Hello and welcome to The Download. I’m your host, Dave Richardson, and I’m joined today by Scott Lysakowski, legendary Canadian equity investor from Phillips, Hager & North (. Scott, happy New Year and welcome back to the podcast.
Hey, Dave, happy New Year to you as well. Thanks for having me.
I know you had a tremendous year, you and the team last year. And as I said, the legend grows!
Always too modest Scott. So let’s get into Canadian equities. We had Stu Kedwell on his normal Stu’s days appearance on the podcast. We were talking a little bit about a resurgence in a big part of what drives Canadian equity markets, which is materials, energy, mining. I wanted to go a little bit deeper with you on that subject. What are your thoughts about what you’re seeing with respect to those sectors of the economy in Canada and really around the world, that have been largely forgotten for much of the last decade?
Yes, well, you know, the composition of the Canadian market is quite unique. I think we’ve experienced the negative aspects of that over the last couple of years, given that most of our market is in more cyclical type sectors; as you mentioned, energy, financials, materials, industrials. Those sectors make up about two thirds of our market and tend to be much more cyclical. So as we move through economic turbulence that we’ve experienced in the last little while, those sectors will fare not very well as their earnings are a little bit more sensitive to the economy. But that said, as we all know, it’s been quite a wild ride over the last year and the markets are looking forward to a recovery. That’s benefited some of those sectors, particularly over the last several months. We’ve got some very positive data points over the last two or three months, mostly around a vaccine, which is getting the markets looking a little bit further afield into a recovery as a result of reopening. Those cyclical sectors tend to do quite better in those environments. As I mentioned, those more cyclical sectors make up about two thirds of our market, whereas if you compared it to the US, it would be probably a third, maybe even less. So Canada has a much more cyclical bias market. We’re starting to see that show itself in the last couple of months.
You see a real prevalence across the Canadian marketplace of investment solutions that invest at a particular risk level balance conservative growth. If you look at those types of portfolio solutions, and how the ones that have an overweight to Canada versus one with a global Canadian weight, the global portfolios tended to do much better than ones with a higher Canadian weighting. So perhaps this is one of those points where we start to see a little bit of an adjustment in that?
Yes, I think Canada has lagged its US benchmark over the last number of years. It held up in this recovery and could start to show a little bit more leadership due to those cyclical factors. If you dig a little bit deeper, looking at consensus estimates, which we know are fairly or rarely right, but directionally accurate, the earnings of the TSX suffered quite dramatically in 2020, but they’re looking for a fairly strong recovery out into 2021, and into 2022. If you add up the earnings growth contribution from those cyclical sectors, it makes up about 80 or almost 90% of the earnings recovery. So, there’s quite a bit of optimism that’s embedded into the forecasts for those cyclical sectors and which is driving a pretty attractive earnings recovery in Canada that could last beyond just this year. So we’re quite hopeful here in Canada.
Yes, and you mentioned when we were talking before we started taping that you have been talking or will be talking to some of the companies. Without being specific, what are they saying in general?
Yes, we were attending an institutional investor conference, virtually. This is a conference that’s typically in Whistler, so right in our backyard in a much more enjoyable location than our home offices. But aside from that, we’re getting really good updates from the companies that we invest in and watch closely. I would say, all told, my team is probably doing close to thirty individual meetings with company management teams, in addition to attending some group presentations as well. So really important time to get an update. The meetings I’ve been focused on are mostly in the energy and utility sectors, so there’s quite a bit of optimism which we haven’t seen from that sector and those management teams in a while, and I think it’s partially based on the recovery we’ve seen since the vaccination news has come out. Then also OPEC made a fairly important move to curtail some supply, which has been very helpful for the oil price and energy stocks. The amount of optimism varies depending on what type of company you’re talking to. If you’re talking to an oil and gas producer, they’re starting to get a little bit more positive. But it’s been a tough couple of years for those companies. I’d say they’re more cautious than optimistic. Then if you’re meeting with a renewable power company, those companies have enjoyed some very good performance in their stocks. So, they’re actually feeling really good. So, generally speaking, I think there’s some optimism in the management teams. One thing that we’ve noticed — and I think you and Stu have talked about in the past — is that as we’ve gone through this crisis in the last year. And as I mentioned, the oil and gas companies have been in a crisis mode or at least in a down market for their business for several years. There’s been an incredible focus on costs, incredible focus on efficiency, and incredible focus on capital structure and balance sheet. So if we do even get a slight recovery — I’m not talking about boom days of old in the oil patch — but if we get a slight recovery in commodity prices, and even if we don’t see a lot of production growth out of western Canada, I think there actually could be some interesting profitability and free cash-flow generation from these companies. Most importantly, I think what the companies have learned over the last several years is discipline around how they spend capital and how they manage their balance sheets. I think that a combination of just a slight recovery and a more efficient cost structure and healthy balance sheet could prove to be very positive for equity holders, and so some of these companies are generating decent amounts of free cash flow and throwing out very attractive dividend yields. There’s an interesting combination there for equity investors in the energy sector that we have not seen for several years.
Well, Scott, thanks for that. Terrific to hear. I think there’s optimism around the world on a number of fronts. I saw the inauguration yesterday of a new administration in the US. We’re starting to see some of these vaccines get out and people get inoculated. And so it’s great to hear from a Canadian perspective that optimism extends to some of those areas that we talked about today. Scott, thanks for your time. And we’ll hopefully catch up soon. Scott : Great. Thanks, Dave.