacDougall &MacTier. Thirty years ago, their market caps ranked among the tops in the world,but they didn’t grow much after that, compared to the likes of Citigroup, Bankof America and Royal Bank of Scotland. But by avoiding many of the pitfalls andrisks those banks made, the Canadians once again look pretty good and the envyof U.S. banks.
Take RBC. It’s poised to gain market share as some of itscore competitors struggle, writes Brad Smith, an analyst at Blackmont Capital,in a recent note to clients. He also notes that the bank is in a good positionto build its global capital-markets franchise with the failure and continueddifficulty of global competitors such as Citigroup, Bear Stearns, Lehman Bros.and Merrill Lynch. In the most recent quarterly conference call, RBC CEO GordNixon noted that the bank’s Capital Markets group had already started to dobusiness with many new customers outside Canada. Mario Mendonca, financialservices analyst at Genuity Capital Markets, calls RBC an easy long-term winner,because it has a huge and solid retail business in Canada, it’s taking marketshare in capital, particularly in the U.S., and it has exceptional capitalratios.
Agrium (tsx: AGU)
Agriculture
“You’vegot to eat, even during a recession,” says Richard Downey, senior director ofinvestor relations at Agrium Inc. “The last thing people want to give up istheir diet.” He calls the agriculture subclass of fertilizer virtually recessionproof, because if it’s skimped on, it won’t be long until crop yields arenegatively affected.
It’s tough to choose between Canada’s top twofertilizer companies, Agrium and PotashCorp (tsx: POT),but the edge goes to Calgary’s Agrium because of its acquisition strategy. “It’snot the best-known like PotashCorp,” says Nakamoto at MacDougall, MacDougall& MacTier. “But it has a very strong record of success inacquisitions.”
Agrium is currently in the process of a hostile takeoverof CF Industries Inc. (nyse: CF).Should it be successful, it would increase its market position in nitrogen toNo. 2 (currently it’s No. 3) and in phosphate to No. 3 (it’s now No. 5) based onglobal capacity on a nutrient tonne basis, notes Paul D’Amico, an analyst at TDNewcrest. Some might question the timing of the deal, given the general gloom,but the willingness to pursue opportunities now means that Agrium could be in awinning position when the economic storm breaks.
Agrium believes itsgrowth initiative will benefit all three of its business units — wholesale,retail and advanced technologies — and expects strong demand as farmers who cutback on fertilizer during last fall’s harvest play catch-up this spring.
The company has US$374 million in cash and about US$2.2 billion in debt.It has secured financing for CF Industries, with current cash resources andcommitted financing underwritten by Royal Bank of Canada and the Bank of NovaScotia. “I am not concerned at this point in time, given the unsolicited bid byAgrium for CF Industries is a combination of cash (debt to be taken on) andequity,” says Nakamoto. “If it was an all-cash offer, I would beconcerned.”
Canadian National Railway (tsx: CNR)
Transportation
CNis among the most efficient railway companies in North America. Need proof? Itsoperating costs as a percentage of revenue are the lowest among its peers.Another good sign: the larger players in the industry like CN have booked 60 percent–66 per cent of its business for 2009 with 3 per cent–6 per cent priceincreases. CN will likely feel the effects of the slowing economy just as muchas its peers, says Tom Varesh, an analyst at Canaccord Adams, but he adds thatthe company is well-positioned to outperform competitors when business doesrecover. And that could happen next year. World trade volumes will decline 2.8per cent in 2009, but grow 3.2 per cent in 2010, according to recent projectionsby the International Monetary Fund.
CN also has an edge because it willsoon be able to bypass Chicago — which becomes a bottleneck for rail transportduring a brisk economy — by using tracks on the outskirts of the city that itacquired from its US$300-million acquisition in January of Elgin, Joliet andEastern Railway. That, says Varesh, combined with CN’s position as the exclusiverail service provider at the Prince Rupert shipping terminal in BritishColumbia, means it will offer the fastest rail service for Chinese cargo comingin from the west coast to the Chicago area, one of North America’s mostimportant trade hubs.
Onex (tsx: OCX)
Privateequity
Onex has reasons to remain upbeat even if banks aren’texactly enamoured with companies taking on huge chunks of debt to finance deals.It specializes in acquisitions that require less than $1 billion in debtfinancing, and lenders are a lot more comfortable in that deal range, says HorstHueniken, an analyst at Thomas Weisel Partners. And Onex has more than $500million in cash, no debt at the parent company level, and US$3.6 billion tospend in its private equity fund.
Onex has certainly managed to keep itsstellar reputation largely untarnished during recent months, while others suchas the Blackstone Group and Fortress Group have taken large losses on realestate and sub prime-related debt. In this sector, it doesn’t pay to make toomany mistakes. “If you’re, say, a pension fund and think your private equityguys are distracted or have gone dumb on you, you will simply not give them yourmoney,” Hueniken says.
Onex’s only misstep recently has been aUS$27-million investment in Cosmetic Essence, a personal-care products businessheadquartered in Holmdel, N.J. That business is now in violation of its bankcovenants, but it makes up only a small portion of Onex’s portfolio, which RBCCapital Markets analysts value at $3.9 billion.
With a few smart bets —like its purchase of Cineplex out of Chapter 11 earlier this decade — Onex couldcome up big as the economy recovers.
Canadian Real EstateInvestment Trust (tsx: REF.UN)
RealEstate
News of plummeting real estate prices might make some waryabout the whole sector, but Canada’s oldest REIT has differentiated itself byboasting the most conservative accounting policies and the lowest payout ratiosin the industry, according to Gail Misfud, analyst at Blackmont Capital. Shegives CREIT top marks for its high-quality assets, diverse income stream, soliddistribution and conservative payout history.
Research In Motion(tsx: RIM)
Technology
TheBlackBerry seems to be everywhere, but that’s hardly the case. AlthoughWaterloo, Ont.’s worst-kept secret has about 21 million subscribers (based onits latest quarterly numbers), that’s tiny compared to 4.7 billion mobiledevices that will be in use this year. Sure, the global economic slowdown willhurt RIM’s sales, but never underestimate the appeal of a device nicknamed theCrackBerry.
Shoppers Drug Mart (tsx: SC)
Retail
Peoplealways need their meds, but Shoppers Drug Mart also boasts a growing cosmeticsbusiness that helps customers indulge a little without breaking the bank.Shoppers plans to install about 15 more BeautyBoutiques in its stores this year.Management is planning for a two-year economic downturn, but Shoppers’ 3.6 percent sales growth in Q4 — which included one of the worst month-to-monthCanadian retail sales declines in 15 years — suggests the company could have arelatively healthy year.
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