National Bank Financial analyst Jaeme Gloyn expects the operating performance and valuation upside for Canadian diversified financial companies in his coverage universe to “remain constrained” in 2023, seeing “downside macroeconomic risks persist (i.e., increasing probability of recession).”
“Our preference to start the year focuses on companies with both robust, yet de-risked growth profiles and ongoing multiple re-rate potential. ‘De-risked’ is the key theme,” he said.
He recommends Element Fleet Management Corp. mid-to-large cap investors and Trisura Group Ltd. for small-to-mid cap investors, believing they “provide the best combination of de-risked growth and compelling valuation upside.”
“While consensus expects more rapid growth for some other companies in our coverage, executing against that forecast could prove challenging should the macro backdrop deteriorate and equity markets falter,” he said. “The big risk to our call? Higher-risk growth/consumer credit driven companies (e.g., ECN, EQB, GSY) will outperform as risks to consumer spending/health subside (the timing of which remains uncertain).”
For Element Fleet, he reiterated an “outperform” rating and $24 target, exceeding the $22.08.
“Element Fleet (EFN) is a ‘core holding’ we believe every PM needs to own in all environments,” he said. “EFN is a low-risk, double-digit FCF and dividend grower, with blue-sky share price potential easily into the $30s over the next two years regardless of the market backdrop. We view growth as de-risked given 1) continued solid execution on an organic growth pipeline of $500 million of revenues (40 per cent above 2022 levels) to be earned in the next few years, 2) a massive order backlog with high-margin revenues to support that growth in H2 2023 through 2024, and 3) mega-fleet wins not baked into guidance or consensus estimates (see Rentokil). In addition, EFN still trades at an FCF Yield of 9 per cent on 2024 estimates, roughly 40 per cent above the yield of Canadian Financials with similar fundamentals (e.g., defensiveness, strong organic revenue growth, expanding profitability, solid FCF generation, low credit risk, and barriers to entry). As EFN executes in 2023, we expect significant yield compression.”
For Trisura, Mr. Gloyn has an “outperform” rating and $68 target. The average on the Street is $57.71.
“Trisura (TSU) is a rapid revenue/EPS growth and significant ROE expansion story with valuation upside,” he said. “We view growth as de-risked given 1) persistent sector tailwinds (e.g., hard markets, high interest rate environment discussed in our 2022 preview), 2) fee-based income drives 40 per cent of earnings, growing above 50 per cent near term, 3) low-risk organic growth strategies (e.g., entry into U.S. surety lines and admitted lines markets) benefiting from secular trends in U.S. MGA markets and growing Canadian distribution relationships, and 4) balance sheet capacity to execute organic growth. Moreover, trading at a P/E multiple discount of 30 per cent to its U.S. specialty insurance peers and 30 per cent below its peak multiple, we see a significant re-rate opportunity as TSU executes against expectations in 2023.”
If investors already hold either company, he said his secondary ideas “offer the most compelling value.” They are:
* Fairfax Financial Holdings Ltd. with an “outperform” rating and $1,100 target. Average: $951.79.
“Fairfax (FFH) will deliver long-run ROE of more than 10 per cent and the market is still only pricing in 5-per-cent ROE. Fairfax will generate run-rate $1.2-$1.5 billion in interest and dividend income in 2023, which translates to 6.5-8.0-per-cent ROE on its own. Meaning, you are buying FFH’s interest income stream and getting the rest of the business for FREE,” he said.
* Brookfield Business Partners LP with an “outperform” rating and US$38 target. Average: US$31.43.
“BBU is currently trading at a 52-per-cent discount to management’s NAV estimate of $39/unit, or 4 times the pre-COVID wide discount,” he said. “Striping out the recent sale of Westinghouse’s $8 per unit of value means BBU is trading at more than 65-per-cent discount to NAV.”