In This Issue

BREXIT VOTE SPOOKS FED

By Gordon Pape, Editor and Publisher

The prospect that British voters will elect to leave the European Union in next Thursday’s referendum has rattling even the staid U.S. Federal Reserve Board.

The Fed held the line on U.S. interest rates last week in a unanimous vote and part of the reason was the uncertainty overhanging upcoming U.K. ballot. There was no mention of the referendum in the open market committee’s formal statement, which focused more on the decline in new job creation, soft business investment, and the continued lack of any inflation pressure.

But Chair Janet Yellen told a press conference after the meeting that Brexit was top of mind among board members in making their hold-the-line decision.

So it should be. If British voters elect to abandon Europe on Thursday, the consequences will be far reaching. Some analysts have suggested it could be the beginning of the end for the great European experiment. That’s a stretch at this point, as Britain was never fully committed to the EU (it did not adopt the euro, for example).

Moreover, and this may come as a surprise to many people, a Leave vote would not automatically trigger Britain’s departure. The referendum itself is not binding. As Britain’s Daily Mail newspaper pointed out last week: “It would signal only that the wish of the British people is to leave the EU, and would spark negotiations to begin setting the terms for separation”.

Those negotiations would take up to two years to complete and the final deal might well see Britain continue its economic, trade, and financial ties with Europe, albeit under revised and less favourable terms.

Despite all the talk about regaining its sovereignty, it appears the real target of many Leave supporters is immigration and the fear the country will be swamped with newcomers who will take jobs while resisting efforts to integrate with British life and culture. Control of borders has become a major political issue across Europe since the wave of Middle Eastern refugees started to flood in last year. So it’s no surprise it could be a tipping point for many voters.

If Britain does vote to exit on Thursday, there will be turmoil in the markets. The pound will drop, gold will rise, European stocks will be shaken, and world markets will probably follow suit. Sovereign bond yields are likely to fall even further. The yields on German 10-year issues slid into negative territory last week as investors sought out safe havens.

However, the disruption will probably be temporary. Two years is a long time for negotiations to drag on and once the initial shock of a Leave vote is over investors will turn their attention to other issues while bureaucrats meet quietly behind closed doors to hammer out a new deal for the Britain outside the E.U.

Hopefully, the polls are wrong and Britain will vote to stay in Europe. But it is is not the end of the world if the Leave side wins. Nothing is going to change overnight and Britain remains geographically part of Europe. The exit negotiations will need to recognize that.

Follow Gordon Pape on Twitter @GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney

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TSX LEADERS: NEW FLYER INDUSTRIES

By Gordon Pape

Gold and materials have been among the leaders on the TSX so far this year but the index is also being boosted by some non-resource categories. The industrials sector is among them, which is where we find this week’s top outperformer, New Flyer Industries.

Background: Winnipeg-based New Flyer is the largest transit bus and motor coach manufacturer and parts distributor in North America. It has manufacturing, distribution, and service centers in Canada and the United States and employs approximately 5,000 people. The company is a leader in the development of clean transportation vehicles, which include those powered by natural gas, diesel-electric hybrid, electric-trolley, and battery-electric.

Stock performance: The company was first recommended in the IWB by former contributing editor Tom Slee in March 2013 when it was trading at $10.30 on the TSX. The shares bumped along at between $10 and $15 until the last summer of 2015 when they took off. Except for a blip last winter they have been in an upward trend since, finishing Friday at $40.47. The shares ended 2015 at $28.32 so the gain thus far this year is just under 43%.

Why we like it: New Flyer is in the right place at the right time. Cities across North America are replacing their aging public transit fleets with leading edge clean technology and this trend will likely continue for years to come.

A quick look at the company’s order book shows the rapid increase in demand for its products. At the end of 2015, the company had firm orders for 2,462 units. As of March 31, that was up to 3,113, an increase of 26% in three months.

Financial results: First-quarter results released last month showed revenue of $553.2 million, up 45.5% from the same period a year ago (note that the company reports in U.S. dollars). Net earnings were $22.6 million ($0.40 per share), an improvement of more than 100% from $10.9 million ($0.20 per share) last year. Free cash flow was C$61.5 million, up 400% compared to $12.3 million in the first quarter of 2015.

Outlook: Bright. The orders keep pouring in. On June 6, the company announced that the Connecticut Department of Transportation had awarded it a contract for up to 485 heavy-duty 35 and 40-foot Xcelsior clean diesel and diesel electric hybrid buses. The contract includes a firm order for 267 vehicles valued at approximately $122 million, with options for an additional 218 units over the next five years. The order will replace older vehicles in the fleet with newer, more fuel efficient Xcelsior models.

Just over a week later, the company announced that the Southeastern Pennsylvania Transportation Authority had awarded it a contract for up to 550 heavy-duty 40-foot Xcelsior diesel electric hybrid buses. It includes a firm order for 90 buses valued at approximately $50 million, with options for an additional 460 units over the next five years. All buses will be delivered from 2017 to 2020. 

Dividend: The company increased its annual dividend rate by 37.5%, effective with the July payment. The quarterly payout is now C$0.2375 per share, or $0.95 per year. The shares yield 2.3% at the current price.

Summary: The company is firing on all cylinders right now. It is suitable for all but the most conservative portfolios.

Action now: Buy.

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PROFITING FROM ORGANIC GROWTH

Contributing editor Shawn Allen back is with us this week. Shawn has been providing stock picks on his website at www.investorsfriend.com since the beginning of the year 2000 and has a great success record. He is based in Edmonton. Here is his report.

Shawn Allen writes:

Last month, in IWB #21620, I addressed the topic of growth-by-acquisition. I pointed out that while Valiant Pharmaceuticals had given the strategy a black eye, other companies including Stantec, Alimentation Couche-Tard, and Constellation Software had relied primarily on acquisitions to drive spectacular growth and returns.

This month I will take a look at companies that have had great success while relying exclusively on organic growth strategies.

The three broad categories of organic growth involve:

  1. Expanding the size of the market within a given geographic area.
  2. Expanding market share within a given geographic area.
  3. Expanding into new geographic areas.

Expanded market: Companies offering newer products and services can expand organically as the penetration of the product or service in a given geographic area expands. Examples include the increased penetration of smart phones (Apple) and the growing penetration of electronic payments (VISA, MasterCard, and American Express).

Expanded market share: Established companies in mature markets may have to rely on increasing market share in order to grow organically. This can be a dangerous strategy as it can lead to price wars. The decline in oil prices since 2014 has been blamed on a fight for market share. Growth that leads to higher sales and sharply lower profits is a dubious strategy. However, Berkshire Hathaway’s GEICO auto insurance company has increased its market share very substantially in a mature industry without making acquisitions and without broadening its product line or geographic reach.

Expanding into new geographic areas: There are a few companies that are in the enviable position of being able to expand successfully simply by opening new locations. I call this approach: “If They Build It, We Will Come”. I like this strategy because it can be relatively predictable once it is established. Here are some examples.

Costco Inc. The company currently has 706 stores. Ten years ago it had 504. In the past decade its earnings per share are up by 142% and its share price is up by about 174%. When Costco opens a new store it automatically attracts new customers. In some cases, there have been traffic jams during opening week. To date, cannibalization of existing locations has not been a problem. Costco’s growth has been entirely organic. Its last acquisition was the 1993 merger with Price Club.

Dollarama Inc. As of January, 2016, Dollarama had 1,030 stores. It became a public company in October 2009 with 585 stores. In the past six years its earnings per share are up 525% and its share price is up about 800%. Dollarama has continued to demonstrate that it can grow simply by opening new stores. A few years ago it reported that its capital cost to open a new store (in leased space) was about $600,000 and that this resulted in an earnings boost of some $300,000 for a two-year payback.

Other notable examples of businesses that can achieve organic growth simply by opening new locations include Starbucks and Tim Hortons. There are limits to this strategy in terms of cannibalizing existing locations. However, some companies have certainly achieved an extremely enviable position in this regard.

Organic growth is often assumed to be superior to growth-by-acquisition. However, there are examples of great success and also great failure in both categories of growth. The future success of any growth strategy is best evaluated on a case-by-case basis.


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SHAWN ALLEN’S UPDATES

American Express Company (NYSE: AXP)

Originally recommended on Feb. 17/14 (#21407) at $89. Closed Friday at $61.86. (All figures in U.S. dollars.)

Background: American Express is a credit and charge card issuer. The company had 118 million cards in forceat the end of 2015. About 63% of revenues are from merchant fees, which average 2.44%. Another 18% is from interest charged to cardholders, 8% is from card fees, and 15% is from other items including fees and commissions.

Amex’s business is about two-thirds within the United States and one-third outside. Traditionally, American Express was an integrated company that did not partner with banks but that policy has changed to allow certain banks to issue Amex branded cards.

Recent earnings growth: Amex’s earnings per share decreased 2% in the latest quarter. Earnings growth was depressed due to the higher U.S. dollar and the loss of the Costco business in Canada. For 2015, earnings per share were down 9% but were up 6% after adjusting for a restructuring charge.

Revenues per share increased 8% in the latest quarter, largely due to a 6% decrease in the share count. Revenues per share were flat in 2015 after being hampered by the higher U.S. dollar, which lowers the value of the company’s non-U.S. revenue, and by the loss of its former Costco business in Canada as the company switched to accepting only MasterCard.

Risks and outlook: Regulations and competition will likely push down the fees charged to merchants. The recent public spate between Wal-Mart Canada and VISA illustrates the fact that merchants are beginning to push back more aggressively against high credit card fees. Amex also faces the loss of its U.S. Costco business this month.

The company is projecting earnings growth of 0 to 6% in 2016 and similar modest growth in 2017, with a return to higher growth thereafter. Amex has a goal of growing earnings per share at 12% to 15% after 2017 (which seems aggressive).

Amex is projecting an unusual gain of $1billion (pre-tax) on selling its Costco card receivables portfolio. It may provide a special dividend or higher share repurchases based on this special gain.

Amex is benefiting from the continuing switch to electronic payments. The company is addressing its speed of payments to become more attractive to small businesses. Amex continues to partner with others in growing its business.

Stock price performance: Amex’s stock price decreased substantially during 2015 and is down about 12% in 2016 year-to-date. The p/e and price to book value ratios decreased very significantly due to disappointing earnings performance in 2015 and projections for continued weak earnings growth in 2016 and 2017.

Valuation: Based on our analysis price of $61.42, Amex is trading at 11.6 times trailing adjusted earnings and 11.1 times projected 2016 earnings. Its return on equity remains very high at 26%. Reflecting the high ROE, its price to book value ratio is somewhat high at 3.0. The dividend yield is low at 1.9% because the company pays out only 21% of earnings.

Action now: Hold. This call is based on the relatively attractive valuation but tempered by a low growth outlook.

Canadian National Railway Company (TSX: CNR, NYSE: CNI)

Originally recommended by Tom Slee on May 6/02 (#2218) at C$12.98, US$8.31 (split adjusted). Closed Friday at C$75.12, US$58.39.

Background: CN operates across Canada and down through the central U.S. to the Gulf of Mexico with over 21,000 miles of track.

Recent earnings growth: Earnings per share in the first quarter rose 16% even though revenues per share declined 1%. The results were affected by volatile fuel prices and fuel price surcharges and by the changes in the Canadian dollar, and this has benefited recent earnings growth. Car loadings were down 7% in the quarter due to weakness in the commodity sector and despite strong increases in the automotive and forest sectors.

Valuation: Analyzed at C$75.13 or US$51.95. CN’s return on equity is extremely strong at 26%. The price to book value ratio at 4.0 is ostensibly unattractive but mathematically simply reflects the high return on equity (ROE) combined with the p/e ratio. The p/e is 16.4, which seems neutral in attractiveness. The dividend yield is modest at 2% and reflects a payout ratio of 32% of earnings.

Outlook: The near-term outlook is negative, as CN now predicts no increase in the profit per share for 2016. Given that earnings per share were up 16% in the first quarter, this suggests a decline on the order of 5% in the remaining three quarters of 2016. Car loadings for North America railroads continue to run noticeably lower than the prior year as of June. However, CN remains well positioned for the long term as North America continues to import goods from Asia.

Management: CN’s CEO is resigning for health reasons and the CFO is taking over. CN has been expertly managed in a similar way for over two decades and has promoted from within. This change in the CEO should not be expected to have a major impact.

Conclusion: Canadian National Railway appears to be reasonably valued. It has an outstanding history of value creation but is facing somewhat lower earnings during the remainder of 2016. It has been very well managed and is worth considering as a long-term investment.

Action now: Hold.

Canadian Western Bank (TSX: CWB, OTC: CBWBF)

Originally recommended on Sept. 15/14 (#21433) at C$40.54, US$36.31. Closed Friday at C$24.72, US$19.45.

Background: This is a Western Canada regional bank with 41 branches. It also has non-branch-based lending activities in the non-western provinces that account for 16% of its loans. Alberta accounts for 40% of its loans, B.C. 35%, and Saskatchewan and Manitoba together account for 9%. While the large Canadian Banks derive a significant portion of revenues and profits from non-lending activities, CWB is almost entirely a traditional “spread” lender taking in deposits and lending those out at a higher rate.

Recent developments: Last Thursday, CWB announced a common share sale at $24.50. The issue was sold out very rapidly. While share sales can depress stock prices, I think this was a prudent move. The share count is being increased by about 7%. This will reduce leverage and will cut earnings per share somewhat. But it will strengthen the balance sheet and reduces risk.

In the latest quarter, CWB’s earnings per share were down 40% due to a large provision for losses related to oil and gas production loans. Management appears to be confident that loan losses will remain manageable, although higher than in recent years.

Dividend: The stock pays a quarterly dividend of $0.23 ($0.92 per year) to yield 3.7%.

Valuation: At Thursday’s price of $25.19, the price to book value ratio seems very attractive at 1.11 (price to tangible book value is 1.23). The trailing adjusted p/e also appears highly attractive at 10.3. The dividend yield is attractive at 3.7% and reflects a payout ratio of 38% of adjusted earnings. The adjusted ROE is good at 11% for the latest four quarters. Intrinsic value per share is calculated as $34, assuming 5% average annual growth for five years and a terminal p/e of 13. These ratios in isolation would indicate a Buy rating.

Outlook: Earnings for the remainder of 2016 will very likely be lower than 2015 with the size of the decline depending on the level of contagion of losses from the direct energy production loans to the equipment financing and other loan categories. The long-term outlook for growth remains good but that depends on a recovery in the Alberta economy.

Action now: Hold.

– end Shawn Allen

 

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GORDON PAPE’S STOCK UPDATES

TransForce Inc. (TSX: TFI, OTC: TFIFF)
Originally recommended by Tom Slee on June 11/12 (#21220) at C$17.49, US$17.06. Closed Friday at C$24.50, US$18.66.

Background: TransForce Inc. is a North American leader in the transportation and logistics industry. The company operates across Canada and the United States, offering package and courier service, truckload and less than truckload haulage, logistics, and other services.

Stock performance: This stock was last reviewed in February, at which time the shares had been in a steep decline. I said at the time that the stock appeared to be oversold, trading at a reasonable 12.5 times 2015 net earnings. My recommendation was to buy. Since then the stock has rallied and is up about $4 as of Friday’s close.

Recent developments: TransForce is recovering from the hit it took when the price of oil fell sharply last year. In announcing the company’s year-end results in February, CEO Alain Bédard said the price drop “caused a significant decline in economic activity in Canada and a serious deterioration in the U.S. energy market”. The company responded by cutting costs and reduced its exposure to operations affected by the downturn.

Those actions are paying off. The company reported first-quarter revenue from continuing operations (before fuel surcharges) of $866.7 million, an increase of only 1% from the year before. However, adjusted net income from continuing operations was $31.5 million ($0.32 per share), a solid improvement from $27.5 million ($0.26 per share) in the same quarter last year. Free cash flow from continuing operations was $24.7 million compared to $18.7 million the year before.

Mr. Bédard said increased e-commerce activity in the U.S. contributied to the profit gains although the weak Canadian economy was a drag on results.

During the quarter the company sold its Waste Management operations for $800 million, generating a pre-tax gain of $559.2 million. The proceeds were used to retire some debt and to repurchase 2.9 million common shares.

“TransForce now has greater financial flexibility and will use free cash flow to further reimburse debt, repurchase shares, or proceed with selective acquisitions,” Mr. Bédard said.

Dividend: The stock pays a quarterly dividend of $0.17 per share ($0.68 per year) to yield 2.8% at the current price.

Action now: Buy. The company has shown its ability to cut costs and adapt to the weak Canadian economy.

George Weston Ltd. (TSX: WN, OTC: WNGRF)

Originally recommended on Aug. 23/15 (#21531) at C$110.55, US$83.73. Closed Friday at C$110.96, US$87.35.

Background: Weston’s main business is food processing and distribution – it owns a 46% position in Loblaw Companies. It is now also in the retail pharmacy industry through Loblaw’s ownership of Shoppers Drug Mart, which was acquired in 2014 for $12.4 billion.

Stock performance: I recommended this company last summer when the stock was trading at $110.55. It got as high as $120.10 in mid-March but has since pulled back to just above its level of last August.

Recent developments: The food business is relatively stable, without a lot of ups and downs. However, there were a few surprises in the first-quarter results. Revenue was $10.8 billion, up 3.8% from the same period last year. Adjusted net earnings were $168 million ($1.31 per share) compared to $152 million ($1.19 per share) in the prior year. The company said the improvement in adjusted earnings was primarily due to an increase in Loblaw’s earnings.

Although adjusted earnings showed an improvement, net earnings were well down from the year before. The company reported losses of $77 million ($0.53 per share) on foreign currency transactions and an $85 million charge relating to an increase in net interest expense and other financing charges primarily due to the fair value adjustment of the forward sale agreement for 9.6 million Loblaw common shares.

The result of these non-operating transactions was a drop in net earnings from $167 million last year to $47 million in the first quarter, a decline of 72%.

Dividend: Despite the sharp drop in earnings, the company increased its dividend by 3.5% to $1.70 annually. The stock yields 1.5% at the current level.

In addition, the company announced a new share buyback program of up to 6.4 million common shares representing 5% of the company’s shares outstanding. However, based on past history it is unlikely the company will ever get near that figure; over the past 12 months it bought back only 196,404 shares at a weighted average price of $106.28 pursuant to its previous buyback bid.

Action now: George Weston remains a Buy.


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GORDON PAPE’S FUND UPDATES

Beutel Goodman American Equity Fund (BTG774)

Originally recommended on Feb. 15/15 (#21507) at $13.65. Closed Thursday at $13.16.

Background: Beutel Goodman’s management team takes a low-risk, value-oriented approach to stock selection, making this fund appropriate for more conservative investors. This sometimes results in lower returns in bull markets but in down periods this fund is likely to lose less.

Recent developments: It has not been a good year for U.S. equity funds in general. Over the 12 months to May 31, the category is ahead only 0.9%, reflecting the turmoil in the American market. This fund did better than the peer group with a 2.7% gain (D units), although it is down year-to-date. One reader wrote to complain about its recent performance and to ask if he should sell.

The answer is no. One of the advantages of mutual funds is that they post historical numbers, which give us a

benchmark for measuring performance against other funds of the same type. This fund has been among the leaders in the U.S. category for many years. It has ranked in the first or second quartile every year since 2011 and its returns are above the peer group average for all periods from six months to 20 years. The 10-year average annual compound rate of return is 9.7% compared to a group average of 5.5%. The beta (a measure of risk) is 0.87, will below the index standard of 1.00.

In short, this is a low-risk, high-return fund. When you choose mutual funds or ETFs for your portfolio, this is the type of fund you look for.

The portfolio is invested in classic value stocks such as Verizon, JPMorgan Chase, Oracle, and Kellogg, the latter of which has enjoying a good run lately. The MER is 1.47% and you need to invest a minimum of $5,000 to take a position.

Action now: Buy.

Leith Wheeler Canadian Equity B Fund (LWF002)

Originally recommended on Jan. 28/08 (#2804) at $18.54. Closed Thursday at $40.16.

Background: The small Vancouver investment house of Leith Wheeler operates this fund. It invests in Canadian stocks, using a conservative investment approach.

Recent developments: The fund has a good long-term track record, with a 9.3% average annual return over the 20 years to May 31. However, it has disappointed recently with an average annual loss of 1.8% in the past two years.

The managers run a small, highly concentrated portfolio, which means they take big bets on individual stocks. Top holdings at present include Saputo (6.42% of assets), Royal Bank (6.34%), TD Bank (6.21%), and CN Rail (5.13%). Financials are the largest sector in the portfolio at 41.2%.

The fund has an MER of 1.49% and you need $25,000 to take an initial position. It is only available to residents of Ontario and the Western provinces.

Action now: The fund’s performance has improved in recent months with a year-to-date gain of 9.6%. So I suggest you maintain current positions but I do not advise new purchases at present.

Black Creek International Equity Fund (CIG11118)

Originally recommended on Sept. 9/13 (#21333) at $18.12. Closed Thursday at $17.79.

Background: This fund is part of the CI group. It invests in countries around the world except for the U.S. and Canada and has good record since it was launched in September 2008. Portfolio manager Richard Jenkins selects his securities on the basis of growth potential, which implies a higher degree of risk.

Recent developments: The units are down by $2.62 since my last review in October. However, we received a distribution of $2.27 at the end of 2015, which almost offsets that. Bottom line, the fund has treaded water since the last update and has beaten the category average. At a time when international markets are broadly down, we can live with that.

This is a true international fund. The largest portfolio holding is in Hong Kong with 12.7% of the assets, following closely by Great Britain (12.5%) and France (11.5%). The five-year average annual compound rate of return of 10.4% compared to the peer group at 6.2%.

I like this fund but global markets are roiled right now with the British vote on whether to stay in the European Community scheduled for this week. So I would not be a buyer at this time. If you have shares, hold on to them; otherwise stay on the sidelines.

Action now: Hold.

Steadyhand Income Fund (SIF120)

Originally recommended on Jan. 23/12 (#21203) at $10.56. Closed Thursday at $11.16.

Background: This balanced fund from a small Vancouver boutique company takes a similar approach to the Mackenzie Income Fund but with a much lower MER (1.04% compared to 1.90%). The portfolio is about 25% in bonds with the rest in fixed income securities.

Recent developments: The fund had a down year of 1.2% in 2015 but it has recovered well in 2016 with a year-to-date gain of 5.1%. The four-year average annual return since the fund was recommended in 2012 is just over 6%, will ahead of the category average of 4.9%. Distributions over the year to March 31 were $0.53 per share. Projected forward, that would give the units a yield of 4.7% at the current price.

Despite the small loss last year, this is a good fund for defensive investors. The distributions are commensurate with the fund’s profits, which is why the net asset value is higher now that at the time of the original recommendation.

However, there are two drawbacks. One is the minimum initial investment of $10,000, which may be out of reach for some readers. The other is that the fund is only available to residents from Ontario and the Western provinces. The cost of registering in the other provinces is too high for a small fund like this (one more reason why we need a national regulator).

Action now: Buy.

In This Issue

BREXIT VOTE SPOOKS FED

By Gordon Pape, Editor and Publisher

The prospect that British voters will elect to leave the European Union in next Thursday’s referendum has rattling even the staid U.S. Federal Reserve Board.

The Fed held the line on U.S. interest rates last week in a unanimous vote and part of the reason was the uncertainty overhanging upcoming U.K. ballot. There was no mention of the referendum in the open market committee’s formal statement, which focused more on the decline in new job creation, soft business investment, and the continued lack of any inflation pressure.

But Chair Janet Yellen told a press conference after the meeting that Brexit was top of mind among board members in making their hold-the-line decision.

So it should be. If British voters elect to abandon Europe on Thursday, the consequences will be far reaching. Some analysts have suggested it could be the beginning of the end for the great European experiment. That’s a stretch at this point, as Britain was never fully committed to the EU (it did not adopt the euro, for example).

Moreover, and this may come as a surprise to many people, a Leave vote would not automatically trigger Britain’s departure. The referendum itself is not binding. As Britain’s Daily Mail newspaper pointed out last week: “It would signal only that the wish of the British people is to leave the EU, and would spark negotiations to begin setting the terms for separation”.

Those negotiations would take up to two years to complete and the final deal might well see Britain continue its economic, trade, and financial ties with Europe, albeit under revised and less favourable terms.

Despite all the talk about regaining its sovereignty, it appears the real target of many Leave supporters is immigration and the fear the country will be swamped with newcomers who will take jobs while resisting efforts to integrate with British life and culture. Control of borders has become a major political issue across Europe since the wave of Middle Eastern refugees started to flood in last year. So it’s no surprise it could be a tipping point for many voters.

If Britain does vote to exit on Thursday, there will be turmoil in the markets. The pound will drop, gold will rise, European stocks will be shaken, and world markets will probably follow suit. Sovereign bond yields are likely to fall even further. The yields on German 10-year issues slid into negative territory last week as investors sought out safe havens.

However, the disruption will probably be temporary. Two years is a long time for negotiations to drag on and once the initial shock of a Leave vote is over investors will turn their attention to other issues while bureaucrats meet quietly behind closed doors to hammer out a new deal for the Britain outside the E.U.

Hopefully, the polls are wrong and Britain will vote to stay in Europe. But it is is not the end of the world if the Leave side wins. Nothing is going to change overnight and Britain remains geographically part of Europe. The exit negotiations will need to recognize that.

Follow Gordon Pape on Twitter @GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney

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TSX LEADERS: NEW FLYER INDUSTRIES

By Gordon Pape

Gold and materials have been among the leaders on the TSX so far this year but the index is also being boosted by some non-resource categories. The industrials sector is among them, which is where we find this week’s top outperformer, New Flyer Industries.

Background: Winnipeg-based New Flyer is the largest transit bus and motor coach manufacturer and parts distributor in North America. It has manufacturing, distribution, and service centers in Canada and the United States and employs approximately 5,000 people. The company is a leader in the development of clean transportation vehicles, which include those powered by natural gas, diesel-electric hybrid, electric-trolley, and battery-electric.

Stock performance: The company was first recommended in the IWB by former contributing editor Tom Slee in March 2013 when it was trading at $10.30 on the TSX. The shares bumped along at between $10 and $15 until the last summer of 2015 when they took off. Except for a blip last winter they have been in an upward trend since, finishing Friday at $40.47. The shares ended 2015 at $28.32 so the gain thus far this year is just under 43%.

Why we like it: New Flyer is in the right place at the right time. Cities across North America are replacing their aging public transit fleets with leading edge clean technology and this trend will likely continue for years to come.

A quick look at the company’s order book shows the rapid increase in demand for its products. At the end of 2015, the company had firm orders for 2,462 units. As of March 31, that was up to 3,113, an increase of 26% in three months.

Financial results: First-quarter results released last month showed revenue of $553.2 million, up 45.5% from the same period a year ago (note that the company reports in U.S. dollars). Net earnings were $22.6 million ($0.40 per share), an improvement of more than 100% from $10.9 million ($0.20 per share) last year. Free cash flow was C$61.5 million, up 400% compared to $12.3 million in the first quarter of 2015.

Outlook: Bright. The orders keep pouring in. On June 6, the company announced that the Connecticut Department of Transportation had awarded it a contract for up to 485 heavy-duty 35 and 40-foot Xcelsior clean diesel and diesel electric hybrid buses. The contract includes a firm order for 267 vehicles valued at approximately $122 million, with options for an additional 218 units over the next five years. The order will replace older vehicles in the fleet with newer, more fuel efficient Xcelsior models.

Just over a week later, the company announced that the Southeastern Pennsylvania Transportation Authority had awarded it a contract for up to 550 heavy-duty 40-foot Xcelsior diesel electric hybrid buses. It includes a firm order for 90 buses valued at approximately $50 million, with options for an additional 460 units over the next five years. All buses will be delivered from 2017 to 2020. 

Dividend: The company increased its annual dividend rate by 37.5%, effective with the July payment. The quarterly payout is now C$0.2375 per share, or $0.95 per year. The shares yield 2.3% at the current price.

Summary: The company is firing on all cylinders right now. It is suitable for all but the most conservative portfolios.

Action now: Buy.

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PROFITING FROM ORGANIC GROWTH

Contributing editor Shawn Allen back is with us this week. Shawn has been providing stock picks on his website at www.investorsfriend.com since the beginning of the year 2000 and has a great success record. He is based in Edmonton. Here is his report.

Shawn Allen writes:

Last month, in IWB #21620, I addressed the topic of growth-by-acquisition. I pointed out that while Valiant Pharmaceuticals had given the strategy a black eye, other companies including Stantec, Alimentation Couche-Tard, and Constellation Software had relied primarily on acquisitions to drive spectacular growth and returns.

This month I will take a look at companies that have had great success while relying exclusively on organic growth strategies.

The three broad categories of organic growth involve:

  1. Expanding the size of the market within a given geographic area.
  2. Expanding market share within a given geographic area.
  3. Expanding into new geographic areas.

Expanded market: Companies offering newer products and services can expand organically as the penetration of the product or service in a given geographic area expands. Examples include the increased penetration of smart phones (Apple) and the growing penetration of electronic payments (VISA, MasterCard, and American Express).

Expanded market share: Established companies in mature markets may have to rely on increasing market share in order to grow organically. This can be a dangerous strategy as it can lead to price wars. The decline in oil prices since 2014 has been blamed on a fight for market share. Growth that leads to higher sales and sharply lower profits is a dubious strategy. However, Berkshire Hathaway’s GEICO auto insurance company has increased its market share very substantially in a mature industry without making acquisitions and without broadening its product line or geographic reach.

Expanding into new geographic areas: There are a few companies that are in the enviable position of being able to expand successfully simply by opening new locations. I call this approach: “If They Build It, We Will Come”. I like this strategy because it can be relatively predictable once it is established. Here are some examples.

Costco Inc. The company currently has 706 stores. Ten years ago it had 504. In the past decade its earnings per share are up by 142% and its share price is up by about 174%. When Costco opens a new store it automatically attracts new customers. In some cases, there have been traffic jams during opening week. To date, cannibalization of existing locations has not been a problem. Costco’s growth has been entirely organic. Its last acquisition was the 1993 merger with Price Club.

Dollarama Inc. As of January, 2016, Dollarama had 1,030 stores. It became a public company in October 2009 with 585 stores. In the past six years its earnings per share are up 525% and its share price is up about 800%. Dollarama has continued to demonstrate that it can grow simply by opening new stores. A few years ago it reported that its capital cost to open a new store (in leased space) was about $600,000 and that this resulted in an earnings boost of some $300,000 for a two-year payback.

Other notable examples of businesses that can achieve organic growth simply by opening new locations include Starbucks and Tim Hortons. There are limits to this strategy in terms of cannibalizing existing locations. However, some companies have certainly achieved an extremely enviable position in this regard.

Organic growth is often assumed to be superior to growth-by-acquisition. However, there are examples of great success and also great failure in both categories of growth. The future success of any growth strategy is best evaluated on a case-by-case basis.


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SHAWN ALLEN’S UPDATES

American Express Company (NYSE: AXP)

Originally recommended on Feb. 17/14 (#21407) at $89. Closed Friday at $61.86. (All figures in U.S. dollars.)

Background: American Express is a credit and charge card issuer. The company had 118 million cards in forceat the end of 2015. About 63% of revenues are from merchant fees, which average 2.44%. Another 18% is from interest charged to cardholders, 8% is from card fees, and 15% is from other items including fees and commissions.

Amex’s business is about two-thirds within the United States and one-third outside. Traditionally, American Express was an integrated company that did not partner with banks but that policy has changed to allow certain banks to issue Amex branded cards.

Recent earnings growth: Amex’s earnings per share decreased 2% in the latest quarter. Earnings growth was depressed due to the higher U.S. dollar and the loss of the Costco business in Canada. For 2015, earnings per share were down 9% but were up 6% after adjusting for a restructuring charge.

Revenues per share increased 8% in the latest quarter, largely due to a 6% decrease in the share count. Revenues per share were flat in 2015 after being hampered by the higher U.S. dollar, which lowers the value of the company’s non-U.S. revenue, and by the loss of its former Costco business in Canada as the company switched to accepting only MasterCard.

Risks and outlook: Regulations and competition will likely push down the fees charged to merchants. The recent public spate between Wal-Mart Canada and VISA illustrates the fact that merchants are beginning to push back more aggressively against high credit card fees. Amex also faces the loss of its U.S. Costco business this month.

The company is projecting earnings growth of 0 to 6% in 2016 and similar modest growth in 2017, with a return to higher growth thereafter. Amex has a goal of growing earnings per share at 12% to 15% after 2017 (which seems aggressive).

Amex is projecting an unusual gain of $1billion (pre-tax) on selling its Costco card receivables portfolio. It may provide a special dividend or higher share repurchases based on this special gain.

Amex is benefiting from the continuing switch to electronic payments. The company is addressing its speed of payments to become more attractive to small businesses. Amex continues to partner with others in growing its business.

Stock price performance: Amex’s stock price decreased substantially during 2015 and is down about 12% in 2016 year-to-date. The p/e and price to book value ratios decreased very significantly due to disappointing earnings performance in 2015 and projections for continued weak earnings growth in 2016 and 2017.

Valuation: Based on our analysis price of $61.42, Amex is trading at 11.6 times trailing adjusted earnings and 11.1 times projected 2016 earnings. Its return on equity remains very high at 26%. Reflecting the high ROE, its price to book value ratio is somewhat high at 3.0. The dividend yield is low at 1.9% because the company pays out only 21% of earnings.

Action now: Hold. This call is based on the relatively attractive valuation but tempered by a low growth outlook.

Canadian National Railway Company (TSX: CNR, NYSE: CNI)

Originally recommended by Tom Slee on May 6/02 (#2218) at C$12.98, US$8.31 (split adjusted). Closed Friday at C$75.12, US$58.39.

Background: CN operates across Canada and down through the central U.S. to the Gulf of Mexico with over 21,000 miles of track.

Recent earnings growth: Earnings per share in the first quarter rose 16% even though revenues per share declined 1%. The results were affected by volatile fuel prices and fuel price surcharges and by the changes in the Canadian dollar, and this has benefited recent earnings growth. Car loadings were down 7% in the quarter due to weakness in the commodity sector and despite strong increases in the automotive and forest sectors.

Valuation: Analyzed at C$75.13 or US$51.95. CN’s return on equity is extremely strong at 26%. The price to book value ratio at 4.0 is ostensibly unattractive but mathematically simply reflects the high return on equity (ROE) combined with the p/e ratio. The p/e is 16.4, which seems neutral in attractiveness. The dividend yield is modest at 2% and reflects a payout ratio of 32% of earnings.

Outlook: The near-term outlook is negative, as CN now predicts no increase in the profit per share for 2016. Given that earnings per share were up 16% in the first quarter, this suggests a decline on the order of 5% in the remaining three quarters of 2016. Car loadings for North America railroads continue to run noticeably lower than the prior year as of June. However, CN remains well positioned for the long term as North America continues to import goods from Asia.

Management: CN’s CEO is resigning for health reasons and the CFO is taking over. CN has been expertly managed in a similar way for over two decades and has promoted from within. This change in the CEO should not be expected to have a major impact.

Conclusion: Canadian National Railway appears to be reasonably valued. It has an outstanding history of value creation but is facing somewhat lower earnings during the remainder of 2016. It has been very well managed and is worth considering as a long-term investment.

Action now: Hold.

Canadian Western Bank (TSX: CWB, OTC: CBWBF)

Originally recommended on Sept. 15/14 (#21433) at C$40.54, US$36.31. Closed Friday at C$24.72, US$19.45.

Background: This is a Western Canada regional bank with 41 branches. It also has non-branch-based lending activities in the non-western provinces that account for 16% of its loans. Alberta accounts for 40% of its loans, B.C. 35%, and Saskatchewan and Manitoba together account for 9%. While the large Canadian Banks derive a significant portion of revenues and profits from non-lending activities, CWB is almost entirely a traditional “spread” lender taking in deposits and lending those out at a higher rate.

Recent developments: Last Thursday, CWB announced a common share sale at $24.50. The issue was sold out very rapidly. While share sales can depress stock prices, I think this was a prudent move. The share count is being increased by about 7%. This will reduce leverage and will cut earnings per share somewhat. But it will strengthen the balance sheet and reduces risk.

In the latest quarter, CWB’s earnings per share were down 40% due to a large provision for losses related to oil and gas production loans. Management appears to be confident that loan losses will remain manageable, although higher than in recent years.

Dividend: The stock pays a quarterly dividend of $0.23 ($0.92 per year) to yield 3.7%.

Valuation: At Thursday’s price of $25.19, the price to book value ratio seems very attractive at 1.11 (price to tangible book value is 1.23). The trailing adjusted p/e also appears highly attractive at 10.3. The dividend yield is attractive at 3.7% and reflects a payout ratio of 38% of adjusted earnings. The adjusted ROE is good at 11% for the latest four quarters. Intrinsic value per share is calculated as $34, assuming 5% average annual growth for five years and a terminal p/e of 13. These ratios in isolation would indicate a Buy rating.

Outlook: Earnings for the remainder of 2016 will very likely be lower than 2015 with the size of the decline depending on the level of contagion of losses from the direct energy production loans to the equipment financing and other loan categories. The long-term outlook for growth remains good but that depends on a recovery in the Alberta economy.

Action now: Hold.

– end Shawn Allen

 

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GORDON PAPE’S STOCK UPDATES

TransForce Inc. (TSX: TFI, OTC: TFIFF)
Originally recommended by Tom Slee on June 11/12 (#21220) at C$17.49, US$17.06. Closed Friday at C$24.50, US$18.66.

Background: TransForce Inc. is a North American leader in the transportation and logistics industry. The company operates across Canada and the United States, offering package and courier service, truckload and less than truckload haulage, logistics, and other services.

Stock performance: This stock was last reviewed in February, at which time the shares had been in a steep decline. I said at the time that the stock appeared to be oversold, trading at a reasonable 12.5 times 2015 net earnings. My recommendation was to buy. Since then the stock has rallied and is up about $4 as of Friday’s close.

Recent developments: TransForce is recovering from the hit it took when the price of oil fell sharply last year. In announcing the company’s year-end results in February, CEO Alain Bédard said the price drop “caused a significant decline in economic activity in Canada and a serious deterioration in the U.S. energy market”. The company responded by cutting costs and reduced its exposure to operations affected by the downturn.

Those actions are paying off. The company reported first-quarter revenue from continuing operations (before fuel surcharges) of $866.7 million, an increase of only 1% from the year before. However, adjusted net income from continuing operations was $31.5 million ($0.32 per share), a solid improvement from $27.5 million ($0.26 per share) in the same quarter last year. Free cash flow from continuing operations was $24.7 million compared to $18.7 million the year before.

Mr. Bédard said increased e-commerce activity in the U.S. contributied to the profit gains although the weak Canadian economy was a drag on results.

During the quarter the company sold its Waste Management operations for $800 million, generating a pre-tax gain of $559.2 million. The proceeds were used to retire some debt and to repurchase 2.9 million common shares.

“TransForce now has greater financial flexibility and will use free cash flow to further reimburse debt, repurchase shares, or proceed with selective acquisitions,” Mr. Bédard said.

Dividend: The stock pays a quarterly dividend of $0.17 per share ($0.68 per year) to yield 2.8% at the current price.

Action now: Buy. The company has shown its ability to cut costs and adapt to the weak Canadian economy.

George Weston Ltd. (TSX: WN, OTC: WNGRF)

Originally recommended on Aug. 23/15 (#21531) at C$110.55, US$83.73. Closed Friday at C$110.96, US$87.35.

Background: Weston’s main business is food processing and distribution – it owns a 46% position in Loblaw Companies. It is now also in the retail pharmacy industry through Loblaw’s ownership of Shoppers Drug Mart, which was acquired in 2014 for $12.4 billion.

Stock performance: I recommended this company last summer when the stock was trading at $110.55. It got as high as $120.10 in mid-March but has since pulled back to just above its level of last August.

Recent developments: The food business is relatively stable, without a lot of ups and downs. However, there were a few surprises in the first-quarter results. Revenue was $10.8 billion, up 3.8% from the same period last year. Adjusted net earnings were $168 million ($1.31 per share) compared to $152 million ($1.19 per share) in the prior year. The company said the improvement in adjusted earnings was primarily due to an increase in Loblaw’s earnings.

Although adjusted earnings showed an improvement, net earnings were well down from the year before. The company reported losses of $77 million ($0.53 per share) on foreign currency transactions and an $85 million charge relating to an increase in net interest expense and other financing charges primarily due to the fair value adjustment of the forward sale agreement for 9.6 million Loblaw common shares.

The result of these non-operating transactions was a drop in net earnings from $167 million last year to $47 million in the first quarter, a decline of 72%.

Dividend: Despite the sharp drop in earnings, the company increased its dividend by 3.5% to $1.70 annually. The stock yields 1.5% at the current level.

In addition, the company announced a new share buyback program of up to 6.4 million common shares representing 5% of the company’s shares outstanding. However, based on past history it is unlikely the company will ever get near that figure; over the past 12 months it bought back only 196,404 shares at a weighted average price of $106.28 pursuant to its previous buyback bid.

Action now: George Weston remains a Buy.


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GORDON PAPE’S FUND UPDATES

Beutel Goodman American Equity Fund (BTG774)

Originally recommended on Feb. 15/15 (#21507) at $13.65. Closed Thursday at $13.16.

Background: Beutel Goodman’s management team takes a low-risk, value-oriented approach to stock selection, making this fund appropriate for more conservative investors. This sometimes results in lower returns in bull markets but in down periods this fund is likely to lose less.

Recent developments: It has not been a good year for U.S. equity funds in general. Over the 12 months to May 31, the category is ahead only 0.9%, reflecting the turmoil in the American market. This fund did better than the peer group with a 2.7% gain (D units), although it is down year-to-date. One reader wrote to complain about its recent performance and to ask if he should sell.

The answer is no. One of the advantages of mutual funds is that they post historical numbers, which give us a

benchmark for measuring performance against other funds of the same type. This fund has been among the leaders in the U.S. category for many years. It has ranked in the first or second quartile every year since 2011 and its returns are above the peer group average for all periods from six months to 20 years. The 10-year average annual compound rate of return is 9.7% compared to a group average of 5.5%. The beta (a measure of risk) is 0.87, will below the index standard of 1.00.

In short, this is a low-risk, high-return fund. When you choose mutual funds or ETFs for your portfolio, this is the type of fund you look for.

The portfolio is invested in classic value stocks such as Verizon, JPMorgan Chase, Oracle, and Kellogg, the latter of which has enjoying a good run lately. The MER is 1.47% and you need to invest a minimum of $5,000 to take a position.

Action now: Buy.

Leith Wheeler Canadian Equity B Fund (LWF002)

Originally recommended on Jan. 28/08 (#2804) at $18.54. Closed Thursday at $40.16.

Background: The small Vancouver investment house of Leith Wheeler operates this fund. It invests in Canadian stocks, using a conservative investment approach.

Recent developments: The fund has a good long-term track record, with a 9.3% average annual return over the 20 years to May 31. However, it has disappointed recently with an average annual loss of 1.8% in the past two years.

The managers run a small, highly concentrated portfolio, which means they take big bets on individual stocks. Top holdings at present include Saputo (6.42% of assets), Royal Bank (6.34%), TD Bank (6.21%), and CN Rail (5.13%). Financials are the largest sector in the portfolio at 41.2%.

The fund has an MER of 1.49% and you need $25,000 to take an initial position. It is only available to residents of Ontario and the Western provinces.

Action now: The fund’s performance has improved in recent months with a year-to-date gain of 9.6%. So I suggest you maintain current positions but I do not advise new purchases at present.

Black Creek International Equity Fund (CIG11118)

Originally recommended on Sept. 9/13 (#21333) at $18.12. Closed Thursday at $17.79.

Background: This fund is part of the CI group. It invests in countries around the world except for the U.S. and Canada and has good record since it was launched in September 2008. Portfolio manager Richard Jenkins selects his securities on the basis of growth potential, which implies a higher degree of risk.

Recent developments: The units are down by $2.62 since my last review in October. However, we received a distribution of $2.27 at the end of 2015, which almost offsets that. Bottom line, the fund has treaded water since the last update and has beaten the category average. At a time when international markets are broadly down, we can live with that.

This is a true international fund. The largest portfolio holding is in Hong Kong with 12.7% of the assets, following closely by Great Britain (12.5%) and France (11.5%). The five-year average annual compound rate of return of 10.4% compared to the peer group at 6.2%.

I like this fund but global markets are roiled right now with the British vote on whether to stay in the European Community scheduled for this week. So I would not be a buyer at this time. If you have shares, hold on to them; otherwise stay on the sidelines.

Action now: Hold.

Steadyhand Income Fund (SIF120)

Originally recommended on Jan. 23/12 (#21203) at $10.56. Closed Thursday at $11.16.

Background: This balanced fund from a small Vancouver boutique company takes a similar approach to the Mackenzie Income Fund but with a much lower MER (1.04% compared to 1.90%). The portfolio is about 25% in bonds with the rest in fixed income securities.

Recent developments: The fund had a down year of 1.2% in 2015 but it has recovered well in 2016 with a year-to-date gain of 5.1%. The four-year average annual return since the fund was recommended in 2012 is just over 6%, will ahead of the category average of 4.9%. Distributions over the year to March 31 were $0.53 per share. Projected forward, that would give the units a yield of 4.7% at the current price.

Despite the small loss last year, this is a good fund for defensive investors. The distributions are commensurate with the fund’s profits, which is why the net asset value is higher now that at the time of the original recommendation.

However, there are two drawbacks. One is the minimum initial investment of $10,000, which may be out of reach for some readers. The other is that the fund is only available to residents from Ontario and the Western provinces. The cost of registering in the other provinces is too high for a small fund like this (one more reason why we need a national regulator).

Action now: Buy.