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Monthly World Markets Report
December 2014
The Benefits Of Low Yields And Commodity Prices
4
Canadian Equities:
WestJet Airlines Ltd.
Whitecap Resources Inc.
Milestone Apartments REIT
Alimentation Couche-Tard Inc.
6
Charting Trends
7
CIBC World Markets Inc.
Interest Rate Outlook
CIBC World Markets Inc.
Economic Outlook
Company Disclosures And
Disclaimers
8
CIBC World Markets Inc.
Research Rating System
CIBC World Markets Inc.
Disclaimers
See Disclosures And Disclaimers at the end of
this report for disclosures, including potential
conflicts of interest. Complete research on any
equities mentioned in this report is available
from your Investment Advisor.
Unless otherwise noted, all prices quoted in
this report are as of the close of markets on
November 25, 2014.
CIBC Wood Gundy is a division of CIBC World Markets Inc., P.O. Box 500, 161 Bay Street, Toronto, Canada M5J 2S8 (416) 594-7000
2014
Cautiously Optimistic
2013
3
2012
Yields Lower For Longer…
So, Now What?
2011
2
2010
Inside This Issue
“Lower for longer,” a term that has been in the financial lexicon for several years now, refers to
the notion that interest rates will remain low for a longer-than-normal period as the world’s
recovery from the 2008 financial crisis continues at a slower-than-usual pace. As consumers and
governments work their way out from elevated debt levels, spending remains restrained and,
thus, muted economic growth has lingered.
We have agreed with the prevailing view that interest rates would remain well below
typical levels for an extended period. However, we had expected that, while short-term interest
rates would remain low, longer-term interest rates would drift higher in 2014, after they hit ultralow levels in 2013, as economic growth improved.
Our prediction has not played out for a number of reasons. While growth in the U.S. has
been stronger than most had expected, the same cannot be said for Europe and Japan. Their
economic growth outlooks deteriorated markedly in 2014, resulting in fears of deflation; this has
been the primary driver of declining interest rates this year. Incredibly, yields on German 10-year
government bonds have fallen below 1%, acting as an anchor on global bond yields. As such,
yields on Government of Canada 10-year bonds have fallen from 2.75% at the start of the year to
1.94% currently.
Bond Yields And Oil Since 2010
Low interest rates have left investors
GoC 10-Year Bond Yield
scouring the equity markets for better sources of
4.0%
WTI Oil
cash flow — a phenomenon that has benefited
US$115
the pipeline, REIT and utility sectors. We had
3.5%
US$105
expected those sectors to suffer as interest rates
3.0%
rose. However, until economic growth in
US$95
Europe and Japan improves, those groups could
2.5%
US$85
remain reasonable places for investors to find
2.0%
US$75
relatively better yields.
The “lower for longer” adage may also
1.5%
US$65
be applied to the resource sectors. With
economic growth (outside of the U.S.) remaining
Source: Bloomberg
soft, we do not expect a rapid rebound in
commodities such as oil, natural gas, and copper. The implication for investors, however, is not
that they should avoid resource-related stocks. Instead, they should focus on lower-cost
producers with reasonable balance sheets and organic growth opportunities, which should allow
them to perform well, even if commodity prices don’t appreciate materially. Among resource
companies that pay dividends, such as those in the energy patch, we contend that investors
should focus on those with lower payout ratios.
There are beneficiaries of lower oil prices, of course. Consumers and companies benefit
from the resulting lower gasoline prices. Areas to consider include companies in the consumer
discretionary sector, as well as transportation companies.
In this month’s Monthly World Markets Report, we highlight two companies that should
benefit from lower interest rates and/or commodity prices: convenience store operator
Alimentation Couche-Tard Inc. and WestJet Airlines Ltd. We also highlight Whitecap Resources
Inc., which has an attractive yield, good growth prospects and low debt levels, and Milestone
Apartment REIT, which should benefit from an improving U.S. economy and low yields.
SUNIL BHARDWAJ, CFA, MBA
Investment Strategy Group
www.cibcwoodgundy.com
Investment Strategy Group Monthly World Markets Report
Yields Lower For Longer…
So, Now What?
As the U.S. Federal Reserve winds down its Quantitative Easing
economic stimulus program and becomes more optimistic in its
forecasts for the American labour market, Bank of Canada
Governor Stephen Poloz has shied away from providing forward
interest rate guidance. In fact, expectations are widespread that
the Bank of Canada (BoC) will lag its U.S. counterpart in raising
rates and that continued strength in the U.S. economy will keep a
bid in the greenback versus most major currencies.
CIBC Economics believes the BoC will wait until the Fed
has brought its benchmark interest rate up closer to Canada’s
own 1% rate before making a move higher, leaving the loonie
headed lower until that date. We believe there are a variety of
strategies fixed income investors can deploy in this “lower for
longer” environment.
Taking Advantage Of Yield Curve Steepness
Staying invested in short-term fixed-income instruments will
provide investors with little to no yield. Looking at the Canadian
Government bond yield curve graph, investors must look beyond
three- to four-year investments to take advantage of the steepness
in the curve and pick up some yield.
Canada And U.S. Sovereign Yield Curves
4%
U.S.
3%
2%
Canada
1%
0%
0
5
10
15
20
25
30
Term
another year to the bond ladder. CIBC’s Targeted Cash Flow
Portfolios (TCFPs) offer investors the opportunity to invest in a
low-maintenance, fixed-income portfolio with a buy-and-hold
strategy. CIBC’s Macro Strategy team conducts extensive credit
analysis prior to including issuers in the portfolios and monitors
the included issuers to ensure continuous model suitability.
Hence, the TCFPs are good alternatives for clients seeking expert
input while aiming to minimize the management fees associated
with fixed-income investment funds. TCFPs might allow
investors to potentially outperform fixed-income benchmarks,
with little more effort than purchasing an exchange traded fund.
For registered accounts, investors may wish to consider
CIBC’s strip bond ladders. Strips are created from standard bonds
that have been “stripped” for their components (coupons and
principal). Think of a bond which pays semi-annual coupons and
then the principal (the residual) at maturity. Each of these
components is sold off individually and represents a claim on a
different piece of the bond. Because strips pay a single cash flow
at maturity and accrue interest until then, they are priced below
par, even though the bond from which they have been stripped
may have been trading at a premium. The systematic laddering of
corporate and government coupons and residuals allows
investors to avoid bond coupon payments that are not needed
and to time their cash flows (from the maturing strips) to match
future known expenses.
Support for the Canadian bond market is found in Ms.
Zapior’s report A Bird’s Eye View of the Canadian Corporate Debt
Market. The Canadian bond market has seen strong inflows of
foreign capital into federal, provincial, and corporate bonds. Part
of this is due to a weakening Canadian dollar, which makes
Canadian bonds less expensive for foreign investors. Year to date,
returns have been highly correlated with term to maturity.
Investors who have invested in longer-term bonds have benefited
significantly as increased demand for longer-dated Canadian
debt has increased prices (and shifted yields down).
Term To Maturity And 2014 Year-To-Date Returns*
Source: Bloomberg, CIBC World Markets Inc.
A Laddered Strategy?
A laddered portfolio strategy, in which a bond matures each year,
allows investors the flexibility to buy bonds with longer maturity
dates when reinvesting periodic cash flows. If rates are rising, the
maturing cash can be put to work with shorter-term bonds at
higher yields. If not, the maturing funds can be used to add
2
12
Communications
10
% Return YTD
The U.S. Treasury yield curve supports the same thesis, but while
yield pick-up can be achieved slightly earlier, U.S. yields don’t
beat Canadian yields until past the five-year term. While the
prevailing view is that Canadian rates will start to rise within the
next one to two years, such a move will likely be quite gradual. It
is correct that interest rate products will decrease in value with a
move up in rates; however, our belief is that, in the near term,
staying invested in short-term securities will provide no benefit to
investors. Instead, investors may want to consider extending term
to take advantage of the steepness of the yield curves.
Industrial
8
BBB Corporates
Energy
Infrastructure
Municipal
Provincial
Real Estate
6
A Corporates
Corporate
4
Financial
2
Federal
AA Corporates
Effective term in years
0
0
5
10
15
20
*As of September 2014. Source: CIBC World Markets Inc.
As investors search for higher yields and credit quality, a
laddering approach may be prudent to take advantage of higher
yields in longer-dated Canadian debt securities, which are
expected to continue to benefit from foreign demand.
HANNA NAIMAN
Wealth Solutions Group, Capital Markets Trading
December 2014
Investment Strategy Group Monthly World Markets Report
Cautiously Optimistic
The market correction that many industry participants had long
awaited finally arrived this fall, resulting in a peak-to-trough
decline of 11.4% for the benchmark S&P/TSX Composite Index
(TSX). However, the pullback proved transitory as the TSX has
since rebounded sharply. These types of market fluctuations
should not deter investors from equity investments. Rather, they
should serve as a reminder that equity markets can be volatile
and that the exceptional gains experienced in many global equity
markets over the past couple of years should not be expected to
continue indefinitely.
TSX Rebounds Sharply
price, undergoes a rigorous review with all analysts and portfolio
managers before a final decision is made. A strict sell discipline is
followed whereby a third of a position will be sold when the
target price is achieved, at which point the investment will
undergo a peer review process. Similarly, if the price falls more
than 15% from its initial price, a review of the investment thesis is
conducted by a different analyst, who did not make the original
recommendation, to determine if any action needs to be taken.
The managers seek to achieve an approximate 3:1 risk/reward
profile (50% upside potential, 15% allowable downside). For
equities with greater estimated upside, the allowable downside
risk will be scaled appropriately.
Three-Year Historical Growth Of $10,000
16000
Beutel Goodman Canadian Equity Class B
$16,000
Source: Bloomberg
The key question is: where do we go from here? On pg. 1 of this
report, we noted that the growth outlooks for Europe and Japan
deteriorated markedly in 2014. However, growth in the U.S. and
Canada has been stronger and we expect that opportunities in
these markets will continue to provide good longer-term
opportunities. That being said, the outsized returns of the past
five years are well above long-term averages and have been
driven in large part by multiple expansion. Given the fuller
valuations, we would expect more muted returns going forward.
Moreover, with the U.S. central bank ending its monetary
stimulus, more volatility is expected relative to that of the past
two years.
A skilled active manager can be a powerful asset in an
environment of lower returns and greater volatility. With U.S.
stocks reaching new record highs, this month we turn our
attention to the Canadian market, where there may be some
greater relative value.
Beutel Goodman Canadian Equity Class
Lead portfolio manager Mark Thomson manages the Beutel
Goodman Canadian Equity Class using a proven disciplined
investment process. Preservation of capital is a central tenant of
Beutel Goodman’s philosophy; to that end, the managers seek
companies trading at a sizeable discount to intrinsic value, which
is calculated as the present value of sustainable free cash flow.
Furthermore, each investment selected for inclusion in the
portfolio must have a minimum expected return of 50% over a
three-year period, providing investors with what the managers
believe is a high margin of safety.
The investment approach also includes a well-defined
buy/sell process. A buy recommendation, along with a target
3
Nov-14
Jul-14
Sep-14
May-14
Jan-14
Mar-14
Nov-14
Nov-13
Sep-14
Jul-13
Jul-14
Sep-13
May-14
May-13
Mar-14
Jan-13
$8,000
13000
Jan-14
Mar-13
13500
Nov-12
$10,000
Jul-12
14000
$14,307
Sep-12
$12,000
May-12
14500
Jan-12
$14,000
Nov-11
15000
$16,323
S&P/TSX Composite Total Return
Mar-12
S&P/TSX Composite Index
15500
Source: CIBC Wood Gundy, Beutel Goodman Investment Counsel, Bloomberg
While the fund is concentrated in 25-45 holdings, it is diversified,
with individual weights typically not exceeding 6%. As the
portfolio only contains names in which the managers have the
strongest conviction, the top 10 holdings typically represent 40%50% of the fund’s assets, with each individual weighting based on
the manager’s level of conviction.
Portfolio construction is driven by the manager’s bottomup stock-selection process. The managers are index agnostic, so
deviations from the broad market indices are expected. As of
September 30, 2014, the fund held just 14% in energy and 7% in
materials versus these sectors’ 24% and 10% respective
weightings in the fund’s benchmark index, the TSX. To ensure
proper diversification, the fund does not permit a sector
overweight by more than 10% relative to its benchmark.
The fund has a predominately large-cap bias; there is an
allowance for a maximum 20% weighting in small-cap stocks but
these typically account for less than 10%. Of the larger-cap names
in the portfolio, the average market capitalization is $45 billion. In
keeping with the managers’ focus on discounted investments, the
larger-cap portion of the portfolio has an average price/earnings
ratio of 14.8x versus 17.0x for the index, while its 2.8% dividend
yield is comparable to that of the index.
The fund has performed very well over the past three
years, providing investors with an annualized return of 18.5%
compared to 12.9% for the index. This strong showing is not in
isolation; with more than 20 years of proven track record, we
fully expect the portfolio manager to continue to follow its strict
investment discipline and provide value to investors.
TROY KILLICK, CFA
Investment Strategy Group
December 2014
Investment Strategy Group Monthly World Markets Report
Whitecap Resources Inc. (WCP, $13.58, Sector
Outperformer) Price Target: $20.00
WestJet Airlines Ltd. (WJA, $30.00, Sector
Outperformer) Price Target: $37.00
CIBC World Markets Inc. (CIBC) analyst Kevin Chiang remains
bullish on the airline industry over the next 12 months, as he
believes it will continue to benefit from air traffic demand growth
and lower fuel costs following the sharp pullback in oil prices
since the summer. WestJet Airlines Ltd. is one of his top picks
within the space. It is a Canadian low-cost airliner, serving 91
destinations in 20 countries, including regional flights to over 31
destinations across Canada under its WestJet Encore banner.
WestJet is pursuing a number of strategies to grow
revenues, including: expanding its airline partnership network to
better serve customers who require flights with multiple airlines
to reach their destination; introducing its own loyalty program
and an “Eastern Triangle” strategy (offering more flights between
Toronto, Montreal and Ottawa) to garner a bigger share of the
lucrative business travel market; and, increasing its fleet of
Boeing 737 aircraft from 107 by the end of 2014 to 120-164 by
2023, and expanding the destinations under its Encore banner.
Mr. Chiang believes WestJet’s recent decision to charge a
baggage fee for each checked bag on its Econo fares will help it
reach its goal of growing ancillary revenues to $15 per passenger
by 2016-2018. He expects approximately $90 million in additional
revenue from this fee to flow straight to the bottom line in 2014.
The energy sector’s decline in recent months may have left
investors wondering how to navigate the space. Investors who
believe lower commodity prices are here to stay might wish to
focus on companies with lower debt and good organic growth
prospects. Whitecap Resources Inc., which is one of CIBC analyst
Jeremy Kaliel’s top picks, fits this profile.
Whitecap is a dividend-paying Canadian energy company
that produces approximately 35,000 barrels of oil equivalent per
day (boe/d) at its properties in Alberta and Saskatchewan.
Production is 76% light oil and 24% natural gas. In Q3/2014,
production was 3% above the average analyst’s forecast, while
cash flow per share was 2% above estimates. The company also
stated that production in early Q4/2014 was exceeding 38,000
boe/d, putting it on track to meet or exceed its Q4/2014 average
production target of 36,750 boe/d.
Rising Production Profile
50,000
40,000
Boe/d
Canadian Equities
2012
20
18
16
14
12
10
8
6
4
2
0
Passenger Count
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2010
2011
2012
2013
Source: Company reports
In addition to revenue growth, the company is focused on cost
containment. In 2013, it launched an initiative to reduce costs by
$100 million by the end 2015. Measures have included a shift to
more fuel-efficient aircraft, seat reconfiguration and the transition
of its flight-attendant-to-passenger ratio from 1:40 to 1:50.
Given its high quality growth initiatives, Mr. Chiang
believes WestJet’s valuation is compelling; based on 2015 consensus
estimates, it trades at an enterprise value / earnings before interest
tax depreciation and amortization multiple of 3.7x, versus an
average of 6.0x for its North American discount airliner peers. Stock
Sector
Company Name
Symbol Rating Weighting
WestJet Airlines Ltd.
WJA
SO
M
Whitecap Resources Inc.a
WCP
SO
M
Market
Cap
$4.0 bln
$3.5 bln
2013
2014E
2015E
2016E
Source: CIBC World Markets Inc.
Passengers (mlns)
Revenue ($mlns)
0
Revenue
2009
20,000
10,000
Total Guest Count vs. Revenue
4.0
3.5
30,000
What makes Whitecap’s model more resilient than others in a
lower oil price environment is that its projected operating cost per
barrel is $11.25 (group average of $13.12) and it has locked in 40%
of its projected 2015 production at an average floor price of
US$85.26 per barrel. That compares to current prices of about
US$75. Assuming West Texas Intermediate oil averages US$76.10
per barrel in 2015 — which is the price implied by recent futures
contracts, and well below the year-to-date average of
approximately US$96 — Mr. Kaliel expects Whitecap’s cash flow
per share to grow 10.3% next year, compared to a 6.8% decline for
its peers. At those prices, its projected debt to cash flow ratio at
the end of 2015 would be 1.4x; the group average would be 2.2x.
Most impressively, the company’s payout ratio in that
lower price environment would be 94% — the lowest in the
group. The company’s shares trade at 5.3x Mr. Kaliel’s 2015E cash
flow per share (using the recent futures oil prices), in line with the
group average of 5.3x, but he believes they should trade at a
premium given Whitecap’s superior growth, below-average
payout ratio, strong balance sheet and attractive 5.5% yield.
Price
25-Nov-14
$30.00
$13.58
Price
Target
$37.00
$20.00
Earnings
2013A
$2.03
$1.86
Per Share (EPS)
2014E
2015E
$2.32
$2.75
$2.14
$2.55
P/E
Dividend
2015E
Yield
10.9x
1.6%
5.3x
5.5%
A — Actual for the fiscal year; E — Estimate for the fiscal year; a – cash flow (CF) per share and P/CF used in lieu of EPS and P/E, respectively. For a full description of the CIBC World Markets Inc.
Research Rating System, please see page 8.
4
December 2014
Investment Strategy Group Monthly World Markets Report
Milestone Apartments REIT (MST.UN, $12.18,
Sector Outperformer) Price Target: $13.50
Alimentation Couche-Tard Inc. (ATD, $39.70, Sector
Outperformer) Price Target: $47.00
Canadian REITs have performed surprisingly well so far this year
with the S&P/TSX REIT Index providing a 13% total return,
matching that of S&P/TSX Composite Index, but with less
volatility. As interest rates remain low and commodity-related
stocks volatile, Canadian REITs should continue to deliver
diversification benefits and attractive yields.
Milestone Apartments REIT is a multi-family-focused
REIT that owns and manages garden-style apartment
communities in the U.S. south. Milestone currently offers
investors a 5.3% yield that, based on CIBC analyst Dean
Wilkinson’s estimates, implies a payout ratio of only 74%.
Moreover, it trades at a 16% discount to Mr. Wilkinson’s estimate
of its net asset value.
The ongoing recovery in U.S. consumer spending and
macroeconomic conditions is expected to be supportive for
convenience store operator Alimentation Couche-Tard Inc., as
nearly half of its gross profit stems from the U.S. Couche-Tard
operates over 6,200 convenience stores in Canada and the U.S. —
including over 4,400 with gas stations — under three main
brands: Couche-Tard, Mac’s and Circle K. It also has a growing
span of 2,250 stores in Europe. Motor fuel accounts for over 70%
of Couche-Tard’s sales.
In-Place Rent*
95.2%
94.5%
95.2%
100%
95.5%
$776
$750
$726
$732
$738
85%
$712
Q3/2014
Q1/2014
Q4/2013
80%
Q3/2013
Q2/2013
95%
90%
$757
$725
$700
95.0%
Q2/2014
$775
94.1%
Occupancy
In-Place Rent (US$)
$800
Occupancy
*Total rent divided by the number of occupied units. Source: Company reports
After the collapse of U.S. home prices during the financial crisis,
and the ensuing lack of new rental property construction, the U.S.
rental market is now experiencing strong rental rate growth and
rising occupancy. Mr. Wilkinson expects this favourable
environment to continue for the next few years, if not longer, as
deferred and pent-up household formation catches up. Milestone
has been a beneficiary, outperforming its Canadian and U.S.
residential peers on occupancy gains and rental rate growth in
recent quarters. Its same-property net operating income grew
8.6% in Q3/2014 versus 2.0% for its peer group.
Despite the above-average growth, Milestone trades at
only 11x 2015E funds from operations (FFO) versus 14x for its
peer group. Part of this discount is explained by its smaller
market capitalization of $657 million, which precludes some
institutional investors from acquiring its units.
Mr. Wilkinson believes that as investors pay more
attention to the U.S. apartment sector and as Milestone’s portfolio
continues to grow, trading liquidity should improve and the REIT
could trade at higher valuation levels.
40,000
Sales (US$mlns)
Rising Rents On Stable Occupancy
Gasoline Fuels Revenues
Merchandise
Motor Fuel
Other*
35,000
2,676
2,801
30,000
25,000
25,271 27,209
20,000
15,000
10,000
5,000
0
12,744
10,169 10,365 10,558
16,375
5,201
5,416
5,882
6,222
6,599
7,596
7,947
F2008
F2009
F2010
F2011
F2012
F2013
F2014
*Revenues from rental of assets, sale of aviation & marine fuel, heating oil, kerosene,
lubricants and chemicals. Source: Company reports
CIBC analyst Perry Caicco notes that U.S. fuel margins have been
trending higher in recent years, with Couche-Tard recently
posting one of its highest U.S. gas margins in five years. He
attributes the uptrend to relatively stable wholesale fuel prices
since 2011, coupled with a lack of any major gas price discounting
among Couche-Tard’s competitors. With Americans driving more
as the economy improves, Couche-Tard has also enjoyed U.S.
same-store fuel volume growth for seven consecutive quarters.
Mr. Caicco foresees no threat to these trends in the near term, and
notes that the strong gas margins are producing the cash flow
necessary for Couche-Tard to rapidly pay down debt and line up
its next acquisition.
Indeed, with the company having paid down US$900
million of debt over the past 12 months, it appears ready to act on
accretive acquisition opportunities. However, Couche-Tard is a
prudent acquirer and unwilling to overpay for assets. Mr. Caicco
notes that it paid a relatively low valuation to acquire Europe’s
Statoil Fuel and Retail in 2012. Moreover, the acquisition
provided a strong platform for more European acquisitions and
Mr. Caicco expects future acquisitions to provide significant
synergies.
Stock
Sector
Market
Price
Company Name
Symbol Rating Weighting
Cap
25-Nov-14
Milestone Apartments REITb
MST.UN SO
M
$657 mln
$12.18
Alimentation Couche-Tard Inc.c ATD.B
SO
M
$22.5 bln
$39.70
MICHAEL O’CALLAGHAN, MBA, CFA; BRAD BROWN, CFA;
JAMIE GRUNDMAN & NADEEM KASSAM
Investment Strategy Group
Price
Target
$13.50
$47.00
Earnings Per Share (EPS)
P/E Dividend
2013A
2014E
2015E 2015Ed Yield
US$0.81 US$1.01 US$1.08 11.2x
5.3%
US$1.35 US$1.88 US$2.08 17.0x
0.5%
A — Actual for the fiscal year; E — Estimate for the fiscal year. b - Funds from operations per share (FFO) and P/FFO are displayed in lieu of EPS and P/E, respectively. c – Alimentation Couche-Tard’s
fiscal year ends April; EPS figures are F2014A, F2015E and F2016E and P/E is based on F2016E EPS. d – FFO for P/FFO and EPS for P/E have been converted to C$ using a US$/C$ exchange rate of
0.8883. For a full description of the CIBC World Markets Inc. Research Rating System, please see page 8.
5
December 2014
Investment Strategy Group Monthly World Markets Report
Charting Trends
Despite the constant spectre of higher interest rates, the U.S. utilities sector has quietly posted one of the best returns thus far in 2014.
Given the appreciation in U.S. utilities stocks this year we look at the factors that may have contributed to the performance.
Utilities During Periods Of Rising Long-Term Yields
S&P Utilities Index Relative
To S&P 500 Index*
Periods Of Rising Rates
0.20
0.18
0.16
0.14
0.12
0.10
Oct-14
Oct-12
Oct-10
Oct-08
Oct-06
Oct-04
Oct-02
Oct-00
0.08
*This ratio falls when the S&P 500 Utilities Index underperforms the S&P 500.
Source: Bloomberg
North American Utilities M&A On The Rise
Total Transactions (US$blns)
120
100
80
60
40
20
0
2009
2010
2011
2012
2013
2014
Source: Bloomberg
Canadian Utilities Look Cheap Relative To U.S.
S&P/TSX Composite Utilities Sector Index
7x
S&P 500 Utilities Sector Index
Price / EBITDA
6x
5x
4x
U.S. utilities
expensive relative to
Canadian utilities
3x
Source: Bloomberg
Dec-13
Dec-12
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
2x
Utilities, which have traditionally been favoured by dividend investors,
have understandably had a strong run year to date given that
government bond yields have remained in a steady downtrend over the
same period. This may have come as a surprise to many investors as,
for much of 2014, economists had been calling for the 10-year U.S.
government bond yield to rise; however, the 10-year yield actually fell
for much of the year, hitting a low of 1.8% in October and averaging
2.5%. As we have pointed out in past issues of Charting Trends, interestrate-sensitive sectors tend to underperform when rates rise. Most U.S.
mutual fund managers have been underweight utilities, suggesting
they are among those investors who avoided the space due to concerns
that long-term yields would begin to rise this year. So if portfolio
managers are not long the sector, then who has been buying and why?
Utilities, naturally, are suitable for infrastructure funds, but their
stable and predictable cash flows also make them appropriate for
pension funds. Recently, an investor group that included British
Columbia Investment Management Corporation and Australian asset
manager Macquarie Group Ltd., through its Infrastructure and Real
Assets fund, bid US$4.7 billion to acquire Louisiana power company
Cleco Corp. and US$6.7 billion for Washington-based Puget Energy.
There has also been an increase in merger and acquisition
activity within the sector — 239 deals valued at US$88.3 billion, more
than double that in 2013 — as many utilities attempt to diversify in the
face of stricter environmental regulations. Under current proposed
rules, the U.S. Environmental Protection Agency (EPA) is seeking a 30%
reduction in carbon emissions from existing power plants by 2030.
States may try to meet that goal by lowering their carbon intensity and
cutting demand growth through efficiency improvements. Such efforts
will likely result in higher demand for natural gas plants and
alternative energy sources such as wind and solar. As such, utility
companies have been keen to diversify their power-generating mix.
With coal plants scheduled to be decommissioned, the EPA estimates
over 30 gigawatts of capacity will be retired in 2015/2016, which may
result in supply constraints and higher power prices.
These positive market dynamics appear to be some factors
driving the utilities’ strong share price performance this year. However,
these same factors have resulted in a large valuation discrepancy
between U.S. and Canadian utility stocks: U.S. utilities trade at a
price/EBITDA multiple of 5.7x while their Canadian counterparts trade
at 5.1x. While the power market dynamics from region to region can
vary, one has to wonder if U.S. portfolio managers who missed the big
run in their own market may use their country’s stronger currency to
buy shares of Canadian utilities trading at a steep discount to their
American peers. Among the utilities in CIBC’s coverage universe,
analyst Paul Lechem has a Sector Outperformer rating on Capital
Power Corporation, Fortis Inc. and Northland Power Inc. and analyst
David Noseworthy has a Sector Outperformer rating on Canadian
Utilities Ltd.
JASON CASTELLI, CFA
Investment Strategy Group
6
December 2014
Investment Strategy Group Monthly World Markets Report
CIBC World Markets
Interest Rate Outlook
Interest Rates (%) – End of Qtr 25-Nov-14 Mar/15
Canada
0.91
1.00
3-month T-Bill
U.S.
0.02
0.40
Canada
1.94
2.55
10-year Gov’t Bond Yield
U.S.
2.25
2.95
US$/C$
0.89
0.88
CIBC World Markets
Economic Outlook
Jun/15
1.05
0.60
3.00
3.60
0.85
Economic Outlook
Real GDP Growth (% Chg)
Consumer Price Index (% Chg)
Canada
U.S.
Canada
U.S.
2013A 2014E 2015E
2.0
2.3
2.7
2.2
2.2
2.9
0.9
1.9
2.1
1.5
1.7
1.8
Source: CIBC World Markets Inc.
Source: CIBC World Markets Inc.
Price Target Calculations
Alimentation Couche-Tard Inc. – CIBC analyst Perry Caicco applies a 20x multiple to his normalized 2016E EPS forecast to arrive at a
valuation of $47.00.
Milestone Apartments REIT – CIBC analyst Dean Wilkinson’s $13.50 price target is based on a price / funds from operations per share
(P/FFO) multiple of approximately 11x 2015E FFO.
WestJet Airlines Ltd. – CIBC analyst Kevin Chiang derives his $37.00 price target by applying a 5.5x EV/EBITDA multiple to his 2015
EBITDA estimate, using current net debt.
Whitecap Resources Inc. – CIBC analyst Jeremy Kaliel calculates his 12- to 18-month price target of $20.00 for Whitecap based on a
1.1x target multiple to his Risked NAV (less forecast dividends of $0.75/share) versus the group average of 1.0x.
Disclosures And Disclaimers
Companies Mentioned In This Report That Are Covered By CIBC World Markets (Prices as of 25-Nov-14)
Alimentation Couche-Tard Inc. (2g, 12) (ATD.B-TSX, C$39.70, Sector Outperformer)
Canadian Utilities Ltd. (2a, 2c, 13) (CU-TSX, C$40.03, Sector Outperformer)
Capital Power Corporation (7) (CPX-TSX, C$27.63, Sector Outperformer)
Fortis Inc. (2a, 2c, 2e, 2g, 7, CD49) (FTS-TSX, C$38.18, Sector Outperformer)
Milestone Apartments REIT (2a, 2c, 2e, 2g) (MST.UN-TSX, C$12.18, Sector Outperformer)
Northland Power Inc. (2a, 2c, 2e, 2g) (NPI-TSX, C$17.07, Sector Outperformer)
WestJet Airlines Ltd. (2a, 2e, 2g, CD17) (WJA-TSX, C$30.00, Sector Outperformer)
Whitecap Resources Inc. (2a, 2c, 2e, 2g) (WCP-TSX, C$13.58, Sector Outperformer)
Companies Mentioned in this Report that Are Not Covered by CIBC World Markets Inc. (Prices as of 25-Nov-14)
Cleco Corp. (CNL-NYSE, US$53.81, Not Rated)
Macquarie Group Limited (MQG-AUS, A$58.53, Not Rated)
Statoil ASA (STO-NYSE, US$22.21, Not Rated)
Key To Important Disclosure Footnotes:
1
2a
2b
2c
2d
2e
2f
2g
3a
3b
3c
4a
4b
4c
5a
5b
6a
6b
7
CIBC World Markets Corp. makes a market in the securities of this company.
This company is a client for which a CIBC World Markets company has performed investment banking services in the past 12 months.
CIBC World Markets Corp. has managed or co-managed a public offering of securities for this company in the past 12 months.
CIBC World Markets Inc. has managed or co-managed a public offering of securities for this company in the past 12 months.
CIBC World Markets Corp. has received compensation for investment banking services from this company in the past 12 months.
CIBC World Markets Inc. has received compensation for investment banking services from this company in the past 12 months.
CIBC World Markets Corp. expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months.
CIBC World Markets Inc. expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months.
This company is a client for which a CIBC World Markets company has performed non-investment banking, securities-related services in the past 12 months.
CIBC World Markets Corp. has received compensation for non-investment banking, securities-related services from this company in the past 12 months.
CIBC World Markets Inc. has received compensation for non-investment banking, securities-related services from this company in the past 12 months.
This company is a client for which a CIBC World Markets company has performed non-investment banking, non-securities-related services in the past 12 months.
CIBC World Markets Corp. has received compensation for non-investment banking, non-securities-related services from this company in the past 12 months.
CIBC World Markets Inc. has received compensation for non-investment banking, non-securities-related services from this company in the past 12 months.
The CIBC World Markets Corp. analyst(s) who covers this company also has a long position in its common equity securities.
A member of the household of a CIBC World Markets Corp. research analyst who covers this company has a long position in the common equity securities of this company.
The CIBC World Markets Inc. fundamental analyst(s) who covers this company also has a long position in its common equity securities.
A member of the household of a CIBC World Markets Inc. fundamental research analyst who covers this company has a long position in the common
equity securities of this company.
December 2014
Investment Strategy Group Monthly World Markets Report
6c
One or more members of Investment Strategy Group who was involved in the preparation of this report, and/or a member of their household(s), has a long position in
the common equity securities of this company.
7
CIBC World Markets Corp., CIBC World Markets Inc., and their affiliates, in the aggregate, beneficially own 1% or more of a class of equity securities
issued by this company.
8
A partner, director or officer of CIBC World Markets Inc. or any analyst involved in the preparation of this research report has provided services to this
company for remuneration in the past 12 months.
9
A senior executive member or director of Canadian Imperial Bank of Commerce ("CIBC"), the parent company to CIBC World Markets Inc. and CIBC World
Markets Corp., or a member of his/her household is an officer, director or advisory board member of this company or one of its subsidiaries.
10
Canadian Imperial Bank of Commerce ("CIBC"), the parent company to CIBC World Markets Inc. and CIBC World Markets Corp., has a significant credit
relationship with this company.
11
The equity securities of this company are restricted voting shares.
12
The equity securities of this company are subordinate voting shares.
13
The equity securities of this company are non-voting shares.
14
The equity securities of this company are limited voting shares.
CD17 The Class A shares of WestJet Airlines Ltd. are variable voting shares. The Class B shares of WestJet Airlines Ltd. are converted to Class A shares if they
become held by a person who is not a Canadian.
CD49 CIBC World Markets Inc. is the adviser to Fortis Inc. in the review of strategic options for its hotel and commercial real estate business.
CIBC World Markets Research Rating System
Abbreviation
Stock Ratings
SO
SP
SU
NR
R
Sector Weightings**
O
M
U
NA
Rating
Description
Sector Outperformer
Sector Performer
Sector Underperformer
Not Rated
Restricted
Stock is expected to outperform the sector during the next 12-18 months.
Stock is expected to perform in line with the sector during the next 12-18 months.
Stock is expected to underperform the sector during the next 12-18 months.
CIBC does not maintain an investment recommendation on the stock.
CIBC World Markets is restricted*** from rating the stock.
Overweight
Market Weight
Underweight
None
Sector
Sector
Sector
Sector
is expected to outperform the broader market averages.
is expected to equal the performance of the broader market averages.
is expected to underperform the broader market averages.
rating is not applicable.
**Broader market averages refer to the S&P 500 in the U.S. and the S&P/TSX Composite in Canada.
"Speculative" indicates that an investment in this security involves a high amount of risk due to volatility and/or liquidity issues.
***Restricted due to a potential conflict of interest.
"CC" indicates Commencement of Coverage. The analyst named started covering the security on the date specified.
This report is issued and approved for distribution to clients in Canada by registered representatives of CIBC Wood Gundy, a division of CIBC
World Markets Inc., Member of the Canadian Investor Protection Fund and Member of the Investment Industry Regulatory Organization of
Canada, and by its affiliates via their registered representatives. This report is not authorized for distribution in the United States. This
document and any of the products and information contained herein are not intended for the use of private investors in the United Kingdom.
This report is provided for informational purposes only and does not constitute an offer or solicitation to buy or sell any securities
discussed herein in any jurisdiction where such offer or solicitation would be prohibited.
The securities mentioned in this report may not be suitable for all types of investors. This report does not take into account the
investment objectives, financial situation or specific needs of any particular client of CIBC Wood Gundy. Recipients should consider this report
as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any,
as a substitution for the exercise of independent judgment of the merits and risks of investments. CIBC Wood Gundy suggests that, prior to
making an investment decision with respect to any security recommended in this report, the recipient should contact one of our client advisers
in the recipient’s jurisdiction to discuss the recipient’s particular circumstances. Non-client recipients of this report should consult with an
independent financial advisor prior to making any investment decision based on this report or for any necessary explanation of its contents.
CIBC Wood Gundy will not treat non-client recipients as its clients by virtue of their receiving this report. Past performance is not a guarantee
of future results, and no representation or warranty, express or implied, is made regarding future performance of any security mentioned in
this report.
Information, opinions and statistical data contained in this report were obtained or derived from sources believed to be reliable, but CIBC
Wood Gundy does not represent that any such information, opinion or statistical data is accurate or complete (with the exception of
information contained in the Important Disclosures section of this report provided by CIBC World Markets or individual research analysts), and
they should not be relied upon as such. All estimates, opinions and recommendations expressed herein constitute judgments as of the date of
this report and are subject to change without notice.
Nothing in this report constitutes legal, accounting or tax advice. Since the levels and bases of taxation can change, any reference in this
report to the impact of taxation should not be construed as offering tax advice on the tax consequences of investments. As with any
investment having potential tax implications, clients should consult with their own independent tax adviser.
© 2014 CIBC World Markets Inc. All rights reserved. Unauthorized use, distribution, duplication or disclosure without the prior written
permission of CIBC World Markets is prohibited by law and may result in prosecution.
8
December 2014