Canadian Stock Picks by Sector

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Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Craig Jerusalim, senior portfolio manager of Canadian equities, CIBC Asset Management.  

The first half of 2024 has quietly been a rather productive year for Canadian markets. In fact, a surprisingly good year considering investor sentiment seems to have swung from recession fears to stagflation fears, not to mention the abundance of macro and geopolitical tensions further straining sentiment.  

Nevertheless, as the market more often than not does, it tends to move higher roughly in conjunction with margins and earnings, and we find ourselves in and around all-time record highs despite the headwinds. So, it may be worthwhile to set the stage for what we think will happen next, by taking a look back at what’s driven the market to these lofty levels.  

Starting from the top performing sectors, it’s been all about resources, with both energy and materials leading the way. While crude oil prices are off their highs for the year, WTI or West Texas Intermediate, is still up close to 10%, partly boosted by geopolitical tensions, but more importantly due to healthy supply-demand fundamentals largely from emerging markets. And likely, most importantly for the performance of the equities, with their newfound commitment to pay down debt and return cash in the form of dividends and buybacks back to shareholders.  

So far this year, we’ve seen companies like Canadian Natural Resources hit their debt target of $10 billion and will now return 100% of its free cash flow to shareholders. We believe Cenovus is next in line to potentially reach their debt target and increase their payout to shareholders. Crescent Point, now known as Barron’s, is also quickly approaching their targets, boosted by successful asset sales. We continue to be overweight, and we expect the group strength to come from both capital appreciation and dividend returns. Similar to the impressive returns of the tobacco stocks over the past 30 years, without nearly as much ESG overhangs, given the Canadian producers’ global leadership in areas of carbon reduction, social commitments and strong governance practices.  

The final reason why we remain overweight the energy group is due to valuation remaining below long-term averages. While the group is no longer trading at trough valuations, we’re still well below long-term average, despite the group’s stronger balance sheets, return on investment, and return of capital focus, and low-cost long-life asset base. Within the energy sector our preference is for producers over pipelines and oil over gas, given the superior profitability of the producers, and the better supply-demand fundamentals over gas, which is often a byproduct in North American production, which leads to excess supply.  

Materials are the next best performing sector aided this year by the strong rally in gold and copper, despite the strength in the U.S dollar. Gold strength has been driven by geopolitical factors and sticky inflation, but we are also seeing central banks continuing to buy gold reserves, led by China. We would be more constructive on the gold sector if the sector didn’t have such a poor track record of destroying shareholder value. And the reason for this less than [inaudible] is the need to consistently be replacing reserves given short timelines. Not to mention the difficult jurisdictions many companies are forced to operate in. We remain underweight the gold and precious metal sector for these reasons, and instead overweight select securities like Agnico Eagle and Osisko Royalty, whose operations are concentrated in safe jurisdictions like North America and Australia. And we avoid countries in Africa, Russia and select South American countries.  

Switching to copper, which is also up handsomely this year, and recently surpassed its all-time record high, we continue to think about the incremental demand from electronic vehicles, along with electrification of the grid, which will require significant amounts of copper that’s expected to turn the market into a deficit beyond 2025. This amounts to an estimated 10-million ton shortfall by 2035, which we think positions the commodity as favourable. Companies like Teck Resources, which we are overweight, should be beneficiaries of that trade.  

The third best sector and largest pillar of the Canadian markets: financials, a sector that we continue to remain overweight. However, within the largest sector on the TSX, it’s been a tale of two subsectors. The big six banks have lagged the performance of the overall market, while insurance companies within the life, property and specialty insurance, have been amongst the best performance year-to-date, driven by big gains from Fairfax and our top pick to start the year, Trisura.  

Canadian banks, from a valuation standpoint, are trading pretty close to their long-term price-to-earnings average, which we think is fair. They do offer attractive growing and safe dividend yields of around 5%. However, we see a bunch of near-term headwinds that could limit any further multiple expansion. Those headwinds include slower loan growth, more regulatory scrutiny. And we’ve seen the banks mandated to hold higher levels of capital, which is going to hurt their return on equity.  

Typically, banks rally close to the point where peak provision of credit losses occurred. But we don’t think we’re quite there yet. We definitely prefer the insurance to the banks, as they both have growth and higher return on equity, which allows them to deploy excess capital at better rates of return. We remain most favourable on specialty insurers like Fairfax and Trisura, and we continue to see upside from outsized earnings growth and further valuation rerating towards both historical and the U.S. peers.  

Industrials are right behind financials in terms of year-to-date performance, but it’s been an eclectic mix of strength and weakness. Some of our strongest performing securities have come from industrials, such as Thomson Reuters and Element Fleet. However, looking forward, towards the second half of the year, we see tremendous upside in some of the laggards such as Cargojet, Brookfield Business Partners and GFL. GFL, which has been steadily reducing their leverage, is very well positioned to double their free cash flow over the next four years, all while trading at amongst the widest discount to their peers since their IPO. Brookfield Business Partners also has tremendous value in some of their operating companies such as Clarios, the largest battery maker for OEM aftermarket vehicles. Given how well Clarios has been performing, we could potentially see an IPO in the second half of the year, which would be a tremendous catalyst for BBU. 

Consumer discretionary and consumer staples have both been middle of the pack performers year-to-date, while slightly underperforming the overall benchmark. We are underweight both sectors given their exposure to the sluggish Canadian consumer as well as elevated valuation, despite subpar growth. Part of the reason for their relative success has been the crowding effect for their perceived quality in Canada. We believe the combination of moderate growth and elevated valuations will lead to these sectors becoming a source of funding for better opportunities in the second half of the year, and therefore continue to underperform.  

Some of the weakest performing sectors this year are in the interest rate sensitive sectors such as utilities, REITs and communication services, three sectors that we have been underweight given balance sheets, lack of growth attributes and challenging valuations. While many of the companies in these sectors will benefit from falling interest rates, we are not pinning our hopes on rate movements given how difficult they are to forecast. Instead, we seek out companies that are able to differentiate themselves by growing regardless of the macro backdrop. Companies like Brookfield Renewable and Brookfield Infrastructure are uniquely positioned to benefit from mega trends in global power demand, and from artificial intelligence and data centre growth. In fact, global data centre power demand is expected to increase 15-fold from 2022 to 2030, which could imply data centre going from about 2% of global power consumption to almost 10% by 2030. Additionally, both companies offer attractive dividend yields to go with double digit growth and the majority of their revenue contracted linked to inflation. They are both set up well to outperform whether rates move higher or lower.  

Brookfield Renewable just recently announced a partnership with Microsoft, which was the largest ever corporate clean energy deal, to provide 10 and a half gigawatts of renewable energy in 2026 to 2030, which is a $10-billion investment from Microsoft to secure renewable energy for its expected data centre powering such growth. We would expect many more of these announcements to come, further differentiating Brookfield Renewables’ value proposition.  

One sector where our views have recently evolved, and where we are expecting better performances, is in the telecom sector. The group now trades well below long-term averages and provides a great source of dividend yields around 7% in some cases, that we believe is sustainable and likely to grow for select companies. Historically, the group has significantly benefited from the strong oligopoly in Canada, which began to deteriorate as Quebecor moved to a national player after their acquisition of Freedom. The result was an extended price war, which was bad for all parties. While, today, we think we are past the point of peak pessimism for the group, as competitive pressures subside, regulatory scrutiny eases, capital intensity declines and quality attributes once again become apparent.  

Within the group we most prefer TELUS given their superior customer service, as evidenced by their lowest industry leading churn, their best-in-class organic growth attributes and their declining capex profile post their fiber expansion, which is leading to their inflection free cash flow growth.  

And finally bringing up the rear in terms of year-to-date performance is the technology sector, which has been dragged down by the recent drop in Shopify following their strong quarter, but disappointing outlook. Following the stock’s significant rerating, we moved to a slight overweight in the Canadian tech juggernaut. With extending e-commerce market, we anticipate Shopify to be a prime beneficiary of market share gains, as they drive higher penetration into the e-commerce ecosystem. We anticipate ample room for Shopify to grow in the U.S. market, with their current penetration at 15% of the U.S. e-commerce market, second only to Amazon. Given their scale, continued innovation and market leading position, we expect continued profitable growth at Shopify as they drive deeper into the e-commerce ecosystem. We remain overweight the sector given technology is the best source of growth on the TSX. Our top pick in the sector, however, is Docebo, a cloud-based artificial intelligence enabled learning management platform for enterprise and training services. The company’s competitive advantage lies in its best-in-class user interface and configurability and leveraging AI for external training use cases. The company trades at a very attractive four times enterprise value to sales, or less than 20 times price-to-free-cash-flow on 2025, despite growing revenue in the high teens, and having a high teens free cash flow margin.  

So just to summarize, one thing that I am certain about is that no one really knows where rate cuts will start, yet alone how deep they will go. Therefore, our best opportunity is to seek out high-quality growing businesses with defensible competitive advantages that can relatively outperform regardless of the rate or macro backdrop.