What Canadian stocks are poised for growth?

Text Transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves.

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Natalie Taylor, portfolio manager, CIBC Asset Management

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To consider the outlook for Canadian equities relative to global markets, let’s review where things stand currently. The S&P/TSX is up 15% year-to-date as at the end of August, comfortably ahead of the S&P 500, which is up 8%, and the Nasdaq, which is up 10%. This may seem hard to believe, given the immense economic uncertainty that Canada has faced in the form of tariffs, political uncertainty, inflation and a pullback in immigration. This is where we stand as of the end of August.

The main sources of outperformance have been fairly narrow, driven by gold, primarily. Gold companies have soared 70% less this year, and more recently, Shopify and Celestica. Celestica itself is up over 100% this year, and the banks have also contributed to the outperformance of the index.

Since April 2, or Liberation Day, low-quality companies, as defined by the S&P/TSX Composite Quality – Lowest 50 Index have outperformed the broader index by 10%. So my interpretation of this is that the last few months have been driven by a de-risking after uncertainty peaked with reciprocal tariff announcements in the spring.

Interestingly, this period of performance has coincided with foreign net inflows into Canada for the first time in a decade, as well. At this point, we believe that the normalization of risk has more or less run its course, and the higher-quality market leaders are more or less fully valued. So for the TSX to continue to perform, we need to see an improvement in underlying business fundamentals, or certainty around the global trade picture, and in particular, the USMCA renegotiation, which is scheduled for 2026.

Economic data and anecdotal evidence suggest that the Canadian economy is slowing, and it could continue to drift for the next six months to a year, until the trade picture clears. On the flip side, we are seeing evidence of stabilization and improvement in the U.S. economy, which will support Canadian businesses with U.S. exposure. As such, in the near term, we believe the U.S. markets are better positioned to outperform.

The good news is Canadian stocks continue to trade at a significant discount to that of the S&P 500, and the S&P 500 equal weight, which is a proxy for the S&P 493, excluding the Mag Seven. Across many sectors, be it banks, telecommunications, consumer, we see Canadian valuations at a discount to U.S. peers. As such, if we do get a resolution to trade uncertainty within the next 12 months, we could see the TSX perform very well.

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All that being said, we are seeing interesting opportunities across sectors if our base case of a USMCA resolution unfolds. We think broadly, there’s upside in economically sensitive sectors without having to go too far out the risk curve.

So an example of this is CPKC. We see good upside in CP over the next year. CP is one of, if not the best run rail in North America, operating under a precision railroading philosophy. The recent merger with Kansas City Southern has enhanced CP’s rail network with connectivity to Mexico. While this has been viewed as a risk in today’s charged trade environment, we believe that ultimately, a truly North American rail network is an advantage.

Similarly, chatter of additional rail consolidation has created volatility near term. However, over the long run, a more consolidated and disciplined rail industry will be beneficial to all scale players.

Lastly, rails and transports tend to be early-cycle industrials. Therefore, if we do see an improvement or stabilization in the North American economy and trade patterns, the rails will likely be among the first to feel the impacts. This is likely to be even more impactful this time around, as the rails have experienced a drawn-out freight recession after the durable goods boom of Covid.

Similarly, in the consumer sector, we believe there’s an emerging opportunity in Couche-Tard, one of the largest global convenience store operators. Couche-Tard has just walked away from a bid for Seven & i, which owns 711 stores, after months of uncertainty as to whether this deal would go through or not. By stepping away from the transaction, Couche-Tard has removed the uncertainty overhang of a large transaction, and committed to doing share buybacks with its excess capital.

In addition, we believe there’s finally some evidence that underlying fundamentals are improving as well. So the industry faced declining traffic from lower miles driven, declining cigarette sales, and a shift to value consumption and away from convenience. Same-store sales outlook appears to be improving, and we’re seeing better traction in food sales, benefits of the loyalty program and some stabilization in cigarettes as well. Add to that that Couche-Tard trades currently at a very undemanding valuation of 17x, which is below its historical average, making what we think is a pretty good opportunity.

We continue to believe that there are also great opportunities in Canada’s energy sector, both in oil and in gas. Our top pick is Keyera, which is a midstream company focused on gas gathering and processing, fractionation and transportation. Keyera is in the process of closing a recently announced acquisition of Plains’ Canadian business, which will enhance its positioning and is expected to be highly accretive financially.

In addition, Keyera stands to benefit from increased gas processing needs with the ramp up of LNG Canada, which is now underway. Lastly, Keyera’s cash flows are highly contracted, and its leverage is among the lowest of the energy infrastructure companies, providing some downside protection. We believe that Keyera is also well-positioned to grow if the government decides to support additional energy infrastructure growth.

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If we assume that domestic growth remains challenged, defensive-growth companies, as well as companies with exposure to U.S. and global economies will likely outperform companies with leverage to the domestic economy. Defensive companies had a great start to the year, but have been somewhat left behind in the low-quality rally we’ve experienced since April.

For example, Intact Financial, Canada’s largest property and casualty insurer, rallied throughout the year, hitting a peak of up 20% at the end of June. Since then, the stock [has] pulled back 13%, while earnings results have remained resilient. We believe that the pullback is unwarranted and is more a function of the rotation in the market, rather than a company-specific reaction.

Intact continues to be incredibly well-positioned in Canadian property and casualty, given its scale and superior ability to segment its risks, as well as in U.S. specialty, where it’s demonstrated profitable growth.

Similarly, we think Bank of Montreal continues to present an attractive opportunity, as the bank continues to deliver improving credit results, is focused on improving ROE across all of its businesses, and is seeing improving growth prospects in the U.S., particularly in its commercial banking segment. In addition, BMO has among the lowest exposure to the Canadian consumer, where we’re seeing delinquencies rise of all the Canadian banks.

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As mentioned previously, uncertainty remains in the current environment. The biggest risk to the Canadian economy is the renegotiation of USMCA, which is due for review in 2026. A dissolution, or complete rewriting of the agreement would unequivocally be a negative for the Canadian economy. However, certainty one way or another would be welcome, and plans could be put in place to support industries and individuals impacted by USMCA changes.

The Canadian government has opportunities to improve interprovincial trade and engage in infrastructure builds to support the Canadian economy. While engagement on these files is ongoing, my sense is that these options would be more targeted once the outcome of USMCA is known.

In addition to fiscal stimulus, the Bank of Canada has lots of room to cut rates further to provide relief to consumers and incentivize investment if need be. Again, we could see bigger cuts if the worst-case scenario on USMCA materializes. But ultimately, uncertainty is the greatest enemy of equity markets. As many companies have told us they can mitigate and execute in just about any environment, but they need to know what the rules and regulations are.

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