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Andrew Allentuck

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A good time to go shopping

Andrew Allentuck


(GlobeinvestorGOLD) — The conventional wisdom is that Canadian business can't compete with the loonie now hitting highs of 1.09 to the Greenback. That's a level that chroniclers of the Canadian dollar report has not existed since January, 1978.

The unconventional wisdom is that there are companies that should be able to do well precisely because the Canadian dollar has taken flight. Trouble is, they are very hard to find.

Richard Howson, executive vice-president and chief investment officer of Howson Tattersall Investment Management Inc. in Toronto, suggests that on the list of currency-driven winners ought to be retailers that buy offshore with empowered Canadian dollars, capital equipment distributors that buy in U.S. dollars and sell in loonies, and capital-intensive companies that buy American-made machinery to produce goods that are sold in currencies stronger than the U.S. dollar. Think of Canadian Tire Corporation Ltd. as a reseller of goods, Caterpiller distributor Toromont Industries Ltd. and auto parts maker Linamar Corp. as a major buyer of capital goods and you have a shopping list of potential thrivers.

Well, maybe. In intensively competitive industries, potential gains from currency moves tend to be eroded by the practice of giving up margin to gain or at least maintain market share, Mr. Howson adds. What's more, retailers like Sobey's Inc. and Loblaw Companies are locked in microbattles that take place on grocery shelves where a penny or two of price difference can pull shoppers in or send them away. While California lettuce may now cost less at wholesale as a result of a lower cost of the U.S. currency, much retail merchandise, which tends to be low- or middle-value goods in terms of weight per dollar of value, actually costs more to ship to Canada, he notes.

The requirement for a stock to rise on the strength of the loonie actually requires that three conditions be fulfilled:

One, the currency gain has to be on a major component of total costs. If cost of goods is less than labour and overhead, the currency-generated gains may not add up to much, warns Ray Steele, chief financial officer of Mavrix Fund Management in Toronto and portfolio manager of the Mavrix Enterprise Fund.

Two, the currency gain can't be compromised by a hedging policy. Major retailers often hedge their currency exposure and thus eliminate or delay whatever gains may come from the rising loonie. For example, Canadian Tire, which imports much of its inventory from manufacturers that use the U.S. dollar or a linked currency, such as the Chinese yuan, sees little immediate gain from the flop of the greenback. Explains Scott Bonikowsky, head of investor relations for the company, "we are hedged six to 18 months out, so we don't have the gain from appreciation of the Canadian dollar. There may be a gradual benefit over time, but to this point, the benefit is slight."

Three, the currency gain can't be wiped out by what has driven it in the first place — higher energy and materials prices. For example, Transat A.T. Inc., which flies tourists to the Caribbean, may gain from the relative strength of the loonie in buying hotel rooms, but it still has to pay a lot more for fuel for the planes that carry the tourists to those rooms, notes Andrew Parkinson, Managing Director of Van Arbor Asset Management Ltd. in Vancouver and manager of the Van Arbor Canadian Advantage Fund.

Investing in companies that can gain from the rising loonie takes a more nuanced strategy than going with the idea of reduced input costs as a basis for rising earnings. For Robert Almeida, senior vice-president at AIC Limited in Burlington, Ontario and manager of the $1.2-billion AIC Advantage Fund, the strong Canadian dollar offers huge investing opportunities in companies in terms of their capitalization rather than their costs.

"Canadian banks now have a high-value currency with higher price/earnings multiples than U.S. banks. The last time Canadian banks were trying to buy U.S. banks in 1998, they had to work with a low value dollar. Now they have a 91 cent dollar. The competitive edge will go to Canadian banks buying more U.S. exposure, such as Toronto Dominion Bank, which can increase its holdings of American financial services, as it has done with its purchase of online broker Ameritrade. But not every bank will gain equally, Mr. Almeida warns. "Royal Bank and Bank of Nova Scotia already have a large U.S. exposure, so they are feeling pain from the decline of the U.S. dollar."

A bet on the enhanced capital of Canadian companies is not limited to banks. Yet other financial services companies like large Canadian life insurers already have extensive U.S. exposure and, if anything, could see their earnings suffer when U.S. income is translated back into Canadian dollars, Mr. Almeida says. What's more, the idea of buying U.S. business with a currency powerful at the moment flops if the U.S. dollar depreciates a great deal more. But Mr. Almeida isn't worried. "When the American dollar rises, today's purchases with powerful Canadian dollars will pay off," he says. "As long as the Canadian dollar is strong, it is a good time to go shopping. If the Canadian company is a powerful generator of cash, then it is in a position to use that power for acquisitions."

Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.

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