In This Issue

ENERGY BOUNCES BACK

By Gordon Pape

Suddenly energy stocks are sexy again. How quickly things change!

Back in January, I wrote that the sector was in a state of uncertainty, faced with a shortage of delivery capacity and forced to accept deep discount pricing. In December, Western Canadian Select had fallen to a record discount of $42.50 a barrel compared to West Texas Intermediate (WTI) crude. The Premier of Alberta expressed concern and frustration over the “bitumen bubble” as oil and gas stocks languished.

The markets reflected this angst in the first half of the year. The energy sub-index, one of the most important components of the TSX, was off by 2.3% for 2013 as of the end of June. But what a difference a month makes! Energy stocks turned around in July, posting a gain of 5.7% as of the close of trading on July 26.

What happened? In simplistic terms, all the stars aligned. Well, almost all of them – we’re still awaiting word on the fate of the Keystone XL pipeline which could be the biggest catalyst of all.

Obviously, the increase in oil prices in recent weeks has been one of the main drivers in the sector’s rebound. It’s not just the fact that the WTI price has soared to well over $100 a barrel. Equally important is the fact that it is now trading at close to par with North Sea Brent, which has been priced at a premium for years. For Canadian producers, the fact that the discount on Western Canadian Select has dramatically declined is also critical. As of July 23, Bloomberg reported that the discount was down to $22 a barrel.

Unrest in Egypt and other parts of the Middle East has been a factor in this but there is much more to the story. For starters, the plug has been pulled from the oil lake in Cushing, Oklahoma. It is a terminus for production from across the continent but until now the infrastructure to move product to refineries has been inadequate. In January, there was a record 51.9 million barrels in storage at Cushing, Bloomberg said.

That is quickly changing. The Seaway pipeline, in which Enbridge (TSX, NYSE: ENB) is a partner, has been reversed and expanded and now moves 400,000 barrels a day to Gulf Coast refineries. Work on TransCanada’s (TSX, NYSE: TRP) 485-mile Gulf Coast pipeline from Cushing to Nederland, Texas, is well advanced. It’s actually a section of Keystone that was hived off to avoid Washington’s maddening bureaucracy. It is slated to come on stream later this year with an initial capacity of 700,000 barrels a day with the potential to transport as much as 830,000 barrels daily.

As a result, there has been a much bigger drawdown in oil surpluses than analysts expected. Less supply almost automatically equates to higher prices.

Another factor in the oil price rise is the refurbishing of the BP refinery in Whiting, Indiana. It is expected to reopen later this year with 85% of its capacity devoted to heavy oil.

The role of railroad transport has also been significant in the turnaround. CN Rail (TSX: CNR, NYSE: CNI) reported that petroleum and chemicals generated $478 million in revenue in the second quarter, a gain of 18% over the same period last year. That makes the category the second-largest contributor to CN’s coffers after intermodal transport.

The tragic events at Lac-Mégantic were a grim reminder to the industry, and the country, that the opportunities presented to the railroads by the shortage of pipeline capacity also increase the dangers of major disasters. Both CN and CP have pledged to review and upgrade their safety procedures to reduce the risk of a comparable wreck on one of their lines but the possibility is always there.

Despite this, there has been no notable push-back against moving oil by rail from politicians and the public. There seems to be a general acceptance that this is a price that must be paid to keep oil (both U.S. and Canadian) moving, at least until such time as the pipeline issues are clarified.

Of course, the oil boom could reverse itself quickly if the global economy falters, thereby reducing demand. Nothing is certain. But as things stand right now, the outlook for Canada’s energy industry is certainly brighter than it was six months ago. The uncertainties are still there, but companies are coping and the prospects for improving returns are better than we’ve seen in a long time.

 

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GORDON PAPE’S ENERGY UPDATES

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Cenovus Energy (TSX, NYSE: CVE)

Originally recommended by Yola Edwards on Oct. 23/06 (#2638) at C$25.93, US$23.06. Closed Friday at C$30.45, US$29.65. Updated by Gordon Pape.

Cenovus shares had been on a nice little run until the company released its second-quarter results on July 24 and the bottom fell out. Although oil sands production was up by 17% and total oil production by 10%, cash flow, operating earnings, and net income were all down. Profit took the biggest hit, falling 55% to $179 million ($0.24 a share) from $397 million ($0.52 a share) in the same period last year. Second-quarter earnings just about matched the dividend payout. Those numbers were well below estimates and the stock sold off sharply losing $1.76 or about 5.5% on the day.

Several one-time costs contributed to the drop in profit. The company’s chief financial officer, Ivor Ruste, was quoted in The Globe and Mail as saying these included a $63 million pre-exploration charge for a conventional oil development, a $57 million impairment from an asset sale, and a $46 million exploration charge for a tight oil project in Saskatchewan.

The bottom line was also affected by higher operating costs at the company’s two big oil sands developments. At Foster Creek, the cost of producing a barrel of oil rose from $12.49 last year to $16.19. The increase at Christina Lake was even worse, from $12.52 to $16.83.

The results took some of the steam out of the recent surge in oil stocks and left investors wondering what to expect from the other major players when they report.

Although the numbers weren’t good, Cenovus remains one of the lowest-cost producers in the oil sands and has excellent growth potential. The company expects to triple its production to about 600,000 barrels per day by 2018-19.

Action now: Buy. Take advantage of the pull-back to establish a new position or add to an existing one.

Suncor Energy (TSX, NYSE: SU)

Originally recommended on June 12/06 (#2622) at C$41.36, US$37.57 (split-adjusted). Closed Friday at C$32.60, US$31.77.

Suncor’s results won’t be released until July 31 so I’ll provide a more complete update after we have seen the numbers. However, the company has released its 2013 Report on Sustainability which examines its role in improving environmental conditions. Highlights include:

Water management: The company is aiming to reduce fresh water consumption by 12% from 2007 levels by 2015. To achieve this, around 10,000 cubic metres per day of tailings water is now used as in situ makeup water instead of being stored in tailings ponds. An equivalent amount of water will be recycled at the mining site, reducing the amount of fresh water Suncor needs to withdraw from the Athabasca River. 

Land and biodiversity. Suncor’s goal is to increase reclamation of disturbed land area by 100% by 2015 (from 2007 levels). By the end of 2012, Suncor had planted nearly six million trees on its oil sands site, including 900,000 in previous 12 months. 

Air quality. Suncor’s environmental performance goal for air emissions aims at a 10% reduction by 2015, compared to 2007 levels. Overall, total reported air emissions in 2012 decreased by 8.7% compared to 2011 levels.

Energy intensity and greenhouse gas emissions. The company has a goal of improving energy efficiency by 10% by 2015. Currently, it is working to implement an Energy Management System at all of its major facilities. Suncor says the system will improve the measurement, control and governance of energy and is expected to result in an improvement of 2%-3% in energy/GHG intensity through better operational control. 

Suncor stock has gained 5.2% so far this month. It finished the first half at $31 on the TSX and closed on Friday at $32.60.

Action now: I’m upgrading Suncor from a Hold to a Buy on the basis of new strength in the industry.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (#21114) at C$10, US$10.44. Closed Friday at C$8.82, US$8.59.

Drilling stocks have moved up along with the fortunes of the oil companies and Trinidad has been no exception. When I last looked at the stock in mid-March it was trading at C$7.11, US$6.80 and showing no sign of momentum. The shares actually dropped a little further after that but then started a strong upward move in early May that is continuing.

First-quarter results were not very good (second-quarter figures will be released on Aug. 7). Revenue was down 5.1% to $247.2 million and funds from operations were off 9.1% year-over-year to $64.9 million. Net earnings were down 5% to $32.7 million and adjusted net earnings showed an even bigger drop of 16.8% to $35.5 million ($0.29 per share).

CEO Lyle Whitmarsh said: “Industry conditions were weaker this quarter than the same time last year; however we are beginning to see signs that the second half of 2013 could provide opportunities for growth, either through reactivating existing rigs or by adding new equipment. Trinidad’s growing free cash flow and improved financial flexibility positions us well to take advantage of the opportunities as they arise.”

Investors appeared to take these comments at face value, pushing the stock higher despite the weak financial numbers. The second-quarter results will give us a better idea as to whether this confidence is justified.

Action now: Hold.

Ensign Energy Services (TSX: ESI, OTC: ESVIF)

Originally recommended on June 9/08 (#2821) at C$22.20. Closed Friday at C$17.49, US$17.12.

Ensign is another energy service company that has been on a roll. After tumbling to just over $15 a share in early May, the stock has turned around and ridden higher on the increase in the price of oil.

Like Trinidad Drilling, Ensign experienced a weak first quarter. Revenue fell 14% to $581.1 million, funds from operations dropped 21% to $140.6 million, and net income was off 38% to just under $65 million ($0.45 a share). The company blamed reduced operating activity in North America for the decline and the share price reacted negatively to the news.

Ensign was somewhat less bullish than Trinidad in its outlook statement for the rest of the year, with several qualifiers and cautions. While noting that general economic conditions in North America appeared to be improving, management said that growth in Asia is slowing and that serious problems persist in Europe.

“While we are optimistic about energy commodity prices, caution is warranted regarding drilling levels in the near term, as there is a relatively high backlog of previously drilled wells, and the impact of new technologies such as pad horizontal programs in resource plays is changing industry dynamics,” the company said. “We continue to believe it may take several quarters to restore stability in market forces.”

Those aren’t exactly inspiring words, yet the stock is up about $3 a share since its May low. The second-quarter results may provide some justification for this but investors should wait and see before making purchases at the current level.

Ensign has renewed its normal course issuer bid, which allows it to repurchase about 4.6 million shares, equal to 3% of the public float. The original bid period ran until June 17 but it was an all talk, no action situation as the company did not buy any shares in the open market.

The company paid a second-quarter dividend of $0.11 a share on July 5.

Action now: Hold.

Penn West Petroleum (TSX: PWT, NYSE: PWE)

Originally recommended on Feb. 18/08 (#2807) at C$28.44, US$28.22. Closed Friday at C$12.47, US$12.13.

Most of our energy stock picks have seen a nice uptick recently. Penn West is another matter, however. This company is really struggling. It recently announced yet another managerial shake-up aimed at “further streamlining and focusing its management structure”. Responsibilities were shuffled, three members of the executive team left, and the company said its new focus would be on “production delivery”.

Maybe it will work this time but investors have already been badly bruised by lack of direction and deteriorating numbers. We’ve waited long enough. Take the loss and move on.

Action now: Sell. – G.P.

 

A MYTH DEBUNKED

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Contributing editor Ryan Irvine is with us this week with a close look at one of the classic theories of investing. Ryan is the CEO of KeyStone Financial (www.keystocks.com) and is one of Canada’s leading experts on small-cap investing. He is based in the Vancouver area. Here is his report.

Ryan Irvine writes:

It always happens. Five months into every year we hear that cute little rhyme: “sell in May, and go away”.

The theory of bailing out of the markets before summer has been around for decades and repeated so often that it’s almost taken as gospel. Talking heads, pundits, and analysts alike trot out this poetic quip as a simplistic method to outperform the market through seasonal investing. Five to seven years of schooling, 10 to 30 years of market experience, and this is all we have for the investing public? Really?

According to the Stock Trader’s Almanac (or perhaps the Farmer’s Almanac), since 1950 the performance of the Dow Jones Industrial Average has significantly lagged during the May-October period, compared with the November-April period.

While the exact reasons for this seasonal trading pattern are not known, lower trading volumes due to the summer vacation months and increased investment flows during the winter are cited as contributory factors.

In essence, the strategy suggests that investors who sell their stock holdings in May and get back into the equity market in November, thereby avoiding the typically volatile May-October period, would be much better off than an investor who stays in equities throughout the year.

Of course, the very essence of an “investor” is an individual who takes a long-term approach. That’s our approach so I find it difficult to classify one who sells each year based on the turn of a calendar and later buys back in again as a true investor.

Rather than digressing into a lecture on the failings of basing financial decisions on a solitary historical stat, I thought it would be more useful to take a look at how this strategy has fared since 2009. Since “Sell in May” can either refer to the start or the end of the month, we split the difference and assessed market performance from the middle of May until the end of August.

Starting with the current year, we don’t yet have a full set of data points to work with. But as we entered July, it did indeed appear that users of this strategy would be basking in the success of their apparent intelligence. As at May 15, the TSX was sitting at 12,473 and after continuing to climb until the end of the month, markets subsequently dropped to a yearly low of 11,836 on June 24.

Yet in spite entering the summer doldrums, markets have since climbed almost back to yearly highs with the TSX closing at 12,648 on July 26. Obviously we cannot yet draw any conclusions from 2013 at this point and the proponents of “Sell in May” may very well be proven to be correct as we continue to the end of the summer. We do however have complete data for previous years which is summarized below.

  TSX – May 15 TSX – August 31 Difference
2012
11,343
11,949
5.3%
2011
13,391
12,768
-4.6%
2010
11,813
11,913
0.8%
2009
9,762
10,868
11.3%

This table illustrates that the “Sell in May” strategy has been effective in only one of the four full sample years used in our analysis. The year was 2011 and we must also remember that the timing of the market decline that year coincided with a spike in negative sentiment related to the credit crisis in Europe and probably had relatively little to do with the month of the year or summer vacations in the Hamptons. We should also take into account that the price information in the table does not include the dividends which would have been lost by any investor who pursued the seasonal strategy.

Of course, our analysis accounts for a relatively short time horizon and we certainly need to be careful with any conclusion we draw. But we would suggest that the most prudent course would be not to draw any conclusion at all, except to say that any overly broad and black and white strategy (including seasonal investing) cannot be relied upon or considered to be intelligent investing.

If we are to assume this historical summer underperformance had something to do with a lack of interest in the market over the summer months then we should also adjust for the fact that, cell phone in hand, almost anywhere in the world and at any time, we can now make a trade. While lower volumes are a relative reality, summer months are no longer unplugged from the markets.

In the end, we buy stocks based on balance sheets, valuations, dividends, and growth potential, not the turn of a calendar. We suggest you do the same.

RYAN IRVINE PICKS PAREX RESOURCES (TSX: PXT, OTC: PARXF)

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This month, we introduce a new junior international oil producer. Headquartered in Calgary, Parex Resources Inc., through its direct and indirect subsidiaries, is engaged in oil and natural gas exploration, development, and production in South America and the Caribbean region. Parex is conducting exploration activities on its 1,349,000 gross acre holdings, primarily in the Llanos Basin of Colombia, and 219,000 gross acre holdings in onshore Trinidad. Parex is a Canadian company.

Parex was originally incorporated on Aug. 17, 2009 for the purpose of completing the takeover of Petro Andina Resources Inc. (the company Parex was spun out of) by Pluspetrol Resources Corporation N.V. Petro Andina shareholders received $7.65 per share in cash and one share of “ExploreCo,” which essentially became Parex. Under the takeover arrangement, PetroAndina’s Argentina assets were acquired by Pluspetrol in late 2009. Petro Andina’s assets in Trinidad and Tobago and Colombia were transferred to Parex and marked the birth of the Colombia light oil producer we are recommending today.

Recent Financial Results

On May 14, the company reported that average first-quarter production was 14,440 barrels per day (bopd), an increase of 13% over the fourth quarter of 2012. The company realized a Brent referenced sales price of $109.63 per barrel ($/bbl) and an operating netback of $67.03/bbl. Parex generated funds flow from operations of $60.2 million ($0.56 per share basic) as compared to $0.50 per share for the previous quarter. This included a net build of crude oil inventory of 97,890 bbls. Funds flow has increased due to continued strong operating netbacks, production growth and exploration success.

The company’s capital expenditures were $47.2 million in the first quarter, of which $45.6 million was related to Colombia and the remainder in Trinidad. Capital expenditures were fully funded from funds flow from operations. Working capital surplus at period end was $17 million compared to a working capital deficit of $12.7 million in the previous quarter. Working capital also reflects Parex’s 196,689 bbls of crude oil inventory valued at cost. The company had bank debt of $20 million on a current available facility of $100 million and a cash balance of $26.8 million.

Outlook

The 2013 average production guidance was provided in January at 14,000-14,500 bopd. As a result of current production and reserves and adding the proposed Cabrestero acquisition along with the planned development activity, Parex is increasing its 2013 full year average production guidance slightly to 14,500-15,000 bopd. The company believes that the increased production guidance can be achieved within the existing capital expenditure budget of $210 million. Parex is awaiting further production history from its successful year-to-date drilling program before considering an additional increase in production guidance.

The mid-year reserves disclosure gives us increased confidence that Parex is adding significant reserves in a very cost-efficient manner. The reserves increase takes Parex’s proved plus probable reserves life to approximately 4.5 years (from approximately 3.5 years previously), which may increase attraction to the stock for some investors.

From a valuation perspective, Parex compares favourably to its peers on a cash flow basis. Price-to-cash flow on a trailing basis is very low at 2.15 and Parex trades at a substantial discount on its 2013 enterprise value to cash flow basis. The company also holds a relatively unlevered balance sheet which allows flexibility and financial strength. The significant cash flow is supporting an aggressive CAPEX (exploration and development) program and the significant free cash flow could be directed to further acquisitions and/or continued share buy-backs.

With the stock in the low to mid $4.00 range prior to the reserve announcement, we believed that the update would force the market to recognize that Parex’s valuation had become unsustainably cheap relative to its peers. To a degree, this has occurred with the stock moving to $5.38 but the valuations continue to look attractive mid-term, particularly with the increase in crude prices. While we stress that it remains pure speculation, it does appear that Parex continues to have many characteristics of a take-out target if the valuation gap is not adjusted.

We believe Parex has a solid management team with extensive Latin America experience. The team has shown the ability to operate, grow and monetize assets similar to those that they are putting together in Parex by growing, developing, and later selling Petro Andina Resources, thereby generating significant returns for shareholders. With an 8% ownership ($45 million) stake in Parex, management is aligned with shareholders.

Action now: We rate Parex Resources as a Buy for readers with above average risk tolerance. The stock should be viewed as speculative due to its above average geopolitical risk. Also, we normally assign a higher risk level to resource producers as they are dependent largely on the prices of the commodities they produce and on the continued risk of successful exploration. At present, Parex’s risk/reward ratio appears favourable. The shares closed on the TSX on Friday at $5.38 and on the U.S. over-the-counter Grey Market at US$5.23.

RYAN IRVINE’S UPDATES

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Exco Technologies Limited (TSX: XTC, OTC: EXCOF)

Originally recommended on Feb. 27/12 (#21208) at C$4.25, US$4.22. Closed Friday at C$6.48, US$6.02 (July 17).

Exco Technologies was recommended in February as a Buy at $4.25. With the stock trading at $6.48, we update our rating with the release of the company’s third-quarter 2013 financial results.

With roots that date back to 1952, Exco is a global supplier of innovative technologies servicing the die-cast, extrusion and automotive industries. Headquartered in Markham, Ontario, Exco, through its ten strategic locations, employs 2,207 people and services a diverse and broad customer base. Exco’s Casting and Extrusion division accounted for 62.52% of sales in the third quarter and its Automotive Solutions division accounted for the remaining 37.48%.

Revenues for the period ended June 30 rose 5% to $62.4 million from $59.2 million in the same quarter last year and were up 5% over the second quarter. Year-to-date consolidated sales were slightly weaker than last year at $180.6 million compared to $180.8 million, primarily reflecting softer sales in the second quarter.

The Casting and Extrusion segment reported quarterly sales of $38.9 million, an increase of 8% from the same period last year. Sales at the large mould group, the largest contributor in this segment, increased by just over 10%. This group experienced strong sales as its product mix between higher priced new dies and lower priced rebuilds/repairs was more favorable. During the quarter this group delivered its first silifont die for a structural part. There are another seven dies for this program and management is optimistic that the company’s decision to enter the silifont structural part die market will result in additional programs. Demand for spare parts in this group is also strong and continues to build, causing inventory to climb.

Sales at Castool increased in the quarter by approximately 9%. Castool’s products are experiencing strong market acceptance in both their traditional North and South American markets as well as in newer Asian markets which, in the future, will be serviced by the company’s Greenfield production facility currently under construction in Thailand.

In the Extrusion Tooling group, sales were also up approximately 10% over last year as Extrusion Texas, which was acquired in January, is contributing to sales and Extrusion Colombia, which started operating in January 2012, continued to grow its sales. The group is also well into the process of constructing an extrusion die facility in Brazil which is expected to begin generating sales in 2014.

Sales in the Automotive Solutions segment increased 1% to $23.5 million from the same quarter last year. Sales at Polytech and Neocon continued at high levels, sustained by strong unit vehicle sales in the North American market. Polydesign sales have held up well given the difficult market conditions in Europe and the delayed launch of several Ford Europe programs. These programs are expected to launch in the next several months but too late to materially impact the current fiscal year.

Consolidated net income was hit by a withholding tax charge of $1.5 million or $0.04 per share occasioned by the repatriation of surplus from a subsidiary. This tax charge increased the consolidated income tax rate for this quarter to 42.9% compared to 30.1% last year. Adjusted consolidated net income before this withholding tax charge (one-time) rose 29% to $7.1 million ($0.17 per share) compared to $5.5 million ($0.14 per share) in the same quarter last year.

Conclusion

Overall, we are pleased with Exco’s financial results which, as promised, marked a return to both top and bottom line growth after a hiccup in the second quarter. Despite significantly higher capital expenditures in the latest quarter and year-to-date, the Exco’s cash position at was $25.1 million ($0.62 per share) compared to $31.2 million ($0.76 per share) at the beginning of the year. As such, the company continues to have an enviable balance sheet from which to grow with zero bank debt. While not immune by any stretch to a global recession, the company’s strong balance sheet and greater efficiency can help insulate it from some of the volatility in the global economy.

The overall outlook for Exco over the next several quarters remains consistently strong. The two major trends of strong light vehicle production volumes in North America and steady introduction of new or refreshed vehicles and powertrain systems by virtually all original equipment manufacturers (OEMs) remain intact. These trends continue to benefit the company’s automotive solutions segment, Castool, and its large mould businesses and the growth in the geographic footprint of the extrusion group should continue to grow its sales as well.

The emphasis in the Casting and Extrusion segment will be to manage several disruptive factors (greenfield expansion) without eroding margins and earnings. These factors include continuing machinery and equipment upgrade and replacement programs and efficiently rolling out greenfield projects (Thailand and Brazil) while continuing to meet delivery dates in an environment of increasing and fluid backlog. Year-to-date efforts have been very successful as gross margin and EBITDA achieved levels not seen since 2004 when the Canadian dollar was approximately 40% weaker than it is today.

In Europe the market situation, although much impaired, is not as problematic for Polydesign as Exco thought it to be at the start of the fiscal year. The recent and smooth launch of company’s new sun visor program for Range Rover is now at full volumes. Several delayed Ford programs are scheduled to launch over the next two quarters and other new programs due in 2014 should not only insulate Polydesign from the worst of the market conditions in Europe but also ensure that its sales and earnings continue to hold up in and improve next year.

Management continues to also look for accretive ‘tuck-in’ acquisition opportunities, particularly in the automotive interior trim cut and sew space in Europe where the prospects for such opportunities are more abundant and promising.

Fundamentally, with a return to growth in the third quarter, a modestly positive outlook heading into the fourth quarter and 2014, and the stock trading at 10.58 times earnings cash in and 9.55 times cash out, it continues to look attractive.

However, 2013 will not see the tremendous growth in earnings per share (EPS) that we saw in 2012. We expect flat to 10% growth over the $0.60 in EPS we saw in 2012. As such, in the near term, we would not chase the stock much above the $6.75 range. Based on the strong third-quarter results and positive outlook, we are upping our estimate on current fair value to the range of $7.25-$7.50 from 6.50-$6.75.

Action now: We are upgrading our near-term rating to Buy over the next three to six months and maintain our long-term rating (one year) at Buy. While the company’s industry is cyclical, we believe the current environment appears positive for the next 18-24 months. With the recent dividend increase, the current yield is in the range of 2.8%.

– end Ryan Irvine

YOUR QUESTIONS

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Where to invest

Q – I’m planning to invest $20,000 in to my RRSP. I’m 51 years old and a medium risk taker. I would like to invest it for next 7-10 year period. I was wondering if you can suggest what type of mutual fund product I can buy for this investment to get a better return. Also I’m interested in ETF funds. I know you are very busy but your advice regarding this will be highly appreciated. – Mustafa B.

A – Your best bet would be to choose a balanced fund with a history of above average results. Given your age, a fund in the Canadian Neutral Balanced category would be appropriate. There are many from which to choose. One that I particularly like, and own myself, is Fidelity Monthly Income Fund but I suggest you talk to a financial adviser before making a decision. – G.P.

Rental property

Q – I have a rental property with a very low mortgage rate that comes due in 2015. I would like to pay it off and then refinance. What are your thoughts? – C.C.

A – It’s very likely that mortgage rates will be higher in 2015 so the idea of refinancing now has appeal. However, you have to analyze the numbers carefully. For starters, there may be a substantial penalty involved if you pay off the current mortgage now. Ask the lender what the cost would be.

Second, you say you now have a very low rate. By refinancing, you will probably end up paying a higher rate for the next two years than would otherwise be the case.

In short, the cost of early refinancing may be so expensive that it would be better to wait until the end of the existing term and then try to negotiate the best possible deal. – G.P.

 

MEMBERS? CORNER

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Andrew Peller

Member comment: A correction is certainly called for in the recommendation of Andrew Peller Ltd. 

In its earlier incarnation as Andres Wines, the company most decidedly was a major player in the Ontario and Canadian wine industries. To gloss over the company’s past role in the industry is to put a lot of lipstick on an ugly old pig.  

Andres vaulted into the big league with one product: “Baby Duck”, a sweet, sparkling wine made with the ignominious foxy-tasting labrusca grape. 

“Baby Duck” quickly became the #1 best-selling domestic wine across Canada. There are many of us who worked for the industry (when it and its products were ignored by wine commentators) who considered “Baby Duck” a singularly destructive force that hit the industry at the worst possible time: as millions of dollars were being invested in importing and planting vinifera varietals (Riesling, Chardonnay, Merlot, Cabernet Sauvignon) by other major  – and, arguably, more responsible – players. Andres Wines and its “Baby Duck” contributed massively to negative opinions of Ontario and Canadian wines. The name change is historical revisionism. The stain remains, as it should. – Joan L.

Response: I remember Baby Duck very well. I agree it was a lousy wine but a lot of people obviously liked it, especially younger people. It might be argued that it introduced a generation to (admittedly bad) Canadian wine. Many of those same people have now grown to have more sophisticated tastes and are among those who have made the Canadian wine industry successful in the face of great odds. – G.P.

 

That’s it for this week and for July. The IWB will take a holiday next week to allow staff to enjoy the long weekend. We’ll be back on Aug. 12.

Best regards,

Gordon Pape

In This Issue

ENERGY BOUNCES BACK

By Gordon Pape

Suddenly energy stocks are sexy again. How quickly things change!

Back in January, I wrote that the sector was in a state of uncertainty, faced with a shortage of delivery capacity and forced to accept deep discount pricing. In December, Western Canadian Select had fallen to a record discount of $42.50 a barrel compared to West Texas Intermediate (WTI) crude. The Premier of Alberta expressed concern and frustration over the “bitumen bubble” as oil and gas stocks languished.

The markets reflected this angst in the first half of the year. The energy sub-index, one of the most important components of the TSX, was off by 2.3% for 2013 as of the end of June. But what a difference a month makes! Energy stocks turned around in July, posting a gain of 5.7% as of the close of trading on July 26.

What happened? In simplistic terms, all the stars aligned. Well, almost all of them – we’re still awaiting word on the fate of the Keystone XL pipeline which could be the biggest catalyst of all.

Obviously, the increase in oil prices in recent weeks has been one of the main drivers in the sector’s rebound. It’s not just the fact that the WTI price has soared to well over $100 a barrel. Equally important is the fact that it is now trading at close to par with North Sea Brent, which has been priced at a premium for years. For Canadian producers, the fact that the discount on Western Canadian Select has dramatically declined is also critical. As of July 23, Bloomberg reported that the discount was down to $22 a barrel.

Unrest in Egypt and other parts of the Middle East has been a factor in this but there is much more to the story. For starters, the plug has been pulled from the oil lake in Cushing, Oklahoma. It is a terminus for production from across the continent but until now the infrastructure to move product to refineries has been inadequate. In January, there was a record 51.9 million barrels in storage at Cushing, Bloomberg said.

That is quickly changing. The Seaway pipeline, in which Enbridge (TSX, NYSE: ENB) is a partner, has been reversed and expanded and now moves 400,000 barrels a day to Gulf Coast refineries. Work on TransCanada’s (TSX, NYSE: TRP) 485-mile Gulf Coast pipeline from Cushing to Nederland, Texas, is well advanced. It’s actually a section of Keystone that was hived off to avoid Washington’s maddening bureaucracy. It is slated to come on stream later this year with an initial capacity of 700,000 barrels a day with the potential to transport as much as 830,000 barrels daily.

As a result, there has been a much bigger drawdown in oil surpluses than analysts expected. Less supply almost automatically equates to higher prices.

Another factor in the oil price rise is the refurbishing of the BP refinery in Whiting, Indiana. It is expected to reopen later this year with 85% of its capacity devoted to heavy oil.

The role of railroad transport has also been significant in the turnaround. CN Rail (TSX: CNR, NYSE: CNI) reported that petroleum and chemicals generated $478 million in revenue in the second quarter, a gain of 18% over the same period last year. That makes the category the second-largest contributor to CN’s coffers after intermodal transport.

The tragic events at Lac-Mégantic were a grim reminder to the industry, and the country, that the opportunities presented to the railroads by the shortage of pipeline capacity also increase the dangers of major disasters. Both CN and CP have pledged to review and upgrade their safety procedures to reduce the risk of a comparable wreck on one of their lines but the possibility is always there.

Despite this, there has been no notable push-back against moving oil by rail from politicians and the public. There seems to be a general acceptance that this is a price that must be paid to keep oil (both U.S. and Canadian) moving, at least until such time as the pipeline issues are clarified.

Of course, the oil boom could reverse itself quickly if the global economy falters, thereby reducing demand. Nothing is certain. But as things stand right now, the outlook for Canada’s energy industry is certainly brighter than it was six months ago. The uncertainties are still there, but companies are coping and the prospects for improving returns are better than we’ve seen in a long time.

 

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GORDON PAPE’S ENERGY UPDATES

Cenovus Energy (TSX, NYSE: CVE)

Originally recommended by Yola Edwards on Oct. 23/06 (#2638) at C$25.93, US$23.06. Closed Friday at C$30.45, US$29.65. Updated by Gordon Pape.

Cenovus shares had been on a nice little run until the company released its second-quarter results on July 24 and the bottom fell out. Although oil sands production was up by 17% and total oil production by 10%, cash flow, operating earnings, and net income were all down. Profit took the biggest hit, falling 55% to $179 million ($0.24 a share) from $397 million ($0.52 a share) in the same period last year. Second-quarter earnings just about matched the dividend payout. Those numbers were well below estimates and the stock sold off sharply losing $1.76 or about 5.5% on the day.

Several one-time costs contributed to the drop in profit. The company’s chief financial officer, Ivor Ruste, was quoted in The Globe and Mail as saying these included a $63 million pre-exploration charge for a conventional oil development, a $57 million impairment from an asset sale, and a $46 million exploration charge for a tight oil project in Saskatchewan.

The bottom line was also affected by higher operating costs at the company’s two big oil sands developments. At Foster Creek, the cost of producing a barrel of oil rose from $12.49 last year to $16.19. The increase at Christina Lake was even worse, from $12.52 to $16.83.

The results took some of the steam out of the recent surge in oil stocks and left investors wondering what to expect from the other major players when they report.

Although the numbers weren’t good, Cenovus remains one of the lowest-cost producers in the oil sands and has excellent growth potential. The company expects to triple its production to about 600,000 barrels per day by 2018-19.

Action now: Buy. Take advantage of the pull-back to establish a new position or add to an existing one.

Suncor Energy (TSX, NYSE: SU)

Originally recommended on June 12/06 (#2622) at C$41.36, US$37.57 (split-adjusted). Closed Friday at C$32.60, US$31.77.

Suncor’s results won’t be released until July 31 so I’ll provide a more complete update after we have seen the numbers. However, the company has released its 2013 Report on Sustainability which examines its role in improving environmental conditions. Highlights include:

Water management: The company is aiming to reduce fresh water consumption by 12% from 2007 levels by 2015. To achieve this, around 10,000 cubic metres per day of tailings water is now used as in situ makeup water instead of being stored in tailings ponds. An equivalent amount of water will be recycled at the mining site, reducing the amount of fresh water Suncor needs to withdraw from the Athabasca River. 

Land and biodiversity. Suncor’s goal is to increase reclamation of disturbed land area by 100% by 2015 (from 2007 levels). By the end of 2012, Suncor had planted nearly six million trees on its oil sands site, including 900,000 in previous 12 months. 

Air quality. Suncor’s environmental performance goal for air emissions aims at a 10% reduction by 2015, compared to 2007 levels. Overall, total reported air emissions in 2012 decreased by 8.7% compared to 2011 levels.

Energy intensity and greenhouse gas emissions. The company has a goal of improving energy efficiency by 10% by 2015. Currently, it is working to implement an Energy Management System at all of its major facilities. Suncor says the system will improve the measurement, control and governance of energy and is expected to result in an improvement of 2%-3% in energy/GHG intensity through better operational control. 

Suncor stock has gained 5.2% so far this month. It finished the first half at $31 on the TSX and closed on Friday at $32.60.

Action now: I’m upgrading Suncor from a Hold to a Buy on the basis of new strength in the industry.

Trinidad Drilling (TSX: TDG, OTC: TDGCF)

Originally recommended on April 11/11 (#21114) at C$10, US$10.44. Closed Friday at C$8.82, US$8.59.

Drilling stocks have moved up along with the fortunes of the oil companies and Trinidad has been no exception. When I last looked at the stock in mid-March it was trading at C$7.11, US$6.80 and showing no sign of momentum. The shares actually dropped a little further after that but then started a strong upward move in early May that is continuing.

First-quarter results were not very good (second-quarter figures will be released on Aug. 7). Revenue was down 5.1% to $247.2 million and funds from operations were off 9.1% year-over-year to $64.9 million. Net earnings were down 5% to $32.7 million and adjusted net earnings showed an even bigger drop of 16.8% to $35.5 million ($0.29 per share).

CEO Lyle Whitmarsh said: “Industry conditions were weaker this quarter than the same time last year; however we are beginning to see signs that the second half of 2013 could provide opportunities for growth, either through reactivating existing rigs or by adding new equipment. Trinidad’s growing free cash flow and improved financial flexibility positions us well to take advantage of the opportunities as they arise.”

Investors appeared to take these comments at face value, pushing the stock higher despite the weak financial numbers. The second-quarter results will give us a better idea as to whether this confidence is justified.

Action now: Hold.

Ensign Energy Services (TSX: ESI, OTC: ESVIF)

Originally recommended on June 9/08 (#2821) at C$22.20. Closed Friday at C$17.49, US$17.12.

Ensign is another energy service company that has been on a roll. After tumbling to just over $15 a share in early May, the stock has turned around and ridden higher on the increase in the price of oil.

Like Trinidad Drilling, Ensign experienced a weak first quarter. Revenue fell 14% to $581.1 million, funds from operations dropped 21% to $140.6 million, and net income was off 38% to just under $65 million ($0.45 a share). The company blamed reduced operating activity in North America for the decline and the share price reacted negatively to the news.

Ensign was somewhat less bullish than Trinidad in its outlook statement for the rest of the year, with several qualifiers and cautions. While noting that general economic conditions in North America appeared to be improving, management said that growth in Asia is slowing and that serious problems persist in Europe.

“While we are optimistic about energy commodity prices, caution is warranted regarding drilling levels in the near term, as there is a relatively high backlog of previously drilled wells, and the impact of new technologies such as pad horizontal programs in resource plays is changing industry dynamics,” the company said. “We continue to believe it may take several quarters to restore stability in market forces.”

Those aren’t exactly inspiring words, yet the stock is up about $3 a share since its May low. The second-quarter results may provide some justification for this but investors should wait and see before making purchases at the current level.

Ensign has renewed its normal course issuer bid, which allows it to repurchase about 4.6 million shares, equal to 3% of the public float. The original bid period ran until June 17 but it was an all talk, no action situation as the company did not buy any shares in the open market.

The company paid a second-quarter dividend of $0.11 a share on July 5.

Action now: Hold.

Penn West Petroleum (TSX: PWT, NYSE: PWE)

Originally recommended on Feb. 18/08 (#2807) at C$28.44, US$28.22. Closed Friday at C$12.47, US$12.13.

Most of our energy stock picks have seen a nice uptick recently. Penn West is another matter, however. This company is really struggling. It recently announced yet another managerial shake-up aimed at “further streamlining and focusing its management structure”. Responsibilities were shuffled, three members of the executive team left, and the company said its new focus would be on “production delivery”.

Maybe it will work this time but investors have already been badly bruised by lack of direction and deteriorating numbers. We’ve waited long enough. Take the loss and move on.

Action now: Sell. – G.P.

 

A MYTH DEBUNKED

Contributing editor Ryan Irvine is with us this week with a close look at one of the classic theories of investing. Ryan is the CEO of KeyStone Financial (www.keystocks.com) and is one of Canada’s leading experts on small-cap investing. He is based in the Vancouver area. Here is his report.

Ryan Irvine writes:

It always happens. Five months into every year we hear that cute little rhyme: “sell in May, and go away”.

The theory of bailing out of the markets before summer has been around for decades and repeated so often that it’s almost taken as gospel. Talking heads, pundits, and analysts alike trot out this poetic quip as a simplistic method to outperform the market through seasonal investing. Five to seven years of schooling, 10 to 30 years of market experience, and this is all we have for the investing public? Really?

According to the Stock Trader’s Almanac (or perhaps the Farmer’s Almanac), since 1950 the performance of the Dow Jones Industrial Average has significantly lagged during the May-October period, compared with the November-April period.

While the exact reasons for this seasonal trading pattern are not known, lower trading volumes due to the summer vacation months and increased investment flows during the winter are cited as contributory factors.

In essence, the strategy suggests that investors who sell their stock holdings in May and get back into the equity market in November, thereby avoiding the typically volatile May-October period, would be much better off than an investor who stays in equities throughout the year.

Of course, the very essence of an “investor” is an individual who takes a long-term approach. That’s our approach so I find it difficult to classify one who sells each year based on the turn of a calendar and later buys back in again as a true investor.

Rather than digressing into a lecture on the failings of basing financial decisions on a solitary historical stat, I thought it would be more useful to take a look at how this strategy has fared since 2009. Since “Sell in May” can either refer to the start or the end of the month, we split the difference and assessed market performance from the middle of May until the end of August.

Starting with the current year, we don’t yet have a full set of data points to work with. But as we entered July, it did indeed appear that users of this strategy would be basking in the success of their apparent intelligence. As at May 15, the TSX was sitting at 12,473 and after continuing to climb until the end of the month, markets subsequently dropped to a yearly low of 11,836 on June 24.

Yet in spite entering the summer doldrums, markets have since climbed almost back to yearly highs with the TSX closing at 12,648 on July 26. Obviously we cannot yet draw any conclusions from 2013 at this point and the proponents of “Sell in May” may very well be proven to be correct as we continue to the end of the summer. We do however have complete data for previous years which is summarized below.

  TSX – May 15 TSX – August 31 Difference
2012
11,343
11,949
5.3%
2011
13,391
12,768
-4.6%
2010
11,813
11,913
0.8%
2009
9,762
10,868
11.3%

This table illustrates that the “Sell in May” strategy has been effective in only one of the four full sample years used in our analysis. The year was 2011 and we must also remember that the timing of the market decline that year coincided with a spike in negative sentiment related to the credit crisis in Europe and probably had relatively little to do with the month of the year or summer vacations in the Hamptons. We should also take into account that the price information in the table does not include the dividends which would have been lost by any investor who pursued the seasonal strategy.

Of course, our analysis accounts for a relatively short time horizon and we certainly need to be careful with any conclusion we draw. But we would suggest that the most prudent course would be not to draw any conclusion at all, except to say that any overly broad and black and white strategy (including seasonal investing) cannot be relied upon or considered to be intelligent investing.

If we are to assume this historical summer underperformance had something to do with a lack of interest in the market over the summer months then we should also adjust for the fact that, cell phone in hand, almost anywhere in the world and at any time, we can now make a trade. While lower volumes are a relative reality, summer months are no longer unplugged from the markets.

In the end, we buy stocks based on balance sheets, valuations, dividends, and growth potential, not the turn of a calendar. We suggest you do the same.

RYAN IRVINE PICKS PAREX RESOURCES (TSX: PXT, OTC: PARXF)

This month, we introduce a new junior international oil producer. Headquartered in Calgary, Parex Resources Inc., through its direct and indirect subsidiaries, is engaged in oil and natural gas exploration, development, and production in South America and the Caribbean region. Parex is conducting exploration activities on its 1,349,000 gross acre holdings, primarily in the Llanos Basin of Colombia, and 219,000 gross acre holdings in onshore Trinidad. Parex is a Canadian company.

Parex was originally incorporated on Aug. 17, 2009 for the purpose of completing the takeover of Petro Andina Resources Inc. (the company Parex was spun out of) by Pluspetrol Resources Corporation N.V. Petro Andina shareholders received $7.65 per share in cash and one share of “ExploreCo,” which essentially became Parex. Under the takeover arrangement, PetroAndina’s Argentina assets were acquired by Pluspetrol in late 2009. Petro Andina’s assets in Trinidad and Tobago and Colombia were transferred to Parex and marked the birth of the Colombia light oil producer we are recommending today.

Recent Financial Results

On May 14, the company reported that average first-quarter production was 14,440 barrels per day (bopd), an increase of 13% over the fourth quarter of 2012. The company realized a Brent referenced sales price of $109.63 per barrel ($/bbl) and an operating netback of $67.03/bbl. Parex generated funds flow from operations of $60.2 million ($0.56 per share basic) as compared to $0.50 per share for the previous quarter. This included a net build of crude oil inventory of 97,890 bbls. Funds flow has increased due to continued strong operating netbacks, production growth and exploration success.

The company’s capital expenditures were $47.2 million in the first quarter, of which $45.6 million was related to Colombia and the remainder in Trinidad. Capital expenditures were fully funded from funds flow from operations. Working capital surplus at period end was $17 million compared to a working capital deficit of $12.7 million in the previous quarter. Working capital also reflects Parex’s 196,689 bbls of crude oil inventory valued at cost. The company had bank debt of $20 million on a current available facility of $100 million and a cash balance of $26.8 million.

Outlook

The 2013 average production guidance was provided in January at 14,000-14,500 bopd. As a result of current production and reserves and adding the proposed Cabrestero acquisition along with the planned development activity, Parex is increasing its 2013 full year average production guidance slightly to 14,500-15,000 bopd. The company believes that the increased production guidance can be achieved within the existing capital expenditure budget of $210 million. Parex is awaiting further production history from its successful year-to-date drilling program before considering an additional increase in production guidance.

The mid-year reserves disclosure gives us increased confidence that Parex is adding significant reserves in a very cost-efficient manner. The reserves increase takes Parex’s proved plus probable reserves life to approximately 4.5 years (from approximately 3.5 years previously), which may increase attraction to the stock for some investors.

From a valuation perspective, Parex compares favourably to its peers on a cash flow basis. Price-to-cash flow on a trailing basis is very low at 2.15 and Parex trades at a substantial discount on its 2013 enterprise value to cash flow basis. The company also holds a relatively unlevered balance sheet which allows flexibility and financial strength. The significant cash flow is supporting an aggressive CAPEX (exploration and development) program and the significant free cash flow could be directed to further acquisitions and/or continued share buy-backs.

With the stock in the low to mid $4.00 range prior to the reserve announcement, we believed that the update would force the market to recognize that Parex’s valuation had become unsustainably cheap relative to its peers. To a degree, this has occurred with the stock moving to $5.38 but the valuations continue to look attractive mid-term, particularly with the increase in crude prices. While we stress that it remains pure speculation, it does appear that Parex continues to have many characteristics of a take-out target if the valuation gap is not adjusted.

We believe Parex has a solid management team with extensive Latin America experience. The team has shown the ability to operate, grow and monetize assets similar to those that they are putting together in Parex by growing, developing, and later selling Petro Andina Resources, thereby generating significant returns for shareholders. With an 8% ownership ($45 million) stake in Parex, management is aligned with shareholders.

Action now: We rate Parex Resources as a Buy for readers with above average risk tolerance. The stock should be viewed as speculative due to its above average geopolitical risk. Also, we normally assign a higher risk level to resource producers as they are dependent largely on the prices of the commodities they produce and on the continued risk of successful exploration. At present, Parex’s risk/reward ratio appears favourable. The shares closed on the TSX on Friday at $5.38 and on the U.S. over-the-counter Grey Market at US$5.23.

RYAN IRVINE’S UPDATES

Exco Technologies Limited (TSX: XTC, OTC: EXCOF)

Originally recommended on Feb. 27/12 (#21208) at C$4.25, US$4.22. Closed Friday at C$6.48, US$6.02 (July 17).

Exco Technologies was recommended in February as a Buy at $4.25. With the stock trading at $6.48, we update our rating with the release of the company’s third-quarter 2013 financial results.

With roots that date back to 1952, Exco is a global supplier of innovative technologies servicing the die-cast, extrusion and automotive industries. Headquartered in Markham, Ontario, Exco, through its ten strategic locations, employs 2,207 people and services a diverse and broad customer base. Exco’s Casting and Extrusion division accounted for 62.52% of sales in the third quarter and its Automotive Solutions division accounted for the remaining 37.48%.

Revenues for the period ended June 30 rose 5% to $62.4 million from $59.2 million in the same quarter last year and were up 5% over the second quarter. Year-to-date consolidated sales were slightly weaker than last year at $180.6 million compared to $180.8 million, primarily reflecting softer sales in the second quarter.

The Casting and Extrusion segment reported quarterly sales of $38.9 million, an increase of 8% from the same period last year. Sales at the large mould group, the largest contributor in this segment, increased by just over 10%. This group experienced strong sales as its product mix between higher priced new dies and lower priced rebuilds/repairs was more favorable. During the quarter this group delivered its first silifont die for a structural part. There are another seven dies for this program and management is optimistic that the company’s decision to enter the silifont structural part die market will result in additional programs. Demand for spare parts in this group is also strong and continues to build, causing inventory to climb.

Sales at Castool increased in the quarter by approximately 9%. Castool’s products are experiencing strong market acceptance in both their traditional North and South American markets as well as in newer Asian markets which, in the future, will be serviced by the company’s Greenfield production facility currently under construction in Thailand.

In the Extrusion Tooling group, sales were also up approximately 10% over last year as Extrusion Texas, which was acquired in January, is contributing to sales and Extrusion Colombia, which started operating in January 2012, continued to grow its sales. The group is also well into the process of constructing an extrusion die facility in Brazil which is expected to begin generating sales in 2014.

Sales in the Automotive Solutions segment increased 1% to $23.5 million from the same quarter last year. Sales at Polytech and Neocon continued at high levels, sustained by strong unit vehicle sales in the North American market. Polydesign sales have held up well given the difficult market conditions in Europe and the delayed launch of several Ford Europe programs. These programs are expected to launch in the next several months but too late to materially impact the current fiscal year.

Consolidated net income was hit by a withholding tax charge of $1.5 million or $0.04 per share occasioned by the repatriation of surplus from a subsidiary. This tax charge increased the consolidated income tax rate for this quarter to 42.9% compared to 30.1% last year. Adjusted consolidated net income before this withholding tax charge (one-time) rose 29% to $7.1 million ($0.17 per share) compared to $5.5 million ($0.14 per share) in the same quarter last year.

Conclusion

Overall, we are pleased with Exco’s financial results which, as promised, marked a return to both top and bottom line growth after a hiccup in the second quarter. Despite significantly higher capital expenditures in the latest quarter and year-to-date, the Exco’s cash position at was $25.1 million ($0.62 per share) compared to $31.2 million ($0.76 per share) at the beginning of the year. As such, the company continues to have an enviable balance sheet from which to grow with zero bank debt. While not immune by any stretch to a global recession, the company’s strong balance sheet and greater efficiency can help insulate it from some of the volatility in the global economy.

The overall outlook for Exco over the next several quarters remains consistently strong. The two major trends of strong light vehicle production volumes in North America and steady introduction of new or refreshed vehicles and powertrain systems by virtually all original equipment manufacturers (OEMs) remain intact. These trends continue to benefit the company’s automotive solutions segment, Castool, and its large mould businesses and the growth in the geographic footprint of the extrusion group should continue to grow its sales as well.

The emphasis in the Casting and Extrusion segment will be to manage several disruptive factors (greenfield expansion) without eroding margins and earnings. These factors include continuing machinery and equipment upgrade and replacement programs and efficiently rolling out greenfield projects (Thailand and Brazil) while continuing to meet delivery dates in an environment of increasing and fluid backlog. Year-to-date efforts have been very successful as gross margin and EBITDA achieved levels not seen since 2004 when the Canadian dollar was approximately 40% weaker than it is today.

In Europe the market situation, although much impaired, is not as problematic for Polydesign as Exco thought it to be at the start of the fiscal year. The recent and smooth launch of company’s new sun visor program for Range Rover is now at full volumes. Several delayed Ford programs are scheduled to launch over the next two quarters and other new programs due in 2014 should not only insulate Polydesign from the worst of the market conditions in Europe but also ensure that its sales and earnings continue to hold up in and improve next year.

Management continues to also look for accretive ‘tuck-in’ acquisition opportunities, particularly in the automotive interior trim cut and sew space in Europe where the prospects for such opportunities are more abundant and promising.

Fundamentally, with a return to growth in the third quarter, a modestly positive outlook heading into the fourth quarter and 2014, and the stock trading at 10.58 times earnings cash in and 9.55 times cash out, it continues to look attractive.

However, 2013 will not see the tremendous growth in earnings per share (EPS) that we saw in 2012. We expect flat to 10% growth over the $0.60 in EPS we saw in 2012. As such, in the near term, we would not chase the stock much above the $6.75 range. Based on the strong third-quarter results and positive outlook, we are upping our estimate on current fair value to the range of $7.25-$7.50 from 6.50-$6.75.

Action now: We are upgrading our near-term rating to Buy over the next three to six months and maintain our long-term rating (one year) at Buy. While the company’s industry is cyclical, we believe the current environment appears positive for the next 18-24 months. With the recent dividend increase, the current yield is in the range of 2.8%.

– end Ryan Irvine

YOUR QUESTIONS

Where to invest

Q – I’m planning to invest $20,000 in to my RRSP. I’m 51 years old and a medium risk taker. I would like to invest it for next 7-10 year period. I was wondering if you can suggest what type of mutual fund product I can buy for this investment to get a better return. Also I’m interested in ETF funds. I know you are very busy but your advice regarding this will be highly appreciated. – Mustafa B.

A – Your best bet would be to choose a balanced fund with a history of above average results. Given your age, a fund in the Canadian Neutral Balanced category would be appropriate. There are many from which to choose. One that I particularly like, and own myself, is Fidelity Monthly Income Fund but I suggest you talk to a financial adviser before making a decision. – G.P.

Rental property

Q – I have a rental property with a very low mortgage rate that comes due in 2015. I would like to pay it off and then refinance. What are your thoughts? – C.C.

A – It’s very likely that mortgage rates will be higher in 2015 so the idea of refinancing now has appeal. However, you have to analyze the numbers carefully. For starters, there may be a substantial penalty involved if you pay off the current mortgage now. Ask the lender what the cost would be.

Second, you say you now have a very low rate. By refinancing, you will probably end up paying a higher rate for the next two years than would otherwise be the case.

In short, the cost of early refinancing may be so expensive that it would be better to wait until the end of the existing term and then try to negotiate the best possible deal. – G.P.

 

MEMBERS? CORNER

Andrew Peller

Member comment: A correction is certainly called for in the recommendation of Andrew Peller Ltd. 

In its earlier incarnation as Andres Wines, the company most decidedly was a major player in the Ontario and Canadian wine industries. To gloss over the company’s past role in the industry is to put a lot of lipstick on an ugly old pig.  

Andres vaulted into the big league with one product: “Baby Duck”, a sweet, sparkling wine made with the ignominious foxy-tasting labrusca grape. 

“Baby Duck” quickly became the #1 best-selling domestic wine across Canada. There are many of us who worked for the industry (when it and its products were ignored by wine commentators) who considered “Baby Duck” a singularly destructive force that hit the industry at the worst possible time: as millions of dollars were being invested in importing and planting vinifera varietals (Riesling, Chardonnay, Merlot, Cabernet Sauvignon) by other major  – and, arguably, more responsible – players. Andres Wines and its “Baby Duck” contributed massively to negative opinions of Ontario and Canadian wines. The name change is historical revisionism. The stain remains, as it should. – Joan L.

Response: I remember Baby Duck very well. I agree it was a lousy wine but a lot of people obviously liked it, especially younger people. It might be argued that it introduced a generation to (admittedly bad) Canadian wine. Many of those same people have now grown to have more sophisticated tastes and are among those who have made the Canadian wine industry successful in the face of great odds. – G.P.

 

That’s it for this week and for July. The IWB will take a holiday next week to allow staff to enjoy the long weekend. We’ll be back on Aug. 12.

Best regards,

Gordon Pape