Let’s go offshore with the loonie
Investing outside Canada still smart
Rob McConnachie
View from the Street, Financial Post
Monday, November 07, 2005
The Canadian dollar has been on a pretty good roll for a couple of years now. If the "Petrodollar" is really on its way to par with the U.S. dollar, then should Canadian investors even bother to look for opportunities outside of Canada?
The short answer is 'yes,' they absolutely still should.
A few years ago, this wasn't even a question. With the Canadian dollar stuck in the low US60 cents range, we heard dire prediction of a US50 cents 'Canadian peso' on the horizon. It made perfect sense to take Canadian dollars and invest them in foreign stocks. Even if the stocks went nowhere, Canadian investors still won as the Canadian dollar lost value.
It has been much more painful for Canadian investors the last couple of years, as the rise of the Canadian dollar has often wiped out many foreign investment gains. It's tempting to think that foreign investment isn't needed if the Canadian dollar is just going to keep heading higher.
But the truth is, some sectors are simply not well represented in Canadian capital markets. It can't be forgotten that Canada makes up only 3% of the world's capital markets. Foreign companies in certain sectors provide industry diversification and -- because many operate globally -- they can also provide geographic diversification.
Health care, consumer staples and information technology are examples of this, so let's take a closer look at those areas:
As the Baby Boom generation ages, health care is (hopefully) going to have to keep pace. Nobody knows how much the sector will make up of our future liabilities, but I'm willing to hazard a guess that it will dwarf the current 1.3% weighting in the S&P/TSX composite index. Companies like Johnson & Johnson and Pfizer don't have Canadian equivalents, so to gain exposure in this sector, investing outside of Canada is prudent.
Another area not well represented in the Canadian markets is consumer staples. While there are a few good domestic companies, most are already richly valued, partly because of their scarcity.
That's why our firm recently ventured outside of Canada to buy stock in Wal-Mart Stores Inc. We bought it at a trailing price to earning ratio of about 17, its lowest value in many years. Compare this to a couple of premiere Canadian retailers, Shoppers Drug Mart Corp. and Loblaw Companies Ltd., which at the time traded at 27 and 20 times trailing earnings, respectively.
Going forward, we believe Wal-Mart will continue to have higher growth than Loblaws, both on a same-store and absolute basis. In fact, Wal-Mart's annual sales increases are greater than Loblaws' total sales. Moreover, if Wal- Mart further penetrates the Canadian grocery market, it could have an adverse affect on Loblaws' bottom line.
Investing in information technology is probably a game best played on a global playing field. Again, I don't believe there is a company in Canada of the same caliber as Microsoft Corp., Intel Corp. or Cisco Systems Inc. All of these companies boast balance sheets with significant net cash positions and have generated consistent and substantial cash flow for a long time now.
Of the three, we believe that Microsoft has the most sustainable business model and is trading at the most attractive value in many years. After paying out a special dividend of US$3 late last year, the company still has almost US$4 per share in net cash and recently announced an acceleration in its share buyback program. With strong operating cash flow and negligible capex, we expect dividend increases and/or share buybacks to continue.
So where will the Canadian dollar go from current levels? I'll leave that prediction to the experts. The point is, making investment decisions based solely on TSX weightings or where a company is domiciled can be shortsighted. It is better to look for reasonably priced and well-managed businesses that can generate a high return on their invested capital in most market cycles.
With apologies to Lee Iacocca, if you can find a better company for better value outside of Canada -- buy it!
Rob McConnachie is a Portfolio Manager at Dixon Mitchell Investment Counsel Inc. View from the Street runs in the Financial Post on Mondays, providing a podium for select investment industry professionals to express opinions.