We’re about a month into the new year, and thus far 2013 has been kind to investors. North American markets have opened the year on the plus side, volatility has vanished, and the daily news is void of the threatening headlines that have been so prominent in recent years. While this environment has brought a complacent smile to the face of many investors, for those of us that love to find a bargain in the stock market, it’s been quite a frustrating time. The pickings are slim when it comes to cheap Canadian stocks.
In an attempt to shake free an idea or two that may warrant further research, I put together a screen that attempts to acknowledge the market’s strength, but which may point to some names that have further to run, based on their historic trading levels.
|Market capitalization||> $2 billion||
|Day close/52 week high (%)||> 98%||
|Day close/All time high (%)||< 50%||
In no specific order…
Company No. 1 – Thomson Reuters (TSX:TRI,NYSE:TRI)
At its core, Thomson provides information to professionals in the financial, legal, and scientific worlds. The biggest contributor to Thomson’s revenue stream is its Financial & Risk division, with Legal following as the second largest. Tax & Accounting, as well as IP & Science are less significant divisions.
Thomson’s business model is predominantly subscription-based, and 86% of its revenues are recurring. The “stickiness” of Thomson’s business is one of the great things about the company. You are unlikely to stray from Thomson’s services once you begin using them as the switching costs, mostly in terms of time and effort, are considerable.
Aside from its business model, Thomson offers several attractive features for investors. The stock trades with a dividend yield of 4.2% and has an enviable record of dividend growth. Thomson is a sizeable generator of free cash, and therefore, likely to continue with its run of dividend hikes. In addition, Thomson’s valuation multiples are well below historic levels.
Though revenues are recurring, organically growing this stream has been an issue and a big reason why the stock has been placed in the penalty box. Revenue growth has been particularly challenging for the Financial & Risk division. This division faces stiff competition from the likes of Bloomberg and Capital IQ. In addition, given the market turmoil over the past five years, financial companies have cut back on personnel, and therefore need less of what Thomson has to offer from this division.
Internally, Thomson is best able to cope with this top-line issue by focusing on costs. Significant organizational and personnel changes have been made, and the board believes that it has hit upon the appropriate structure with the right leadership team to deal with these headwinds.
Should these internal changes take hold, Thomson’s levered FCF multiple is likely to expand. Currently it sits at 9.9 and has historically traded between 10 and 20. The company generated more than $3 per share in levered FCF over the most recently reported 12 months. An expanding multiple could easily put Thomson’s stock into the $40 range.
Company #2 – Manulife Financial (TSX:MFC,NYSE:MFC)
One of Canada’s big 3 life insurers, Manulife’s struggles during the financial crisis made headlines from coast to coast. But the company survived, and it’s now poised to make a dramatic comeback, should the appropriate market conditions evolve.
Similar to Thomson, Manulife offers investors an attractive yield of 3.5% and trades at a price-to-book value multiple of 1.2, which compares favourably to its historical highs of 2-2.5 and its long-term average of 1.9.
Unlike Thomson, which needs to demonstrate to the market that management has the company pointed towards sustainable growth, Manulife’s shares need some external help. Canadian accounting standards have severely penalized Manulife, and the entire Canadian life insurance industry, because of the current low interest rate environment. If and when interest rates begin to move up, Manulife, and the others, are going to begin reporting sizeable increases in accounting profits.
Given Manulife’s relatively low P/B multiple, it appears as though the market is not yet fully pricing in higher rates. A more normalized rate environment could see MFC’s stock climb north of $20. For investors that have poured significant funds into the bond market, and who stand to feel some pain should interest rates begin to rise, owning a company like Manulife seems like a very logical way to partially hedge this exposure.
The Foolish Bottom Line
Though neither is as cheap as it was, both Thomson and Manulife continue to offer investors upside under the right circumstances. My preferred play would be Manulife, since I put better odds on interest rates rising than on Thomson’s headwinds subsiding. In addition, Manulife stands to benefit from the ageing baby boom dynamic, which could provide a tailwind for this financial-services company for decades to come. Both, however, are solid businesses, and worthy of consideration for your portfolio.
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Fool contributor Iain Butler does not own shares in any of the companies mentioned in this post at this time. The Motley Fool has no positions in the stocks mentioned above.