Over the last 3-4 months, more and more reports have been coming out stating that inflation is not only not transitory (meaning temporary), but could be more severe than expected.
As a result, the markets have remained relatively flat over the last 3 months. Most all major North American indexes have gained around 4% over the last 3 months.
While this should be considered a relatively normal return over the course of a quarter year, the fact that markets are up north of 22% year to date makes this 4% gain seem like watching paint dry.
And if it feels like you’re not reaping the rewards of this 4% return, you’re likely not alone. That is because, especially on the Toronto Stock Exchange, energy companies are accounting for a significant portion of the gains, and beyond this the index is struggling.
In this piece, we’re going to go over a couple of Bull List stock earnings, including a shift to “Neutral” status on Bull List stock Aecon (TSE:ARE) due to a dispute over a project, and Restaurant Brands International (TSE:QSR).
Then to cap it off, we’re going to highlight the number one tool we’ve been preaching to Stocktrades Premium subscribers to combat inflationary measures, and one that still has our portfolios generating market beating returns in 2021, despite growth stocks having a setback.
Aecon moved to “Neutral” status on our Bull List
Aecon was quietly putting together quite the year in 2021, up over 25% heading into this recent earnings report and at some points of the year was up over 36%.
So why the near 10% drop on earnings, especially on a relatively strong earnings report?
And, why are we shifting our status to Neutral at this point?
It is not necessarily anything that Aecon has done, but instead somewhat of a construction spat between its partner and Coastal GasLink.
The company came out with surprising news that Coastal GasLink has not compensated Aecon and its 50/50 partner RB Somerville the capital it is entitled to as a result of significant delays because of weather and COVID-19. As a result, RB Somerville has stated that if it is not paid, it cannot continue to fund the project.
If this were to happen, all funding would fall on Aecon, and the company has stated there is the potential it would not be able to fund the project to completion. As a result, the companies have entered arbitration to come to a conclusion and get back on track.
Generally there are two things that will impact the severity in terms of the market’s reaction to an event. One being the general surprise of the event, and the other being the overall uncertainty it has on a company in terms of its impact.
This release by Aecon certainly had elements of both, as it was neither expected, or is the future certain in terms of overall impact. In fact, the company came out and stated:
“While this commercial dispute could result in a material impact to Aecon’s earnings, cash flow, and financial position if not resolved favourably in a timely manner, the ultimate results cannot be predicted at this time. “
This is primarily why you witnessed the stock take a near 10% dive on Friday, and is also why we are moving to Neutral on the company and will wait for a resolution.
If the situation were to resolve itself in a positive way, it’s likely Aecon’s share price would return to normal relatively quickly. There is a lot of “unknown” priced in to this dip. But over the short term, the stock could face pressure until the situation is resolved.
Mat holds Aecon, and will continue to hold Aecon moving forward. Once the situation is resolved, it’s likely we would transition Aecon back to a mainstay on the Bull List. For now, we patiently await some news.
You can read our updated report of Aecon here
Any questions, feel free to utilize the Discord or the Q&A!
Restaurant Brands International earnings
Restaurant Brands International (TSE:QSR) came out with a relatively solid quarter. In fact, earnings beat estimates, and revenue came in just over 1% shy of expectations.
But, cautionary statements relayed by the company pertaining to both labour shortages and supply chain bottlenecks has put the stock under significant pressure.
Post pandemic, workers are reluctant to get back into the workplace, especially for lower entry level jobs like fast food service. This is due to a multitude of catalysts, including government subsidies but also due to workers reevaluating if they really want to dedicate their time to such low paying jobs with the rising costs of living.
This is causing RBI (and many other chains) to reduce hours, ultimately impacting the top line.
However, RBI has stated that it will return to pre-pandemic sales levels this year, and will continue to accelerate growth in 2022. The mention of supply and labour issues has resulted in a significant amount of FUD (Fear, Uncertainty, and Doubt) and as a result, the stock is feeling the heat.
Our thesis behind QSR was a company that provided strong value in the midst of the pandemic. For now, that thesis still stands. Headwinds and the overall impacts right now are uncertain. But, the market tends to overreact in situations like this, and we believe they are overreacting here as well.
You can view our updated report here.
Rising costs, inflation and how you can fight them with a key Stocktrades Premium tool
If you’ve been a member here at Stocktrades Premium for all of 2021, you’ll likely remember a piece we issued in mid January, detailing how we plan to navigate this overvalued market and more importantly some strategies on investing during inflation.
If you’re looking to read the piece, you can click here to do so. It still contains some interesting commentary, including a warning when it comes to the valuation of small cap companies at that time. Interestingly enough, a month after this piece was sent out to Stocktrades Premium members, small cap growth stocks underwent a significant correction.
An important highlight from that piece was our thoughts on stocks that might perform best in an inflationary environment:
“With high levels of inflation, it is even more important to select companies capable of producing strong cash flows. Because in an inflationary environment, companies that consume cash will face the brunt of the impact, while companies that produce cash will survive.”
Cash flows are paramount, but are not the only important factor when it comes to investing in an inflationary environment.
You also want companies with strong pricing power
A company with strong pricing power is more likely to be able to raise prices to compensate for inflation without losing market share. There’s many ways to accomplish this. But, there are two major factors that contribute to a company’s pricing power.
The first one? A strong brand
A company like Apple has gotten away with this for a long time, and will likely continue to do so. If you’ve ever shopped for a computer, you’re probably well aware of how much of a premium comes with an Apple product versus a PC.
This doesn’t just come down to the actual computer either. Accessories and software often come with a high premium.
The second factor? An economic moat
The pricing power behind a strong brand likely has its limits, but pricing power due to a wide economic moat can be significantly more powerful. This is precisely why governments outlaw things like monopolies.
A prime example here in Canada would be our telecom companies. Unlike someone who is more than happy to pay the extra money for an Apple product over a PC, a cell phone bill here in Canada is more of a begrudging expense. We aren’t paying high cell phone bills because we want to, we’re paying them because we have to.
This is because the 3 major telecoms here in Canada own over 92% of the total market share. Poor for consumers, but excellent for both investors and an inflationary environment. Because when prices go up, we will still pay.
The outperformance and importance of our 11 Foundational Stocks
Going back to our piece on inflation and investing in an overvalued market, we stated at the end of the article:
“There is still value in “boring” stocks like Canadian utility, telecom and financials, primarily due to the fact these companies don’t carry the “exponential gain” factor with them.
But as you’ve probably heard the phrase “a rising tide lifts all ships”, when the tide goes back out these companies will still be afloat. The same cannot be said about a lot of popular stocks right now.”
It took a significant amount of discipline to invest in large cap blue-chips while the small cap market was providing significant gains. It has also required a significant amount of discipline to hold them while their performance was so-so at the start of the year.
But since inflationary fears have started to ramp up, our Foundational Stocks have outperformed the markets by quite a wide margin. These are the “boring” stocks. They don’t carry with them explosive returns. But most carry the two key things we’ve been talking about in this piece. That is pricing power and large economic moats.
We can see below that since inflation fears ramped up mid year, our Foundational Stocks have outperformed the TSX by a wide margin. In fact, they’ve outperformed every major index in North America, including high fliers like the NASDAQ.
They’ve erased the lagging returns versus the TSX from the start of the year and are now underperforming only the S&P 500 (and by a small margin) year to date.
Many beginners ignore the basic building blocks to a portfolio like our Foundational Stocks and instead chase higher returning options, many of which are experiencing significant struggles right now.
These stocks do have a place in a portfolio. But, they shouldn’t be at the expense of a core set of holdings that will provide stability through volatile environments, including the one we are likely going to be in for the next few years.
Many members ask us “when is a good time to buy Foundational Stocks” and the answer to this question is: whenever possible.
