From Individual Investor -
I highlighted CKEY's part.
Thursday June 22, 12:00 pm Eastern Time
Individual Investor
Other: Canada Nears Economic Hat Trick
By: Judith Graham (06/22/00)
O, Canada!
Oil and gas, hydroelectric power, pulp and paper, minerals and fish - and
let's not forget hockey - are just a handful of industries typically viewed
as driving the Canadian economy.
While there's some truth to that generalization - Canada is the world's
largest exporter of zinc, uranium, potash, and asbestos, in addition to
being the biggest exporter of timber, pulp and newsprint, and one of the
world's largest fish exporters - in recent years, services and
manufacturing have emerged as key drivers of the Canadian economy.
Canada has begun to lose some of that commodity-based economy
reputation as tech names such as JDS Uniphase (NASDAQ: JDSU -
news) and Nortel Networks (NYSE: NT - news) have wowed Wall Street
in the past year.
Canadian companies may be poised to stage an economic hat trick - continued growth in three main
sectors -technology, commodities and financial services.
After weathering a recession, multiple international market crises and currency issues in the past
decade, the Canadian economy is showing more positive signs of life. Last year, it grew a robust 4.2%.
Merrill Lynch forecasts 4% growth this year, while Salomon Smith Barney sees 4.25%, and some
strategists expect growth as high as 4.5%. Regardless, they're all well ahead of the 3.5% growth rate
projected by the Conference Board of Canada.
The Toronto Stock Exchange's (TSE) recent performance provides further evidence of Canada's
economic upturn. Its gains have far exceeded the New York Stock Exchange in the past year. The
TSE 300 outperformed the S&P 500 last year, rising 31.7% in Canadian dollar terms. And last year
Americans also bought $16.9 billion worth of Canadian stocks - more than double what they
purchased in 1997.
Foreign inflows into Canadian equities have already been running at their strongest in well over a
decade,`` says Karim Basta, a global strategist at Merrill Lynch. ''It's a market that's already been
discovered in last six to nine months. But I think it will continue to do well, and it's a market that has
proved itself to be part of (investors') regular scope.``
In a survey conducted late last year by Broadgate Consultants with 23 U.S. institutional investors, all
respondents said they intended to increase or maintain their Canadian holdings in the next 12
months.
That trend is a notable departure from foreign investors' sentiments toward Canada for the better
part of the1990s, during which the country's debt-to-GDP ratio hit a high of 99.2% and it struggled
to maintain credibility.
After emerging from deep recession in the early '90s, the Canadian economy was fraught with slow
growth, high taxes, spending cuts and high unemployment. Commodity prices rose in 1994, but the
Canadian dollar didn't budge, under pressure from the effects of the Mexican peso crisis and political
uncertainty surrounding the 1995 Quebec referendum.
Then when the Asian economic crisis hit in 1997, the Canadian economy suffered another blow as
demand for commodities slipped (Canada's economy depends more on foreign trade than most - its
imports and exports are equivalent to 82% of the GDP versus 24% in the U.S. and 21% in Japan).
Meanwhile, the U.S. economy was booming.
But now, as Asian countries recover and commodity prices rise, Canada's economy is looking up. In
fact, export prices are rising faster than imports. And even a U.S. slowdown at this point is unlikely to
thwart Canada's economic momentum.
''Things look very good,`` says Jim Johnson, vice president and dollar bloc economist specializing in
Canada at Morgan Stanley. ''A U.S. slowdown will cause Canada to slow, but it won't send Canada
into recession. Traditionally, when the U.S. sneezes, Canada catches a cold. But maybe it will be
different this time because [Canada] has tremendous domestic momentum. Canada's budget is in
excellent shape. It's on the verge of prosperity it hasn't seen since the '60s. Canada is today where the
U.S. was in 1996.``
Further assisting the country's upward economic shift, Quebec's ongoing political issues have abated
for the time being, and inflation will likely remain benign. Strategists also predict a rise in the
Canadian dollar.
''Commodity price movement still explains a lot of [Canada's] currency movement,`` Johnson says.
''The Canadian dollar is still fairly cheap right now. That helps in the way that currency is able to
provide additional incentive - it lowers the cost of research and doing business. We're optimistic that
U.S. investors in Canadian companies will get a bit of a return from the Canadian dollar. We do
think it's undervalued and the currency can give some extra kick.``
As the U.S. economy slows to a simmer, Johnson says all three dollar-bloc countries - Canada,
Australia and New Zealand - will see their currencies improve. He says the Canadian dollar
weakness is really the result of U.S. dollar strength.
Considering Canada's current low inflationary environment, once the U.S. economy slows, the
Canadian dollar could strengthen, provided commodity prices remain at current levels or climb
higher. Half of the Canadian dollar's volatility is explained by commodity prices, Johnson says.
However, assuming the U.S. economy does slow, Johnson sees the Canadian dollar rising to $0.72 to
$0.74 versus the U.S. dollar by year-end.
Given the projected economic strength north of the border, several Canadian companies should
enjoy continued prosperity in the months ahead, analysts said.
TECHNOLOGY
While less tied to the Canadian economy as energy and financials, the technology sector, led by
heavyweight Nortel Networks (it comprises 26% of the TSE 300's market value), should further
outperform as growth persists. The usual tech suspects aside, a number of tech companies, particularly
in the wireless segment, show particularly promising growth prospects.
724 Solutions
One such company is Toronto-based 724 Solutions (NASDAQ: SVNX - news), whose technology
enables investors to trade over handheld devices, such as cellular phones and Palm Pilots. As the
consumer world moves toward high-speed wireless access, 724's technology is poised to benefit from
the next evolutionary stage in investing.
The company's customer list already includes such big names as Citigroup (NYSE: C - news), Bank of
America, (NYSE: BAC - news) and Wells Fargo (NYSE: WFC - news), with whom it will be fully
operational by fall. The company plans to add another three or four major bank customers this year.
724 has also entered into strategic agreements with Palm (NASDAQ: PALM - news), Qualcomm
(NASDAQ: QCOM - news) and Ericsson (NASDAQ: ERICY - news) to develop applications that
will enable investors to perform various tasks through new wireless Web initiatives. In March, the
company agreed to buy ezlogin.com and YRLess Internet Corp. to increase the services offered with
its software for banking and financial transactions over wireless devices.
Following its initial public offering (IPO) in February, 724 shares surged to $240. But they've since
dropped off to about $50 in the aftermath of April's tech sell-off, which presents an attractive
buying opportunity. While profitability is still a long way off, revenue is expected to reach $19 million
this year and $47 million in 2001. For the first quarter, 724 booked $3.1 million in revenue, up from
$400,000 in the fourth quarter.
Clearnet
Clearnet Communications (NASDAQ: CLNT - news) could be a clear winner this year. The
Canadian wireless provider will be the first of its peers to roll out wireless data and Internet services
in the second half of the year.
It will also introduce a pre-paid wireless service, something that Clearnet's competitors, such as
Microcell (NASDAQ: MICT - news), have been using to garner the lion's share of new subscriber
growth. About 50% of all new Canadian wireless subscribers sign up through pre-paid services.
What's more, the company has some high-end phones that are hitting the market, the potential to
outbid others for spectrum in the government's auctions this fall, and it is an attractive takeover
target with its nationwide PCS (personal communication service) wireless network and mike network
(for two-way messaging).
Jeff Hines, a Deutsche Banc Alex. Brown analyst, expects Clearnet's subscriber (subs) growth to
accelerate from 62,500 new subs in its second quarter to 150,000 new subs by the fourth. He also
believes Clearnet will see a boost in its average revenue per unit or subscriber (ARPU) as people get
more use out of the phones and spend more money on the new services.
Losses still plague the company's income statement, however, with a $7.04 per share loss expected for
this year. But with the Canadian mobile market just 23% penetrated at the end of the first quarter,
there's plenty of room for growth. Its shares are now trading around $31.75.
CrossKeys
Little-known Crosskeys Systems (NASDAQ: CKEY - news) looks poised to make a big splash from
its perch in the Great White North. The company, which develops software for telecom service
providers, is rolling out new products, and is seeing a great deal of interest from potential customers.
Advance buzz about those new products sent the company's stock up to $14 in early March, but the
broader market sell-off brought the shares back down to a recent $6.25.
Over the last year, Crosskeys has been weaning itself from its traditional role as a provider of services.
In addition, roughly 80% of sales went to just two companies -- Newbridge Networks (NYSE: NN -
news) and Siemens every year. Weaning itself from those relationships has caused sales to plunge
20% through the first three quarters of the current fiscal year.
Leveraging the existing relationships, Crosskeys is now pushing a new suite of software products that
ensure that telecom networks stay stable and operative. And sales efforts are starting to bear fruit.
Though overall top line growth is advancing only slightly on a sequential basis, results would be even
more robust were it not for a continuing decline in service-related sales.
As an intriguing kicker, Crosskeys recently acquired a small company that helps Internet Service
Providers (ISPs) control how their bandwidth is being deployed. Ongoing bandwidth constraints
continue to slow the Internet. Many providers are offering tiered pricing that let a customer choose a
desired amount of bandwidth. Crosskeys' newly acquired software provides just such a service.
Management recently indicated that this new effort, known as Dyband, is generating a lot of interest
from ISP, although it's too soon to call the timing of a revenue ramp.
ENERGY
As oil and natural gas price increases continue to lift the revenues of Canadian natural-resources
companies, energy companies could rise on Canada's economic strength.
''Canada is cheap when you look at the global oil patch,`` says Robert Spector, a senior Canadian
economist and strategist at Merrill Lynch Canada. ''The fundamentals look good because oil prices at
roughly $23 a barrel are discounted in these markets. There's quite a big valuation gap.``
Talisman Energy
One industry favorite is Talisman Energy (NYSE: TLM - news), one of Canada's largest oil and
natural gas producers. In addition to its considerable Canadian assets, Talisman has substantial
reserves and production in the U.K. North Sea, Indonesia and Sudan, giving it greater international
exposure than most of its peers.
Trading just north of $32, Talisman has already reaped the rewards of its international operations.
For the first quarter, the company reported a 51-fold profit increase as it began pumping oil in
Sudan and bought new oilfields in the U.K. North Sea. Profit rose to $0.98 per share from a loss of
$0.06 per share in the year ago period, beating analysts' average $0.86 per share estimate. Sales also
more than doubled to $627.5 million.
With production growth of 35% and leverage to high oil and gas prices fueling year-over-year cash
flow gains of 75%, Talisman continues to trade at a 40% discount to its peers. Analyst Tom
Covington of A.G. Edwards & Sons projects Talisman will have matched last year's record cash flow
of $1 billion in the first six months of this year.
However, protests against Talisman's involvement in Sudan could lead the company to sell its stake
in the Sudan oil project, according to recent news reports. Human rights groups have said doing
business in Sudan is helping to finance the country's civil war. Talisman's stake in the Greater Nile
Project Operating Co. in Sudan contributed 42,100 barrels a day in the first quarter.
However, Covington says he doesn't believe Talisman is seriously considering selling its stake. He
warns that there is still some slight risk, but says investor aversion to the project is dissipating as the
political situation improves. If Talisman was to sell the stake, Covington says it would probably
expand its multiple for the short term, but shouldn't have any serious long term ramifications.
Other Canadian energy industry favorites include Alberta Energy (NYSE: AOG - news) and
Canadian Occidental (NYSE: CXY - news).
FINANCIALS
Canadian banks should also benefit from current economic trends. With most trading around 10 or
11 times earnings, Canadian banks are currently the cheapest in the world and have the strongest
earnings growth potential, says Merrill Lynch's Spector.
''You've got an environment where you see the Fed and the Bank of Canada on hold probably
indefinitely, you have a favorable interest rate backdrop and bond rates are coming down. It's a very
good time for financials to outperform the broader market,`` Spector says.
Toronto-Dominion and Royal Bank of Canada
Canadian banks have already attracted numerous investors this year in search of companies with
solid profits. hey boosted the financial services index to its highest level in over a year as Canada's six
largest banks reported second-quarter profit at 23% above the year ago period. At
Toronto-Dominion (NYSE: TD - news), profit rose 50%, while Royal Bank (NYSE: RY - news) saw
a 30% profit growth.
Unlike Royal Bank, which bought the country's biggest brokerage, RBC Dominion Securities,
Toronto-Dominion went the discount brokerage route and built its own investment bank. It took a
place on the international stage when it bought New York-based Waterhouse Investors Services in
1996. The discount brokerage, renamed TD Waterhouse, now accounts for 20% of
Toronto-Dominion's earnings.
That said, Toronto-Dominion has under-performed the Canadian bank sector almost 30%
year-to-date despite its stronger growth prospects. Toronto-Dominion's banking business trades at
10.5 times projected 2001 earnings, in the middle of the range for the entire sector, making its shares
undervalued. Goldman Sachs projects a 12-month target price of $34 per share - 33% above current
levels. Toronto-Dominion shares currently trade around $25.
On Tuesday, Royal Bank, which continues to expand through acquisition - lapped up U.S. insurer
Liberty Insurance for $580 million. The company trades closer to fair value at $51. However, its solid
fundamentals give it little downside risk. If the company continues to grow earnings above sector
averages, its shares could appreciate in line with earnings growth. Goldman Sachs projects a
12-month Royal bank price target of $54.
Bottom Line:
A number of Canadian companies in a variety of sectors are under-valued and poised for growth.
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