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Canadian Tire is A Buy; Update on STN, RCI, SCCO

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Gordon Pape
Jun 11, 2011
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I think that Canadian Tire (TSX: CTC.A, OTC: CDNAF) is now starting to look attractive. In July 2010 we issued a Sell recommendation at $55 because the company was struggling. Earnings at the time were flat and Tire's blue collar market was in a serious slump. In fact, the entire merchandising sector was under siege and discretionary retail stocks underperformed the S&P/TSX Composite Index by 5% on average during the first quarter of 2011. Now, however, the picture is improving.

For a start, according to the Royal Bank, consumer spending is increasing at the fastest rate since late 2007, spurred by a 4% gain in Canadian disposable income. At the same time, Ontario's auto and parts industries are rehiring the thousands of employees who have traditionally been loyal Tire customers. Meanwhile, the company has been implementing productivity initiatives and these were reflected in the encouraging first-quarter results. Revenues were up 4.6% year-over-year while earnings of $0.71 a share jumped 13.4% from $0.63 in 2010. Unseasonable weather in March prevented the numbers from being even better.

The big news here, however, is Tire's $771 million acquisition of The Forzani Group, Canada's top sporting goods retailer with 500 outlets and 16% of the market. This is a very good deal. It is 'friendly", which means the highly successful Forzani management team is cooperative and synergies that could generate cost savings of $35 million per annum have already been identified. Another plus is that Tire, with $500 million of cash on hand, can finance the purchase internally and Forzani could add as much as $0.55 a share to the bottom line in 2012.

Given the new acquisition, improved consumer confidence, and the productivity initiatives, I think that CTC.A has a renewed lease on life. Earnings of $5.75 a share are expected in 2011 and as much as $6.50 next year. The shares closed on Friday on the TSX at $61.58. In the U.S., they can be purchased through the over-the-counter Pink Sheets, where they finished the week at US$62.90.

Action now: Canadian Tire is reinstated as a Buy with a target of $70. I have set a $54 revisit level.

Stantac Inc. (STN, Financial)

Originally recommended on Aug. 28/06 (IWB #2632) at C$20.48, US$18.45. Closed Friday at C$28.23, US$28.86.

Stantec turned in a solid but unexciting first quarter. Earnings of $0.52 a share were up from $0.35 in 2010 and in line with consensus forecasts. Net revenue jumped 13.7% year-over-year but 12.7% of this resulted from acquisitions.

Looking ahead, the relatively slow U.S. recovery is going to hamper organic growth although the company's mining sector is showing signs of life. Canadian and U.S. mass transit projects are also likely to boost revenues. Stantec's environment division was hampered by bad weather in the first quarter but better numbers are expected for the balance of 2011. Buildings and land development remain stable.

As you can see, it's a mixed bag for the moment with growth again dependent on new acquisitions. The company is tightly managed and margins are being maintained. Any strength in the U.S. dollar would be very helpful. Foreign exchange cost Stantec $5.7 million of net revenues in the first quarter.

Pulling it all together, I still like the company but the stock is likely to mark time for a while. Earnings of about $2.25 per share are expected this year and $2.50 in 2012. A lot depends on acquisitions.

Action now: Stantec becomes a Hold but I will keep a close eye on developments with a view to reinstating the Buy rating at the appropriate time.

Rogers Communications (RCI, Financial)

Originally recommended on April 23/07 (IWB #2716) at C$42.10, US$37.41. Closed Friday at C$36.69, US$37.45.

Rogers is successfully weathering the increased wireless competition. First-quarter earnings of $0.76 a share were up from $0.67 the year before and better than the $0.72 most analysts were expecting. Revenues of $3 billion were in line with forecasts. Most important, the company booked 50,000 net wireless subscriber additions and 17,000 net new subscribers. Cable subscribers remained almost unchanged.

Rogers still controls the most attractive telecom assets in Canada and maintains a strong balance that generated $558 million of free cash flow during the first quarter. So normally it would be onward and upward. The government's decision to allow foreign competitors into Canada's airwaves has, however, thrown a spanner into the works. We have had seven new entrants during the last year or so and Rogers, as the major wireless market player, has been the prime target. As a result, the stock has stalled. Investors are concerned. Rogers, Bell, and Telus are locked in a discount war and a fight for subscribers.

Personally, I am optimistic. It was only a matter of time before the Canadian wireless market was opened up and it's now apparent that the onslaught could have been much worse. The market itself is relatively small and the new players are already competing against themselves a lot of the time. One expert has pointed out that Rogers would have been hurt much more by the arrival of one major U.S. telecom with a marketing plan and deep pockets.

It is also obvious that the Canadian companies were well prepared for the invaders and they quickly added four discount brands to their existing national labels. As a matter of fact, it now looks as though some form of consolidation amongst the new entrants themselves seems inevitable.

I am not dismissing the competition. Rogers will feel the pinch but that is already in the stock price. On the other fronts, the company is going to benefit from improving advertising markets and increasing consumer confidence.

Action now: Rogers remains a Buy with a target of $43. I have set a $33 revisit level.

Crew Energy Inc. (CWEGF)

Originally recommended on Feb. 14/11 (IWB #21106) at C$19.78, US$20.18. Closed Friday at C$14.92, US$15.31.

Energy prices plunged at the end of May and Canadian oil stocks sold off. The two junior producers on our Buy list were no exception. Their fundamentals, however, remain sound.

Tourmaline Oil Corp. had an excellent fourth quarter. Production climbed to 22,953 barrels of oil equivalent per day (boepd), a 217% increase over 2009 and up 22% from the third quarter. Average production for the full year was 17,859 boepd, a 417% increase over the year before. It was a good performance. Cash flow from operations in 2010 came in at $1.10 a share, the balance sheet remains strong with no bank debt, and, most important, total proven reserves grew 167%. After-tax earnings for the year were $0.12 a share compared to a loss of $0.03 in 2009.

First quarter 2011 numbers, which were released on May 27, were also very good. Cash flow jumped 52% year-over-year to $44.9 million on a 52% improvement in sales. It was an impressive performance that led The Wall Street Journal to add Tourmaline to its "Canadian Hot Stocks" list. The company now expects to average production of 29,000 boepd this year, a 55% improvement over 2010. There is a real sense of activity and management plans to operate eight rigs and drill 55 wells during the next six months. We could see a cash flow in the $1.85 a share range this year and there is now a potential asset value of $23.50. Given that, the company has unusual potential that makes the shares, which are up 22% since our recommendation in February, good value.

Action now: Tourmaline remains a Buy with a target of $36. I will revisit the stock if it drops to $23.

Crew Energy Inc. has also racked up some respectable, although slightly disappointing, numbers. The company reported a loss of $0.12 a share in the first quarter due to a 19% year-over-year drop in natural gas prices and part of its facilities being offline for six days to allow for expansion. At the same time, average production increased 7% from the previous quarter to 15,608 boepd.

The important news is that the company has acquired Caltex Energy for $622 million in shares and assumed debt. This means that Crew will issue 33.2 million shares at a deemed price of $16.30 and this has been overhanging the stock. However, that's short-term pain for long-term gain. The deal gives Crew exposure to significant heavy oil deposits in Saskatchewan as well as rich gas assets in Alberta and increases the company's expected 2011 production by 75% from 14,000 to about 24,000 boepd.

Action now: Crew Energy remains a Buy with a target of $25. I have set a $12 revisit level.

Southern Copper (SCCO, Financial)

Originally recommended on May 9/11 (IWB #21118) at $35.49. Closed Friday at $31.51. (All figures in U.S. dollars.)

The unexpected victory of nationalist Ollanta Humala in the Peruvian presidential election has sent shock waves through the international copper markets. Peru is the world's second-largest copper producer after Chile and during the campaign Humala suggested that he would impose substantial windfall taxes on the copper producers. Since the election Peru's stock market has plunged 12.5% and the country's debt is being treated like junk.

I think that is an overreaction. Peru depends on its copper industry and Humala's economic policies are going to be tempered by a divided Congress and moderates who supported him. More specifically, I think that Southern Copper, now trading at $31.51 and paying a $2.24 dividend to yield 7.1%, remains a Buy for investors who can assume some risk. The fundamentals for copper remain strong and its price is likely to climb if there is any interruption of Peruvian supply.

Action now: Buy.

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