A Comment -- General Comments From an Expert (A Commentary)

An area he's not involved with, mainly because it involves too much predicting. For example, if you held uranium in 2010 you probably started to feel pretty good about things. Then the Fukushima crisis knocked it down. Now in 2024, it's just starting to come back.

He gets why people get excited about it. But he's been at this for 25-30 years now, and there have always been pockets of enthusiasm for the clean, cheap, safe, wonderful energy of uranium. Earnings can be challenged, ROIC isn't strong. A lot of expectation built into recent action.

This question may be the best one he's ever had in 5 years on Market Call, as it speaks to the process of identifying securities to invest in. #1 metric is ROIC, and there are variations on that theme.

Average ROE of the market is 8%. Standard economic theory states that if a business has an ROE of 20-30%, competitors will come in and eat the lunch such that the returns for all businesses in that space will come down to the cost of capital, around 6-8%. However in practice, looking at the likes of CSU or ATD or NKE or META, we see businesses that have been able to produce a 20% ROIC for years. That tells him there's a moat around that business preventing others from coming in and reducing ROIC.

Businesses set to outperform will have a history of strong ROIC.

He generally won't touch a business unless the people running the business also own a sizable portion of that business through insider ownership. He wants them to be acting like the rest of the shareholders.

Not really a huge difference. Return on Equity can be juiced by levering up your balance sheet. Return on Assets is probably the single most important return metric you can look at, because it can't be increased by debt.

If you have a stock that "goes down every day", and this is a high-quality, predictable stock, you should be getting excited, smiling, rubbing your hands together. Because the lower the stock, the higher the forward return, as long as you can predict that earnings will be higher in the future.

Often when he comes on BNN, there's disappointment that he offers stocks that are down. Well yes, they're on sale! Who doesn't like a sale? Focus on the fundamentals of the business, and the stock price second.

Believes interest rates will remain "higher for longer" in USA. Expecting interest rate cut in 4th quarter (USA) - at the earliest. Since employment is strong, and inflation is sticky - there will not be an interest rate cut (USA). Canada on the other hand, may get an interest rate cut earlier. Mortgage's are renewing faster in Canada which (among other reasons), will be more reason to cut rates (as early as June). Generally speaking, not too positive on Canadian banks. Falling interest rates mean weakness in consumers (not good for banks). Will wait for more weakness in Canadian banks before buying. 

Believes "Sell in May & Go Away" can be affected by US Presidential election. During US election years - returns are historically bad. However, this year (2024) returns have been good. Markets are very different than historical averages. Therefor "Sell in May & Go Away" is not good advice this year. Instead, would recommend buying on dips. 

Market Update:

Canada’s annual inflation rate slowed to 2.7 percent in April, increasing the chance that the Bank of Canada will start cutting rates as early as June. On the other hand, the prices of crude oil closed lower for a fourth-straight session on mild demand, and rising inventories, indicating a voluntary supply cut by OPEC+. The Canadian dollar was 72.84 cents USD. The U.S. S&P500 ended the week down 0.7%, while the TSX was down 0.4%.

Another week of greens and reds mixed. Consumer staples added 1.5%, while technology and energy added 0.9% and 0.2%, respectively. Real estate and consumer discretionary and technology gave up 2.1%, each. Materials slid by 0.6%, while financials and industrials both ended the week down 0.5%. The most heavily traded shares by volume were Enbridge, Suncor Energy, and Cenovus Energy.
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Believes it is an exciting time for dividend investors. Increase in power demand resulting from re-shoring, A.I. and data centers will increase demand for infrastructure/power companies (dividend payers). Canadian markets are not overvalued compared to US markets since major US tech has been attracting too much capital. As currencies devalue - will increase value in commodities. Copper & Lithium demand expected to grow with EV demand rising. Expecting strength in the TSX as a result of all of these forces. 

Company Highlight: Hammond Power Systems (HPS.A)

Prior to HPS.A releasing first quarter earnings, the stock had been a small-cap darling on a strong uptrend. What appears to be a huge earnings miss, was heavily impacted by non-cash expenses through share-based compensation when employees exercise stock options. With the growth of the company, hiring has increased, but with the shares up 242% the value of share-based compensation has increased dramatically and is charged against earnings. While this is not a positive, it is something common that high growth companies can experience. We do not think it should be a big factor driving the stock down, but the big EPS miss and high levels of stock-based compensation were a talking point leading to the stock taking a hit. Sales growth did also slow a bit from prior quarters which the market further did not like. However, HPS.A is increasing prices for Q2, and if demand is inelastic to this price change, then growth could be back up into the teens. Distribution growth was strong in the US, and the backlog rose 11.1% year over year. Margins were still decent despite a less-attractive product mix and start-up costs in Mexico. SG&A costs did rise. While not a great quarter overall and there is some reason for the sell-off, HPS.A still has plenty of potential and recently increased its dividend substantially.
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Complete elimination of any political risk premium that was in the oil price. About 2 months ago, he started getting far too many interview questions about whether oil was going to hit $100. As a contrarian that made him nervous, so he raised quite a bit of cash (about 33%). And he's been actively spending that given the selloff.

Heading into a key OPEC meeting in a few weeks. His best read on the situation is that they'll extend the voluntary cuts through to the end of this year. Still concerns about a weak China, whether the Fed will cut or not, and how is the US consumer holding up. That means sharper than average inventory draws beginning next month. 

Given these headwinds plus seasonal weakness, high $70s is pretty good. Energy is up 20% YTD. As we look to the second half of this year, sees demand seasonally increasing, OPEC continuing cuts. Falling inventories are bullish for oil. Possibility of $90 Brent by end of 2024.

Bullish heading into 2025. LNG Canada starting to ramp up and will start taking nat gas in the next month or so. Outlook remains solid.

Weekly numbers that come out are typically of low quality. Last year, underestimated US demand by 400K barrels a day. So he waits for the monthly numbers and wouldn't be surprised to see an upward revision. 

No tangible evidence that the consumer is faltering. We hear all these stories about trade downs to Walmart and people buying fewer Big Macs, but if you look at miles driven, the consumer seems fine. Demand is not shooting the lights out, but it's fine.

He still sees enduring religion of returning free cashflow to investors, irrespective of tax changes. It's likely that people will do some estate planning by the deadline and take some gains off the table. But he doesn't see the impact occurring on share buybacks.

Right now companies are awash in free cashflow, not meaningfully growing, and paying down debt. There's really nothing to do with that cash except give it back in the form of dividends or buybacks. Investors very clearly want share buybacks.

We've had a bit of a rerating. Stocks aren't trading at 2x cashflow, now more like 10-12x free cashflow yield. Still sees meaningful upside at $80 oil and $4 gas. Real power in the next couple of years is the compounding effect of buying back 10-15% of outstanding shares every year. Three to four years from now, the remaining shares will be so much more valuable.

Personally, he likes to buy when others do not. He likes panic and fear. Be greedy when others are fearful. The best buys are when you're sick to your stomach. That's not the case today.

When there was so much going on geopolitically and there was euphoria in oil, that was not the time to be deploying capital. Huge premium risk to the oil price, and you could wake up one morning with oil down $5.

Where global oil inventories are today, there's no risk premium in the oil price. He's bullish on oil, so that makes him want to deploy capital. He's gone from 33% cash weight to about 10.5%. Now actively spending.

What to buy? You could buy oil names. The valuation gap between large cap and small is the widest in history. The large guys are trading at such a massive premium, and the small guys are at a discount. It's an inefficient market and there's not as much interest in small caps. You'd think that would make you want to buy large caps, but he's a contrarian.

He sees opportunity in small- and mid-cap stocks, as long as you have asset quality and a management team you can trust. Also free cashflow will allow for meaningful share buybacks. There's always a bit of hair to the story, so you need to figure out if it's a mispriced stock (a catalyst will drive the rerating) or a value trap (stays cheap forever).