The TSX finished the week in the green while the major US indexes finished in the red. Although the TSX has lagged the US markets significantly over the last while, it’s one of the best performing markets over the last month.
The Bank of Canada held interest rates steady this week and it will be interesting to see when we start to see rate cuts happen from the bank.
Our economy is a bit weaker than the US right now which puts the bank in a difficult situation, as cutting too aggressively would no doubt put pressure on our dollar and may even fuel inflation further.
As always, we’re long term investors so policy rates won’t ever impact our decisions when it comes to buying solid companies. However, it is interesting nonetheless.
Next weeks newsletter will feature a brand new Bull List addition, but for this week, we’ll continue on with some earnings reports. But first, portfolio moves.
My moves this week
I sold my entire Parkland Fuels (TSE:PKI) position due to Simpson Oil situation. I have held Parkland for quite some time, and this certainly wasn’t a decide I made right away.
But the spat it is having with its major shareholder Simpson Oil is not really something I wanted to be a part of, so for that reason I exited my position. I won’t go over the whole situation in this email. However, if you have any questions on it, just head to the website and ask via the Q&A.
I put the proceeds towards bulking up positions in Boyd Group Services (TSE:BYD), Granite REIT (TSE:GRT.UN), BRP Inc (TSE:DOO), and Constellation Software (TSE:CSU).
In addition to this, I added to my Equitable Bank (TSE:EQB) position with weekly contributions.
As always, my full portfolio is available by logging in, going to the “Premium” menu option, and selecting my portfolio.
Earnings
Granite REIT (TSE:GRT.UN)
Granite REIT ended the year on solid footing as Funds From Operations (FFO) per unit of $1.27 (+6%) topped consensus estimates for $1.25. Same-property net operating income increased by 4.7% year-over-year (YoY), bolstered by higher rents and strategic expansions.
The company’s strong performance is slightly mitigated by an uptick in vacancy rates, leading overall occupancy to decline to 95% (-460 bps YoY). The U.S. segment experienced a sharper drop of 110 basis points quarter-over-quarter (QoQ) to 92.2%. The Netherlands, Canada, Austria, and Germany showed more stability or improvement QoQ.
Despite this, GRT remains positive on its leasing outlook for 2024, which is underscored by negotiations for 1.5 million square feet of new and renewal leases. It has adopted a proactive approach and thus far has addressed 74% of 2024 lease expiries, including 33% in the U.S., with renewal spreads coming in at approximately 15%.
The company’s outlook for 2024 came in as follows (does not reflect acquisitions or dispositions):
- FFO per unit between $5.30 to $5.45 (+8.1% at the midrange) vs estimates of $5.22
- AFFO per unit between $4.65 to $4.80 (+5% at the midrange)
Granite’s financial health remains one of the best in the industry, with a net debt-to-asset of 33% (+100 bps YoY) and a debt-to-EBITDA ratio of 7.6x (-70bps YoY).
On the company’s conference call, management remained optimistic about their leasing. Their slowed approach to new builds is likely to help the company generate higher NOI and help stabilize occupancy rates.
We view this as a prudent approach in this environment, and overall, Granite remains one of our preferred REITs.
Canadian Natural Resources (TSE:CNQ)
Canadian Natural announced strong Q4 results as it beat on the top and bottom lines. Earnings of $2.34 (+19.3%) beat by $0.18, while revenue of $9.55 billion (-1.4%) topped expectations for $9.36 billion.
The company also posted record quarterly production and a 9% increase in adjusted funds flow from operations (AFFO) per share ($4.05), topping the street consensus by $0.35 per share.
Notably, the company reached its $10 billion net debt target at the end of 2023.
Why is this important? It will enable the company to fulfill a promise to pay out 100% of free cash flow (FCF) to shareholders. CNQ’s net debt was approximately $9.9 billion at the end of December, significantly lower than expected, with a quarter-over-quarter (QoQ) reduction of about $1.6 billion from September.
Circling back to FCF, CNQ intends to pay out 100% of FCF via dividends and share buybacks in Fiscal 2024. Beyond this year, it will manage this allocation of FCF annually as required. What does this mean?
Beyond 2024, it is not committing to distributing 100% of FCF, as it will revisit this payout annually based on a myriad of factors as it manages working capital, leverage, and capital expenditures.
Along with its results, the company declared a 5% increase to the annual dividend to $4.20 per share. Additionally, a 2:1 stock split is planned for later this year, and CNQ has renewed its Normal Course Issuer Bid (NCIB), allowing for the repurchase of up to 10% of its public float.
All in all, it was another good year for Canadian Natural. It remains a cash flow machine, has one of the best spreads in the industry, and is one of the best in execution. Their performance over Fiscal 2023 simply reiterates our stance that CNQ is a best-in-class producer.
Costco (COST)
Costco reported a mixed quarter in which the company saw revenue fall below expectations but earnings beat by a wide margin. Revenue of $58.44B missed by about $600M and earnings per share of $3.92 beat by 30 cents.
The company is still reporting strong same-store sales growth, up 5.8% on the quarter. Its Canadian segment has been the most impressive in this regard. Same-store sales came in at 9%, well above the 6.3% expected.
When we compare this to the 4.8% and 8.2% from its US and International segments, which beat expectations but not by as wide of numbers as Canada, it is clear that Canadians are feeling the pinch and are looking for alternatives to try and save money on food.
Although a trip to Costco seems more expensive, it is mostly because you’re buying in bulk and dollar for dollar, the company provides exceptional value relative to other grocers and it is starting to show.
Membership fees totaled $1.11B, an 8% increase from Q1 of 2023, and through the first six months of the year they’re up 8% as well. Membership fees are a large contributor to Costco’s profits and are also a strong indication of the popularity of the company among new consumers.
The company’s E-commerce segment is also growing nicely. Costco reported comparable sales growth of 18.2% on the quarter, and online sales have grown by 12.2% through the first six months of the year.
Although many retailers are witnessing steady traffic, increasing revenue and earnings through higher ticket prices (average spend per customer), Costco is undergoing a different situation. Its traffic numbers are, for a major retailer, increasing significantly. The company is reporting a 5.3% year-over-year increase in foot traffic through its stores, amplified by an 8.2% increase in Canada.
On a final note, the company repurchased over $159M shares in the second quarter.
Overall, it was a strong quarter from Costco, but with current valuations the way they are, we’re not surprised to see some investors take profits on weaker-than-expected revenue.
A&W Royalty (TSE:AW.UN)
A&W put up solid numbers in a challenging environment. During the quarter, royalty sales increased by 5.1% compared to Q4 of Fiscal 2023, which was a strong quarter for them.
On the year, royalty sales grew by 5.3%. If we look at same-store sales (SSS) growth, which would not account for new restaurants added to the pool, they were up 2.1% year-over-year (YoY) and 2.7% year-to-date.
As inflation persists and rates rise, we are starting to see royalty sales slow. However, the fund’s restaurants have been able to absorb most of the rising food costs into the menu while still growing sales. As a top line royalty company, A&W benefits from this.
The growth in SSS was “primarily driven by growth in average check size due to industry-wide inflation on goods, services and labour, a rebound in sales at shopping center and urban locations and innovative new menu items such as the A&W Brew Bar.”
The fund’s payout ratios continue to normalize. Its YTD payout ratio is 91.8%, a material improvement over the 96.6% it had through Fiscal 2022.
Remember, this fund’s objective is to earn revenue from the restaurants, pay its expenses, and then dish out the rest as a distribution. So, even a 99% payout ratio is nothing to be alarmed about. The fund is designed to operate with high ratios.
In addition to this, seasonal impacts of taxes and different expenses may cause payout ratios to rise above 100%, even topping 110% at times. Over the year, these tend to normalize, highlighted by the fact the payout ratio this quarter was only 89.9%.
This is also why we believe the fund will eventually raise the distribution. It may be just waiting for rates/inflation to stabilize before making such an announcement.
The total restaurant count sits at 1037, and the company added 22 restaurants to the royalty pool over the last year. These numbers are f lat quarter over quarter.
We are still in the early stages of the Pret pilot. For those interested in an update on the Pret pilot, 5 A&W locations (3 in Vancouver and 2 in Toronto) offer a range of Pret products in their restaurants, with another 20 locations across the country offering Pret coffee and pastries.
Interestingly, as of last report, there were 5 stores in Toronto, and in their annual report, that dropped to 2.
Overall, we’ll have to wait until the company makes a more formal announcement on the future of this program. The company is nearing the end of its 2-year test period and is gathering data on the initiative.
As we talked about last time, it is clear that the company is still testing things out. While it does believe there “is an opportunity for PRET inside A&W restaurants,” they haven’t “figured out exactly what the right way to do that is.”
