**August 26th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer
- The JMRD Team Welcomes Melanie McCann Back from Rio
- Faith Hatt
- Infra spending bonanza – 2006 sets a precedent; we see more upside ahead as the tide will lift all the boats
- JMRD Basket Corner
- Retirement Corner
- Reads of the Week
- Economic Calendar
- Earnings Report
The JMRD Team Welcomes Melanie McCann Back from Rio
In the June 3rd issue of the JMRD Market Observer, we profiled local Olympian Melanie McCann, who was training to compete in the Modern Pentathlon in this year’s Rio Olympics. Last night the JMRD Team, along with family and friends in Grand Bend, welcomed her back from the Olympic Games. We congratulate Melanie on a great showing at the Olympics and look forward to offering our continued support. Well done Melanie!
Faith Hatt has been a member of the JMRD Team for over a year and has recently decided to pursue other employment opportunities closer to her family. We wanted to thank Faith for her contribution to the team while she was here and wish her all the best in her future endeavours.
Infra spending bonanza – 2006 sets a precedent; we see more upside ahead as the tide will lift all the boats
2006 provides a blueprint for current infra spending spree; this precedent suggests more E&C upside ahead: In Canada, E&Cs emerged as an “asset class” in 2006 when the Harper government put forward a seven-year $33 bln Building Canada Plan in 2007 Budget. Now, after several years of sub-par global (and Canadian) growth, governments are facing diminishing returns from monetary policy and by extension have reached out for the fiscal toolkit, to the delight of Keynes proponents and more importantly, E&C shareholders. In this report we make the argument that when overlaying the 2006 precedent onto the Liberal $120 bln / 10-year spending plan (80% of which comes post 2021E), we are only in the second inning of the share price appreciations (Figure 1).
When will the E&C companies see incremental contract flow? 2018E: There are multi-quarter lags between official pronouncements and the hard dollars benefitting E&C companies’ backlogs. Using Aecon/Stuart Olson infrastructure exposure (the companies with the longest by-division backlog histories), the peak of y/y changes in quarterly backlog metrics took place nine quarters post the initial 2006 infra spending announcement (Figure 2) as agreements between the Federal government, provinces and municipalities had to be inked, priority projects had to be identified and social license for pushing the chosen works had to be obtained, an exactly similar-to-now situation. Using the 2006 yardstick, it would put us in Q1/18E when Canadian E&C companies should start feeling the impact of incremental spending.
Canada / US / UK all portend to higher infra dollars – the United States has been an under-investment outlier: On a relative basis, Canada has been catching up to the UK in terms of infra spending as % of GDP. With a caveat that every geography defines “public” spending using a slightly different methodology (in addition to availability of consistent data), Canada / US / UK have spent respective 2.1% / 1.8% / 2.5% of their GDP on infrastructure since 1981 / 1993 / 1997. Over the last decade, Canada and the UK have actually been the most aggressive infrastructure investors. The United States is clearly an outlier in the group of three having curtailed spending to only 1.6% of the country’s GDP. According to our math, just getting back to its long-term median trend in the United States (measured as % of GDP) would add an incremental $35 bln in infra spending/annum (or a 12% increase vs. 2015 level).
Bottom line – fiscal stimulus theme will be gaining momentum – investors will continue to latch onto E&Cs due to CAPEX certainty in a major part of the companies’ end markets (Ex. commodities): In a growth-starved world fiscal stimulus is beginning to capture the imagination of investors. There are three key takeaways from this discussion: 1) political will appears to align with those of E&C investors, making the spending likelihood a reality, not just in Canada but in the United States (regardless of who comes to power as both parties agree on one thing only – infra spending) and the UK (to offset Brexit drag); 2) in a thematically driven industrial space such as E&C/machinery, even the relatively removed 2018E timeframe, when we can actually expect to see the spending flow, is more than enough for investors to be positively predisposed towards our coverage universe; 3) as demonstrated in our 2006-anchored infra spending spurt in Canada, we are likely only in the second inning when it comes to E&C share price momentum. In terms of individual stocks, we like SNC, WSP, STN, BDT, TIH and IBG at the moment as they are not only thematically positioned (Aecon is extremely well positioned in Canadian infra/nuclear) but also sport attractive risk-reward profiles. (Full report attached)
JMRD Basket Corner
Toronto-Dominion Bank (TD) – Strong operating performance. TD reported Q3 f2016 core cash EPS (excluding IFRS dilution) of $1.27. This compares with $1.20 last quarter and one year ago. Earnings exceeded our forecast of $1.19, and the consensus estimate of $1.21. This quarter, TD delivered a strong operating performance, with each business segment beating our forecast on both an earnings and pre-provision income (PPI) basis. In particular, the segments that TD will rely on to offset the headwinds facing its core Canadian business – Wholesale Banking and U.S. Retail – led the way. From a defensive perspective, we observed sound cost control in the bank’s personal & commercial banking operations on both sides of the border. Overall, this quarter re-affirmed many of the positive qualities that underpin our Outperform rating, and this should strengthen the bank’s valuation. (Full report attached)
All Cap Growth Basket
Innergex Renewable (INE) – INE announced that its 40.6 MW Big Silver Creek hydro project in B.C. began commercial operations; with an effective commissioning date on July 29th (construction began in June 2014). This facility should generate average annual production of 139,800 MWh under a 40-year PPA with BC hydro which includes inflation escalators. We believe that Big Silver should generate approximately $18 mln of annual revenue and $15 mln of annual EBITDA. This project was already built into our existing model, so we do not expect any changes to our estimates. INE remains one of our top picks, given its long life hydro assets and stable cash flows. With a recent pullback in the stock, it trades an implied IRR of about 8.9% (among the highest in its peer group). Since most of the IPPs in our sector are typically discounted at 6.5-8% and with the private markets acquiring assets in the <6% range, we believe this stock could see a rebound. INE should see future dividend increases given its relatively low dividend payout ratio (we estimate about 60% on CAFD in 2017E), which could offset pressure on the stock from rising interest rates. (Full note attached)
Parkland Fuel (PKI) – Parkland announced this week an agreement to acquire the majority of CST Brands Canadian business and assets. The acquisition is expected to add more than 3.0 billion litres in annual fuel volume taking Parkland’s annual run rate volume to over 13.3 billion litres for a purchase price of approximately $965 million. The transaction is expected to be immediately accretive to distributable cash flow by over 20% on a pre-synergy, trailing twelve month basis. Parkland traded higher by 14% on the week and a new year-high, following the news announced on Monday.
Spartan Energy (SPE) – We are now off restriction following the close of Spartan’s recently announced $81 mln bought deal equity financing. Proceeds from the raise will help to reduce indebtedness under the company’s $150 mln credit facility and will provide funding support for general corporate purposes. On the day the financing was announced and over the course of our restricted period, SPE made mention of yet another completed SE Saskatchewan acquisition ($24 mln; 4th deal YTD), provided details of its second half budget and reported Q2/16 results. (Full note attached)
U.S. Growth Basket
Applied Materials (AMAT) – “Stacking More Chips on Applied Materials” (The Wall Street Journal)
- “Later Retirement is a fallback that has companies sweating” (Globe and Mail)
- “Postsecondary education planning tips for the family” (Globe and Mail)
Reads of the Week
- NBF Hot Charts – Canada: Record foreign demand for securities Foreign investors can’t seem to get enough of Canadian securities. Securities transactions data for June showed a sixth consecutive monthly increase in net foreign buying. As today’s Hot Charts show, the first half of 2016 saw net foreign portfolio inflows totaling C$80.4 bn, the highest ever recorded for a semester. The massive inflows were directed primarily towards bonds (+C$48.7 bn), equities (+C$26.2 bn is the highest in 16 years) and money market instruments (+C$5.5 bn). The bond net purchases in the first half were largely denominated in foreign currencies (roughly 70%) and directed towards corporates (C$31.3 bn), federal government bonds (C$10.7 bn), and provis (+C$6.7 bn). Clearly, foreign investors are keen to add to their portfolios not just AAA-rated Canadian government bonds but also riskier corporates. In a world where a significant chunk of global bonds have negative yields, Canadian bonds can be relatively attractive. With foreign appetite so strong, domestic issuers are keenly tapping markets in the third quarter as well. Strong portfolio inflows explain in part the resilience of the Canadian dollar amidst persistently weak oil prices. (Full report attached) Hot Charts
- “Michigan’s Lessons for Ontario” (Wall Street Journal)
- Hot Charts Canada Watch: While the benefits of a cheap Canadian dollar may not be immediately obvious by just looking at the record merchandise trade deficit, they are evident in data on international travel. The weak loonie has not only encouraged international travel to Canada (more than 10% increase in the first semester this year compared to the same period last year) but also acted as a disincentive for Canadians wishing to travel abroad (-10% compared to last year). As today’s Hot Charts show, the country’s big four provinces are all benefiting from same-day travel by U.S. citizens, with Alberta even seeing the biggest year-on-year increase ever. (Full report attached)
- “Worried About The Election?” (The Irrelevant Investor)
- “Todd Newman: Hedge Fund Trader Who Beat the Feds Over Insider Trading” (Fortune) After Todd Newman’s insider-trading conviction was overturned, his case became a landmark.
Monday August 29th – None
Tuesday August 30th – US S&P/Case Shiller Home Price Index, US Consumer Confidence
Wednesday August 31st – US Chicago ISM Index, US Pending Home Sales
Thursday September 1st – Canada Manufacturing Index; US Initial Jobless Claims, US Manufacturing Index, US ISM Service Sector Index
Friday September 2nd – US Non-Farm Payrolls and Unemployment Rate
Monday August 29th – None
Tuesday August 30th – Bank of Nova Scotia, Grenville Strategic Royalty
Wednesday August 31st – National Bank, Laurentian Bank
Thursday September 1st – Canadian Western Bank, Dollarama,
Friday September 2nd – None
Have a good weekend!