Bloomberg News

Commodities Sink Canadian Stocks as Jobs, Housing Boom

May 16, 2012

Canada’s commodity shares have fallen to their cheapest prices since the recession, wiping out the stock market’s best start to the year since 2004 as global economic concerns overshadowed the best two-month job growth in more than 30 years.

Energy (STENRS) and materials stocks in the Standard & Poor’s/TSX Composite Index (SPTSX) trade for 15.3 times and 11.9 times reported earnings, the lowest since 2009. Both groups traded for as much as 29 times earnings in March last year. The S&P/TSX has fallen 7.9 percent this month, and is off 5.3 percent in 2012 after rallying 5.8 percent in January and February.

While employment rose by 58,200 in April after a 82,300 jump in March and housing starts rose to their highest since September 2007 last month, energy and mining shares are dragging the country’s stock benchmark toward a second-straight yearly loss. Commodity stocks account for 44 percent of the S&P/TSX compared with 17 percent in the MSCI World Index, which has gained 1.9 percent in 2012, and 14 percent in the S&P 500 Index, up 5.3 percent.

“For the gold and energy companies, people aren’t valuing the fundamentals or cash flow,” Craig Basinger, chief investment officer for Macquarie Group Ltd.’s Canadian private wealth unit in Toronto, said in a May 7 telephone interview. The unit oversees about C$15 billion ($14.9 billion) of assets. “Those factors are taking a back seat to a lot of the global market events we’re seeing develop around the world.”

Market Movers

Gauges of materials and energy producers in the S&P/TSX have declined 15 percent and 9.9 percent, respectively, in May as the U.S. added fewer jobs than forecast, European austerity measures ran into political opposition and China signaled slower growth. Barrick Gold Corp. (ABX), the world’s biggest producer of the metal, has dropped 11 percent, while Suncor Energy Inc. (SU), Canada’s biggest oil sands producer, lost 16 percent.

The S&P/TSX was led higher in 2010 by raw-material producers, which surged 36 percent as copper, gold and agricultural commodities advanced. Mining companies gained as gold and copper each increased at least 29 percent in 2010.

The benchmark gauge fell 11 percent in 2011, the first year Canada lagged behind the U.S. since 2003, as the level of the S&P/TSX Energy Index relative to profits fell as much as 43 percent after hitting the highest multiple since at least 2002 in March.

The depressed valuations compared with cash flow are making oil and gas producers a relatively cheap way for acquirers to enter or expand in the market, according to Barry Schwartz, who helps manage about C$400 million at Baskin Financial Services Inc.

Below Replacement

“You’d be crazy right now to build a new oil sands mine, drill for oil or acquire land when you can buy companies that are trading, in my opinion, below replacement value,” Schwartz said in a telephone interview.

Suncor, Canadian Natural Resources Ltd. (CNQ) and Talisman Energy Inc. (TLM) are potential takeover targets because of their low valuation relative to cash flow, Schwartz said.

Suncor, the country’s largest energy company, has an enterprise value 3.99 times its earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg. That’s lower than 52 of the 64 other companies in the S&P/TSX energy index. Enterprise value is measured by subtracting cash from market capitalization plus debt.

Canadian Natural Resources, the country’s third-biggest energy company, has an enterprise value 5.47 times Ebitda, 22 percent below the median for companies in the index of 7.03 times. Talisman, the 10th largest, is the third-lowest valued energy company at 2.75 times.

‘More Consolidation’

Suncor didn’t respond to a phone call and e-mail to its media relations department requesting comment. Mark Stainthorpe, a spokesman for Canadian Natural Resources, didn’t respond to an e-mail requesting comment. Berta Gomez, a spokeswoman for Talisman Energy, said the company doesn’t comment on market rumors.

“There’s going to be more consolidation because to access capital and exploit the plays that are out there, you basically need a bigger company,” said Geoff Ready, an analyst at Haywood Securities LLC in Toronto. Larger companies trading at better valuations could buy cash-strapped “juniors,” which would aid capital funding to meet rising costs of wells while adding to the acquirers’ earnings, Ready said.

Arcan Resources Ltd. (ARN), which explores for oil and gas in Alberta, Bellatrix Exploration Ltd. (BXE), a western Canadian oil producer and Fairborne Energy Ltd. (FEL), an oil and natural gas trust, are potential takeover targets, according to Ready.

Reluctant Sellers

Douglas Penner, chief financial officer and spokesman for Arcan Resources, and Aaron Grandberg, chief financial officer for Fairborne Energy, didn’t respond to phone calls and e-mails requesting comment. Troy Winsor, a spokesman for Bellatrix Exploration, said the company doesn’t comment on market speculation.

Companies are less likely to entertain the idea of a takeover when their stocks are depressed, Basinger said.

“Consolidation in industries doesn’t happen when prices are going down,” Basinger said. “Consolidators don’t tend to be value investors.”

This is especially true for gold companies, which aren’t hurting for cash even after their “terrible” stock performance, he said. Barrick Gold has a price to cash flow ratio of 6.87, compared with 9 for the S&P/TSX metals and mining index.

The selloff in commodity producers may be overdone, according to Robert Cohen, who oversees $1.25 billion in precious-metals and resources stocks at GCIC Ltd., manager of the Dynamic Gold and Precious Metals Fund.

‘Something Wrong’

The S&P/TSX Gold (STGOLD) index has fallen 42 percent since the metal reached its peak of $1,920.70 an ounce on Sept. 6, more than twice the 18 percent decline in gold futures. The S&P/TSX Energy Index has fallen 26 percent since oil futures hit their two-year high on May 2, 2011, while crude oil has decreased 18 percent.

“There’s something wrong with what investors are willing to pay for a stock right now,” Cohen said. “Companies in the gold and oil business are producing enviable products. They’re mining monetary assets.”

Commodity stocks may stay depressed until the Federal Reserve takes additional measures to stimulate growth with a third round of bond purchases, or quantitative easing, Cohen said.

Stocks surged around the world in 2009 and 2010 as the Fed helped the U.S. economy recover from the subprime-mortgage crisis through $2.3 trillion of bond purchases known as quantitative easing. A separate $400 billion program called Operation Twist, in which the Fed is replacing short-term debt in its holdings with longer-term securities, ends in June.

“The market is not ready to run on its own,” Cohen said. “In the last five years, it’s clear that quantitative easing is the best catalyst for the stock market.”

To contact the reporter on this story: Joseph Ciolli in New York at jciolli@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; David Scanlan at dscanlan@bloomberg.net


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