Economic news out of Canada has been far from positive for the past several months, with several economic indicators pointing to a weak 2015 for Canadian economic growth.
With the United States Energy Information Administration reporting that oil inventories are an 80-year high, TD Bank is forecasting WTI prices to average a very low US$41 a barrel in the first half of 2015, averaging US$47 for the entire year. This has been the source of Canada’s economic woes, which prompted the Bank of Canada to slash its overnight interest rate from the historically low 1% to 0.75%, as an “insurance policy” against lower oil prices.
The price weakness also prompted the Bank of Canada to slash its GDP growth rate to 1.5% for the first half of 2015, down from the 2.4% forecast in October. The Canadian dollar has followed suit, dropping to US$0.79, the lowest level since March 2009.
What does this all mean for investors? It underscores the need to have a well-diversified portfolio, not only between industries, but also geographically. However, for investors not willing to undertake the risk involved with buying foreign stocks, it is possible to achieve geographic diversity within the TSX. This can be done by purchasing companies with highly diversified global revenue sources, and in this regard, CGI Group Inc. (TSX: GIB.A)(NYSE: GIB) and Magna International Ltd. (TSX: MG)(NYSE: MGA) are premier choices.
CGI Group
Although the Canadian economy has seen its growth forecast downgraded, it’s extremely unlikely that CGI will notice any impact on its bottom line. The IT services provider has a geographically diverse revenue base, protected by a decent economic moat.
Currently, CGI has a global platform, with 400 offices located in over 40 countries. Only 15% of their global revenue is Canadian, with 27% being American, and the rest originating in Europe and Asia. Although 15% of CGI’s revenue is Canadian based, it is unlikely this revenue would be at all influenced by any Canadian economic weakness due to the contractual nature of the work, and its origin.
The majority of CGI’s work (33%), originates from government contracts, with an average duration of seven years. In Canada, CGI has partnered with dozens of federal agencies, most provinces and territories, as well as national defense agencies, to provide a wide variety IT solutions.
With a 98% renewal rate for government contracts, largely due to CGI’s 95% on-time and on-budget record (well above the industry average), combined with the unique privacy and security concerns present in government contract work, CGI’s Canadian revenue should be secure even through economic weakness.
Through this diversified, secure revenue base, Canadian investors can reduce volatility in their portfolio tied to oil prices and Canadian consumer spending. With nearly $1 billion in free cash flow for 2014 and excellent growth prospects, CGI offers growth and security.
Magna International Ltd.
Like CGI Group, auto parts manufacturer Magna International also offers strong global revenue diversification. Currently, Magna has a worldwide customer base, and sells to nearly every major car manufacturer in the world. As of 2013, 51% of revenue comes from North America, and with 46 manufacturing plants in Canada compared to 59 in the United States and 29 in Mexico, it is likely only a portion of this revenue is Canadian based.
Magna is poised to benefit from a recovering U.S. economy and a rapidly expanding Asian middle class. U.S. retail auto sales are expected to reach a record high in 2015, at an estimated 13.83 million sales, ahead 2004’s 13.8 million record. This American growth will be matched by Chinese growth, and Chinese sales are expected to grow from 23.3 million in 2014, to 24.9 million in 2015.
Magna’s global platform allows it to capitalize on global growth, while minimizing risk from the Canadian economy. Interestingly, however, many of Canada’s weak economic indicators will serve as a boon for Magna. Low oil prices will be a boost to auto sales, and the weak Canadian dollar will allow manufacturing-heavy Magna to pay employees with the weak Canadian dollar, while obtaining revenue in the much stronger American currency, which should be a boost to their top line.
