Stephen Takacsy, president, CEO & CIO, Lester Asset Management

FOCUS: Canadian stocks 

MARKET OUTLOOK:

We continue to see a positive environment for both stocks and bonds in 2024. We always believed inflation was transitory and that inflation would naturally and gradually decline to near two per cent as supply chains and demand normalize, not because of the rapid interest rate hikes by central banks. We believe that rate hikes actually contributed to inflation through an increase in shelter costs, particularly in Canada where there’s been massive immigration combined with a housing shortage. This is why central banks pivoted last fall and are now finally starting to cut. The North American economy has been resilient despite higher rates, with the job market remaining strong and savings rates still high. We may be entering a “goldilocks” scenario where disinflation or even deflation occurs allowing for rate cuts along with a still-growing economy. And if the economy weakens too much, this will still be seen as “good news” because rate cuts would be faster and deeper.

In such a scenario, the Canadian fixed-income market still offers very attractive returns, particularly in parts of the corporate bond and preferred share market, which still trade at inflation-beating yields in the six to seven per cent range representing equity-like returns with very low risk. In Canadian equity, small/mid-cap stocks offer compelling value and have rarely been so cheap having been decimated over the past few years by institutional flows out of Canada and mutual fund redemptions. Private equity firms and strategic buyers have taken notice and have been snapping up Canadian companies at huge premiums, including a few in our portfolio lately like Logistec, MDF Commerce, and Park Lawn, and as recently as yesterday with Copperleaf and Canadian Western Bank. Other pockets of value include large-cap dividend stocks in sectors such as telecoms (Telus yielding seven per cent), Energy Infrastructure (Enbridge yielding 7.5 per cent) and Banks (BMO yielding 5.4 per cent).

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TOP PICKS:

Neo Materials (NEO TSX)

Neo Materials is a very unique company. It is the global leader in the manufacture of materials for magnets used in micro-motors and one of the largest processors of rare earths in the world to make highly engineered materials. Its customers are mainly in the automotive, electronics and semiconductors as well as specialty chemicals industries. It is the best-positioned company to supply magnets for traction motors in the EV market and is building a new plant in Europe to supply European car manufacturers. The stock has come down with rare earth prices and is very depressed now trading at around $7, well below its Tangible Book Value. Yet Neo is very profitable, generates strong cash flow, has no debt, is buying back shares aggressively, pays a dividend of over six per cent, and trades at around four times EBITDA. A strategic buyer, Hastings Technology Metals, acquired 20 per cent of the company for $15 per share last year, and we wouldn’t be surprised if it or another mining company makes a bid for Neo (which was acquired for $1.3 billion in 2012 before going public again in 2018). With a market cap of only $300 million today, there’s considerable upside for Neo’s stock to triple or even quadruple over the next few years.

High Liner Foods (HLF TSX)

High Liner is one of North America’s leading suppliers of frozen seafood to both food retailers and to the food service sector. High Liner is the number one player in Canada in the retail sector and the number one player in the U.S. in the food service sector. The seafood industry has good growth potential due to the increasing emphasis on healthier eating habits and still very low per capita consumption of seafood in North America. High Liner’s sales have stalled recently due to slower demand for higher-priced protein as consumers have traded down in a higher interest rate environment, although we expect this to reverse soon as consumer confidence increases. Strong free cash flow has allowed HLF to raise the dividend by 30 per cent in the past 18 months, pay down debt, and buy back massive amounts of shares including a large block two days ago at $13.30. This is a classic value stock trading at a cheap valuation of under six times EBITDA and a seven times P/E. Insiders own 40 per cent of the company, so have plenty of skin in the game. We expect the company to eventually be sold to a larger food company for a price somewhere in the $20’s.

Definity Financial (DFY TSX)

DFY is Canada’s seventh-largest property and casualty insurance company. Roughly 70 per cent of its policies are personal insurance (auto and property) and 30 per cent commercial. Roughly 60 per cent of its personal insurance is auto and it is looking to add more home and other types of insurance. DFY demutualized two years ago by listing on the S&P/TSX Composite Index and is still not well known compared to Intact Financial which is the number one player in Canada. DFY’s stock has pulled back recently after a strong run because overall results were a bit lower than expected. However, the key metrics like gross premium income were well ahead of last year, and the combined ratio was excellent as premium increases are more than covering rising costs from car theft and catastrophe losses. DFY recently received approval to continue under the CBCA, so it’s now allowed to leverage its balance sheet to make acquisitions and it can also itself be acquired starting next year. DFY is growing faster than Intact and can expand its return on equity to the mid-teens, yet trades at a significant discount to Intact at 1.7 times book value versus 2.7 times for Intact. Meanwhile, Swiss Reinsurance recently announced that it had acquired 10 per cent of DFY, so there may be a creeping takeover in the works. We see DFY’s multiple expanding to over two times BV and have a target price of $60+ one year out.

PAST PICKS: JUNE 28, 2023

QUARTERHILL (QTRH TSX)

• Then: $1.38
• Now: $1.74
• Return: 26%
• Total Return: 26%

POLLARD BANKNOTE (PBL TSX)

• Then: $25.59
• Now: $31.00
• Return: 21%
• Total Return: 22%

AG GROWTH (AFN TSX)

• Then: $49.50
• Now: $51.96
• Return: 5%
• Total Return: 6%

Total Return Average: 18%