Canada Shrugs Off Us Market Jitters
With strong macro fundamentals and limited impact as yet from the slowing US economy, most analysts see strong prospects for Canada in the coming year
The Canadian market, although subject to the cyclical nature of its biggest industriesenergy and natural resourcescontinues to do well in the face of a slowing US market, with continued debt reduction plans and stable economic policies. Global investors looking to take a chunk of the Canadian market are finding there are opportunities aplenty, both for direct and indirect investment. Sidestepping the slowdown in the United States, the Canadian economy continues to push forward full steam ahead, with only a slight slowdown predicted for the coming year.
However, the state of Canadas markets says as much about the global economy as it does about the domestic economy. With its great reliance on exports in energy, natural resources and manufacturing, Canada could be particularly exposed to any wobbles in the US and global economies.
David Wolf, chief strategist and head of Canadian economics at Merrill Lynch, says: A lot of Canadian companies are more leveraged to global growth than domestic growth, particularly in resource sectors, and they make up 50% of the domestic stock market. This is higher than most other countries, so they follow the global economy more than the domestic economy.
Nevertheless, so far, the macro picture looks reasonably good for Canada in the coming year. Wolf says that domestic demand in Canada has remained quite firm. We are not seeing any of the crumbling housing market that is having an impact in the US. We really see a two-speed economy here: Externally oriented companies, such as manufacturers, are feeling the pressure, but domestically focused companies are enjoying the robust demand environment, he says.
Earnings and cash flow for Canadian businesses have risen sharply during the past three years, driven by rising commodity prices, brisk growth in global demand and good cost performance, according to Richard Egelton, chief economist at the Bank of Montreal. These factors have more than offset the steep rise in the Canadian dollar, which, on its own, can reduce the competitiveness of domestic producers and reduce revenues and earnings, he says. This is particularly the case for products and services priced in US dollars.
Net earnings of Canadian businesses increased at an average annual pace of 32% over the past three years, according to the Bank of Montreal, reflecting the massive capital expenditures needed to develop natural resource projects and upgrade facilities in order to increase productivity and meet rising competition. However, so far, investment spending within Canada has lagged the expansion in profits. This has resulted in substantial growth in cash on the balance sheets of Canadian businesses, says Egelton. Rising cash flow has also been bolstered by excellent capital marketsboth equity and bondwhich have provided businesses with low-cost financing and refinancing opportunities, he notes.
The equity capital markets saw a huge number of deals done in recent months across a range of sectors, from airlines to financials and beyond. Much discussed was certainly the $900 million Tim Hortons IPO, arranged by RBC, JPMorgan, Goldman Sachs and Scotia Capital. The iconic Canadian coffee chain benefited from strong market demand and a sterling reputation from Canadian consumers. It was one of the most talked about transactions of the year and generated interest from a range of investors, both institutional and retail.
The market also saw a unique C$288 million (US$198 million) IPO of Air Canadas customer loyalty program, Aeroplan, and another Air Canada IPO: the spin-off in January of its regional unit, Jazz Air, into a trust. Jazz Air Income Fund sold 23.5 million shares at C$10 each.
With ready capital available from both equity and debt investors, and much cash piling up on the balance sheets, Canada is buzzing with both internal and external investment. According to the International Monetary Fund, direct investment was US$34 billion, which matched quite closely with outflows abroad. Where you can really see investment progress is in the number of firms that have been acquired. That shows quite a bit of confidence in Canadian companies and the overall macroeconomic operating environment, says Mary ODonnell, an analyst at ratings agency Moodys. With Canada reducing government debt consistently, it gives more room for corporate tax cuts and tax incentives that make it attractive to both foreign and domestic investment, which is what we are seeing, she adds.
Many global firms have picked up Canadian assets over the past year, and there are a number of sectors that promise more of the same this year. Interest has come from the US, Europe and Asia. Energy and natural resources are, as always, high on the list for assets to purchase. Rob Baillie, CEO of investment firm Northern Trust, says: The Canadian market has been a very hot market for quite a while now. It is one of the strongest markets in the world, and the strongest demand for market-driving energy and natural resources is coming from China and India and, of course, the US.
Late last year China National Petroleum Corp. acquired 100% of Canada-based PetroKazakhstan (PKI) in a $4.2 billion transaction. In November Pengrowth Energy Trust announced plans to buy Canadian oil and gas properties and undeveloped lands from ConocoPhillips for C$1.04 billion. In addition, Swiss firm Xstrata finally finished its much-discussed takeover of Canadian firm Falconbridge. Another big M&A; transaction to come out of Canada is the C$1.06 billion Zucker Investment acquisition of historic Canadian department store chain Hudsons Bay Company.
Financial Sector Strengthens
While the energy and natural resources sectors have been hot, the financial sector is the one that has benefited most from the solid Canadian picture. Canadian banks, which have long produced steady returns, have lately seen record profits. The one thing, however, that continues to hold back banking firms in the country is the regulatory framework. Canadas competition laws have long frustrated the big banks by disallowing any large-scale mergers.
After a number of potential mergers were announced in the late 1990s, competition laws were reviewed, but, to the consternation of banking firms, Canadas finance minister at the time upheld the competition guidelines, and big banking firms remain unable to merge. Nonetheless, there have been some big developments in the financial sector. Investment firms are set to benefit from a more liberal M&A; framework, with restrictions loosened on both foreign growth into the Canadian investment market and M&A; activity for domestic firms.
Baillie at Northern Trust explains: The border between Canada and the US seems to be opening up and will continue to open up. More Canadian investment firms are managing foreign assets than ever before. But on the flipside there are more US and global shops setting up in Canada due to the foreign content restrictions being lifted.
We have seen a lot of activity and many players changing in a market that for many years seemed to be pretty consistent, Baillie adds. This opens up the market, which is a positive. There are a lot of great firms that are now focused on this marketplace, and if nothing else it is a benefit to institutional investors.