When big stocks slim down, profits can go up
More conglomerates are breaking up and that’s good for investors, says this Canadian advisory, which details the pros and cons with six stocks.
Conglomerates were supposed to rule the world.
Not so long ago, many predicted that a handful of mega-corporations would control everything from missiles to matchsticks.
Certainly, there are very big companies with very long arms, but the trend of late has been for conglomerates to break up rather than make up.
And that’s good for shareholders, says one Canadian advisory.
A company can become less efficient as it adds new tentacles, says The Investment Reporter.
What’s more, conglomerates tend to trade at a depressed value on the stock market, says this advisory, which has been monitoring Canadian stocks for many decades.
It points to a classic case of a big Canadian firm that became a better firm once it slimmed down into its component parts.
And it notes two cases of companies splitting themselves in half to stimulate their growth, one of them unfolding now.
To be fair, the advisory also looks at two Canadian conglomerates that have mastered the art of multi-tasking to their shareholders’ benefit.
The one left standing
“Conglomerates in general have fallen out of favor in the past couple of decades,” says the advisory. “That’s because they often trade for less than the combined value their underlying businesses would fetch as stand-alone companies.”
That’s also why a process of “de-conglomeration” has been going on over a decade or so.
One of the most famous cases is that of CP Ltd. Just about 10 years ago, it spun off its five subsidiaries into separate businesses. One was CP Ships, swallowed up by Hapag Lloyd of Germany in 2005. Fording Coal disappeared into Teck Resources Ltd. (TSX-TCK.B) in 2008.
Pan Canadian Petroleum merged with Alberta Energy to create Encana Corp. (TSX-ECA), which in turn has split itself in two (more about that below). Fairmont Hotels and Resorts went to Colony Capital LLC and Kingdom Hotels of Saudi Arabia.
The one left standing was Canadian Pacific Railways (TSX-CPR), which has done very well as a streamlined, railroad-only company while shipping by rail has grown, especially in commodity-rich Canada.
The advisory has this as a buy. It trades today at $61.99 and yields 1.7 per cent on the dividend of $1.08.
Sensible independent strategies
Encana encompassed large interests in natural gas and in oil, especially in the oil sands. Late in 2009, it became two companies, as its oil interests were all packaged into Cenovus Energy (TSX-CVE).
The Investment Reporter has both as buys. Despite uninspiring natural gas prices, Encana has been a solid performer. It trades today at $32.79 and yields 2.3 per cent on a dividend of $0.77.
Cenovus has risen with the price of oil, reaching a 52-week high of $38.98 on April Fools’ Day. Today it’s at $37.80, yielding 2 per cent on its $0.77 dividend.
On May 16, the shareholders of Toromont Industries Ltd. (TSX-TIH) will vote on the proposal to turn its gas compression business, Enerflex Systems, into a separate firm known as Enerflex Ltd.
The shareholders will then own shares of both companies. It should be to their advantage, says the advisory.
“The spinoff will free both Enerflex and Toromont to follow sensible independent strategies — without having to answer to a higher level of management. They can do what’s best for their individual businesses without regard to the other.”
Toromont, one of Canada’s two big Caterpillar dealers, has seen its shares coast along pretty well in the run-up to the vote. Reaching a high of $32.56 yesterday, they’re at $32.25 today, yielding 2 per cent on the dividend of $0.64.
We must wait and see how the shares of Enerflex perform. History would appear to be on their side.
Distinct advantages
The Investment Reporter doesn’t take a hidebound stance against conglomerates. They can offer distinct advantages, like diversity.
Fortis Inc. (TSX-FTS) is a large electrical and gas utility with a side business in real estate. But it does a good job of spreading its interests around, owning utilities across Canada from Newfoundland (its original base) to B.C., but also in New York State and the Caribbean.
Thus no single event (like a hurricane in the Caribbean) can cripple its revenues. And no one hostile regulator can cause trouble for the entire firm. Indeed, Fortis is set to add more acquisitions in the U.S.
Fortis has raised its dividend 38 straight years, the longest active stretch among Canadian firms. That in itself makes it a strong buy for this advisory. Trading at $32.87, it yields 3.5 per cent on the $1.16 payout.
ATCO Ltd. (TSX-ACO.X) is another diverse performer. Yet its businesses — Utilities, Energy and Structure and Logistics (like workforce housing) — aren’t particularly foreign to each other.
It’s not like a phone company owning a trust company (one of the less glorious chapters in the history of BCE Inc.).
With this compatible set of businesses, ATCO is a buy for the advisory, trading at $58.90 and yielding 2 per cent on the $1.14 dividend.
While a handful of conglomerates may be solid, the rule of thumb for this advisory is that less is more. The fewer pies for a company to stick its fingers into, the better the chance investors will taste greater profits.
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