The magnificent sevenFrom Canadian Business magazine, March 30, 2009
Recession management
The good, the bad and the ugly:
The magnificent seven
It's not all bad. Or ugly. Here are seven companies poised to continue doing well, even through hard times.
By Sharda Prashad, Calvin Leung
Goldcorp (TSX: G)
Mining
When gold prices topped US$1,000 in February, they didn’t stay there long, but it did serve investors notice that gold’s role as a safe haven in turbulent times is still intact. Canada, of course, is home to some of the world’s largest gold companies in Barrick (TSX: ABX), Goldcorp and Kinross (TSX: K), all of which are in a good position to survive 2009.
Top marks go to Goldcorp, 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 sector because of its longer-term growth profile, low costs, solid balance sheet and the low political risk profile of its asset base. Indeed, 70% of its net asset value comes from North American mines.
Goldcorp produced 2.3 million ounces of gold last year at a cost of US$306 per ounce. By 2013, it expects to produce 3.5 million ounces at US$300 per ounce. The compounded annual production growth rate of 8.8% is the highest among the senior gold producers, says Gray, and it is driven by two main projects, Peñasquito in Mexico and Pueblo Viejo in the Dominican Republic.
Gray also notes that Goldcorp’s balance sheet, which at the end of 2008 boasted US$262 million in cash and no debt, provides the financial flexibility necessary to take advantage of any opportunities that may come its way.
SNC-Lavalin (TSX: SNC)
Infrastructure
With governments around the world pumping billions into their respective economies, there’s one sector that’s an obvious winner: infrastructure. That puts Canada’s largest and highest-profile engineering design firm, SNC-Lavalin, in a pretty good spot. “
It’s the Canadian champion internationally in the space,” says Ian Nakamoto, head of research at MacDougall, MacDougall & MacTier.
Corey Hammill, an analyst at Paradigm Capital, noted in a January report that SNC is well-positioned to take advantage of a worldwide infrastructure debt that will cost billions to address. China alone has a stimulus plan worth approximately US$600 billion, featuring a significant infrastructure component.
SNC has a healthy balance sheet — about $800 million in cash and roughly $100 million in unsecured debt — and a track record of increasing its dividend by more than 20% in each of the past five years. It’s also been in business for 100 years, giving it plenty of experience at taking on often complex core infrastructure projects in more than 100 countries.
Although there might be some exposure to risk because of the high spending levels required on these large-scale projects, Hammill counters that many governments have little or no choice but to spend money on them. And while half of SNC’s contracts are sealed at a fixed price, which carries the risk of cost overruns, Hammill notes that SNC has a good record of delivering projects on time and on budget.
EnCana (TSX: ECA)
Oil and gas
Energy prices might be dropping,
but there is still a lot of growth potential in the sector, says John Stephenson, senior vice-president and portfolio manager at First Asset Funds Inc. With the United States facing an unprecedented debt because of its massive bailouts and stimulus packages, more money will be in the system and that, in turn, sets the stage for inflation and a falling greenback. The beneficiary? None other than U.S.-denominated commodities, and its largest asset class is energy, says Stephenson. Energy supplies have been dropping for years, and while there has been slowing demand in Europe and North American,
Stephenson expects emerging markets, such as China and India, to pick up the slack as the barriers to entry for owning energy-sucking devices like cars fall.
EnCana is widely viewed as the benchmark company in the industry by national and international investors, and is the leader in the natural gas field in terms of technology, operational effectiveness and strategy, says Stephenson. The company has $383 million in cash and a debt-to-capital ratio of 34.6%, versus an average of 41.38% by Canada’s senior energy and petroleum producers.
Randy Ollenberger, an analyst at BMO Capital Markets, in a February note to clients, also believes EnCana will do better than most, noting its ability to “deliver consistent growth in production and free cash flow from its impressive asset base given its positioning in almost every key and emerging resource play in North America.”
Royal Bank of Canada (TSX: RY)
Financial services
In some ways, the Canadian banks have made a full 360-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,
Bank of America and Royal Bank of Scotland.
But by avoiding many of the pitfalls and risks those banks made, the Canadians once again look pretty good and the envy of U.S. banks.
Take RBC. It’s poised to gain market share as some of its core 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 position to build its global capital-markets franchise with the failure and continued difficulty of global competitors such as Citigroup, Bear Stearns, Lehman Bros. and Merrill Lynch. In the most recent quarterly
conference call, RBC CEO Gord Nixon noted that the bank’s Capital Markets group had already started to do business with many new customers outside Canada. Mario Mendonca, financial services 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 market share in capital, particularly in the U.S., and it has exceptional capital ratios.
Agrium (TSX: AGU)
Agriculture
“You’ve got to eat, even during a recession,” says Richard Downey, senior director of investor relations at Agrium Inc. “The last thing people want to give up is their diet.” He calls the agriculture subclass of fertilizer virtually recession proof, because if it’s skimped on, it won’t be long until crop yields are negatively affected.
It’s tough to choose between Canada’s top two fertilizer companies, Agrium and PotashCorp (TSX: POT), but the edge goes to Calgary’s Agrium because of its acquisition strategy. “It’s not the best-known like PotashCorp,” says Nakamoto at MacDougall, MacDougall & MacTier. “But it has a very strong record of success in acquisitions.”
Agrium is currently in the process of a hostile takeover of CF Industries Inc. (NYSE: CF). Should it be successful, it would increase its market position in nitrogen to No. 2 (currently it’s No. 3) and in phosphate to No. 3 (it’s now No. 5) based on global capacity on a nutrient tonne basis, notes Paul D’Amico, an analyst at TD Newcrest. 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 a winning position when the economic storm breaks.
Agrium believes its growth initiative will benefit all three of its business units — wholesale, retail and advanced technologies — and expects strong demand as farmers who cut back on fertilizer during last fall’s harvest play catch-up this spring.
The company has US$374 million incash and about US$2.2 billion in debt. It has secured financing for CF Industries, with current cash resources and committed financing underwritten by Royal Bank of Canada and the Bank of Nova Scotia. “I am not concerned at this point in time, given the unsolicited bid by Agrium for CF Industries is a combination of cash (debt to be taken on) and equity,” says Nakamoto. “If it was an all-cash offer, I would be concerned.”
Canadian National Railway (TSX: CNR)
Transportation
CN is among the most efficient railway companies in North America. Need proof? Its operating 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%–66% of its business for 2009 with 3%–6% price increases. CN will likely feel the effects of the slowing economy just as much as its peers, says Tom Varesh, an analyst at Canaccord Adams, but he adds that
the company is well-positioned to outperform competitors when business does recover. And that could happen next year. World trade volumes will decline 2.8% in 2009, but grow 3.2% in 2010, according to recent projections by the International Monetary Fund.
CN also has an edge because it will soon be able to bypass Chicago — which becomes a bottleneck for rail transport during a brisk economy —
by using tracks on the outskirts of the city that it acquired from its US$300-million acquisition in January of Elgin, Joliet and Eastern Railway. That, says Varesh, combined with CN’s position as the exclusive rail service provider at the Prince Rupert shipping terminal in British Columbia, means it will offer the fastest rail service for Chinese cargo coming in from the west coast to the Chicago area, one of North America’s most important trade hubs.
Onex (TSX: OCX)
Private equity
Onex has reasons to remain upbeat even if banks aren’t exactly enamoured with companies taking on huge chunks of debt to finance deals.
It specializes in acquisitions that require less than $1 billion in debt financing, and lenders are a lot more comfortable in that deal range, says Horst Hueniken, an analyst at Thomas Weisel Partners. And
Onex has more than $500 million in cash, no debt at the parent company level, and US$3.6 billion to spend in its private
equity fund.
Onex has certainly managed to keep its stellar reputation largely untarnished during recent months, while others such as the Blackstone Group and Fortress Group have taken large losses on real estate and subprime-related debt. In this sector, it doesn’t pay to make too many mistakes. “If you’re, say, a pension fund and think your
private equity guys are distracted or have gone dumb on you, you will simply not give them your money,” Hueniken says.
Onex’s only misstep recently has been a US$27-million investment in Cosmetic Essence, a personal-care products business headquartered in Holmdel, N.J. That business is now in violation of its bank covenants, but it makes up only a small portion of Onex’s portfolio, which RBC Capital 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 could come up big as the economy recovers.