Selkirk- Care to pull the curtain back a little more on these?
Stock Strategist
These Canadian Stocks May Be Worth a Look
By Jonathan Schrader, CFA | 08-10-07 | 06:00 AM
At Morningstar, we now cover more than 2,000 stocks, each with its own analyst, fair value estimate, and Morningstar Rating. While the majority of these companies are based in the United States, Morningstar's coverage of non-U.S. stocks has been growing quickly. We're now approaching 400 non-U.S. companies under coverage, and the country with the biggest representation in this group by far is Canada.
While Canada's economy is relatively small compared with the U.S., investment opportunities abound. Canada is one of the United States' most vital trade partners, and with its abundance of natural resources, Canada is an increasingly important player on the global stage. Natural-resources companies--mining and energy in particular--represent a big chunk of Canada?s equity market and have generally performed very well in the past five years, leading the Canadian equity market higher. Over the past five years, in fact, Canada's S&P/TSX Composite index has returned 16.6% annually compared with just 10.7% for the S&P 500 (through June 30).
Morningstar covers about 50 natural-resources companies based in Canada, and two of them, Compton Petroleum (CMZ) and Talisman Energy (TLM) (Its Canada-listed ticker is TLM as well) now have 5-star Morningstar Ratings.
There's more to the Canadian equity market than natural resources: financial services, communications, and health-care companies are also well-represented in Canada and make up the majority of our Canadian coverage outside of natural resources. One of these health-care companies, Angiotech Pharmaceuticals (ANPI), also has a 5-star rating now.
The Canadian firms that Morningstar covers have been steadily releasing their results from the second quarter. To introduce some of the Canadian companies we cover, we'll share our recent thoughts on second-quarter results from five of these firms. To learn even more about what Morningstar equity analysts think about the Canadian companies in Morningstar's coverage universe, our fair value estimates, and star ratings, visit us today at Morningstar.com.
Potash Corporation of Saskatchewan, Inc. (POT) (Canadian ticker: POT)
Analyst: Ben Johnson
Date of Analyst Note: 07-26-2007
Potash Corp continued to ride the rising tide in global agriculture in the second quarter. Its quarterly results, released July 26, were in line with our long-term operating projections, and we are maintaining our $84 fair value estimate.
Year-over-year comparisons are muddied by the fact that potash shipments to China were delayed well into the second half of 2006 as a result of drawn-out contract negotiations. But despite skewed comparisons, there is little doubt that business is booming in Saskatchewan. Average selling prices for potash, nitrogen, and phosphates rose by 5.8%, 12.9%, and 23.8%, respectively, versus the second quarter of 2006. The firm's year-to-date operating margin has soared 600 basis points against its full-year 2006 level to 29%. The company also continues to spew cash, having generated more than $520 million in free cash flow (almost 21% of sales) thus far in 2007.
During the quarter, Potash also announced that it will be (quite literally) digging its moat even wider, unveiling plans to develop a new Greenfield potash deposit in New Brunswick, Canada. The mine, scheduled for completion in 2011, will have an annual capacity of 2 million metric tons and cost approximately $1.6 billion to develop. The total cost of the project--which is 30% less than what it might cost a competitor to develop a similar project--is mitigated by the quality and structure of the deposit. That the mine will be able to share top-side resources with Potash's existing operations in the area provides further justification for the project. We view this expansion as a shrewd strategic investment and an efficient use of shareholders' capital.
Rogers Communications, Inc. (RCI)
(Canadian ticker: RCI.B)
Analyst: Jonathan Schrader, CFA
Date of Analyst Note: 08-01-2007
After reviewing Rogers second-quarter results, we're maintaining our $43 fair value estimate. In our opinion, Rogers' above-average prospects are already priced into its shares.
Compared with a year ago, Rogers increased total sales by 16% in the second quarter, to CAD 2.53 billion. With CAD 270 million more in sales compared with a year ago (a 25% jump), the wireless segment again led the way. This top-line growth was driven by an 8% increase in average revenue per wireless user, to CAD 72.65, on data growth of 51%. The wireless segment has been on fire in recent quarters, with average revenue per user increasing, churn decreasing, and the number of lucrative postpaid subscribers growing, to 5.56 million at the end of the second quarter. Given its momentum, the company raised the upper end of its guidance for this segment. We're not changing our assumptions, however, as we were already optimistic about the wireless segment's prospects for 2007.
Cable and telecom, Rogers' second-biggest business, also expanded its sales line nicely in the quarter, up 13% from a year ago. Profit results were less impressive, however, as operating costs increased even faster than sales. While management suggested on its conference call that it plans to increase margins to peer levels (above 40%), we suspect that this will take at least a year or two, especially if Rogers reaccelerates investment in the cable business to safeguard against the threat of terrorism or natural disaster, a potential use of growing cash flow suggested by Ted Rogers during the call.
In the second quarter, Rogers had a net loss of CAD 56 million because of a one-time charge related to its stock options. The company has altered its option plan to settle with cash rather than stock. This change mandates use of intrinsic value accounting rather than fair value accounting and also requires Rogers to carry the total intrinsic value of outstanding options as a liability on the balance sheet. This triggered a CAD 452 million charge to earnings in the quarter. This change in accounting will result in higher stock option expense in the future and will cause some volatility in results as movement in Rogers' stock price will cause changes in the marked-to-market value of its balance sheet liability and stock option expense.
Excluding this charge, Rogers' second-quarter results still weren't great, mostly because of rising costs in the cable and telecom segment. However, these 13 weeks of results don't alter our opinion that Rogers is one of the best-positioned communications companies in North America and a fine stock to hold in your portfolio, if you can buy it at a reasonable price.
Talisman Energy, Inc. (TLM)
(Canadian ticker: TLM)
Analyst: Kish Patel
Date of Analyst Note: 08-03-2007
Talisman Energy's second-quarter results reflected the ongoing sales of the company's noncore assets in an effort to improve the overall quality of its portfolio. Proceeds from the sales are being used to buy back shares, and this, in our opinion, is a smart move, given the current cost environment and the market valuation of the company's shares. The company noted that it has hired advisors to sell its midstream assets, a process that could be complete by year-end.
Tight industry conditions are causing a delay in bringing the Tweedsmuir field up to full production, and slower-than-anticipated production of a pipeline in Indonesia has led the company to reduce 2007 production guidance to the lower end of its guidance range (465,000 barrels of oil equivalent per day instead of the initial 485,000 barrels of oil equivalent per day). We still expect to see strong production growth in the fourth quarter from the North Sea and continued growth into 2008 and 2009.
John Manzoni is expected to take over the reins at Talisman at the beginning of September, with longstanding CEO Jim Buckee staying through October as part of the transition. We are eagerly anticipating Manzoni's vision for the company, and we are leaving our $26 fair value estimate intact for now.
Fairfax Financial Holdings, Ltd. (FFH)
(Canadian ticker: FFH)
Analyst: Bill Bergman
Date of Analyst Note: 08-03-2007
On Thursday, Fairfax Financial Holdings reported outstanding results for the second quarter and first half of 2007. The insurance holding company's year-over-year earnings decline was due to a tough comparison, with realized investment gains doubling in 2006. Very positive trends lie underneath the reported earnings decline. Underwriting profitability continues to improve. The consolidated combined ratio for its underwriting subsidiaries came to a healthy 92% for the second quarter and 94% for the first half.
Fairfax's underwriting profits have coupled with high investment leverage and good investment results to produce outstanding operating returns. We like the quality of Fairfax's reported investment income, which is up 15% from the first half of 2006. Fairfax has been critical of securitized debt markets now under stress and put its money where its mouth is. It holds no mortgage or asset-backed securities or collateralized debt obligations and actually increased its hedges against risks facing counterparties active in those markets. Those hedges produced unrealized gains exceeding $500 million in recent months. This comes on top of a 60% increase in operating income in the first half of 2007. Our $292 fair value estimate is unchanged.
Telus Corporation (TU)
(Canadian ticker: T)
Analyst: Jonathan Schrader, CFA
Date of Analyst Note: 08-03-2007
Telus reported disappointing second-quarter results August 3. Sales gained 4.4% from the year-ago quarter, as a result of 11% growth in wireless revenue. The fixed-line business experienced a 0.8% decline in sales due to an 18% drop in long-distance sales. This poor fixed-line showing from wasn't unexpected; we forecast 0% growth from this business for 2007.
Our disappointment largely relates to Telus' cost increases in the quarter. The wireless unit experienced an 18% jump in operating expenses--adjusted for charges related to Telus' stock option cash settlement plan--compared with a year ago. All four of this unit's primary expense lines increased faster than sales in the quarter, leading to an earnings before interest, taxes, depreciation, and amortization margin of 45.5% compared with 49.9% a year ago. This showing is particularly poor relative to rival Rogers (RCI), which actually boosted its EBITDA margin to 51.7% in the quarter. Telus also trailed Rogers in net subscriber additions in the second quarter, though Telus did perform much better than the currently slumping Bell Mobility (BCE), which added only half as many (63,000) wireless subscribers as Telus.
Costs in the fixed-line business also climbed in the second quarter, up 2.2% after adjustments. Even though a 2.2% increase may seem small, its impact is significant given the challenges Telus faces in expanding this legacy business. Costs were higher in the quarter because of higher compensation expense and implementation of a new billing and client care system in Alberta. The hope of Telus' management is that costs associated with the Alberta rollout will reduce costs for future rollouts.
Management suggested that much of its higher costs in the second quarter would be reduced going forward, and this is what we continue to assume in our model. At present, we're giving management--which was very contrite on the conference call while reiterating its full-year forecast--the benefit of the doubt and expect improvement in the third quarter. If we don't see signs of improvement, we may opt to lower our $52 fair value estimate.
Jonathan Schrader, CFA, is a senior stock analyst with Morningstar.
Stock Strategist
These Canadian Stocks May Be Worth a Look
By Jonathan Schrader, CFA | 08-10-07 | 06:00 AM
At Morningstar, we now cover more than 2,000 stocks, each with its own analyst, fair value estimate, and Morningstar Rating. While the majority of these companies are based in the United States, Morningstar's coverage of non-U.S. stocks has been growing quickly. We're now approaching 400 non-U.S. companies under coverage, and the country with the biggest representation in this group by far is Canada.
While Canada's economy is relatively small compared with the U.S., investment opportunities abound. Canada is one of the United States' most vital trade partners, and with its abundance of natural resources, Canada is an increasingly important player on the global stage. Natural-resources companies--mining and energy in particular--represent a big chunk of Canada?s equity market and have generally performed very well in the past five years, leading the Canadian equity market higher. Over the past five years, in fact, Canada's S&P/TSX Composite index has returned 16.6% annually compared with just 10.7% for the S&P 500 (through June 30).
Morningstar covers about 50 natural-resources companies based in Canada, and two of them, Compton Petroleum (CMZ) and Talisman Energy (TLM) (Its Canada-listed ticker is TLM as well) now have 5-star Morningstar Ratings.
There's more to the Canadian equity market than natural resources: financial services, communications, and health-care companies are also well-represented in Canada and make up the majority of our Canadian coverage outside of natural resources. One of these health-care companies, Angiotech Pharmaceuticals (ANPI), also has a 5-star rating now.
The Canadian firms that Morningstar covers have been steadily releasing their results from the second quarter. To introduce some of the Canadian companies we cover, we'll share our recent thoughts on second-quarter results from five of these firms. To learn even more about what Morningstar equity analysts think about the Canadian companies in Morningstar's coverage universe, our fair value estimates, and star ratings, visit us today at Morningstar.com.
Potash Corporation of Saskatchewan, Inc. (POT) (Canadian ticker: POT)
Analyst: Ben Johnson
Date of Analyst Note: 07-26-2007
Potash Corp continued to ride the rising tide in global agriculture in the second quarter. Its quarterly results, released July 26, were in line with our long-term operating projections, and we are maintaining our $84 fair value estimate.
Year-over-year comparisons are muddied by the fact that potash shipments to China were delayed well into the second half of 2006 as a result of drawn-out contract negotiations. But despite skewed comparisons, there is little doubt that business is booming in Saskatchewan. Average selling prices for potash, nitrogen, and phosphates rose by 5.8%, 12.9%, and 23.8%, respectively, versus the second quarter of 2006. The firm's year-to-date operating margin has soared 600 basis points against its full-year 2006 level to 29%. The company also continues to spew cash, having generated more than $520 million in free cash flow (almost 21% of sales) thus far in 2007.
During the quarter, Potash also announced that it will be (quite literally) digging its moat even wider, unveiling plans to develop a new Greenfield potash deposit in New Brunswick, Canada. The mine, scheduled for completion in 2011, will have an annual capacity of 2 million metric tons and cost approximately $1.6 billion to develop. The total cost of the project--which is 30% less than what it might cost a competitor to develop a similar project--is mitigated by the quality and structure of the deposit. That the mine will be able to share top-side resources with Potash's existing operations in the area provides further justification for the project. We view this expansion as a shrewd strategic investment and an efficient use of shareholders' capital.
Rogers Communications, Inc. (RCI)
(Canadian ticker: RCI.B)
Analyst: Jonathan Schrader, CFA
Date of Analyst Note: 08-01-2007
After reviewing Rogers second-quarter results, we're maintaining our $43 fair value estimate. In our opinion, Rogers' above-average prospects are already priced into its shares.
Compared with a year ago, Rogers increased total sales by 16% in the second quarter, to CAD 2.53 billion. With CAD 270 million more in sales compared with a year ago (a 25% jump), the wireless segment again led the way. This top-line growth was driven by an 8% increase in average revenue per wireless user, to CAD 72.65, on data growth of 51%. The wireless segment has been on fire in recent quarters, with average revenue per user increasing, churn decreasing, and the number of lucrative postpaid subscribers growing, to 5.56 million at the end of the second quarter. Given its momentum, the company raised the upper end of its guidance for this segment. We're not changing our assumptions, however, as we were already optimistic about the wireless segment's prospects for 2007.
Cable and telecom, Rogers' second-biggest business, also expanded its sales line nicely in the quarter, up 13% from a year ago. Profit results were less impressive, however, as operating costs increased even faster than sales. While management suggested on its conference call that it plans to increase margins to peer levels (above 40%), we suspect that this will take at least a year or two, especially if Rogers reaccelerates investment in the cable business to safeguard against the threat of terrorism or natural disaster, a potential use of growing cash flow suggested by Ted Rogers during the call.
In the second quarter, Rogers had a net loss of CAD 56 million because of a one-time charge related to its stock options. The company has altered its option plan to settle with cash rather than stock. This change mandates use of intrinsic value accounting rather than fair value accounting and also requires Rogers to carry the total intrinsic value of outstanding options as a liability on the balance sheet. This triggered a CAD 452 million charge to earnings in the quarter. This change in accounting will result in higher stock option expense in the future and will cause some volatility in results as movement in Rogers' stock price will cause changes in the marked-to-market value of its balance sheet liability and stock option expense.
Excluding this charge, Rogers' second-quarter results still weren't great, mostly because of rising costs in the cable and telecom segment. However, these 13 weeks of results don't alter our opinion that Rogers is one of the best-positioned communications companies in North America and a fine stock to hold in your portfolio, if you can buy it at a reasonable price.
Talisman Energy, Inc. (TLM)
(Canadian ticker: TLM)
Analyst: Kish Patel
Date of Analyst Note: 08-03-2007
Talisman Energy's second-quarter results reflected the ongoing sales of the company's noncore assets in an effort to improve the overall quality of its portfolio. Proceeds from the sales are being used to buy back shares, and this, in our opinion, is a smart move, given the current cost environment and the market valuation of the company's shares. The company noted that it has hired advisors to sell its midstream assets, a process that could be complete by year-end.
Tight industry conditions are causing a delay in bringing the Tweedsmuir field up to full production, and slower-than-anticipated production of a pipeline in Indonesia has led the company to reduce 2007 production guidance to the lower end of its guidance range (465,000 barrels of oil equivalent per day instead of the initial 485,000 barrels of oil equivalent per day). We still expect to see strong production growth in the fourth quarter from the North Sea and continued growth into 2008 and 2009.
John Manzoni is expected to take over the reins at Talisman at the beginning of September, with longstanding CEO Jim Buckee staying through October as part of the transition. We are eagerly anticipating Manzoni's vision for the company, and we are leaving our $26 fair value estimate intact for now.
Fairfax Financial Holdings, Ltd. (FFH)
(Canadian ticker: FFH)
Analyst: Bill Bergman
Date of Analyst Note: 08-03-2007
On Thursday, Fairfax Financial Holdings reported outstanding results for the second quarter and first half of 2007. The insurance holding company's year-over-year earnings decline was due to a tough comparison, with realized investment gains doubling in 2006. Very positive trends lie underneath the reported earnings decline. Underwriting profitability continues to improve. The consolidated combined ratio for its underwriting subsidiaries came to a healthy 92% for the second quarter and 94% for the first half.
Fairfax's underwriting profits have coupled with high investment leverage and good investment results to produce outstanding operating returns. We like the quality of Fairfax's reported investment income, which is up 15% from the first half of 2006. Fairfax has been critical of securitized debt markets now under stress and put its money where its mouth is. It holds no mortgage or asset-backed securities or collateralized debt obligations and actually increased its hedges against risks facing counterparties active in those markets. Those hedges produced unrealized gains exceeding $500 million in recent months. This comes on top of a 60% increase in operating income in the first half of 2007. Our $292 fair value estimate is unchanged.
Telus Corporation (TU)
(Canadian ticker: T)
Analyst: Jonathan Schrader, CFA
Date of Analyst Note: 08-03-2007
Telus reported disappointing second-quarter results August 3. Sales gained 4.4% from the year-ago quarter, as a result of 11% growth in wireless revenue. The fixed-line business experienced a 0.8% decline in sales due to an 18% drop in long-distance sales. This poor fixed-line showing from wasn't unexpected; we forecast 0% growth from this business for 2007.
Our disappointment largely relates to Telus' cost increases in the quarter. The wireless unit experienced an 18% jump in operating expenses--adjusted for charges related to Telus' stock option cash settlement plan--compared with a year ago. All four of this unit's primary expense lines increased faster than sales in the quarter, leading to an earnings before interest, taxes, depreciation, and amortization margin of 45.5% compared with 49.9% a year ago. This showing is particularly poor relative to rival Rogers (RCI), which actually boosted its EBITDA margin to 51.7% in the quarter. Telus also trailed Rogers in net subscriber additions in the second quarter, though Telus did perform much better than the currently slumping Bell Mobility (BCE), which added only half as many (63,000) wireless subscribers as Telus.
Costs in the fixed-line business also climbed in the second quarter, up 2.2% after adjustments. Even though a 2.2% increase may seem small, its impact is significant given the challenges Telus faces in expanding this legacy business. Costs were higher in the quarter because of higher compensation expense and implementation of a new billing and client care system in Alberta. The hope of Telus' management is that costs associated with the Alberta rollout will reduce costs for future rollouts.
Management suggested that much of its higher costs in the second quarter would be reduced going forward, and this is what we continue to assume in our model. At present, we're giving management--which was very contrite on the conference call while reiterating its full-year forecast--the benefit of the doubt and expect improvement in the third quarter. If we don't see signs of improvement, we may opt to lower our $52 fair value estimate.
Jonathan Schrader, CFA, is a senior stock analyst with Morningstar.
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