Value Library

The following is an excerpt from the ABC Perspective - October 2000 - Pg. 4-5

Value Laggards

The volatility of this market has been treacherous for all investors. While the past two years have put value investors in the doldrums, the current market environment has actually left every species of investor looking for their place in the investing food chain.

Over this period, value investing has taken a backseat to Nortel, along with many other telecommunication, technology and biotechnology stocks. We have watched the prices of these high-flying stocks soar to record levels while the fundamentally strong old economy stocks have hit rock bottom. But recently many of these overvalued stocks have been under a great deal of pressure. It seems that this sporadic, risky environment may be giving investors the jitters. Our feeling is that uneasy investors will begin to flock to the security of lower risk and higher income value investments.

It appears that the current market and economic behaviour has classified the financial sector as a stable investing arena. With an economic slowdown on the horizon, the need for interest rate increases will be reduced. This will prove to be very positive for the banks. In fact, this sentiment has already begun to be reflected in the market, with most of the big banks trading near their 52-week highs.

As value investors, a stock trading near its 52-week high is not exactly something we would like to tuck in our portfolio. But, we must remember that the big six banks are not the only institutions in the financial sector. Once they are perceived as fully-valued investments, we may see investors moving down the food chain to the second tier banks such as Laurentian Bank or Canadian Western Bank and then to other financial institutions such as credit unions.

As can be seen in the stocks highlighted below, ABC Funds has seized the opportunity to take advantage of this upward trend through many undervalued financial holdings in our portfolio. Also highlighted below is an undervalued telecommunication stock, along with three fundamentally cheap, old economy holdings.

Laurentian Bank of Canada

Laurentian Bank has shown considerable improvement since our last ABC Perspective. As expected, management targeted Laurentian’s net interest margin and its efficiency ratio in order to return to acceptable levels of profitability. This strategy was validated, as the return on common shareholders’ equity grew from 8.1% in 1999 to 12.4%. In addition to improving profitability, Laurentian acquired 43 bank branches in Quebec in order to expand its operations and client base. Notably, the Bank issued 2.5 million shares as partial payment for this purchase. Laurentian Bank’s recent share price appreciation demonstrates returning investor interest in this fundamentally attractive bank.

Surrey Metro Savings Credit Union

Surrey Metro, with its B.C. customer base, has grown to become the second largest credit union in Canada. Currently trading at $12, Surrey Metro experienced considerable volatility in 1999 with two unsuccessful merger attempts. Also, being an illiquid, small capitalization stock that is under-followed by investment analysts has hindered Surrey’s stock price performance. In spite of its present price weakness, we feel that Surrey Metro is a fundamentally attractive company. Trading at 29% below its year-end 2000 estimated book value of $17, yielding 3.2% and having purchased 145,300 shares out of a 5% or 272,732-share buyback, Surrey Metro is grossly undervalued.

Dundee Bancorp

Dundee Bancorp is a merchant banking and financial services holding company that provides wealth management services, manages the Dynamic Mutual Funds and operates Dundee Securities. Dundee Bancorp reported substantial revenue and asset growth in the first half of 2000, reflecting the recent acquisition of Fortune Financial. Despite good operating results, Dundee was still trading at a discount to its net asset value. In an effort to improve the Company’s valuation, management announced a normal course issuer bid for approximately 10% of its common shares. We believe that this buyback represents a good long-term use of funds for Dundee Bancorp and its shareholders.

MFP Financial Services Ltd.

MFP is a niche provider of technology and equipment leasing and financial services to large public and private North American companies. Trading at a 20% discount to an estimated September 2000 book value of $13, this under-followed, small capitalization company trades at a 5.6 times estimated March 31, 2001 year end earnings of $1.80. Moreover, MFP just increased its dividend to $0.60 for a 5.9% dividend yield. MFP is overcapitalized and has just filed a 5% or 510,000-share buyback. It has been cutting expenses, has an improving 2001-2002 earnings outlook and no controlling shareholder.

Regional Cablesystems

Regional Cablesystems is a Canadian rural cable operator based in St. John’s, Newfoundland with over 242,000 basic subscribers. Regional Cable is extremely undervalued relative to the larger cable companies. It is trading at under $1,500 per subscriber versus over $2,500-$3,000 for the larger cable operators. Though Regional Cable is relatively illiquid and is the smallest publicly traded cable company, it is comparatively more profitable. The company has reported positive earnings since the first quarter of 1996. With only 24% of its subscribers regulated by the CRTC, its systems are predominantly non-price regulated. We feel that Regional Cable is a well-run company with considerable future growth and net asset value potential.

Fishery Products International

Newfoundland-based Fishery Products is one of North America’s leading seafood companies. FPI is an old economy, under-followed fundamental value play trading at 0.85 times book value with a dividend yield of 1.7%. Instituting an annual dividend of $0.12 per share in 1999, the first since 1988, is a reflection of the company’s improving operations. In addition, FPI announced a 3.3% or 500,000 share buy back. 

Fletcher Challenge Canada

Fletcher, a B.C.-based producer of pulp and newsprint continues to be one of our favourites in this sector. The company enjoys a pristine balance sheet with a huge cash position of $855 million or $6.90 per share. It is trading at 0.9 times its book value of $17.07 and yielding almost 4%. As an under-leveraged company it has many options for the use of its cash position such as a levered buyout, paying a large cash dividend or purchasing attractive acquisitions. While awaiting the catalyst, the company is a huge potential beneficiary of rising commodity prices

Hudson’s Bay Company

Hudson’s Bay runs Canada’s largest retail-department store chain under the well-known banners of The Bay and Zellers. In light of its new operational strategies and steady progress, Hudson’s Bay remains extremely undervalued. It is presently trading at only 0.5 times its $31.02 book value with a 2.3% dividend yield. The company has recognized its low market valuation and as a result has instituted a 3.5 million or 5% share buyback plan. Hudson’s Bay’s overall corporate debt now stands at $962 million, which is $69 million less than last year. We believe that Hudson’s Bay’s management plan is progressing well in an extremely difficult and challenging retail market.

We made a few significant changes to our portfolio during the quarter ended September 30. In particular, we wish to discuss the sale of our holdings of Industrial-Alliance and Westcoast Energy. We believed in both of these companies and feel that a brief comment is warranted. We do not wish to imply that these companies will not appreciate further but rather that we identified other opportunities that may hold greater potential.

Industrial-Alliance

We purchased Industrial-Alliance when it demutualized in February of this year. As IAG appreciated in price, we reviewed each of the company’s quarterly financial results and raised our target price three times. When Industrial-Alliance was included in the TSE 300 index, the stock rose sharply and traded heavily due to index buying. We seized this opportunity and sold our entire position for a substantial gain.

Westcoast Energy

We originally purchased Westcoast Energy for its defensive nature during a turbulent market clouded by the anticipation of interest rate hikes. As the market outlook became more favourable, Westcoast became less attractive relative to other opportunities. Our disciplined approach to investing demanded that we reallocate our capital in the belief that the market will reward our efforts.

Irwin A. Michael, CFA