Value Library

The following is an excerpt from the ABC Perspective - July 2008 - Pg. 3

ABC Fund Value Favourites

CANAM GROUP INCORPORATED

ABC Fund’s unitholders should be familiar with the Canam Group story.  We originally purchased our shares through a secondary issue at $5.75 in March 2005.  By late 2007, as infrastructure stocks became front page news, Canam was trading around $14.00 per share.  With a weakening economic outlook and full valuation of the stock price, we decided that it was time to take profits.  Although Canam’s shares eventually hit a high of $15.98 four weeks later, the relative thinness and the overvaluation necessitated an early exit.

Now, just because we had sold the stock, it didn’t mean that we stopped following Canam.  As the economic data worsened, shares of Canam began to sell off, bottoming at a 52-week low of $9.40.  Canam’s lower share price provided an excellent re-entry point.  Yes, the shares were higher on an absolute basis, but the multiples were almost identical to what we paid back in March 2005.  Essentially we rebuilt a position in Canam at 1.3 times book value, 10 times trailing earnings and approximately 8.5 times forward earnings.

Today, we believe that Canam is an even more compelling investment than three years ago.  At the trough of the last infrastructure cycle in 2002/2003 Canam was unduly leveraged for a cyclical business.  Net debt totaled $333 million on $256 million of equity for a net debt to equity ratio of 1.3 times.  Currently, net debt has been reduced to only $63 million on equity of $367 million.  This massive debt reduction is significant in that Canam now has the firepower to make acquisitions at the bottom of the business cycle.  An accretive purchase in the $150 million range is easily doable given the Company’s improving financial strength.

Canam’s earnings outlook is very solid, with a revenue backlog of $291 million.  Canam has recently won contracts for the New York Red Bulls’ soccer stadium and for the Pittsburgh Penguins’ hockey arena.  The Company also recently acquired an American bridge manufacturer.  This acquisition will allow the Company to participate in the repair and rebuilding of aging bridges in North America.  Finally, Canam has turned around its money losing Mexican operation.  This joint venture is now breakeven and should add $0.20 per share to the bottom line in 2008.  At the next peak of its business cycle, we believe that Canam could earn $1.20 to $1.50 per share.

When Canam fell more than 30% after we sold our original position, we believed that investor capitulation presented a terrific opportunity.  The fact was:  we knew the Canam story, we thought highly of management and we believed that the Company’s outlook was bright.  The investment attraction of Canam is that it is thinly-traded and under-followed by the Canadian investment community.  In summary, it is our belief that stabilization of the North American economies and greater investor awareness throughout the balance of 2008 should prove quite rewarding to Canam’s shareholders.

EQUITABLE GROUP INCORPORTATED

The financial services industry has been in turmoil since the middle of 2007.  The US housing market collapse resulted in a breakdown in the asset-backed commercial paper market.  Credit tightened, assets declined in value and lenders were forced to raise dilutive capital.  The failure of a well-known and several other lesser-known financial institutions struck fear into investors.  However, we believe that this scenario presented an opportunity to purchase a high-quality financial services company, Equitable Group Incorporated (TSX: ETC), cheaply.

Equitable Group is a niche mortgage lender that avoided the three major pitfalls of the current crisis: excessive leverage, unsound lending practices and asset-backed commercial paper funding.  First, the Company’s assets-to-capital ratio of 12.9 isn’t even close to the most aggressive US lenders, which were leveraged as high as 35 to 1.  Second, Equitable is a relatively conservative lender with a high quality credit book.  In 2007, the Company realized loan losses of only $21,000 out of total mortgage assets of $2.87 billion.  Finally, the Company’s GICs remained a stable, low-cost and liquid source of funding during a period of tremendous market volatility.

We purchased our position by participating in a bought deal at $21.50 on June 25, 2008.  The Company was raising equity capital in order to meet its 2008 objectives.  Management was targeting a return on equity of 16% to 18% and net income growth of 16% to 18% while keeping total capital to assets of 13%.  With the stock priced at 8.7 times 2007 earnings, 1.3 times book value and yielding 1.86% we felt Equitable offered excellent value.  It is interesting to note that the Company last raised $25 million in April 2007 at $32.50 per share so this recent issue at $21.50 was priced very attractively.

The upside potential of our investment is demonstrated by the valuation discount between Equitable Group and its closest peer, Home Capital Group.  Equitable currently trades at 1.3 times book value and 8.7 times 2007 earnings compared to Home Capital at 3.7 times book value and 15.2 times 2007 earnings. Admittedly, Home Capital is larger, more liquid and has a higher return on equity.  Common sense dictates that Equitable can narrow this discount by growing its mortgage book and improving its return on equity.

Irwin A. Michael, CFA