2009 Q3 Newsletter September 30, 2009
During the third quarter (Q3) of 2009 the strong rebound in equity markets continued. Accelerating growth in China and other Asian nations supported a rebound in copper, oil and other commodity prices in Q3. These commodity price gains aided Canadian equity markets in their recovery. The rebound in oil prices to the $70 level offset a serious drop in natural gas prices and assisted our energy holdings.
Our strategy in Q3 was to reinvest cash into trusts and equities. We also shifted some weighting from very conservative trusts such as pipeline trusts to more growth oriented equities. Our strategy was to increase our participation in the rebound in equities and position for growth in 2010.
Overall, LDIC performance was up 13.5% in the third quarter. The S&P TSX gained 9.8%, underperforming both US indices in contrast to last quarter. The S&P 500 was up 15.0% and the lesser Dow Jones Industrial Average gained 15.0% in the second quarter. On a year to date basis LDIC achieved a 31.2% gain well above all of the other indices. The S&P TSX gain 26.8% while the Dow Jones and the S&P 500 underperformed at 10.7% and 17%.
All but one of the top 10 positions achieved gains in Q3 led by HudBay Minerals (68%) TriStar Oil and Gas (42%) H & R REIT (27%) Keyera Facilities dropped a mere 1% in Q3. The average gain for our top 10 holdings was 19.7%.
Major Portfolio Exits
We exited five equity and trusts positions and reduced one other major holding in Q3.
New Flyer Income Trust (NFI.UN)
We exited our position in New Flyer Income Trust over the last quarter. Despite a $6 billion U.S subsidy program for US cities to buy transit buses, New Flyer had a major Chicago order cancel due to a delay in receiving state funding. We are concerned their revenue, earnings and backlog may suffer as American cities struggle with debt burden.
Rogers Communication (RCI.B)
We exited our position in Rogers Communications during the quarter as we believe margins may weaken given increased competition in the wireless market from both Bell and Telus.
We exited our position in Vermillion Energy Trust over the last quarter given the lack of growth and gas-weighing of the company. We favour oil over natural gas in the near term. Vermillion’s production is projected to decrease by 3% going into 2010. Further its gas weighting is set to increase slightly to 38% of their production. The units look fairly valued trading at 7x 2010 cash flow per share and 1x net asset value. We believe there are better positioned growth companies that present a more compelling return on investment.
Teck Resources (TCK.B)
We exited 50% of our position in Teck Resources during the quarter because we felt the shares were fully-valued, trading at a premium to net asset value and a generous multiple to cash flow. We believed taking profits was prudent given the downside risk to the share price was increasing.
Pipeline Trusts: Pembina Pipeline Income Fund (PIF.UN) & AltaGas (ALA.UN)
We reduced our weighting on pipeline trusts during the quarter. We sold Pembina Pipeline Fund & AltaGas Income Trust and retained Inter Pipeline Fund & Keyera Facilities. Our view is that Pembina and AltaGas have greater risk from frac-spreads, the price difference between natural gas and NGL price, then Inter Pipeline Fund or Keyera Facilities.
Major Portfolio Additions
We added six new holdings in Q3. Not all of these additions will be in each portfolio as we base selections on the objective selected by each of our clients.
Brookfield Properties (BPO)
Brookfield Properties is one of North America's largest office property companies with interests in 74 million square feet of predominantly premium-quality downtown space and 15 million square feet of development. We added Brookfield Properties to the portfolio because 1) the valuation remains compelling – Brookfield shares are currently trading at a 25% discount to net asset value versus peers trading at a premium 2) the dividend payout ratio is low at 60% (based on 2010 funds flow), the distribution is safe and there is potentially room for an increase and 3) the company has US$1.3 billion of cash which the company is planning to redeploy opportunistically. The company has been growing net operating income year-over-year despite the downturn in commercial real estate and the portfolio occupancy remains high at 95%.
TriStar Oil and Gas (TOG)
In August, Petrobank Energy & Resources and TriStar Oil & Gas announced that they agreed to a strategic combination of TriStar and Petrobank’s Canadian Business Unit. The transaction will create a new publicly-listed company called Petrobakken, a Bakken-focused light oil exploration and production company. Petrobakken will begin trading under the TSX symbol PBN and be a pure-play, southeast Saskatchewan-focused company. By the end of 2009, production is projected to be 37,000 barrels of oil equivalent per day (more then 95% light oil and 70% from the Bakken). We like the prospects for Petrobakken because 1) the company will be cash-flowing $650-700M in 2010, 2) the company will pay a 3.5% dividend with a low payout ratio of 23% and 3) the company will be selling non-core production for $250-450M which will allow them to pay down nearly half of their outstanding debt.
Churchill Corp (CUQ)
Churchill Corporation provides building construction, industrial construction and maintenance services throughout western Canada. Over 80% of the company’s revenue comes from the institutional sector such as public infrastructure and the balance comes from the commercial sector. We like Churchill Corp because 1) the company has not only been growing earnings over the past few years but they have been doubling EBITDA margins year-over-year, 2) there has been an underinvestment in Canadian infrastructure over the past few decades (60% of Canadian infrastructure is 40 to 100 years old) and we believe that Churchill is well positioned given its public infrastructure focus to take advantage of the opportunities to come – the federal government announced a $12B infrastructure package and Churchill’s backlog is up 32% year-over-year, and 3) the company’s cash balance continues to grow (now at $150M or $8.57 per share) giving the company ample financial flexibility.
HudBay Minerals Inc (HBM)
HudBay Minerals owns and operates zinc-copper mines, concentrator facilities, a zinc refinery and a copper smelter in the region surrounding Flin Flon, Manitoba and in Saskatchewan. We like HudBay because the company has 1) an extremely strong balance sheet with no debt and over $900 million in cash, 2) is trading at a discount to peers on a price to net-asset-value basis of 0.8 times versus peers at +1.0 times and 3) the company has just announced the discovery of a new copper-gold zone discovery at its 100%-owned Lalor project in Flin Flon, Manitoba. An updated resource on this new zone is to be released in October which will give us more clarity on how significant it is. Thus far, the deposit is proving to be better then expected and Lalor is poised to be HudBay’s next key mine.
Precision Drilling (PD.UN)
Precision Drilling Trust is a leading provider of oilfield services in North America and the largest in Canada. The company has a fleet of over 600 drilling and well servicing rigs. We added Precision Drilling to the portfolio because 1) we like the leverage the company has to recovering natural gas prices and thus rebounding drilling activity, 2) the company has successfully intergraded it’s acquisition of Grey Wolf (completed last December), 3) we believe at some point in the future the company will re-introduce a dividend which will serve as a positive catalyst for the share price and 4) the company is in a good position to make further accretive acquisitions in the directional drilling space given that there are many distressed sellers willing to sell their company’s at book value.
Daylight Energy (DAY.UN)
Daylight Resources Trust is a Calgary-based natural gas (67% weighted to natural gas) and oil medium-sized conventional royalty trust, producing 22,00 to 26,000 barrels of oil equivalent per day in 2009 and growing to 36,000 barrels of oil equivalent per day in 2010. In August of 2009, Daylight acquired Highpine Oil & Gas for approximately $523 (in cash, equity & debt assumed) to gain exposure to the Pembina-Nisku field which includes 600,000 net undeveloped acres and a drilling inventory of over 600 locations. Successful wells in this play can exhibit initial production rates greater than 1,000 barrels of oil equivalent per day of light (40 API) oil, condensate and associated sour gas. Daylight’s management has experience with this play through its 2006 acquisition of Sequoia Oil & Gas. We like this acquisition because 1) we believe it is accretive on a cash flow basis (2010E increased by 16%), 2) it reduces the trusts leverage and 3) reduced the trust’s payout ratio (payout ratio reduced to 57% from 65%). We added Daylight to the portfolio because the distribution appears safe and we believe this trust offers solid leverage to an eventual rebound in natural gas prices.
Our outlook for Q4 2009 and for 2010 remains positive. We believe economic recovery will continue and gradually accelerate. We expect that Q4 will begin with a retreat from Q3 highs but that further gains will occur towards year end. We intend to take advantage of opportunities presented by a market pullback to invest in equities with good solid value. We continue to favour infrastructure, energy and income producing companies. Dividends and distributions are an important element of over ongoing strategy. They provide income as well as a defensive posture when negative sentiment befalls markets.
We continue to favour Canada over the United States as a country in which to invest. Our banks have proven much sounder and better regulated. Our housing market avoided the subprime catastrophe. We believe Canadian economy will rebound more rapidly then the United States economy over the next 18 months.
Our strategy will be to protect the gains achieved in Q2 and Q3 by adapting a patient and prudent stance. We will await further progress in the economy before shifting further weighting to growth equities.
Michael Decter President and CEO