The economy may be slowing, but three stocks distinguished themselves at CIBC World Markets institutional investor conference.
CIBC World Markets analysts Kevin Chiang, Krista Friesen, and Seth Rubin concluded the consistent message from their 18th annual Eastern Institutional Investor Conference was that the macro backdrop is slowing.
Presenting companies included Air Canada (TSX—AC), Bombardier Inc. (TSX—BBD.B), CAE Inc. (TSX—CAE; NYSE—CAE), Chorus Aviation Inc. (TSX—CHR), Cargojet Inc. (TSX—CJT), Canadian National Railway Company (TSX—CNR; NYSE—CNI), Canadian Pacific Railway Limited (TSX—CP; NYSE—CP), Magna International Inc. (TSX—MG; NYSE—MGA), Martinrea International Inc. (TSX—MRE), NFI Group Inc. (TSX—NFI), Parkland Fuel Corporation (TSX—PKI) and TFI International Inc. (TSX—TFII).
Both Canadian railways noted that rail volume trends underperformed in the third quarter of 2019, with RTMs (revenue per one tonne of cargo transported one mile) down one per cent year-over-year, quarter-to-date. (CN’s RTM was down 1.2 per cent year-over-year and CP’s RTM was down 0.7 per cent year-over-year quarter-to-date).
Air Canada and Cargojet noted that the air cargo market has been soft with the latter pointing to significantly lower international interline traffic year-over-year with the company also exiting the South American market. IATA reported air freight volumes were down 3.5 per cent year-over-year through July.
Non-cyclical stocks in a better position
Avery Shenfeld, CIBC’s chief economist and the luncheon keynote speaker, echoed this sentiment. He sees the global market moving into a slow growth period with global GDP falling to 2.9 per cent in 2020 from 3.8 per cent in 2017. Both Canadian and US GDP growth is expected to fall to below two per cent in 2020 and average roughly two per cent in 2019.
Companies that have a less cyclical earnings stream should be better positioned during this uncertain economic backdrop. Names that fit the bill here are CAE Inc. (benefits from a multi-year backlog and structural tailwinds related to pilot training), Chorus Aviation (contractual cash flow from its third-party aircraft leasing business and capacity purchase agreement with Air Canada, while offering a six per cent-plus dividend yield), Cargojet (growth in e-commerce volumes, a recent strategic agreement with Amazon.com Inc. and high market share that should more than offset an overall slowing freight environment) and Parkland Fuel (strong organic and inorganic growth pipeline, retail fuel demand being less economically sensitive, synergy opportunities from recent acquisitions).
The consumer remains strong
While there are growing concerns on the broader economy, it was also clear the consumer remains strong.
Air Canada noted that while there are pockets of weakness (such as in China and Hong Kong), it continues to see a healthy booking curve across its product offerings.
Cargojet and TFI International noted that the growth in e-commerce remains a significant tailwind, with the former noting that e-commerce volumes are growing at double-digit percentage. Both Magna and Martinrea also continue to point to a healthy auto market in North America.
Names that stood out
We believe this reflects unemployment rates at record lows and a supportive interest rate environment. We would argue that companies that have a business-to-consumer business model versus business-to-business look to be better-positioned.
The names that stood out at our conference were the ones that had a number of positive catalysts and where hitting these catalysts was not overly dependent on the economic backdrop.
The three presentations that distinguished themselves the most were:
■ Air Canada. AC laid out a long list of positive catalysts and we would argue that there is a low risk that it will not successfully execute against these. This includes continuing to grow its loyalty program, achieving investment-grade debt next year, accelerating its share buyback program with its growing free cash flow, and upside from its acquisition of Transat AT Inc.
At a high level, AC noted that the markets in which it operates are meeting expectations and little has changed since it released its 2019 second-quarter results earlier this summer.
AC continues to see some pressure in Hong Kong and China, and its cargo business continues to be under some pressure. However, on the other end of the spectrum, AC is seeing some of its markets perform above expectations. The company also noted that corporate traffic remains healthy, aided by the addition of its Premium Economy class. On a system-wide basis, AC has not seen any degradation in its booking curve when looking across its network.
We continue to see AC as being undervalued with the company benefiting from a more resilient business model. AC’s 2020 estimated EV/EBITDA (enterprise value divided by earnings before interest, taxes, depreciation and amortization) multiple sits at 3.5 times versus its US peers averaging 5.9 times.
■ Chorus Aviation. Chorus has more than 90 per cent of revenue under a long-term contract and it can grow its third-party leasing business by 20 aircraft annually without external equity (which removes the equity overhang concerns), and, as we noted above, the shares have a dividend yield of more than six per cent.
We view Chorus as a good name to own given where we are in the economic cycle. It is a defensive name with a growth angle. The company has successfully addressed concerns over its relationship with Air Canada and whether it can become a major player in the regional aircraft leasing world.
■ NFI Group. NFI reiterated its confidence that is has moved past the execution issues that have weighed on earnings over the past year, while the underlying transit bus market remains healthy. We have greater comfort that NFI will return to an earnings growth story in 2020. We are forecasting a US$30-million increase in EBITDA next year.
We see this as achievable as it laps a number of non-recurring issues: Klauber Machine and Gear issues costing US$8 million; additional costs related to elevated work-in-progress time; additional six months of contribution from recent UK-based acquisition Alexander Dennis Ltd. (US$10 million or more); and margin pickup from in-sourcing parts and positive mix.
Also, about 80 per cent of NFI’s revenue is from public customers, which is less cyclical. Lastly, NFI noted that its maintenance capital spending is around US$35 million, which helps drive its high free cash flow conversion. Net-net, we see a $10-per-share (or more) equity pickup looking to the end of 2020 as the company moves past its non-recurring costs and shifts from debt to equity within its enterprise value.
Kevin Chiang, Krista Friesen and Seth Rubin are equity analysts for CIBC World Markets covering the industrial sector. All three are based in Toronto.
This is an edited version of an article that was originally published for subscribers in the November 1, 2019, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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