After a reasonable amount of time being told that rate hikes were indeed being paused, the Bank of Canada went back on their word last week and hiked the overnight rate by 0.25%.
If there is anything we can learn from a situation like this, it’s that we must not design our portfolios based on policymakers’ actions. Many investors did this in 2020/2021 when the Bank of Canada stated that interest rates would be “very low for a long time,” and now many are getting caught the other way, investing and planning like rate cuts are coming when in reality, hikes are still underway.
Inflation, as expected, is relatively stubborn. Although we have peaked, it now seems to be getting sticky. Clearly, the Bank of Canada sees no other solution than hiking rates even further. This leads us to believe that rates may stay higher than anticipated for longer.
The primary strategy for an investment portfolio should be to buy strong companies and hold them for the long term. Companies that may not necessarily perform well through economic cycles like this, but ones that have been able to weather the storm consistently through many different occasions and who will inevitably come out on top when this rate cycle is over.
Now that earnings have concluded, we can return to our monthly Value Call announcements. This is where we highlight some stocks here that we feel provide strong value at current valuations.
Because of the rising rate environment, many companies, particularly those with less than optimal debt situations, are trading at attractive valuations. As long-term investors, we can weather the short-term headwinds and buy at more attractive price levels while we’re at it.
Let’s get started!
Jamieson Wellness (TSE:JWEL)
Jamieson is certainly an interesting option for investors. For one, it’s a Canadian Dividend Aristocrat, having raised dividends for six straight years. But outside of that, it is a company growing extensively, having nearly doubled its revenue over the last six years. It is a rare profitable, dividend paying small-cap stock in a relatively defensive sector.
The company’s main growth driver is in China. In Canada, the company has cornered much of the supplement market, being one of the more mature supplement companies in the country. Most of its competition is either big box stores like Walmart or privately run supplement companies.
Expected to grow earnings and revenue at a double-digit clip for the foreseeable future, it might seem puzzling why this Dividend Aristocrat would be on a 16% slide to start 2023, despite the markets being up significantly more than this. The reasoning, in our opinion, is quite simple.
For one, the company’s acquisition of Nutrawise Health & Beauty. The acquisition was significant, coming in at over $260M. Much of the acquisition was financed utilizing debt. In fact, Jamieson had been debt free for the first time in its publicly traded history before acquiring Nutrawise. Post-acquisition, its debt to equity rose to a higher but still respectable 0.9x.
The acquisition is weighing on the bottom line through higher-than-expected integration costs and overall costs of debt due to rising rates. As a result, the company has been on a significant slide to start out the year.
For the glass half full, long-term investors, however, revenue is up significantly due to the acquisition and faster-than-expected e-commerce growth. The company’s dividend currently makes up only 49% of earnings, and there is plenty of buffer room here in the event higher rates continue to impact the bottom line for the next while.
It is now trading at what we would call value territory, at only 15 times expected earnings and a Price to Earnings to Growth (PEG) ratio of only 0.55 (anything under 1 typically signals undervaluation.) If it can maintain double-digit growth throughout the next 4 to 5 years, which we would believe is the low range of estimates because of the considerable growth potential in China, we see fair value in the high $30 range.
However, make no mistake about it; the growth in China is never guaranteed. We witnessed a retailer like Canada Goose get hammered by relying too much on China to fuel growth. Although, with a more defensive product like supplements, and a good distribution network like Costco, although the risk is present, we don’t view it as high.
You can view our full report on Jamieson Wellness here
TELUS International (TSE:TIXT)
It has been a rough year for TELUS International (TIXT). Spun out of TELUS back in 2019, TELUS International has lost 20.89% of its value year-to-date and is now trading at all-time lows. While recent share price struggles are disappointing, the company is still well-positioned to deliver outsized growth.
First, let us talk about why the company is struggling, which in our opinion, is simple. Rising rates are weighing heavy on high-growth companies as it makes growing more expensive. Over the past few years, TELUS International has made several acquisitions, but it has taken on debt to fund most of these deals.
As of last quarter, TELUS International had $2.589B in long-term debt, the highest it has had on the books since going public. It is also double the $1.308B it had when it closed out Fiscal 2022 last December. The company exited last quarter with a leverage ratio (net debt/Adjusted EBITDA) of 2.8x, a significant jump from the 1.1x it had in Q1 of last year.
Why the jump? The company made a transformative move when it closed on the $1.3B deal to acquire WillowTree earlier this year. That is the bad news, which is only bad from a debt perspective. The company reiterated guidance last quarter in which it expects WillowTree to grow revenue by 30% this year and for the deal to positively impact total company revenue by +10-12% in Fiscal 2023.
The other good news is that TELUS International has been here before. Its strong free-cash-flow profile has proven capable of absorbing high debt loads. In 2020, the company’s debt ballooned to north of $2 billion when it closed on the acquisition of Lionbridge AI. Within a year of closing that deal, the company’s debt dropped by almost $1B as it aggressively paid down debt.
We expect a similar approach post-WillowTree deal. In fact, when the deal closed, the company’s leverage ratio stood at 2.9x, so it has already managed to pay down some debt. TELUS International targets a leverage ratio at the low end of its targeted range (2-3x) by the end of this Fiscal year.
While it will take some time for the company to digest this deal, TELUS International is also expected to deliver strong, double-digit organic growth (10-12%). With that in mind, the current weakness could be an entry point as we believe it to be attractively valued here.
You can read our full report on Telus International here
TELUS (TSE:T)
Even though it’s faring much better overall, parent company TELUS Inc. which owns a 55% stake in TELUS International, is also on a bit of a slide. The telecom’s share price is down by 11% since late May and, from a technical standpoint, is firmly in oversold territory.
With an RSI of 20.30, TELUS has not seen an RSI this low over the past decade.
A very quick primer on the Relative Strength Index. It tracks the movement of a stocks particular closing prices over the last two weeks, and signals to investors when things may have been overdone in either direction. The RSI works off a scale of 0 to 100.
A stock that has an RSI of under 30 is considered “oversold” and could be due for a bounce. A stock that has an RSI of over 70 is considered “overbought” and could be due for a pullback.
To put the magnitude of the current selloff into perspective, TELUS has only entered oversold territory 7 times over the past decade and only twice has it dipped below 25.00. Not only that, but each time the share price rebounded relatively quickly (within days), making the company’s 2-week stint in oversold territory much more glaring.
While we are not big traders, nor do we encourage timing entries, rarely has there been this much pressure on TELUS’ share price. With that in mind, this may be an opportune time for those seeking to start a position (or add to an existing one) to start accumulating.
Today, TELUS is trading relatively in line with historical averages; in our opinion, this also makes it a good time to start accumulating. Rarely does TELUS trade below historical averages. Usually, when it rises above or dips below, it returns to trade in line with its averages.
If you consider that, buying when the company is either undervalued or fairly valued (as it is today) is likely the best time to accumulate. As Buffett once famously said, buying a wonderful company at a good price is better than a good company at a wonderful price.
The reason why we are adding TELUS to our value list today is that rarely does it get super cheap. True, rising rates and the company’s growing debt load (in which TELUS International’s recent acquisition plays a part) may lead to further pressure on the stock.
However, given the company’s current oversold status, we believe it is only a matter of time before TELUS catches a bid and starts to work its way upwards. While we can always wait and try to time the bottom, in our experience, those who wait usually end up waiting too long and then eventually cave and buy at a higher price.
Catching the bottom is a rarity and is typically out of luck. If it were so easily done and if there was a systematic way of timing the bottom, everyone would do it. The reality is there is no tried-and-true method of timing the bottom.
When it is not abundantly clear downward pressure is over, we typically take the approach of averaging in. This takes the guessing game out of the equation.
If the price continues downwards, you can average down in a few weeks. If it goes up, you can be satisfied knowing that you at least got a portion of your allocation at cheaper prices.
All in all, the company’s oversold status is reason enough to put TELUS on your watchlist.
