A majority of market participants expect a mild recession before markets move decisively up from here. The inflation and the pace of rate-hike cycle will be key drivers going forward. Till then, it makes sense to grab the undervalued names and be ready for the upcoming rally. So, here are three such TSX stocks that could soar higher.
Dollarama
Canadian discount retailer Dollarama (TSX: DOL) is a solid bet in an inflationary environment. While markets at large have lost 10%, DOL stock has gained a decent 8% in the last 12 months. After the rise, it is trading 30 times its 2023 earnings. It would be imprudent if we assess that number on an absolute basis. However, when it comes to Dollarama’s earnings growth and margin stability, the valuation looks reasonable.
Dollarama operates the largest chain of value stores, which is an important competitive advantage for the company. Its product mix, efficient supply chain, and a special appeal in a rising-cost environment have facilitated industry-leading margins for the last several years. For example, Dollarama has consistently seen operating margins above 20% while peers saw it around 10%.
Dollarama does not try too many things. It introduces additional price points every few years and works on expanding its geographical footprint. Its strong execution has been the key over the years, which has created massive shareholder value. It looks an appealing buy in the current environment considering steep macro challenges.
Air Canada
Agreed, Air Canada (TSX: AC) could be a highly risky bet given the uncertain macro environment. Lower discretionary spending in case of a recession, could be potentially negative for the flag carrier. However, what makes it an attractive name is the recent management guidance.
Based on the guidance, AC stock is currently trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) valuation of five, which is lower than the industry average.
Air Canada’s recent quarterly earnings certainly show the light at the end of the tunnel. After back-to-back years of losses and cash burn, Air Canada might finally be comfortably profitable in the next few years.
Apart from a decent financial growth, Air Canada has a manageable debt and a strong liquidity position. The leverage is still higher than its peers. But if the guidance materializes, the leverage will not be a big concern in 2023 and 2024. So, AC stock looks particularly attractive for the second half of this year.
MEG Energy
MEG Energy (TSX: MEG) is one of the top gainers across TSX energy stocks. It has returned 33% in the last 12 months, while peers have returned 5% in the same period. Despite the outperformance, it is trading eight times its earnings and seven times its 2023 free cash flows. That’s lower than the industry average and looks appealing.
MEG Energy’s net income almost tripled last year amid higher production and strong oil prices. Its debt has significantly come down since the pandemic, which has notably strengthened its balance sheet. To be precise, MEG’s leverage ratio was beyond five in 2020, but it has now come down to 0.8.
Driven by notable balance sheet improvement and earnings visibility, MEG Energy stock looks in great shape this year. As crude oil prices have again started moving higher, undervalued names like MEG should outperform.
