Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

 Stock markets took a breather in August after a scorching hot run, particularly for U.S. stocks, throughout the first seven months of the year. In the glass half-empty column, second-quarter earnings for both the S&P TSX Composite Index and the S&P 500 Index declined versus the same period last year. However, in the glass-half-full column, the declines were shallower than analysts had feared they might be. Equity investors are bravely shaking off concerns of a slowing economy and the lagged effects of interest rate increases, but clearly remain uneasy about when and at what level central bankers will stop raising rates, as the hyper-focus on U.S. Federal Reserve and Bank of Canada meetings and inter-meeting speeches demonstrates.

Our portfolios are conservatively positioned, with a primary emphasis on well-capitalized, high-quality businesses rather than credit-dependent, or deeply cyclical companies. Perhaps counterintuitively to some, many of the companies we own are actually quite pleased with the shifting sands of monetary policy. Many of our investee companies are very capable, active and disciplined acquirers, and are now finding a fuller opportunity set of well-priced targets, with the zero interest rate sugar-rush that two years ago fuelled a feeding frenzy among special purpose acquisition companies (SPACs), private equity and other less disciplined acquirers now out of the picture. 

We continue to find more opportunities in Canada, so our portfolios accordingly are 60 per cent invested in Canada versus 40 per cent invested in the U.S. The S&P TSX Composite Index dividend yield is 2.2 times the S&P 500 yield, it trades at a 58 per cent discount to the S&P 500 on price/book measures and a 31 per cent discount in terms of its price/earnings ratio. These metrics are at or near 20-year extremes, favouring Canada. Valuation is a poor short-term timing tool but matters a lot over a decade.      

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TOP PICKS

Alimentation Couche-Tard (ATD TSX)

Latest purchase December 2022 at $61.85

Alimentation Couche-Tarde is the world’s second-largest convenience store operator with nearly 13,000 stores across Canada, the United States, Europe and Hong Kong. The company earns returns on equity of 25 per cent and has grown earnings per share at a 21 per cent compound rate over the last decade. The company uses procurement scale to price sharply on fuel, drawing traffic to its sites and then luring shoppers into attractive, modern, well-merchandised stores where merchandise gross margins are three to five times higher than its profit margin on gasoline. The company is a very capable acquirer with a demonstrated pattern of realizing significant synergies from acquired businesses, in this still highly fragmented industry and recently announced a deal to acquire 2,200 stores in Germany, Holland, Belgium and Luxembourg from TotalEnergies. Its growth algorithm increasingly emphasizes organic growth, with merchandising sophistication increasing and digital marketing and loyalty programs gaining traction. This acceleration of organic growth should over time earn a higher valuation.

Royal Bank of Canada (RY TSX)

Latest purchase August 2023 at $121.62

Royal Bank is one of the ten largest banks in the world and is soon to become significantly larger, pending the completion of the acquisition of HSBC Canada. With a dominant domestic personal and commercial banking franchise, a top ten global capital markets business and the leading Canadian wealth management franchise rounded out with smaller insurance and investor services and treasury businesses, Royal has a very solid and well-diversified earnings stream. Royal is well diversified by geography with large-scale businesses in Canada, the U.S. and Europe and in various other global financial centres. The bank is a leader in digital banking and AI. It is using its scale to invest heavily in these drivers of long-term competitive advantage. With a dividend yield of 4.5 per cent and with dividends growing at a seven per cent annual rate over the last decade, we see a highly visible path to ongoing sustainable double-digit returns over a cycle, and in fact, the bank has outperformed the S&P TSX Composite in 19 of the last 25 years.

Public Storage (PSA NYSE)

Latest purchase October 2022 at $289.53

Public Storage acquires, develops, owns and manages self-storage facilities for personal and business use and is the U.S. market leader in this industry. Somewhat unique among real estate operators recently, this real estate investment trust is growing funds flow from operations (FFO) at a high single-digit pace. Growth is driven by higher rental rates (pricing power), record tenant lengths of stays, stringent cost containment/energy efficiency initiatives, new build developments and targeted acquisitions. With a 4.3 per cent yield and a nine per cent compound growth rate in dividends over the past decade, and with the shares trading at a 22 per cent discount to its five-year average multiple of FFO we see a very timely opportunity here.

 PAST PICKS: November 9, 2022

Tractor Supply (TSCO NASD)

• Then: US$203.40
• Now: US$220.13
• Return: 8%
• Total Return: 10%

Franco-Nevada (FNV TSX)

• Then: $178.72
• Now: $193.80
• Return: 8%
• Total Return: 9%

Brookfield Corp. (BN TSX)

• Then: $54.86
• Now: $45.24 (after the spinoff on December 12, 2022)
• Return: 2%
• Total Return: 2%

Total Return Average: 7%