“Considering the management and the systems involved, and considering the complex nature of the business, there’s nothing in the world quite like Canadian National Railway.”
Contrary to conventional wisdom, the less working capital a company has on hand, the more likely it is to be a worthy investment, according to notable Canadian money manager Scott Fraser. “Under my system, working capital must be controlled,” he says. He sums up his views as “Fraser’s Law”: “Increments to adequate working capital provide no economic benefit” or, in other words, “Excess working capital makes lazy equity.”
Mr. Fraser, who is based in Montreal, serves as vice-president of private wealth management and head of equities at Landry Investment Management, which he joined in 2015. In the 1950s, he co-founded investment manager Jarislowsky Fraser with Stephen A. Jarislowsky as a boutique research firm, which now operates independently as a wholly-owned Bank of Nova Scotia subsidiary. Since 1979, he has worked as an independent investment counsellor with several firms, and that freedom appears to be very well-earned: Mr. Fraser has managed to achieve a 19.5 per cent compound annual growth rate on his investments since 1990.
Mr. Fraser worked with former Montreal Gazette financial columnist and author Peter Hadekel on Picking Winners: The Inside Story from Scott Fraser, co-founder of the legendary investment firm, Jarislowsky Fraser, due to be released in October. Along with relating business experiences and anecdotes from his long career, Mr. Fraser explains, “I hope to have it as a (clear but detailed) guide to people who want to make capital gains.”
Excess working capital is “just baloney”
To that end, Picking Winners includes tools for tracking the source and application of funds at a company. It outlines the four ways money can come into a corporation and the three ways it can be used. Subtracting the latter (accounts payable) from the former (accounts receivable), whether the balance is positive or negative, leaves one with the company’s working capital.
Mr. Fraser takes to task “all the stockbrokers and the talking heads” who interpret a large positive working capital balance as a sign of a company’s strength, reasoning that it has a cash reserve to deploy as “future opportunities” come up.
“That’s just baloney,” he says.
The money manager explains that having high accounts receivable means, in essence, that a company has already provided goods or services but has not yet been paid for them. “Does that sound good?” Mr. Fraser asks.
By contrast, having high accounts payable means that a company has already received goods or services and has not yet paid for them. Thus, they are doing more, or getting more done for them, while paying less. “Is this not the sign of a well-run company?”
When to buy CN? When you have the money
The money manager concedes that companies of all stripes have different working capital requirements and models. Nevertheless, Mr. Fraser has found that their success hinges on whether the money they spend is used to produce something (whether a good or service), if that good or service causes payment to come in, and how quickly that payment arrives.
For example, wine bottle label makers boast a straightforward, easy-to-follow path between its business operations and payment for the same. Typically, they deliver the invoice for an order of labels specific to a certain vintage or type of wine at the same time that they deliver the labels. Then, they will not make another run of labels until they are paid for the last batch.
“So it’s easy to check,” says Mr. Fraser.
Similarly, under workplace IT consulting and outsourcing firm CGI Inc.’s subscription model, it basically has no accounts receivable because its invoices are settled every month.
Asked if there are any companies spinning in this virtual cycle that he would highlight to investors, Mr. Fraser points to “best buy” selection Canadian National Railway Co. (TSX—CNR; NYSE—CNI), a stalwart in his clients’ portfolios.
“In my opinion, considering the management and the systems involved, and considering the complex nature of the business, there’s nothing in the world quite like Canadian National Railway. They’re absolutely brilliant.”
As for when to buy CN shares, he quips: “When you have the money.” Its annual reports paint a picture of stability and predictability, he adds. “They increase the dividend, they buy back shares, not many but a few. The debt goes up each year (given inflation) and the working capital is very well-controlled.”
At the end of 2020’s first quarter, CN’s working capital stood at -$1.1 billion, money used to maintain its roadbeds, locomotives, and other infrastructure. Even more impressively, since the company securitizes its accounts receivable and sells them to investors through financial institutions, banks are in effect lending cash short-term to CN that it can deploy today on the “collateral” of future promised payment from CN’s own customers, not CN itself.
This is an edited version of an article that was originally published for subscribers in the July 17, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
Investor’s Digest of Canada, MPL Communications Inc.
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