Post by
SunsetGrill on Sep 05, 2018 12:56pm
Scotia's Diversified Financial Anlysis
Diversified Financials
Best Ideas & Q2/18 Overview
OUR TAKE: We have published our Best Ideas & Q2/18 Overview report. Key themes in the report include: (1) maintaining a late-cycle barbell approach as we progress through 2H/18; (2) an investment framework tailored to diversified financials; (3) IFC – we remain positive given recent operational progress and defensive positioning; (4) MSI – acquisition of LifeWorks appears to be progressing well; (5) Element Fleet Management Corporation – with a refreshed management team in place, investors await results of the strategic assessment; and (6) valuation disparities widen across the asset management sector. Across the diversified financials space, 2018 continues to be characterized by a wide disparity in stock performance, likely creating large opportunities for alpha generation. On a year-to-date basis, we estimate roughly 55 percentage points of separation between top- and bottom-performing stocks. Our best ideas by investment style range from value to GARP. On the large cap growth side, we like IFC and IGM, and for value, we like POW. Our top small cap names are FSZ for GARP and GCG.A and ECN for value. We remain sensitive to valuation, and a number of large cap stocks are on our watch list, including TMX. KEY POINTS We are maintaining our late-cycle barbell approach as we progress through 2H/18. Global trade tensions continue to make headlines and spur market volatility. According to Scotiabank GBM's Portfolio Strategist, Hugo Ste-Marie, although headline risks related to global trade tensions abound, and although volatility could remain high, fundamentals continue to be supportive – for now – underpinned by a solid corporate earnings outlook. In light of the return of volatility and given a number of lingering market concerns, we believe investors have become increasingly selective, particularly across the financial services sector. We continue to see an investor bias toward quality and dividends across the sector. An all-out defensive stance is still premature, in our opinion, and we maintain our late-cycle barbell approach.
We updated our investment framework, which highlights some key attributes that we believe financial services investors screen in their selection process. These include: (1) Company Quality & Industry Fundamentals; (2) Dividends & Earnings Growth Outlook; (3) Valuation & Upside Potential; and (4) Quant Score & Momentum Indicators. While our rankings were largely intact, we do highlight some movement in overall rankings for our top names. On the large cap side, PWF took the top spot while IFC was bumped out of the top three, and on the small cap side, MSI jumped into the top three, edging out GCG. Our ratings remain unchanged coming out of the Q2/18 reporting season; however, we have made some revisions to our targets. We have trimmed our targets for AGF, HCG, and IGM after revisiting our target multiples, but increased our target for GCG given an upward revision to our NAV forecast.
COVERAGE SUMMARY Rating 1-Yr. Target Return
AD-T SP C$17.50 1.3%
AGF.B-T* SP C$8.50 43.4%
CIX-T SP C$24.00 17.7%
ECN-T SO C$5.00 37.0%
EFN-T SP C$7.50 11.0%
EQB-T SP C$70.00 9.4%
FFH-T SP C$750.00 6.4%
FN-T SP C$27.00 -0.9%
FSZ-T SO C$15.00 29.5%
GCG.A-T* SO C$31.00 31.4%
GS-T SP C$19.00 20.4%
HCG-T* SP C$17.00 17.3%
IFC-T* SO C$112.00 11.0%
IGM-T* SO C$44.00 27.5%
MIC-T SP C$47.00 11.6%
MSI-T SP C$29.00 8.1%
ONEX-T SP C$107.00 14.7%
POW-T SO C$35.50 26.7%
PWF-T* SP C$37.50 29.1%
X-T SP C$93.00 8.9%
Maintaining a Late-Cycle Barbell Approach As We Progress Through the Back Half of 2018 An Investment Framework Tailored to Diversified Financials Intact Financial Corporation – We Remain Positive Given Recent Operational Progress and Defensive Positioning Morneau Shepell Inc. – Acquisition of LifeWorks Appears to Be Progressing Well Element Fleet Management Corporation – With a Refreshed Management Team in Place, Investors Await the Results of the Strategic Assessment Valuation Disparities Widen Across the Asset Management Sector Across the diversified financials space, 2018 continues to be characterized by a wide disparity in stock performance, creating opportunities for alpha generation. The recent earnings period saw some big stock moves by Element Fleet Management Corporation (Element) and Intact Financial Corporation (Intact), along with some solid gains by Fiera Capital Corporation (Fiera) and ECN Capital Corp. (ECN). This contrasted to a sell-off in CI Financial Corp. (CI) and Home Capital Group Inc. (HCG) and further pressure across the fund group, with some valuation multiples testing new trough levels. On a year-to-date (YTD) basis, we estimate a separation of roughly 55% between top- and bottom-performing stocks. We maintain our late-cycle barbell approach. Global trade tensions continue to make headlines and spur market volatility. According to Scotiabank GBM’s Portfolio Strategist, Hugo Ste-Marie, although headline risks related to global trade tensions abound, and although volatility could remain on the high side, fundamentals continue to be supportive – for now – underpinned by a solid corporate earnings. In light of the return of volatility, and given a number of lingering market concerns, we believe investors have become increasingly selective, particularly across the financial services sector. We continue to see an investor bias toward quality and dividends across the sector. An all-out defensive stance is still premature, in our opinion, and we maintain our late-cycle barbell approach. For large cap investors with a bias toward lower-beta names, we would suggest looking at Intact and Power Corporation of Canada (POW), and for those with a constructive market outlook, we would suggest looking at IGM Financial Inc. (IGM). On the small cap side, our top pick for GARP investors continues to be Fiera, while for value, we like Guardian Capital Group Limited (Guardian) and ECN. We have summarized our best ideas by investment style in Exhibit 1. We will continue to monitor the investment landscape as the year progresses.
TMX Group Ltd. (TMX) remains on our radar. We remain sensitive to valuation, and a number of our larger cap stocks are on our watch list. This includes TMX, one of the more market-sensitive names we cover, which has an inherently uncertain outlook that likely warrants a discounted valuation to provide for a greater margin of error. We think an increase in volatility is generally good for TMX and supportive of equities and derivatives trading volumes; however, the combination of strong debt markets and elevated volatility adds risk to our near- to medium-term outlook for financing activity and listing fees. While we remain positive on TMX, following a strong run and an expected return in the single digits, below the average of our coverage universe, we currently remain sidelined. That said, if TMX is able to materially accelerate Trayport’s growth and if the financial market backdrop stabilizes, we see upside to our target multiple and estimates. An Investment Framework Tailored to Diversified Financials The diversified financials space offers a range of opportunities with attractive investment characteristics. Our diversified financials universe consists of 20 companies in seven sub-sectors, broadly defined as asset managers, capital markets, financial conglomerates, mortgage lending and services, property and casualty (P&C) insurance, specialty financial services, and specialty investment management (see Exhibit 2). The market cap of the companies covered ranges from around $500 million to more than $20 billion. Of the companies under coverage, 10 are classified as small cap, with a market capitalization of less than $2 billion, and 10 have a market cap of more than $2 billion. Our investment framework was developed to help investors gain greater insight into the investment characteristics and opportunities across our broad and diversified coverage universe. The framework scores and generates relative rankings based on four unique categories that we dynamically weight, based on attributes that we believe financial services investors screen in their selection process. These include (1) Company Quality and Industry Fundamentals, (2) Dividends and Earnings Growth Outlook, (3) Valuation and Upside Potential, and (4) Quant Score and Momentum Indicators (see Exhibit 3). Each category considers a number of key factors, scored on a five-point relative scale across our coverage universe. The framework generates an overall composite score and ranking, along with relative rankings by category and market cap segment. As our coverage universe is both large and heterogeneous, with companies active across a range of different sub-sectors, we believe the framework provides a useful tool for investors to efficiently gain insights into key investment characteristics and opportunities
Power Financial Corporation (PWF), POW, and IGM score the highest across our larger cap names, while ECN, Morneau Shepell Inc. (MSI), and Fiera rank as the top smaller cap names. Exhibit 4 provides the top three overall rankings by market cap and category. Our larger cap names generally led in scoring for Company Quality and Industry Fundamentals, as well as for Dividends and Earnings Growth Outlook, while the smaller names scored well on Valuation and Upside Potential. On the large cap side, PWF jumped into the top spot as Intact got knocked out of the top three; this move was largely attributable to PWF’s attractive valuation and upside potential compared with Intact’s shares, which rallied on the back of Q2/18 results. On the small cap side, the most notable change was MSI’s jump into the top three, edging out Guardian this quarter, which is likely largely based on MSI’s sustained operating momentum along with expected benefits related to the recent LifeWorks acquisition. That said, while we like the stock, its extended rally, notwithstanding the recent pullback, puts it a bit lower on our Valuation and Upside Potential scale, and that gives us pause. Exhibit 5 provides the quartile rankings for our universe of coverage. Exhibit 4: Overall Company Rankings by Category and Market