In this week’s newsletter, I’m going to highlight 3 Premium featured companies that are trading at what I believe are cyclical lows.
What I mean by this is that the situation with the economy has impacted their businesses in a way that is entirely out of their control. In addition to this, what I mean by cyclical “lows” is that I believe there is likely to be a turnaround in terms of the headwinds they’re facing right now, and investors accumulating at these lows have a reasonable chance of outsized returns moving forward.
The reasoning for this piece? Primarily the commentary I am hearing from members on these particular companies in terms of “losing their patience.”
Make no mistake about it, this is a common thought process among many investors. If you’re thinking this, you’re not alone. I even find myself getting overly frustrated with the lack of returns from seemingly solid companies, especially as the markets in general are heading upwards.
After all, we do have the Toronto Stock Exchange leading the pack in terms of major North American indexes over the last while, which further adds to the frustration of your underperforming Canadian equities.
However, it’s important we think about the long game. Cyclical stocks are interesting in the fact that they are best acquired during the times when it feels the worst to acquire them.
Going against the grain like this is counterintuitive to how we are wired mentally. Naturally, we want to buy the stocks hitting 52-week highs and continuing to provide immediate benefits. We tend to ignore the stocks trading at 52-week lows that aren’t providing any short-term returns.
Flip this script when it comes to cyclical stocks inside your portfolio, and you will have yourself earning more over the long term.
Let’s get into it.
Of note, I didn’t make any portfolio moves this week. Again, I am utilizing a lot of my cash to develop my basement and will return to weekly purchases and commentary in late July.
Stock #1 – Alimentation Couche-Tard
Judging by the feedback and commentary I am getting from members, Couche-Tard has been a frustrating one. The company had been one of the best-performing blue-chip stocks in Canada over the last decade, and this 15~ month time period of flat returns has a lot of people questioning whether or not the stock still deserves a position inside their portfolio.
I’ve attached a chart below that highlights the fact that Couche-Tard is not immune to longer periods of flat or declining returns, especially in rougher economies.
2015 is the most notable one, in which Canada entered a recession due to the rapid decline in oil prices in 2014/2015. Fuel margins are a big way this company makes money, so volatility in commodity prices does have the potential to impact earnings. They certainly are now.
What you’ll also notice during these time periods is a pullback in earnings, as highlighted by the red lines below. These are often short-term in nature, as the company’s operations tend to rebound relatively quickly.
You can also see that this time the pullback is larger, longer, and more pronounced. However, we do have to take into consideration the current situation. We are coming off one of the lowest interest rate environments in history.
People were spending money at an incredible pace. Travelling, vacations, new vehicles, new recreational toys. When money is abundant, those vacations and travel ultimately bring more people into Couche-Tard’s gas stations.
We’ve started to witness a recovery in terms of fuel margins here in Canada. However, US fuel margins remain under pressure. Of note, the large difference in numbers below is because of the cost per gallon in the US versus costs per liter in Canada/Europe.
The difficulty here is that although Couche-Tard is a Canadian company, the primary driver of its business is in the United States. Interest rates remain elevated, and consumers are just not travelling/spending as much at gas stations.
In addition to this, higher levels of food inflation in 2022/2023 have forced consumers to make that extra trip to the grocery store for pop, chips, etc, whereas prior, they might have found it more convenient to make the couple-minute drive to their local Circle K.
Combine this with the fact the company is making less on every gallon of fuel it sells south of the border, and you have a double headwind here.
But, these are also headwinds that are likely to fade when the US drops rates and economic activity picks back up.
Valuations are the best they’ve been in years
Outside of the global lockdowns during the pandemic, these are some of the cheapest valuations Couche-Tard has traded at in years. At just 17.5X free cash flow, the company is trading at a 15% discount to its 10-year historical average.
Why there’s still plenty of reason to be bullish
Once we understand why Couche-Tard is struggling, that being the impact of a slower consumer and volatile commodity prices, it becomes relatively simple to figure out whether or not the company is still a buy.
Can we imagine travel/consumer spending being this muted for the foreseeable future, or will the economy eventually pick back up again? It is hard to imagine an environment over the long term where consumers are this tight. Generally, people like to spend as much discretionary income as they have. Right now, that income is tight. But it won’t be in the future.
It’s not just me who thinks this either. If you look to a chart below, analysts are expecting a rough 2025/2026 from the company before rebounding in a big way in 2027/2028.
I won’t speak much on the 7 and I deal, simply because it is up in the air right now and is in the early stages.
However, if we look at the company from a fundamental basis, returns on invested capital are in the double digits, the balance sheet is rock-solid, and the next year or so here should provide a strong opportunity to accumulate shares of this compounder at discounted prices, something that often happens only once in an entire economic cycle for Couche-Tard.
TFI International (TSE:TFII)
TFI’s drawdown was extensive, and it was fast. Much like Couche-Tard, the company realized some large-scale tailwinds from the COVID-19 pandemic that caused operations to soar. In addition to this, the company acquired a lot of struggling trucking and logistics companies during the lockdowns for large discounts that ultimately fueled earnings during the large runup in freight activity.
This is another Canadian-listed company that has the majority of its operations south of the border, primarily due to its acquisition of UPS Freight a few years ago. As a result, the US economy has a large impact on the company’s results, and with interest rates remaining elevated and consumers remaining stingy, spending has pulled back, which has ultimately put the United States into a freight recession.
There is also another headwind TFI is feeling right now, that being freight rates. During the pandemic, freight was booming so much that there were enough pieces of pie to go around to all freight operators. However, now that activity has declined, prices are being undercut, and TFI is having to adapt its pricing to its competition, which is ultimately impacting margins.
If we look to margins, we can see that during the last freight recession (collapse of oil prices in 2014/2015), TFI’s margins were impacted quite a bit. However, the recovery was relatively swift in 2018. In the situation where interest rates decline in the US and consumer activity picks back up, although it is certainly not guaranteed, there is a strong likelihood TFI can get margins trending upwards again, much like it did 6-7 years ago.
Valuations are attractive, but there are some caveats
TFI is trading at a large-scale discount to historical averages. As you can see by the chart above, the company typically trades at 17x free cash flow. Currently, it’s trading at 10.89x.
The caveat here, however, is that free cash flow could continue to face pressure amidst a clear freight recession. Out of the 3 companies I talk about in this newsletter, TFI has the largest amount of competition and arguably the lowest amount of pricing power. If freight volumes continue to dip, there is likely going to be pricing pressure from competitors that will force them to move freight at lower prices.
This could continue to have an impact on margins, free cash flow, and thus valuations.
Despite this, I’m still bullish, and here’s why
First, freight demand will eventually rebound with the economy. Trucks remain vital to commerce (over 70% of goods tonnage moves by truck in the U.S.), and downturns inevitably give way to upcycles in this industry.
When volumes do pick back up again, I expect prices to pick back up as well. With TFI’s scale of operations, being one of the largest providers in North America, it should stand to benefit from this inevitable rebound.
The company’s diversified operations, proven management, and continued expansion should position it well to ride the next freight upcycle. Investors who can look past the current “trucking recession” may find significant value here.
For long-term investors, I believe this provides a solid opportunity. The only disclaimer here is that out of all 3 of these stocks, TFI will likely be the most volatile, as the space is highly competitive.
Canadian Pacific Kansas City (TSE:CP)
CPKC has weathered this economic downturn better than both TFI and ATD over the last 12-18 months, but this is primarily due to the rock-solid economic moat the company has.
From the TFI portion of the newsletter, I mentioned the industry is highly competitive with many players. In the case of CPKC, there are few players in the space, which has allowed it to control the pricing environment despite a relatively rough decline in overall volumes.
This is why you’ll see revenue ton miles, a key performance indicator for railways, continue to tick upwards despite falling volumes.
A return of demand for railways is an inevitability
With CPKC having the only interconnected track between Canada, the US, and Mexico, it is safe to say that when freight demand picks back up again, so too will CPKC’s results.
In the meantime, the company is getting more efficient. Its cars are becoming heavier, carrying more goods to their final destination. Their trains are getting longer, meaning more goods are being shipped in a single load.
And despite heavier, longer trains, the company’s fuel mileage per train is increasing, meaning operating expenses per shipment are going down.
Although these operational efficiencies are not being felt at this moment due to offsetting declines in volumes slowing them down, when the economy picks back up, businesses shipping via rail don’t have a lot of options, which allows CPKC to directly benefit.
Valuations aren’t cheap, but they never are
For those looking for “bargains” with the railways, they simply never exist. The main reason for this is what I have explained above. The moat is so wide, and the return to higher volumes through railways is an inevitability. What we need to look at instead is valuations relative to historical averages and just accept the fact we will pay premium valuations for these rails at all times.
You’ll notice the company is trading at a premium to its historical averages. However, it is important to remember that the acquisition of Kansas City Southern is expected to lead to much higher growth rates moving forward. As such, the railway is trading higher than usual.
CP Rail is not cheap, nor is it expensive here. But, I rarely ever fuss about valuations when it comes to the railways.
It’s fairly easy to be bullish on the railways for the future, but I’m particularly bullish on CPKC
I find CPKC to be the better-operated railway over CN Rail. It is a more efficient capital allocator, has a more disciplined management team, and the acquisition of Kansas City Southern is setting it up nicely for outsized growth relative to CN Rail moving forward.
If you’ve been a member for a while, you’ll remember that I sold my position in CN Rail to buy CPKC. I just like the company better, and I do believe the North American interconnected track should give it more flexibility to handle shipping routes and drive pricing power.
Both are outstanding companies, don’t get me wrong. I just like CPKC a little bit more here.
Overall, I think these 3 stocks are solid opportunities at cyclical lows
Sometimes, the most hated stocks are the best opportunities. It is important to distinguish between a company falling to 52-week lows on the back of cyclical pressures it cannot do anything about and companies trading at 52-week lows due to weak operations.
I believe these 3 are due to economic pressures, and strong management teams for all 3 should have them coming out of the next boom on top.
