What to watch for in feds’ budget update

This article is part one of a two-part series on issues affecting the Canadian market. Part two, focused on trade talks and the loonie, will be available on Sept. 27. 

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When looking for undervalued companies that have “surfacing value,” associate portfolio manager Catharine Sterritt supplements her bottom-up analysis with research on trends and by following news.

She looks for “significant changes in the marketplace that could change a company’s relative positioning in its industry,” she said during a Sept. 19 interview.

“We are actually right in front of a series of important events: we can talk about the federal government and [its] priorities, and the budget update that we’re expecting,” said Sterritt, who works for CIBC Asset Management and co-manages the Renaissance Canadian All-Cap Equity Fund.

On top of that, she’s watching NAFTA negotiations and the risks associated with other trade negotiations that the U.S. is undertaking, particularly with China and the European Union.

Progress has been slow leading up to the U.S.-imposed end of September deadline for NAFTA, with the Trump government threatening to proceed with a Mexico-U.S. deal and impose a 25% tariff on Canadian auto exports. This week, Prime Minister Justin Trudeau and Foreign Affairs Minister Chrystia Freeland are attending the United Nations General Assembly in New York, where informal talks will occur.

Sterritt’s also thinking about the federal government’s upcoming fall economic update, which she’s expecting in mid-October and which Finance Minister Bill Morneau said in July is likely to touch on NAFTA as well as business taxation and the energy sector.

“One of the things that has really held back Canadian companies is the relative disadvantage that we are now at compared to U.S. companies with respect to capital investment,” Sterritt said.

U.S. tax reform passed late last year lowered the U.S. corporate tax rate from just north of 30% to 22%. That’s led to “a very noticeable increase” in capital expenditure activity, she said, with multi-year capital programs awarded to the U.S.

“Canada is now clearly at a disadvantage for major manufacturing and capital infrastructure investments,” Sterritt said.

She also pointed out that the U.S. offers accelerated depreciation, which allows companies to write off their assets faster in earlier years so they can minimize taxable income through greater deductions.

To boost Canada’s competitiveness, Sterritt anticipated “that the Canadian government is going to take steps to deliver some capex efficiencies. Certainly, we’ve been seeing a lot of vocal petitioning from the business community.”

Corporations and interest groups including PwC, the C.D Howe Institute and CIBC CEO Victor Dodig have called for tax changes to boost competitiveness. The government is reportedly considering targeted measures over broader corporate tax cuts.

Pipeline problems

Alongside tax and trade issues, Canada is also facing pipeline hurdles that are weighing on the energy sector—particularly with the Trans Mountain pipeline (TMX).

Last month, the Federal Court of Appeal rejected the government’s approval of the project based on flaws it identified in the National Energy Board’s environmental assessment.

“We still are waiting for a federal government response on how they’re going to handle that,” Sterritt said. The federal government will need to account for marine safety issues and further consultation with First Nations.

While there are major roadblocks for the government, a strategy to move Trans Mountain ahead as well as capex changes in the fiscal update would “significantly help” open up the domestic market and build confidence in the energy sector, she said.

She’s found the sector has been “significantly underperforming” its U.S. counterpart. And if the tables turn, Sterritt would expect to see “some of our marquee oilsands producers benefit,” including Calgary-based Canadian Natural Resources.

She’s also monitoring the LNG Canada project in Kitimat, B.C. A final investment decision by the five energy companies behind LNG Canada (Shell, PETRONAS, PetroChina, Mitsubishi Corporation and KOGAS) is expected by the end of this year.

The project would result in “a major, long-term capex build and we’re hoping, if it comes through, that it would be the start of several LNG projects in Canada. We’re looking for a favourable environment for that [final investment decision] to go ahead.”

If LNG Canada is a go, Sterritt will look at opportunities like service companies that will be beneficiaries. Those include Horizon North Logistics, “a small-cap company that has already been awarded the contracts for the camp build associated with LNG Canada,” she said, and there are also players like Calgary-based TransCanada PipeLines, LP, which plans to begin construction on the $4.8-billion Coastal GasLink pipeline in 2019 if LNG Canada gets the greenlight.

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