Photographer: Aaron Harris/Bloomberg

Performance Gap With U.S. Creates `Layup' for Canada Stocks

  • Canada slump contributes to widest value disparity since 2008
  • Tricon, Supremex, Hardwood Distribution, among picks

The disparity between underperforming Canadian stocks and their shining U.S. peers never stays this wide for long, which is why the manager of more than C$600 million ($478 million) at IA Clarington Investments Inc. is significantly overweight Canada.

“You’re just seeing such a huge divergence in both performance and valuation, and I do feel there’s an opportunity to close that gap a little bit,” said Terry Thib, portfolio manager at the firm, a unit of Quebec City-based Industrial Alliance Insurance & Financial Services Inc. “I think it’s overdone. This environment is a layup for Canada.”

Canada’s S&P/TSX Composite Index is down 1.2 percent year-to-date, while the S&P 500 Index is up 9 percent, leading to the widest valuation gap since 2008.

Thib, who focuses on North American small- and mid-cap equities, said less than 15 percent of his investments are in U.S. securities, with the rest in Canada. His U.S. investment allocation has trended lower this year as he believes equities are in a "classic later stage," where cyclicals rally and investors reallocate capital from growth to value stocks -- moves that tend to be good for Canada.

A broad commodity rally, stabilizing oil prices, a strong economy, firming inflation and rising interest rates should also help boost beaten-down Canadian stocks, which Thib believes are “extremely cheap.”

He sees particular opportunity in unappreciated companies that are exposed to the U.S. Although the stronger Canadian dollar has negatively affected stocks that generate revenue south of the border, the healthy economy helps offset any currency losses, Thib said. The loonie is up 7.3 percent this year against its U.S. counterpart.

"We’re trying to find what I like to call mini-blue chips, or tomorrow’s blue chips," he said.

Envelope Maker

Thib’s fund owns Tricon Capital Group Inc., a residential real estate firm that gets about half its income from managing single-family rentals in the U.S. Toronto-based Tricon has recurring cash flows, strong return on equity, a healthy balance sheet and a 2.4 percent dividend yield, he said. The stock has gained 14 percent this year.

He also likes Supremex Inc., a La Salle, Quebec-based envelope manufacturer that has been moving into packaging and specialty products and is well positioned to take advantage of the growth in e-commerce. It got about a quarter of its revenue from the U.S. and the rest from Canada in the second quarter, according to its earnings statement.

"Amazon’s just killing everybody, all of retail really, so there’s a real trend there and it’s growing rapidly," Thib said, adding that the stock is inexpensive with a 5.7 percent dividend yield, a strong balance sheet and a good track record of acquisitions. The company trades at a price-earnings ratio of 8.3, and the stock is down 16 percent this year.

Sticking with the theme of Canadian stocks that generate a significant portion of their revenue in the U.S., Thib also owns Hardwoods Distribution Inc., a Langley, British Columbia-based wholesale distributor of hardwood lumber and other wood products used in floors and cabinets. Hardwoods got more than 80 percent of its revenue from the U.S. in 2016, according to data compiled by Bloomberg. Hardwoods has jumped 8 percent this year.

Besides offering exposure to the U.S. market, these three stocks are not widely covered by analysts or followed by investors.

"That’s key to what we’re trying to do. We’re trying to go into the smaller areas of the market and exploit those inefficiencies," Thib said. "People don’t follow these names so you typically find better growth and better value."

Thib’s IA Clarington Growth & Income Fund has lost 0.5 percent this year. IA Clarington manages C$14 billion overall.

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