In This Week’s JMRD Market Observer
- ECONOMIC NEWS – CANADA: OUTPUT SURGE IN MAY
- FED TO START BALANCE SHEET NORMALIZATION “RELATIVELY SOON”
- HOT CHARTS – CANADA: APPRECIATING LOONIE EQUIVALENT TO INTEREST RATE HIKE
- JMRD BASKET CORNER
- RETIREMENT CORNER
- READS OF THE WEEK
- ECONOMIC CALENDER
- EARNINGS REPORTS
Economic News – Canada: Output surge in May
The Canadian GDP results for May were simply stunning, leaving consensus expectations in the dust. And it wasn’t just the headline number that impressed because the breadth of output gains was also very encouraging. The services sector remained as dependable as ever, registering its 21st consecutive month of gains despite the lack of hockey playoffs (which hammered arts/recreation in May), as solid employment creation and a hot housing market powered retail spending and finance/insurance respectively. But the turnaround in the goods sector is what’s generating those stunning growth numbers. Goods sector output is up almost 9% year-on-year, something not seen since 2010. So much so that goods sector output is now at an all-time high. Oil and gas (+26% year-on-year) is driving the gains with support from manufacturing as well (+5.2% year-on-year). The massive gains in May prompt us to raise our Q2 GDP growth forecast to 3.5% annualized, i.e. above the Bank of Canada’s 3.0% print. Remember, this is on top of Q1’s +3.7% print. Accordingly, we have revised up our 2017 GDP growth forecast to 2.9%. The vast improvement from last year (when growth was a meagre 1.5%) can be attributed to the pick-up in oil prices, a strong housing market and the Federal government’s Child Care Benefit which is benefiting the majority of Canadian households.
Fed to start balance sheet normalization “relatively soon”
As widely expected, the Federal Reserve left the fed funds rate unchanged at 1.00-1.25%. The FOMC was encouraged by “solid” job gains since the start of the year and continued expansion of household spending and business investment. Near-term risks continue to be viewed as “roughly balanced”.
However, the Fed continues to be frustrated by low inflation. It says that on a year on year basis, core inflation is “running below 2 percent”, a slight change from the prior statement’s “somewhat below 2 percent”. Even then, the Fed continues to expect inflation to stabilize around the 2% objective “over the medium term”. The FOMC still expects that economic conditions will evolve in a manner that “will warrant gradual increases in the federal funds rate”.
The Fed is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. But it expects to begin implementing a balance sheet normalization program (i.e. reduce the amounts it reinvests) “relatively soon” if the economy evolves as anticipated. There were no dissenters among FOMC participants with regards to the July decision.
Bottom line: The Fed’s statement was largely unchanged from last June. Of note was a new clue about the timing of the start of balance sheet normalization ─ the FOMC says this will happen “relatively soon”. In other words, the Fed could start in September or October to limit the amount it reinvests in bonds. The FOMC also wants to raise the fed funds rate, although the lack of inflation pressures is likely to delay such a move. At this point we’re expecting another Fed rate hike only in December.
Hot Charts – Canada: Appreciating loonie equivalent to interest rate hike
Canada Watch – The Bank of Canada’s sudden change in monetary policy stance has been an expensive proposition for exporters. Since June, when one of the Deputy Governors hinted at an upcoming interest rate hike (which was subsequently delivered by the central bank in July), the Canadian dollar has appreciated about 8% against the USD. Such a surge in the currency is probably not welcome at the Bank of Canada considering the resulting drag on the economy – the central bank’s ToTEM model suggests C$ appreciation weighs on real exports and hence on real GDP and core inflation, albeit with some lag. According to that model, the resulting drop in core inflation eventually forces the central bank to cut interest rates by roughly 50 basis points. In other words, as today’s Hot Charts show, the 8% appreciation of the loonie since June (if sustained) is equivalent to a 50 basis point interest rate increase, something that chops about 0.3% from real GDP. Does that mean the Bank of Canada will now relax its tightening bias? The answer is no if the central bank’s objective is to cool down the hot housing market. Indeed, from the standpoint of a potential home buyer, an “equivalent” rate hike is not much of a deterrent compared to say an actual interest rate increase.
JMRD Basket Corner
Capital Power (CPX) – CPX reported Q2/17 adj. EBITDA of $125 mln (excluding unrealized losses), versus our $119 mln estimate and consensus at $130 mln, reflecting timing differences related to closing the $500 mln York Energy, East Windsor and EnPower asset acquisition from Veresen during the quarter. Meanwhile, the company announced a 7% increase to its annual dividend (to $1.67/sh), matching our expectation, and also extended its 7% annual dividend growth guidance through 2020 (previously 2018). See the full article
Open Text (OTEX) – OpenText is set to report FQ4 (June) results on August 3rd after market close. With FQ4 being the first full quarter with ECD included in the results we’re obviously focused on the integration progression. On that note, we believe the integration is progressing well and that the transition services agreement expenses will moderate through to FQ1 (Sep). We’re looking for an in-line quarter from OpenText. Having recently attended OpenText’s annual user conference and investor day, investors following our research will know our current view as documented in our note titled Organic Plans in the Works? The bottom line from that note is that while we see continued opportunities for acquisitions (with another one being announced this morning in Guidance Software) – we also think there’s growing optionality in OTEX’s valuation for organic growth. See the full article
Waste Connections (WCN) – WCN delivered a great result this week, reporting a $0.02 EPS beat, guiding Q3 EBITDA ahead by 2% and raising FY’17 guidance. FCF is now expected at $750M (~$2.84/sh) this year – an impressive 52% FCF/EBITDA conversion. WCN put up a strong guide despite headwinds from its Chiquita landfill ($15-20M EBITDA hit in first year due to tonnage limitations/higher taxes) and a cautious tone on recycled commodities. With FCF exceeding expectations, WCN is now a cash deployment story in 2H as tuck-in M&A appears to be heating up. Mgmt is seeing the most active deal environment in 15 years and executed several letters of intent in the quarter while extending several offers. WCN also likely boosts its dividend another double-digits %. “We remain buyers at these levels as WCN’s FCF story could see upside driven by fundamental EBITDA expansion, cost efficiencies, more M&A and potential E&P upside. We raise our 2017-2019 EPS est’s to $2.13, $2.41 and $2.74. Our TP of $75 assumes 22x our 2018 FCF/sh and we reiterate our Outperform. Risks to our TP include the health of the housing market and sustainable commodity prices.” See the full article
U.S. Growth Basket
Waste Management (WM) – Waste Management income grew in Q2 but fell short of expectations
Reads of the Week
Monday July 31st – Pending home sales (USA)
Tuesday August 1st – Personal income (USA) Manufacturing PMI (CAD)
Wednesday August 2nd – None
Thursday August 3rd – Initial jobless claims (USA)
Friday August 4th – Unemployment rate (CAD)
Monday July 31st – None
Tuesday August 1st – Pembina Pipeline Corporation, Saputo Inc., Shopify Inc. Class A, Baytex Energy Corp, Hanesbrands Inc., Herbalife Ltd., Pfizer Inc., Apple Inc.
Wednesday August 2nd – Cineplex Inc., GWO, Home Capital Group Inc., Home Capital Group Inc., Restaurant Brands International Inc., Veresen Inc., Sleep Country Canada Holdings Inc., MetLife Inc., Square Inc. Class A
Thursday August 3rd – BCE Inc., Big Rock Brewery Inc., Canadian Natural Resources Limited, Canadian Tire Corporation, Enbridge, Whitecap Resources Inc., ZCL Composites Inc., Allergan plc
Friday August 4th – Berkshire Hathaway Inc.
Enjoy the weekend!