JMRD Market Observer for September 8, 2017

September 8, 2017

In This Week’s JMRD Market Observer

 

 

  • Canadian Banks and Lifecos – Recent macro fluctuations favour banks over lifecos

  • Geopolitical Briefing: How will NAFTA negotiations play out?

  • BoC Policy Monitor – Strengthening economy prompts BoC to hike overnight rate again

  • JMRD Basket Corner

  • Retirement Corner

  • Reads of the Week

  • Economic Calendar

  • Earnings Reports

 

 

Canadian Banks and Lifecos – Recent macro fluctuations favour banks over lifecos

 

  • As the Bank of Canada hikes rates, banks are compelled to quantify EPS upside.With the Bank of Canada (BoC) raising rates earlier this week, its second hike in 2017, we are interested to quantify the impact of higher short-term rates on bank earnings. At a competitor conference, several banks quantified revenue/earnings upside potential from the BoC rate actions: (1) BNS indicated that 50 bps of rate hikes in 2017 would add 2-3 bps to its Canadian banking margins in 2018; (2) NA disclosed that a 25 bps increase in rates would add 4-5 cents to its EPS on an annualized basis; and (3) RY stated that each 25 bps rate hike would add approximately $100 million to revenues, rising to $300 million over five years as its loan book re-priced. We note that CM reiterated rate sensitivity disclosure from its public disclosures (i.e., impact of a 100 bps parallel shift across the curve), while others did not provide any quantification. On apples-to-apples basis, we derive annualized EPS upside potential for each 25 bps rate hike of less than 1% on average. While such upside isn’t dramatic, it is important to a sector with a 2018E consensus growth forecast of 5% (and could offset negative FX headwinds described below).

 

  • Meanwhile, long bond yields declining are a bigger (negative) issue for the lifecos.A discussion on interest rates would not be complete without including the lifecos. However, we believe the issue is a more negative one at this stage, since these companies are more sensitive to long bond yields, rather than the overnight rate. And with these bond yields dipping ~30 bps since the end of Q2/17, the rate environment represents a near-term earnings headwind. Moreover, lower long-term rates also carry negative implications for capital ratios, as their bond portfolios are marked to market (i.e., higher values result in a higher required capital charge).

 

  • Meanwhile, the impact of a stronger CAD is an earnings headwind for “everybody”, especially the lifecos.The CAD has strengthened 14% from its trough earlier this year. Since most of our companies have operations outside of Canada, this trend is negative for foreign-denominated earnings translation. The lifecos, in particular, are challenged by this headwind. For upcoming Q3/17 results, we estimate that CAD strengthening could depress core earnings by 1-2% for GWO, MFC and SLF (with GWO being the least impacted due to its greater GBP exposure). Moreover, we estimate that if current FX rates persist into 2018, the companies could face downward EPS revisions in the 2-5% range, all else equal. In contrast, the banks with the most USD-translation exposure (i.e., BMO and TD) would have roughly half of this downside in their upcoming fiscal Q4/17 results, and similar relative downside (i.e., ~2%) to 2018E. For perspective, though, FX-related downside on bank earnings could offset (or possibly exceed) upside potential tied to higher BoC rates, as described above.

 

See the full article

 

 

Geopolitical Briefing: How will NAFTA negotiations play out?

 

Donald Trump’s promise to take a much tougher line on trade was a key part of his election platform. After withdrawing from the Trans-Pacific Partnership, he is now focused on renegotiating NAFTA.

This report analyzes:

  • The main sectors up for negotiation
  • Changes that could be made to NAFTA
  • Why Trump will not attempt to withdraw from NAFTA
  • Why the disagreements between NAFTA members will ultimately pale in comparison to the growing trade tensions between the United States and China

 

Despite President Trump’s repeated threats to walk away from NAFTA if he is unable to negotiate a better deal, his main goal is to extract enough concessions from Mexico and Canada to declare victory without overly disrupting the U.S. economy and alienating his electoral base.

 

See the full article

 

 

BoC Policy Monitor – Strengthening economy prompts BoC to hike overnight rate again

 

The Bank of Canada raised the overnight rate by 25 basis points to 1.00% at today’s meeting. The central bank supported its decision by pointing to solid growth in consumption, business investment and exports and said growth “is becoming more broadly based and self-sustaining”. The central bank, however, thought there is still some excess capacity in Canada’s labour market, highlighting subdued wages and prices to prove its point. The BoC also acknowledged downside risks such as geopolitics and uncertainties with regards to trade and fiscal Policy.

 

See the full article

 

 

JMRD Basket Corner

 

DIG Basket

 

Canadian Natural Resources (CNQ) – Canadian Natural announced the acquisition of Cenovus’s Pelican Lake assets and other northern AB volumes for consideration of $975 million, in an all cash deal expected to close by September 30th. Given the relative small size of the acquisition, we believe the deal is marginally positive, but strategic to Canadian Natural. We estimate that cash flow accretion is in the 2% range. The Pelican Lake assets are currently producing at 19,600 boe/d, which represents per flowing barrel metrics of $50,000/BOE/d, and implies a cash flow multiple of approximately 7.0x. This transaction consolidates Canadian Natural’s position in the Pelican Lake region, where the company currently produces about 47,000 bbl/d and owns 62% of the pipe line that will also be consolidated. We expect additional operating synergies to be captured over time which likely improves both volume and costs, improving the netback from what is approximately $20/bbl today. Through infill and polymer flood initiatives across the acreage, the acquired assets could potentially be doubled over time.

 

Dollarama (DOL) – Dollarama, the largest holding in the DIG Basket, delivered another solid quarter predicated on positive same store sales growth (sssg), gross margin expansion, SG&A leverage and share repurchases. The EPS beat vs. NBF was largely due to the net impact of higher than expected gross profit (+$0.07 to EPS), lower than expected SG&A (+$0.05 to EPS) and a higher than expected tax rate (-$0.01 to EPS). (2) Same store sales growth was 6.1% vs. NBF at 6.0%; last year was 5.7%. Basket growth was 5.9% vs. NBF at 6.0% and transaction growth was 0.2% vs. NBF at 0.0%. Revenue was $812 mln vs. NBF at $817 mln; last year was $729 mln. (3) EBITDA was $209 mln vs. NBF at $190 mln; last year was $169 mln. (4) Net income was higher by 23.9% y/y while EPS was higher by 30.7% y/y.

 

See the full article

 

TransCanada (TRP)TransCanada may abandon Energy East pipe facing tougher review

 

U.S. Growth Basket

 

A quieter news week for the U.S. Growth Basket but a couple of transactions to report. This week, we sold the S&P Regional Bank ETF (KRE) and added new positions in IAC-Interactive (IAC) and PayPal Holdings (PYPL). IAC is an Internet company with more than 50 brands serving consumer audiences across more than 30 countries. The Company operates in four business segments: Search, Match, Service Magic & Media and Other Businesses. PayPal was spun off from eBay in July 2015 and is a technology platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. It accepts payments from merchant websites, mobile devices and applications, and at offline retail locations through its PayPal, PayPal Credit, Venmo and Braintree products. PayPal processes transactions in more than 200 markets and in more than 100 currencies, and allows customers to withdraw funds from bank accounts in 56 currencies and hold balances in PayPal accounts in 25 currencies.

 

 

Retirement Corner

 

 

 

Reads of the Week

 

 

 

 

  • Economic News – Canada: A ninth consecutive employment gain in August:  The headline number for job creation was a bit stronger than expected by consensus but the details of the report were unimpressive. First, the composition of the gains were tilted towards self-employment. Moreover, the net gain in August is the result of a massive drop in full-time employment (the worst since July 2010) and a surge in part-time employment. Despite this development, we should not ring the alarm bell since the full-time job decline was concentrated in the 15-24 (-65K) as students returned to school after massive hiring in the prior months. All in all, we remain constructive on overall employment conditions. Keep in mind that the Canadian labor market extended in August its streak of consecutive gains to 9 months, making it the longest since the recession. Evaluating gains on a 12-month basis ─ a more reliable measure for a survey such as the LFS ─, job creation is still running at an torrid pace of 374K with gains being mostly full-time and more than half of which is in the private sector (middle chart). Not only did the jobless rate drop to its lowest level since October 2008, the “augmented” jobless rate (known as U-6 in the U.S.) also fell to a cyclical low in August. With the employment rate of prime-age workers being back to its pre-recession peak, the labor market looks to be near full-employment (bottom chart). Not surprisingly, wage inflation picked up over the past 4 months, running at a 3.3% annualized pace over this period. See the full article

 

 

 

 

 

 

 

 

Economic Reports

 

Monday September 11th – Canadian Housing Starts

Tuesday September 12thNone

Wednesday September 13th – U.S. PPI

Thursday September 14th – Canadian New Housing Price Index, U.S. Jobless Claims

Friday September 15th – Canadian New Motor Vehicle Sales, U.S. Retail Sales, U.S. Industrial Production

 

 

Earnings Reports

 

Monday September 11th – None

Tuesday September 12thNone

Wednesday September 13th – None

Thursday September 14th – Oracle

Friday September 15th – None

 

 

Enjoy the weekend!

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