Scotia Capital Raise Target Scotia Capital analyst Phil Hardie continue to see opportunities across the Canadian Diversified Financials space entering 2023.
In a research report released Wednesday, he said there remains attractive opportunities for investors, believing “best position is through a barbell approach that balances defensive names with appealing value plays.”
The analyst said his game plan is to ”remain defensive in the first half of 2023 but to also look for value.” He’ll then transition to transition into higher beta plays, including asset managers “as well as some attractive prospects with smaller cap lenders,” when “uncertainties recede and market sentiment shifts.”
“The degree of economic weakness in 2023 and outlook for the trajectory of recovery will likely be the factors that separate the leaders from the laggards across the Canadian diversified financials space, however, relative valuation will also play a critical role,” he added. “P&C insurance continues to be well positioned for those taking a defensive stance within the Canadian financials space; however, in the wake of relatively strong stock performance for a number of companies through 2022, investors will likely need to be more selective on valuation to drive outperformance. We think key themes for the P&C space will include (1) personal auto line performance as return to the office builds momentum and a new normal for driving patterns evolves, (2) inflationary trends, and (3) duration of the current pricing cycle.
“Recession risks and the expected impact of recession have put pressure on the valuations of the smaller cap lenders in 2022. We expect mortgage lenders to experience a significant decline in origination volumes and moderate loan growth in 2023. Subprime consumer lenders have already pivoted their focus toward lower-risk loans and migration up the credit ladder for new borrowers. We believe this will not only de-risk these companies but also serve as a source of growth. We expect this group to continue to deliver solid EPS growth in 2023. Given the uncertain macroeconomic conditions, we expect the stocks to continue to trade below fundamental valuations in the near term; however, greater clarity or a shift in the outlook could serve as a key inflection point for stocks in the back half of 2023.”
Calling it his “top value play,” Mr. Hardie named Fairfax Financial Holdings Ltd. as his “top pick” for the year.
“We see attractive opportunities for investors to buy Fairfax shares, given their discounted valuation that likely does not truly reflect the company’s underlying earnings power,” he said. “Fairfax’s valuation discount relative to its direct peer group has widened relative to its long-term average despite its enhanced ROE and growth potential. We remain bullish that Fairfax is well-positioned to successfully navigate the current environment with the recent rise in interest rates likely to provide a strong tailwind for its short-duration fixed-income portfolio. As a result, we expect further acceleration of its interest and dividend income as the company benefits from reinvesting capital in the higher rate environment and the short-duration portfolio mitigates the downside risk of capital erosion if rates rise further. We anticipate the pricing environment to remain favourable in the next 12 to 18 months with the hard market continuing across commercial lines, supporting an increase in underwriting leverage and is an additional lever to grow its BVPS. We also think the value approach to investing is likely to bode well for the upcoming environment with a more modest return from equity markets anticipated. Fairfax has demonstrated resilience through the business cycle and turbulent financial markets, but we view it as a less-defensive play than more traditional publicly listed insurers. At this stage of the market cycle, this likely provides an attractive balance: downside protection thanks to the relative resilience of insurance operations through a potential recession, and upside potential when markets recover.”
Mr. Hardie has a “sector outperform” rating and a target of $1,050 for Fairfax Financial shares, up from $995 previously. The average target on the Street is $994.29.
He also made these other target price changes:
- AGF Management Ltd. ( “sector perform”) to $8.75 from $8.50. The average is $8.36.
- CI Financial Corp. ( “sector perform”) to $19 from $17. Average: $18.94.
- Definity Financial Corp. (“sector outperform”) to $44 from $43. Average: $42.77.
- IGM Financial Inc. ( “sector perform”) to $45 from $44. Average: $43.13.
- Intact Financial Corp. (IFC-T, “sector outperform”) to $231 from $224. Average: $222.23.
- Power Corp. of Canada ( “sector perform”) to $39 from $38.50. Average: $36.88.
- TMX Group Ltd. ( “sector perform”) to $164 from $165. Average: $154.
“Other top ideas by investment style: For defensive quality, our name remains Intact, and for small-cap growth, we like Trisura,” he said. “We continue to like Definity and believe it is attractive for GARP investors looking for a defensive mid-cap play with solid growth prospects. Our other top value ideas include: Guardian Capital, Onex and Brookfield Business Partners. goeasy is on our radar, but a reduced risk to the economic outlook, and a broader shift in investor sentiment and risk appetite are likely needed for the stock to sustain a meaningful rebound.”