Written by: Dominique Beauchamp
Original source: Les Affaires
Les Affaires – What is the focus of your investing approach?
Gil Lamothe – We buy quality companies that generate strong cash flows from their operations, paying special attention to the executives’ backgrounds. Our review of their credentials and achievements is qualitative, but it influences our belief in a stock, the price we are willing to pay, its portfolio positioning, and analysis of the risk/return ratio. I always ask myself if I would put my own money in the hands of the company’s executives.
L.A. – Does a post-pandemic return to normalcy play a significant role in your stock picks?
Edward Friedman – In the short term, the virus may slow Canada’s recovery, but once vaccines reach a certain percentage of the population, hospitalizations and deaths decline and the economy picks up. So the portfolio has a cyclical bias with banks and industrials, but we mostly made our purchases a year ago when the flight of investors caused some stocks to fall by half or more. We like to take measured risks when the risk/return ratio of companies we know well is in our favour.
L.A. – What investments do you still find attractive after the strong market rebound?
E.F. – Banks should return to normal earnings growth of between 4% and 5% per year. After a period of saving, consumer and corporate lending will increase again. As lending rates will rise faster than interest on deposits, this will have a significant effect on margins. Bank prices are still attractive because higher net interest income will increase their book value. We favour TD Bank (TD, $85.25) for its exposure to the U.S. recovery, Scotiabank (BNS, $78.80) for its loans to South American mining companies, and CIBC (CM, $129.88) for its efforts to regain mortgage market share. Two years ago, we also purchased alternative lender Equitable Group (EQB, $144.61), whose quality is not fully recognized. After a strong period, the lender tightened several lending criteria to protect itself from a hypothetical 25% drop in house prices.
L.A. – What do you think of the feud between Canadian National and Canadian Pacific for Kansas City Southern?
G.L. – At first glance, Canadian Pacific (CP, $468.87) would have the most to gain, but not at any price. We would not like to see it overbid. CN's counter-offer is also intended to prevent CP from becoming a better competitor, but this type of tactic and the capital involved increase the risk. The possibility of overpaying has prompted us to equalize the portfolio weighting of the two stocks.
E.F. – The two railroads are battling each other for a long-term lucrative asset. CN has a good hand, because its network already stretches from ocean to ocean. If CN were to win, the acquisition would add to its growth. If CP were to outbid and be successful, CN might seek to take advantage of the financial and integration pressures that will weigh on CP for several years for improving the fluidity of its own network and stealing away customers. Without Kansas City Southern, CP would still be a strong competitor in Canada and the United States. The saga will give us time to adapt to the outcome.
L.A. – Is Rogers another example of a stock purchased during a downturn?
E. F. – We purchased our first shares in December 2020, 18 months after the launch of the first unlimited wireless plans and before the Canadian Radio-television and Telecommunications Commission (CRTC) announced the possibility of giving the competition access to established networks. Since Rogers draws more of its revenue from wireless services than its rivals, its valuation fell to 15.7 times earnings. With the CRTC finally choosing a compromise that gives regional competitors access to established networks under certain conditions, the situation seems manageable for Rogers. It also has the most to gain from the economic recovery, which should increase wireless roaming revenues, among other things. In addition, the purchase of Shaw will provide it with a national wireless network as 5G service takes off.
L.A. – What do you think of the purchase of UPS Freight by trucking company TFI?
E.F. – We purchased our first shares in April 2018 at $35. The head of the company, Alain Bédard, is a decisive operator in whom we have great confidence. The purchase of UPS Freight is brilliant because TFI paid a good price, keeps the contracts, and leaves all financial obligations including pension funds with UPS. The market recognized the potential a little too quickly by pushing the stock up 32% at the time of the announcement. We then cashed in the gains we had made since 2018, but we are keeping a portion of our shares. As with any major acquisition, the risk lies in the execution. TFI has a lot of work to do to raise UPS’s margins from 1% to 12%. The tariff increase that TFI wants to impose when the contracts expire could cause it to lose customers. The cyclical stock is a bet on the economic recovery and the integration of UPS Freight, as well as an increase in margins for the entire group.