The ongoing spread of the COVID-19 virus around the world, along with the implications of shutting down entire economies, terrified equity markets in the month. Against a backdrop of lower energy demand, the OPEC+ (including Russia) countries could not agree to production cuts in early March, causing Saudi Arabia to discount oil to its customers. All governments and central banks have begun to throw everything they can at this problem (monetary and fiscal stimulus) to confront the challenges as economic uncertainty rises. On the OPEC news, oil prices tumbled with Brent -57% to US$21.70/bbl, WTI -54% to US$20.48/bbl and WCS -87% to US$3.90/bbl. U.S. natural gas prices fell 5% to US$1.71/MMBtu while Canadian AECO added 8% to US$1.75/gigajoule. Base metal prices fell 7%-15%, while gold and silver fell 0.6% and 16%, respectively, to US$1577/oz and US$13.97/oz. The Canadian dollar fell 4.6% to US$0.7111.
With fear and uncertainty gripping the markets, the S&P/TSX fell 17.4% with all sectors in the “red”. Energy (-31%), Real Estate (-29%) and Consumer Discretionary (-26%) led the decline while Communication Services (-4%), Consumer Staples (-8%) and Information Technology (-10%) fell less than the market.
Our portfolio underperformed as investors scrambled for liquidity selling somewhat indiscriminately. In this sell off, security selection in Energy, Materials, Consumer Discretionary and Industrials detracted value. In addition, our sector underweights in the traditionally “safe sectors” (to which investors looked for cover) hurt performance as Consumer Staples, Utilities and IT outperformed the market by 7-10%.
In Energy, Ovintiv Inc. (-74%), Crescent Point Energy (-70%) and Cenovus Energy (-71%) all fell with oil prices. Despite Ovintiv announcing results with better post-acquisition cost savings and higher free cash flow, there are concerns about their debt and maturity schedule. We do not believe the global oil market to be viable at current prices such that at some point, oil prices will need to move higher. That said, the market’s reaction was to sell off sharply those companies with higher relative levels of operating and financial leverage, including the above names.
In Materials, Methanex (-54%), Teck Resources (-21%) and Hudbay Minerals (-18%) underperformed as commodity prices declined. We believe that both Methanex and Teck are very attractive as each company operates at the bottom half of their respective industry cost curves, each has a decent balance sheet and an attractive valuation. While Hudbay Minerals is very cheap, we are concerned about their lack of diversity in operations (two mining areas and their biggest/most valuable asset, Constancia, is shutdown). To address this concern, we have moved our weight out of Hudbay into Teck (which gives us more diversity, better balance sheet and similar upside today) as well as Methanex.
In the Industrials sector, our position in NFI Group (-48%) detracted value. Despite reporting strong Q4 results (EBITDA was 4.2% above the average analyst estimate), the stock declined as the company was forced to shutter its manufacturing plants as they were deemed “non-essential”. The company has ample liquidity to cope during this time and we believe will survive as they continue to build transportation vehicles for many municipalities throughout North America. The U.S. Coronavirus Aid, Relief and Economic Security (CARES) Act includes a $25 billion funding support for municipal transit authorities which collectively as a group is NFI’s most important customer.
In the Consumer Discretionary sector, no position in Dollarama (-1%) and overweights in Sleep Country (-45%) and UniSelect (-52%) hurt performance. We have not owned Dollarama as the stock is expensive and we believe that their strategy to continue to grow their store count across Canada will be a challenge as they start saturating their markets. Year-end numbers show that while store count increased 5% (yr/yr), absolute sales grew less than 1%. Ironically, both Sleep Country and UniSelect reported decent results for Q4 2019, with UniSelect making positive changes in their management team. However, these changes were effectively ignored by the market on concerns about them shutting their retail outlets.
Vice President & Portfolio Manager
Scheer, Rowlett & Associates Investment Management Ltd
1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at March 31, 2020; e) since inception (March 29,2018). The index is 100% S&P/TSX composite Index and is computed by Ninepoint Partners LP based on publicly available index information.
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