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Canada

What to expect in a market downturn – Inovestor Asset Management

Market conditions suddenly changed in February after a strong start in 2018. This new development is not surprising considering equities made these new all-time highs on thin volume. This prompts us to ask ourselves: Is this the beginning of a bear market or a bump down the road? Only time will tell…

In this article  written by Inovestor Asset Management, you will learn how our Canadian Model Portfolio behaved when equities tanked and infer what could happen with the Horizons Inovestor Canadian Equity ETF (INOC) in a downturn.

Canadian Portfolio Transactions – October 2017

Sell : 

1) Sector rotation : Imperial Oil (IMO). As indicated by Market Trend, we reduced our number of positions from 1 to none in the Energy sector. Imperial Oil was the only stock held in this sector.

Buy : 

1) Sector rotation : Gildan Activewear (GIL). We increased our number of positions, from 6 to 7, in the Consumer Discretionary sector. Among the stocks we did not own, Gildan was ranked #2, with an SPscore of 69%, behind Dollarama (DOL). We chose GIL over DOL because of the lower premium on GIL : The P/IV ratio for GIL was of 1.1, and 1.6 for DOL. The Future Growth Value premium was of 15% for GIL, and 45% for DOL.

Canadian Portfolio Transactions – July 2017

Sales : 

– North West Company (NWC) – Market Trend. Decrease of our number of positions (-1) in the Consumer Staples sector. We decided to keep Metro Inc (MRU) because of its higher SPscore, more attractive multiples (P/IV, FGV) and higher free cash flows. NWC’s intrinsic value has been slowly decreasing over the past 2 quarters and now sits below the stock price.

– Winpak (WPK) – SPscore. Winpak got replaced by CCL Industries (CCL.B). With WPK’s quick price increase over the past months, the stock is now overvalued by one of the largest margins observed in the past 5 years. Its EVA is stagnant since 5 quarters, which tells us the economic performance has stopped improving even though it is still good.

Buys : 

– Constellation Software (CSU) – Market Trend. Increase of our number of positions (+1) in the Technology sector. CSU ranks #2 among Canadian Large Cap Technology stocks. The company generates the highest EPI (4.0) of the group and its free cash flows are constantly increasing. The stock trades below its intrinsic value and the premium of 22% reflected by the Future Growth Value (FGV) is reasonable considering the high growth profile of the company.

– CCL Industries (CCL.B) – SPscore. CCL now represents a better opportunity than WPK, which it replaced in the model. CCL’s stock trades below its intrinsic value and is also discounted when looking at the negative future growth value. The amount of EVA it generates is still increasing, just like the free cash flows. The WPK – CCL.B replacement allowed us to improve the portfolio quality : we sold a stock with a 61% SPscore for another one at 75% in the same sector and a very similar profile.

The two new positions entered the model portfolio with a weight of approximately 5.7%.

Canadian Portfolio Transactions

Sales :

– Home Capital Group (HCG) – Market Trend. We reduced our number of positions in the Finance sector from 8 to 6. Despite a high SPscore due to a considerable discount relative to its intrinsic value, HCG’s stock lost its attractiveness with the marked and steady decline in Economic performance of the company. The return on capital had declined sharply over the past two years, as had net profit after tax (NOPAT). The EVA has suffered the consequences, also declining since December 2014. HCG’s stock is still under pressure from the “scandal” of summer 2015, and the CEO got fired last week.

– National Bank of Canada (NA) – Market Trend.  We reduced our number of positions in the Finance sector from 8 to 6. From an EVA point of view, National Bank was undoubtedly the “least interesting” bank among those we hold in the portfolio. Its return on capital has been declining for the past 5 years. The effect on intrinsic value was greater in 2016, and it is now below the stock price for the first time in five years.

– CGI Group (GIB.A) – Market Trend. We reduced our number of positions in the Technology sector from 2 to 1. On several aspects, Open Text (OTEX) had better attributes than CGI. Here is a summary table of the elements analyzed :

Buys :

– Imperial Oil Limited (IMO) – Market Trend. We increased our number of positions in the Energy sector from 0 to 1. Imperial Oil is ranked #1 by SPscore filtering : Canadian Equities, Large Cap, Energy. No company could meet all our standard buy criteria, however IMO came the closest.

– New Flyer Industries (NFI) – Market Trend. We increased our number of positions in the Industrial sector from 2 to 4. New Flyer Industries, a manufacturer of transit buses and passenger buses,  is also ranked #1 in its sector with an SPscore of 67%. The company is growing quickly with revenues more than tripling over the last 4 years. Both the EVA and intrinsic value have been steadily increasing over the past 5 years with growth accelerating since the beginning of 2015. The company generates good free cash flows, which enables it to fuel part of its growth plans.

– WSP Global (WSP) – Market Trend. We increased our number of positions in the Industrial sector from 2 to 4. WSP Global adds to our portfolio some exposure to global infrastructure and engineering investments. The company’s revenues are segmented as such; 37% from Europe, Middle East, India & Africa, 30% from the United States and South America, 19% from Canada, and 14% from Asia-Pacific. The EVA generated by WSP is increasing and has been positive for the last 3 quarters. The EVA is sometimes unstable, as is the return on capital, in particular because of the very frequent acquisitions. In 2016 only, WSP made 8 acquisitions, which quickly increased the invested capital without the NOPAT benefiting instantly. The NOPAT should catch up in the coming quarters.

The three companies added to our portfolio entered with a 2.7% weight.