Monthly Update May 2013
Bank of Nova Scotia (BNS)
About the Company: The Bank of Nova Scotia is one of Canada’s Big 5 banks, offering retail and commercial banking, wealth management and capital markets services. It is Canada’s most international bank, with nearly half of revenue coming from outside Canada’s border.
Investment Thesis: Despite concerns over a slowing Canadian economy and slowing loan growth (both of which are warranted), we think the Canadian banks have many levers to pull to drive earnings. Scotia, particularly, has exposure to high growth economies through its business in Latin America. The recent selloff in shares provides a good entry point to gain exposure to the banking sector, especially given below average valuations and compelling dividend yields.
Valuation: Scotia is trading at 11x earnings. This provides 16% upside to a multiple of 12.8x, which is more in line with historical norms. Investors get additional return from the dividend, which currently yields 4%+.
Expectations: We expect BNS to be a relatively stable position within the portfolio. We also expect the shares to trade up to their historical norms.
- Scotia is Canada’s most international bank, with nearly 50% of revenue coming from outside Canada.
- Compelling valuation at 11x earnings and 4%+ dividend yield.
- Should act as a relatively stable holding within the portfolio.
About the Company: Oracle sells a wide range of enterprise IT solutions, including databases, applications and hardware. They are a leader globally in database solutions and have been very active with acquisitions to participate in the trend towards the cloud or internet based computing.
Investment Thesis: We have been following Oracle for a while based on their free cash flow generation and valuation, waiting for an appropriate entry point. Their last quarter (Q3) results disapointed investors as a result of poor sales execution causing missed revenue expectations in key segments. Q3 is generally a weak quarter as sales get pushed into Q4 as the sense of urgency becomes greater. We believe the sales issue is temporary not permanent, so we used this opportunity to build a position in a company that will benefit long term from the “big data” trend, where companies are continually looking for ways to better analyze all the data available to them. Oracle leads the industry on this front.
Valuation: Oracle is trading at 11.3x earnings. This provides 15% upside to their historical multiple of 13x. They generate a significant amount of free cash flow (7% free cash flow yield) and also have a 0.7% dividend yield.
Expectations: We expect to see positive results in Q4 considering the miss in Q3. If this is a temporary issue, than revenue should be stronger year over year in Q4. Longer term we like the stability of their database business as we consider their dominant position there to lead to increased sales in the cloud and other “big data” sales as this positive trend continues.
- Oracle is a leader in enterprise IT solutions, particularly database solutions.
- Very compelling valuation at 11.3x earnings with a very strong free cash flow profile.
- Provides exposure to the growing trend of data analytics. Companies have massive amounts of data available at their fingertips and will need database management solutions to be able to intelligently utilize it.
There were no major sales within the portfolio this month, however, we did lock in profits from stocks that have had strong performance by trimming the positions to get back down to a normal portfolio weighting.
Most of the companies we own reported earnings this month. Here are some highlights:
GIB.A – CGI Group was the portfolio’s strongest performer as the company showed tremendous progress on its Logica acquistion. Investor focus was on margins as CGI restructures the workforce and weeds through loss-producing contracts. Margins significantly beat expectations (10.4% vs 9.2%) and the company announced that synergies from the acquisition will grow to $375 million (from $300 million) and arrive a full year ahead of schedule. This is exactly the reason we bought the stock and we look for continued strong performance as CGI leverages its new, global platform.
Celestica – While results were in line with expectations, investors grew increasingly comfortable that margins will start to improve through the second half of the year. The valuation remains extremely compelling, with the business trading at less than 7x earnings when one accounts for cash and the company’s land position.
Suncor – Suncor delivered strong earnings by demonstrating the value of its refining business. We also like management’s discipline in allocating capital – the recent cancellation of its large Voyageur Upgrader project leaves the company with excess cash, which will go towards a $2 billion share repurchase program and 54% increase in the dividend.
KKR – KKR continues to fire on all cylinders. We are in a unique time where conditions are favourable for both investing new capital and realizing strong pricing on investments being sold. This latter category is particularly important as it drives performance fees, which are then distributed to shareholders. KKR announced that, based on investments sold in the quarter to date, its distribution from this earnings driver will set a record in the upcoming quarter.
Performance – We rarely discuss performance. This is because we want investors to make good decisions on how to allocate their capital, and believe this is achieved when the focus is on understanding how we are investing capital on their behalf, versus making decisions based on past performance. Having said that, we have now completed the first full year of managing our portfolio according to this investment process and we are very pleased with the result, particularly given the volatility we have seen in the past year.
For the one year period ending April 30, 2012 we had a return of 11.2% after all fees. This return placed us solidly in the second quartile or ranked in the 34th percentile within our Morningstar Category which had a median return of 8.3% over the same period.
Continue to Focus on Process – We continue to focus on making good decisions by staying disciplined to our investment process. We believe this will allow us to continue producing superior results over time.