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Feb 7, 2020

Bargains Tough To Find After A Good Year In The Market; Solid Companies Whose Shares Fell More Than 20% In 2019

by Richard Morrison

Richard MorrisonIt’s always difficult to find solid companies trading at attractive valuations after a good year, and 2019 was reasonably good, at least better than 2018. The S&P/TSX Composite climbed 19.4% in 2019, with 39 companies more than doubling in price. Many of these high-flyers were the financial version of winning lottery tickets: start-ups and small-cap companies that are suitable for speculation only. Among the 14 companies with a market capitalization (shares times share price) of more than $1 billion that doubled last year, the largest is Shopify Inc., followed by a handful of gold, silver and copper mines and pharmaceutical companies.

At the other end of the spectrum, there were 21 Canadian companies with market caps of more than $1 billion whose shares fell by more than 20%, with marijuana companies making up a large part of the losers’ list. Regulatory issues, competition and thin profit margins have erased the optimism that propelled marijuana stocks to astronomical valuations a year or two ago. Despite the price correction, the marijuana sector appears too new and volatile for conservative investors.

Among the other large companies that had a miserable 2019 were those in the long-suffering oil and gas sector. Energy stocks have long been trading at what looks like attractive multiples to cash flow and assets, but value investors who bought along the way have had their patience tested. Over the past five years, many major energy companies have lost more than half their value, led by Pengrowth Energy, down 98%, Baytex Energy, off 91% and Crescent Point Energy, down 81%. Even with dividends factored in, $10,000 invested in the iShares S&P/TSX Capped Energy Index ETF (XEG) in late 2014 would be down 26% to just $7,400 at the end of 2019, figures from Blackrock show.

Here are three large, solid companies that had poor years last year, with their shares dropping into what some analysts see as undervalued territory. As the energy sector shows, a bad year does not mean the market is wrong and a turnaround is imminent. But it does offer a place to start looking. Despite the drop, Teck’s mid-January market capitalization of $11.7 billion keeps it among the 60 largest companies in Canada.

Teck Resources Ltd. (TECK.B)

Vancouver based Teck is among the world’s largest producers of steel making or metallurgical coal, copper and zinc. In 2018, Teck produced 26 million tonnes of metallurgical coal from six mines, accounting for 62% of the company’s gross profit for the year.

Teck’s copper production reached 294,000 tonnes in 2018. The company operates the Highland Valley Copper mine in British Columbia, two copper mines in Chile, has an interest in the giant Antamina copper-zinc mine in Peru and has several other copper projects under way. Copper represented about 22% of the company’s gross profit in 2018. Teck is the world’s third-largest producer of mined zinc and operates one of the world’s largest zinc and lead smelting and refining plants. Zinc accounted for 18% of the company’s gross profit in 2018.

In the energy sector, Teck has a 21.3% interest in the Fort Hills oil sands mining and processing operation, and a 100% interest in the Frontier oil sands project, as well as other interests in oil sands leases in the Athabasca region of northeastern Alberta.

Coal and oil sands are unpopular with environmentalists, but in its third-quarter report Teck said it had been named to the Dow Jones Sustainability World Index for the tenth straight year. Teck was the top-ranked metals and mining company on the index, which measures a company’s economic, environmental and social sustainability.

Teck’s variety of products, together with the fact that its mines and smelters are in areas with relatively low political risk, makes the shares less risky than those of companies that specialize in only one commodity or operate in unstable jurisdictions. Even so, Teck’s revenue and earnings depend on global demand for metallurgical coal, copper and zinc, and are particularly vulnerable to coal demand from Chinese steelmakers.

Most analysts expect Teck’s 2019 and 2020 earnings to come in below 2018 levels, pessimism that appears to be well reflected in the share price. Teck shares fell 23% in 2019 to a year-end price of less than $23, the cheapest they have been since the summer of 2017 and well down from the $32 level reached in April. Despite the drop, Teck’s market capitalization (shares times share price) of $12.7 billion keeps it among the 60 largest companies in Canada.

Teck’s results for the third quarter of 2019 compared poorly with the banner quarter of the previous year. Third quarter 2019 profit was $369 million (66c per share) compared with $1.3 billion ($2.23 per share) for the same quarter of 2018. The company has begun a cost cutting program, deferring some projects, while its balance sheet remains strong with $1.6 billion in cash.

In an October report, Morningstar analyst Mathew Hodge gave Teck a four-star rating out of five and said the shares were undervalued, trading at a discount to Morningstar’s $28 fair value estimate. Teck’s share price reflects concerns around weak global trade and slowing economic growth, Mr. Hodge wrote: “The zinc, copper and, in particular, coking coal prices have all sold off. With Teck shares now pricing in those concerns and the market’s expectations for future profits more reasonable, we think there’s value on offer in Teck’s shares,” he added.

CFRA rated Teck a strong buy in a December report: “We think Teck is poised to buy back a significant number of shares and continue to reward shareholders with higher base dividends and potentially special dividends,” analyst Matthew Miller wrote in a December 21, 2019 report.

Teck pays an annual dividend of just 20c per share for a yield of less than 1% but has a history of paying out special dividends. Teck does not have a dividend reinvestment plan.

Canada Goose Holdings Inc. (GOOS)

Canada Goose started in 1957 as Metro Sportswear, a small Toronto shop that made woolen vests, raincoats and snowmobile suits. Founder Sam Tick’s son-in-law, David Reiss, joined the company in the 1970s that later became Canada Goose. Mr. Reiss’s grandson Dani Reiss became Canada Goose chief executive in 2002. Now majority owned by Bain Capital, Canada Goose designs, makes and sells what it calls “performance luxury” clothing and accessories, although it is best known for its expensive parkas. The company’s products are sold in 49 countries, with Canada representing about 35% of sales and the United States about 30%.

The company raised $340 million when it went public at $17 a share in March 2017. The stock climbed steadily and peaked above $80 in November 2018, then began to slide. Canada Goose’s sales have almost quadrupled over the past four years, with revenue climbing to $831 million in fiscal 2019 from just $218 million in 2015. Earnings per share has also climbed dramatically, to $1.28 per share in fiscal 2019 from just 26c in 2015. The company does not pay a dividend.

The steady growth means investors sell on the slightest hiccup. The shares dropped 30% in a single day last May, falling from $66 to $46, after the company tempered its forecast for future revenue growth over the next three years to 20% from 25%, prompting investor panic.

Canada Goose shares fell 21% in 2019 to a year-end price of about $47, trading at about 37 times trailing 12-month earnings per share or about 6.5 times sales per share.

Canada Goose has come under fire from animal rights groups. In a December news release, People for the Ethical Treatment of Animals (PETA) said the fur trim that lines the hoods of the company’s winter jackets comes from wild coyotes who were trapped, killed, and skinned, adding that the company also uses down from birds who died violently. For its part, the company insists all its materials come from animals that are not subject to willful mistreatment or undue harm, while its down comes as a by-product of the poultry industry.

In the second quarter of its 2020 fiscal year, the company’s net income reached $60.6 million or 55c per diluted share, up 23.9% from the same quarter of fiscal 2019, on revenue of $294 million, itself up by 28.3% on a constant currency basis, Canada Goose said in a November release. Sales in Asia nearly doubled to $48.9 million from $26.6 million, while U.S. sales climbed by 38.5% on a constant currency basis, the company said.

CFRA has a strong buy rating on Canada Goose shares. In a December 21, 2019 report, CFRA analyst Camilla Yanushevsky set a 12-month target price of $86 based on her forward P/E of 44.8 times fiscal 2020 earnings of $1.92 per share.

TripAdvisor Inc.

In the United States, Needham, Mass.-based online travel company TripAdvisor is one of a handful of large corporations whose shares fell more than 40% last year. Unlike most of the others, however, TripAdvisor’s strong balance sheet showed it had U.S.$2.167 billion in assets and only US$696 million in liabilities in 2018.

TripAdvisor, which describes itself as the world’s largest travel platform, serves about 460 million travelers each month, allowing visitors to browse 830 million reviews on 8.6 million accommodations, restaurants, experiences, airlines and cruises in 49 markets and 28 languages. TripAdvisor is not a booking agent or tour operator, nor does it charge any fees to users. Steve Kaufer, current president and chief executive, who was a co-founder of the company in 2000.

In early November, the company announced weak third-quarter 2019 results. Net income plunged 28% to just U.S.$50 million or U.S.36c a share on revenue of U.S.$428 million, itself down 7% from the same quarter of 2018. The company scrambled to appease shareholders, announcing a cost structure evaluation and a special cash dividend of U.S.$3.50 per share, together with a U.S.$100 million buyback of shares.

Despite the company’s efforts, the poor results prompted the stock to sell off 22% in a single day, dropping to U.S. $28.15 from U.S. $36.27, repeating a similar post-result selloff that had occurred in November of 2017. Analysts followed up by tempering their recommendations and cutting their price targets. The shares drifted higher toward the end of the year to end at about U.S.$30.

Morningstar is among brokerages that now see the stock as undervalued. Dan Wasiolek, a senior equity analyst at Morningstar, said the November selloff was an overreaction to the increased uncertainty about marketing costs. Tripadvisor would be fairly valued at U.S.$51 a share, his report says.

Nothing here is to be taken as a buy recommendation, but for conservative investors looking for reasonably large companies with strong balance sheets or steady growth, they are worth a closer look.

 

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca