EQUITY RESEARCH CIBC Capital Markets
December 8, 2020 Industry Update 2021 Equity Outlook Sector: CIBC Capital Markets Research Equities Are The Only Place To Be Our Conclusion Our 2021 Equity Outlook can be succinctly summarized like this – equities are expensive but, frankly, we see no alternative. The novel coronavirus has brought sub-1% long-term yields to North America, and while long rates are expected to rise next year, we doubt meaningfully north of 1%. Extremely low interest rates should continue to increase the attractiveness of equities. In this CIBC Equity Research equity outlook piece, a 50-page collaborative report across all major 11 GICS, we focus on the key themes within each sector. We believe this year’s outlook piece is particularly important given the impact of the novel coronavirus and what a return to “normal” looks like across each sector.
Key Points The market’s optimism for 2021 seems to only increase day by day, but we note uncertainties remain next year. We are in a second wave that looks likely to get worse rather than better, and face the most challenging vaccine rollout in modern history. Economically, it is anyone’s guess how deeply entrenched recently acquired consumer and business habits are. In that light, we believe investors are best served by focusing on companies that can generate respectable returns even through a bumpy recovery. Dividends, in this low rate environment, look even more attractive than normal. In our view, this will suit investors irrespective of how long it takes to get back to “normal.” Our sector recommendations reflect this. We are overweight Financials, Materials and Utilities. We believe Canadian Banks have demonstrated an ability to earn through this crisis, and specifically note Financials actually should benefit from margin expansion as rates rise. Within Materials, we remain bullish on gold given the expectation of either negative or near-zero real interest rates. As well, China appears to be rebounding best and this supports the outlook for base metals. On Utilities, the high-yielding, stable nature of the business is coupled with a strong outlook for the Renewables names as ESG continues to increase in significance across equities. Most of our readers will likely have had the good fortune of seeing equities rebound to pre-pandemic levels. Many others in this world were less fortunate and remain economically challenged. This, of course, says nothing of the human cost the novel coronavirus has waged on the world this year. While social distancing may make for a unique holiday season, we believe it is important to be thankful for all that we have in our lives amongst family and loved ones.
All figures in Canadian dollars unless otherwise stated.
For required regulatory disclosures please refer to "Important Disclosures" beginning on page 46. 2021 Equity Outlook - December 8, 2020 Table of Contents
2021 Equity Outlook...... 1
2020 At A Glance ...... 3
Are Equities Expensive? Yes, But We See No Alternative ...... 4
Stable Business Models Please, And We Want Dividends...... 4
ESG Continues To March On...... 5
S&P/TSX Communication Services – Marketweight...... 7
S&P/TSX Consumer Discretionary – Marketweight ...... 11
S&P/TSX Consumer Staples – Marketweight ...... 12
S&P/TSX Energy – Underweight...... 17
S&P/TSX Financials – Overweight...... 21
S&P/TSX Health Care – Underweight...... 24
S&P/TSX Industrials – Marketweight ...... 28
S&P/TSX Information Technology – Marketweight ...... 32
S&P/TSX Materials – Overweight ...... 36
S&P/TSX Real Estate – Underweight ...... 39
S&P/TSX Utilities – Overweight ...... 43
2 2021 Equity Outlook - December 8, 2020 2020 At A Glance
Ian de Verteuil What a year! It is near impossible to recap 2020 in a “glance” when equity investors (and the Head of Portfolio and world’s population itself) have experienced such a roller coaster ride. In U.S. dollar terms, Quantitative Strategy nearly all major developed equity indices are up on the year (save the FTSE 100), after +1 416-594-7462 having declined between 30% to 35% during the worst of the sell-off. Asian equities have [email protected] performed the best, with the KOSPI 200 and the Nikkei 225 leading the way, up 29% and 20%, respectively, as seen in Exhibit 1. Better handling of the virus and China’s rapid rebound are likely owed the credit for this. Canadian equities have been laggards amongst the group, and meaningfully underperformed their U.S. peers this year – as has been the case the last four years.
Exhibit 1: Equity Performance Of Major Developed Economies (G7 + Korea & Australia), Ranked By 2020 (USD) Total Return Performance 2019 Total Return 2020 YTD Total Return Country Index Local Terms USD Terms Local Terms USD Terms Korea KOSPI 200 14.6% 10.5% 23.0% 29.1% Japan Nikkei 225 20.7% 22.4% 15.4% 20.2% USA S&P 500 31.5% 31.5% 15.5% 15.5% Germany DAX 25.5% 23.0% 0.5% 8.4% Australia S&P/ASX 200 25.0% 24.7% 2.2% 7.6% Canada S&P/TSX Comp. 22.8% 29.0% 4.9% 5.2% Italy FTSE MIB 33.8% 31.1% -4.5% 3.0% France CAC 40 30.5% 27.9% -4.5% 2.8% UK FTSE 100 17.2% 22.0% -11.6% -11.0%
Source: Bloomberg and CIBC World Markets Inc.
The economic impact has clearly benefitted the work-at-home names in the U.S., namely within Technology, Consumer Discretionary (Amazon) and Communication Services. In Canada, Shopify and the gold names have been the best performers across the S&P/TSX Composite. The extremely low interest rate environment has failed to uplift the Canadian rate-sensitive sectors, except for Utilities. Canadian Energy has been the worst performer across the S&P/TSX Composite, for the fourth time in the last six years. Returns for all 11 GICS across both the S&P 500 and the S&P/TSX in 2020 YTD are shown in Exhibit 2.
Exhibit 2: 2020 YTD Index/Sector Performance, S&P/TSX Composite And S&P 500 (Local Currency)
100% 76% 75% Total Return From Dec 31 , 2019 - Dec 2, 2020
50% 38% 30% 24% 16% 21% 17% 25% 12% 12% 13% 11% 6% 9% 10% 5% 1% 1% 0% -5% -7% -3% -3% -25% -16% -26% -34% -50% TSX / SPX COND CONS FINL ENRS MATR INFT UTIL INDU HLTH RLST TELS S&P/TSX S&P 500
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
3 2021 Equity Outlook - December 8, 2020 Are Equities Expensive? Yes, But We See No Alternative While equities have recovered, interest rates remain well below their pre-pandemic levels – and likely will for some time. The Federal Reserve has already taken a lower-for-longer approach to managing the front end of the yield curve, and has once again shown to be a committed buyer during this era of QE 4. Our house call is for higher interest rates in 2021 as the economy rebounds, but only to levels slightly above the 1% threshold.
An extended period of extremely low interest rates in 2021 bodes well for equities. While forward P/Es for the S&P 500 are at the highest level they have been in the last 30 years (see Exhibit 3, left chart), equities are the cheapest they have been on a relative yield basis (Exhibit 3, right chart). On average, the forward earnings yield (pre-Financial Crisis) was about 120% of the U.S. 10yr Treasury yield but today the level is about 550%. This implies that equities are very attractively priced, even while P/E ratios are at near all-time highs.
Exhibit 3: S&P 500 Forward P/E (Left) And Forward Earnings Yield As A Percent Of U.S. 10yr Yield (Right)
S&P 500 Fwd P/E Avg Fwd P/E Fwd Earnings Yield Yield as % of 10yr 30 30 12 1200%
25 25 9 900%
20 20 6 600%
15 15 3 300%
10 10 0 0% 1990 1995 2000 2005 2010 2015 2020 1990 1995 2000 2005 2010 2015 2020 S&P 500 Fwd P/E Avg Fwd P/E Earnings Yield % of US 10yr
Source: Bloomberg and CIBC World Markets Inc.
Of course, this is still dependent on the timing and viability of a vaccine rollout but consensus expectations are for a global economic rebound in 2021. However, even with that said, we note that in the most recent Q3 earnings season, S&P 500 earnings were only down 10% Y/Y, a remarkable achievement that highlights the earnings resilience for equities. Against this backdrop, we believe that equities will be a superior asset class in 2021 – though overall returns could be quite modest. Stable Business Models Please, And We Want Dividends Assuming the progress on vaccines continues, we expect a much stronger economy in 2021. Having said this, there is still a variety of unknowns that will dog investors (and us all) as we move forward.
As we sit today, there is a good chance that a reasonable proportion of the developed world has some form of protection from the virus by summer 2021. Between here and there, however, we have to deal with winter conditions in the northern hemisphere, rising case counts and a population that is understandably frustrated with lockdowns.
4 2021 Equity Outlook - December 8, 2020
Furthermore, it is unknown how deeply entrenched recently acquired consumer and business habits really are. Granted, we have all embraced the convenience of home delivery and many businesses seem to have learnt that work-from-home, for the most part, works. However, it is difficult to be confident in predicting winners over the next 12 months. Will business or vacation travel come roaring back (and how quickly?)? Will the social aspect of “the trip to the mall” affect the trajectory of e-commerce? And what does mass transit look like even if 70% of a regional population base is inoculated? These are just a few questions to which the answers are anyone’s guess.
All this to say, investors will likely want to know the companies they own can generate respectable returns regardless of how long it takes to get back to “normal,” and what that term even means. Against this backdrop, we maintain a defensive tilt with our sector recommendations – even as we position ourselves for a better 2021. Businesses that have weathered 2020 with reasonable levels of profitability, but have some (but not excessive) leverage to a better economy, stand out. If we can find those with solid yields on the side, that sounds like a winning proposition.
Our sector recommendations (shown in Exhibit 4) can be described as “bullish equities, but selectively bullish.” We continue to be supportive of Financials. We have had a solid rally since our dividend report at the end of October (link) but much-better-than-expected fourth-quarter results suggest that there is more to come. Utilities also have appeal as they offer the yield – and several seem to be on the right side of the ESG trade (see next section).
Exhibit 4: S&P/TSX Sector Recommendations Overweight Index Sector Marketweight Index Sector Underweight Index Sector Sectors Weight Rating Sectors Weight Rating Sectors Weight Rating Financials 30.4% Overweight Industrials 12.0% Marketweight Energy 11.5% Underweight Materials 13.8% Overweight Technology 10.0% Marketweight Real Estate 3.2% Underweight Utilities 5.0% Overweight Communications 5.0% Marketweight Health care 1.2% Underweight Staples 3.9% Marketweight Discretionary 3.8% Marketweight
Source: Bloomberg and CIBC World Markets Inc.
Our call on Materials is quite specific. We still think gold can perform – it has pulled back nicely, interest rates are expected to remain low, inflation should return in 2021 (due to easy comps, particularly from energy), and gold companies are finding religion with dividends. In addition, if there is one country that has come through the COVID-19 fiasco well (at least from an economic sense), it is China. Most of the “non-precious” companies in the Materials sector supply Chinese demand.
From a quantitative perspective, we are effectively calling for outperformance from Low Volatility, coupled with a slight dose of Value. As we detailed in our October Quantifier (link), Low Vol performed poorly through the March pullback but it is a factor style with a great long-term track record. On the Value front we are reluctant to go all in, and have rather selectively focused on Dividend Yield, which should be attractive in a low interest rate environment. Our Quantifier from late November (link) highlighted a dislocation within Value factors, with Earnings and Cash Flow factors responding negatively while Yield and Book Value had a strong positive reaction following the Pfizer vaccine announcement. ESG Continues To March On One of the most notable aspects across equities in 2020 was the divergence in flow between ESG and non-ESG funds. While total global equity mutual funds and ETFs saw, in aggregate, large negative outflows (US$92B), the split between flows across ESG and non-ESG funds was particularly stark: net positive inflow of US$111B for ESG funds and net negative outflow of US$204B for non-ESG flows (Exhibit 5).
5 2021 Equity Outlook - December 8, 2020
Exhibit 5: Estimated Global Net Equity Flows Into ESG Funds And Non-ESG Funds
USD Billions 250 200 150 100 50 0 -50 Non-ESG Flow -100 ESG Flow -150 Q1 17 Q3 17 Q1 18 Q3 18 Q1 19 Q3 19 Q1 20 Q3 20
Note: Includes mutual funds and ETFs. Source: Refinitiv Lipper and CIBC World Markets Inc.
We expect the flow into ESG funds to continue – possibly even accelerating in 2021. To some extent, this will be due to the increased pressure on money managers to conform to guidelines such as those defined by the Taskforce on Climate Related Financial Disclosure (TCFD). And, let’s not forget that there should be much more pressure to embrace climate concerns in the U.S. under a Biden administration.
Equally important is the reality that “money chases performance” – and extremely poor performance of fossil fuel stocks will take some reversing. Not every ESG “oriented” fund is outperforming, but if anything highlights the tailwinds supporting ESG it is the significant gap in performance between Energy stocks and the Renewables. As seen in Exhibit 6, the S&P/TSX Renewables equities have greatly outperformed the S&P/TSX Energy names over the last five years. We are not sure precisely which ESG topic will dominate in 2021, but we believe investors should beware management teams that either ignore the topic at worst, or issue platitudes at best.
Exhibit 6: Total Return For S&P/TSX Energy And Renewables, Last Five Years
Total Return 400
300
200
100
0 2015 2016 2017 2018 2019 2020 TSX Energy TSX Renewables
Source: Bloomberg and CIBC World Markets Inc.
6 2021 Equity Outlook - December 8, 2020 S&P/TSX Communication Services – Marketweight
Bob Bek, CFA 2020 At A Glance Telecom and Media The Canadian Communications Index was down 3% in USD, well behind the +24% return +1 416-594-7454 posted by the U.S. Communications companies in the S&P 500 Index. While the S&P 500 [email protected] Communications Index includes tech giants such as Netflix and Google, the U.S. large-cap telecom players returned a strong +14% on their own. In recent years, U.S. Wireless has absorbed the pain of revenue melt from overage, and its revenue stream became more resilient, and more stable, during the pandemic. U.S. Cable operators continued to fire on all cylinders as broadband became a backbone for working from home. Notwithstanding the emergence of some new trends, this U.S. outperformance versus Canadian Communications has been evident for a few years now.
Exhibit 7: Global Communication Services Performance By Equity Index, 2020 YTD Total Return Performance 2020 YTD Total Return Country GICS Level 1 Index Local Terms USD Terms Korea MSCI Korea Communications 55.2% 63.0% Japan MSCI Japan Communications 24.5% 29.8% USA S&P 500 Communications 23.5% 23.5% Australia MSCI Australia Communications 15.9% 21.5% Germany MSCI German Communications 6.1% 14.0% France MSCI France Communications -7.2% -0.4% Canada S&P/TSX Communications -3.2% -2.9% Italy MSCI Italy Communications -24.5% -18.9% UK MSCI UK Communications -21.7% -20.8%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
Exhibit 8 highlights the sub-sector performance and the equities that contributed most meaningfully to the Canadian Communications Services return in 2020. TELUS led the index due to its favorable asset mix, with no direct exposure to headwinds in the media space and higher growth potential driven by the TELUS International and Health units. Cineplex was the laggard, greatly affected by the collapse of the Cineworld sale and by pandemic closures.
Exhibit 8: S&P/TSX Communication Services Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
0% 2% y
-0.9% t S i r C u I c G e - -1% 1% 0.9% b S
u y S b
-0.9% y n Top 3 Negative Contributors b o 0.1% i t n u o i b t 0%
-2% i r u t b t i r A -0.1% t
. t A m
.
-1.4% m m o -1% Top 3 Positive Contributors m -3% C -0.8%
o
X -1.0% C
S T X -3.2% -1.4% S T -4% -2% Communications Telecom Media Enter- T QBR/B CJR/B RCI/B BCE CGX (Level 1) tainment
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
7 2021 Equity Outlook - December 8, 2020 Macro Backdrop Will Continue To Emphasize The Safety Of The Canadian Telecom Space As A Yield Play Over the last decade, Canadian cable/telecom stocks have offered stability and safety supported by a largely benign regulatory environment and disciplined behaviour from industry participants. Visible long-tail opportunities in a late-cycle market are amplified by the low interest rate environment. Even with pandemic pressures and uncertainty, sector valuations continue to range between 7.5x-8.5x forward EBITDA, which continues to reflect a discount to U.S. peers that developed in early 2019 (Exhibit 9 – left side) as late-stage maturity settled into the Canadian names.
Expected headwinds in 2020 from a rising interest rate environment proved false as the pandemic hit home. The Canadian 10-year yield (Exhibit 9 – right side) remains at historic lows, with no expectation of recovery in 2021. As such, Canadian cable/telecom names should continue to stand out given their stability and strong yield positioning for investors.
Exhibit 9: Canadian Telecom FY2 EBITDA Multiple Vs. U.S. Peers (Left) And 10Yr Interest Rates (Right)
9
Source: Company reports and CIBC World Markets Inc.
Conclusion: Cable/Telecom To Follow Consistent Thesis – Valuation Range Bound, But Still A Core Portfolio Holding We again argue that many equities within the Canadian telecom sector possess excellent quasi-bond defensive characteristics, which will continue to influence investor sentiment in the current interest rate environment. While predicting the Canadian yield curve lies beyond the scope of our research, the current 10-year Canadian bond yield of 0.75% compares to dividend yields in the 5%-6% territory offered by BCE, Shaw and TELUS, followed by Rogers at 3.3%.
We consider these names to be stable Canadian companies, operating in a high-profit oligopoly ecosystem, with regulatory barriers that materially limit foreign entrants. While the wireless industry pricing reset under way will likely cap near-term valuation expansion, we believe the downside risk remains limited, as the visibly long tail of free cash flow (FCF) growth and strong dividend yields dominate the thesis.
8 2021 Equity Outlook - December 8, 2020 Headwinds In Wireless Should Abate Over The Next Year; 5G Opportunities Await While temporary pandemic pressures have clouded the outlook, Canadian wireless assets continue to deliver superior returns compared to wireline businesses. However, the maturity of the industry has become more apparent, especially for the Big 3. We expect the continued move to unlimited plans to further cause a wireless industry reset, as another ~$250MM in industry overage revenue will largely be eliminated by this time next year, without an immediate offset. Again, the pandemic has accelerated this unwind in 2020. The counter to this near-term pressure is the prospect of medium- to long-term opportunities from 5G. While a meaningful contribution from 5G is still unlikely in 2021, progress in networks, spectrum, handsets and global use cases should begin to support financial models this time next year.
Canadian fundamental variables such as population growth and wireless penetration – the drivers for buoyant wireless subscriber growth over the last many years – will remain in place for 2021 and point to higher growth rates compared to the U.S market. While we expect Canadian wireless net additions (Exhibit 10 – left side) to moderate from the ~1.5MM posted in 2019, a rebound from the 2020 pandemic pressures should see Y/Y growth in this metric, and a still solid total of ~1.1MM.
Regional wireless operators Shaw and Quebecor (both Outperformer rated) should continue to capture an outsized proportion of wireless additions, presenting a continuing challenge to the Big 3. We continue to favor these smaller players for their wireless growth prospects, which argue that current valuations are more compelling.
Exhibit 10: Wireless Net Additions (Left) And EBITDA Margin % (Right)
Note: 2019 margin expansion is mainly attributable to IFRS-16 accounting.
Source: Company reports and CIBC World Markets Inc.
Conclusion: Wireless Players Should Exit 2020 Positioned To Rebound, And Better Positioned For 5G In 2021 Looking to 2021 and beyond, we continue to favour wireless assets within the sector, as they remain an important source of growth and value potential. While the wireless industry appears to be passing an inflection point, marked by the elimination of overage revenues, we expect market participants to react in a proactive and disciplined fashion, and use the post-pandemic rebound to open up 5G opportunities and revenue streams as 5G networks expand.
9 2021 Equity Outlook - December 8, 2020 Wireline Capex Savings Should Boost FCF And Aid 5G Investments In contrast to the remaining Canadian wireless growth potential, little to no growth is implied in our wireline business thesis. Cost-cutting initiatives have been an ongoing exercise for every company in our cable/telecom coverage universe. That being said, margins should naturally expand as asset mix drifts away from video towards high-margin Internet services.
Capex efficiency accounts for most of the wireline cash flow expansion in 2020 (Exhibit 11). We expect that 2021 will continue this path of capex-centric efficiency, aiding opex in the process. Canadian telecom leaders (Bell and TELUS) have turned the corner in fiber investments, with Bell having crossed 56% of homes passed and TELUS approaching 80% by the end of 2020. The future pace of fiber deployment will slow down, while the cost of new customer installations will drop. Cable companies are already reaping the benefits from the switch to low capex-intensive video platforms and, in our opinion, have a long runway of efficiency opportunities ahead.
Exhibit 11. Wireline OCF (EBITDA – Capex) Margin %
Source: Company reports and CIBC World Markets Inc.
Conclusion: Mature Wireline Business Drives FCF Through Capex Efficiencies As the distinction between wireless and wireline networks increasingly blurs, it becomes challenging for companies to allocate investments between the two, especially as we move closer to a full 5G world. However, on the consolidated level, we expect capital intensity to decrease for most of the cable/telecom companies in our coverage universe. The current asset mix within the wireline space will require lower capital investment. Ultimately, we expect wireline capex efficiency to find its way to FCF in the near term, freeing up capital for further 5G investments. Both implications are positive for the sector and support our modest, but positive, long-tail FCF growth thesis.
10 2021 Equity Outlook - December 8, 2020 S&P/TSX Consumer Discretionary – Marketweight
Mark Petrie, CFA 2020 At A Glance Consumers North American discretionary stocks had an exceptional year. While discretionary indexes fell +1 416-956-3278 in similar fashion to the broader market in March and April, their recovery off the bottom was [email protected] noticeably stronger. While this may have been initially puzzling during a recession, Matt Bank, CFA discretionary companies did not see as much earnings pressure as many feared in Q2, many Consumers posted excellent growth in Q3, and the sector has been one of the biggest sources of positive +1 416-594-7831 earnings surprises this year. American discretionary stocks notably outperformed all other [email protected] geographies, though Canadian names performed well ahead of the TSX.
John Zamparo, CFA, CA Exhibit 12: Global Consumer Discretionary Performance By Equity Index, 2020 YTD Consumers +1 416-956-6108 Total Return Performance 2020 YTD Total Return [email protected] Country GICS Level 1 Index Local Terms USD Terms USA S&P 500 Discretionary 30.4% 30.4% Kevin Chiang, CFA Italy MSCI Italy Discretionary 8.8% 17.3% Auto Parts Australia MSCI Australia Discretionary 11.1% 17.0% +1 416-594-7198 France MSCI France Discretionary 7.6% 15.9% [email protected] Germany MSCI German Discretionary 4.2% 12.4% Canada S&P/TSX Discretionary 11.7% 12.1% Japan MSCI Japan Discretionary 6.8% 11.3% UK MSCI UK Discretionary -10.7% -10.1%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
Retailers were the biggest driver of returns in 2020, led by Dollarama, which held in far better during the lows due to its defensive product mix, and grew nicely off that better base. Magna added meaningfully to index returns, as auto suppliers outperformed expectations and bolstered confidence in a multi-year recovery in production. Within our coverage universe, BRP, AutoCanada, and Sleep Country have had excellent years but are smaller components in the index, while Canadian Tire has performed well, too. On the negative side, Gildan struggled due to its end-consumer mix.
Exhibit 13: S&P/TSX Consumer Discretionary Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
14% 6% S y C t I i r G
- 0.0% 11.7% u 5% 4.5% b 12% c e u S S
-0.3% 3.7% y y 4% b b
10% n 4.8% n o o i i t t 3% u u 2.3%
b 8% b i i r r t t t t 2% A A
y 6% y r r a a 1% Top 3 Negative Contributors n n o o i i t 4% t e e r 7.1% r 0% c c s s i i D D
2% -1% Top 3 Positive Contributors X X -0.7%
S -0.8% S T T -1.3% 0% -2% Discretionary Retailers Autos and Services Durables and DOL MG CTC.A QSR MTY GIL (Level 1) parts apparel
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
11 2021 Equity Outlook - December 8, 2020 S&P/TSX Consumer Staples – Marketweight
2020 At A Glance Mark Petrie, CFA Consumers Staples played their role in investors’ portfolios this year. Earnings held in – and often +1 416-956-3278 improved – in the spring and summer as the pandemic impacted the economy. Stocks [email protected] outperformed early on, although since May, Staples have lagged the market’s strong recovery, and significantly underperformed Discretionary. Canadian Staples were in the Matt Bank, CFA middle of the pack globally, just behind the U.S., though our index is more concentrated. Consumers +1 416-594-7831 Exhibit 14: Global Consumer Staples Performance By Equity Index, 2020 YTD [email protected] Total Return Performance 2020 YTD Total Return John Zamparo, CFA, CA Country GICS Level 1 Index Local Terms USD Terms Consumers Italy MSCI Italy Staples 17.3% 26.5% +1 416-956-6108 Australia MSCI Australia Staples 5.7% 11.3% [email protected] USA S&P 500 Staples 8.9% 8.9% France MSCI France Staples -0.6% 7.0% Canada S&P/TSX Staples 6.0% 6.4% Japan MSCI Japan Staples 0.2% 4.4% Germany MSCI German Staples -8.3% -1.1% UK MSCI UK Staples -5.7% -5.0%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
The Canadian Staples Index is dominated by the grocers and Alimentation Couche-Tard and, unsurprisingly, these stocks comprised the bulk of the positive attribution in the index. Couche-Tard fared better than expected through the pandemic, and fuel margins were a significant net positive. Grocery stores also performed very well, though Loblaw (and Weston) underperformed Metro and Empire due to its business mix being more heavily skewed towards underperforming pharmacy and general merchandise, and its grocery business having greater exposure to the discount channel, which lagged full-service. Saputo underperformed this year due to commodity headwinds and a foodservice-heavy customer base.
Exhibit 15: S&P/TSX Consumer Staples Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
8% 4% S y t C i 2.9% I r 3% G 6.0% u - c b 6% 0.2% 0.2% e u 2.1% S
S
y y
b 2%
b
n n o i o t i t
u 0.9% u 4% b 1% i b r Top 3 Negative Contributors i t r t t t A
A
s s
5.6% e
l 0% e l p p a t
a 2% t
S -0.3%
-0.3% S
X -1% X Top 3 Positive Contributors S S T -1.0% T 0% -2% Staples Food Beverages Food ATD/B MRU EMP/A L WN SAP (Level 1) Retailing Products
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
12 2021 Equity Outlook - December 8, 2020 Recovery Mode
Vaccine Adoption Paves Way To New Normal 2020 was a tale of two stunningly different realities as our lives were flipped upside down in early March. In some respects we expect 2021 to have some parallels, and the end of the year to look very different than the beginning. The transition will likely be more gradual given the vaccine rollout will take time, but as it is adopted, we expect consumers to settle into behaviour patterns that have more in common with pre-pandemic times than those we are observing today. Perhaps more importantly, we expect investors to look to 2022 even earlier than they might otherwise.
However, select aspects of consumer demand will be irrevocably altered. Working from home (WFH) will be more widely adopted than ever before and that has wide-ranging implications across spending habits, eating patterns and transportation. The shift of consumer spending to online channels has also been permanently elevated (more on this in the next section). The trend to spend on and around the home was one of the most material tailwinds in the market. Likewise the trend toward personal health and self-care. We expect these will prove somewhat sticky in early 2021, but ultimately decline over the course of the year and beyond. The last point to mention here is the ~$90B of “excess cash” accumulated by higher-income households during the pandemic and currently sitting on the sidelines. We expect a vaccine will likely serve as a catalyst for the deployment of this cash, with spending supporting the resumption of the trend of experiences over goods.
Given our view of “mean reversion” in consumer behaviour, we highlight the YTD share price performances of members of the Staples and Discretionary sub-indices. While all stocks have recovered from their bottom – discretionary > staples – and there are company-specific factors to be considered, we believe this is a good starting point to approach a year in which we expect consumer behaviour to finish the year looking more “normal” than it starts.
Exhibit 16: YTD And “From Bottom” Performance
YTD Return Market Bottom YTD Return Market Bottom
Consumer Staples Consumer Discretionary JWEL-CA 41.8% 49.4% ACQ-CA 145.4% 530.5% CLIQ-CA 34.4% 309.6% LNF-CA 30.2% 97.2% NWC-CA 25.7% 106.9% DOO-CA 29.1% 276.3% EMP.A-CA 15.8% 42.1% LNR-CA 32.6% 160.8% MRU-CA 13.5% 16.1% MAV-CA 23.2% 126.8% PBH-CA 17.1% 67.4% CTC.A-CA 22.1% 131.5% PRMW-CA 13.4% 66.4% ATZ-CA 25.5% 124.2% ATD.B-CA 7.7% 42.7% ZZZ-CA 23.3% 193.6% MFI-CA 7.4% 35.1% DOL-CA 21.9% 53.4% TTCS-TSE 4.1% 26.3% MG-CA 14.5% 128.8% L-CA -3.8% 7.4% TTCD-TSE 11.0% 99.3% WN-CA -4.6% 12.3% BYD-CA 4.9% 61.1% SAP-CA -9.1% 18.6% MRE-CA 11.1% 177.5% GOOS-CA -10.6% 80.9% QSR-CA -6.5% 61.3% GIL-CA -9.7% 122.7% GC-CA -11.3% 99.9% RECP-CA -11.2% 103.7% ROOT-CA -7.3% 130.1% TOY-CA -22.8% 171.2%
Source: FactSet, company reports and CIBC World Markets Inc.
13 2021 Equity Outlook - December 8, 2020
Within Staples we believe most companies will have difficult comparison periods as consumer behaviour reverts. For the grocers, while we do expect food-at-home to remain elevated from historical levels, we expect diners will jump at the opportunity to enjoy a meal away from home. So while WFH will provide a boost to home-based consumption, and some cooking behaviours may stick, lapping the tighter lockdown periods will prove challenging.
Looking at the laggards, we highlight Loblaw and Weston as potential positive outliers. We believe that business mix (beauty at Shoppers, general merchandise and apparel in food retail, ~60% of food sales in the “discount” channel) was the single-largest factor driving their relative underperformance in 2020 and we expect much of that will turn tailwind in 2021. Saputo was the largest underperformer and, while it will benefit from a rebound in foodservice, a lack of clarity on the broader dairy commodity landscape keeps us more cautious.
Discretionary has a much wider range of share price performance and a much wider range of consumer shifts. These have had particularly positive effects on businesses such as AutoCanada, BRP and Canadian Tire. Going into 2021 we believe it is still to be determined exactly how much of the growth seen is representative of a permanently larger end-market, simply pulled forward from a future period, or something in between. An expected resumption of the shift toward experiences over goods, which was paused by the pandemic, adds further complexity. Overall, we favour businesses that have adapted to the evolutions in the market and are positioned to emerge stronger, regardless of what type of macro environment or consumer they face.
Gildan has suffered from shutdowns and severe damage to several of its end-markets, though we believe it has executed well on its Back To Basics strategy through the pandemic and dramatically re-shaped its business in several ways. We believe that margins will improve materially as revenue re-builds and that the visibility to $2 of EPS will emerge as 2021 progresses. Recipe and Roots have deeper challenges with their brands and platforms and could take longer to deliver fundamental turnarounds. Spin Master entered 2020 on the back foot, and early pandemic-driven disruptions in Chinese toy production piled on to push shares down 25% before COVID-19 even hit sector valuations. As a result, the subsequent share price recovery and reversion activity since March lows have only returned the share price to levels seen at the start of the crisis. Into 2021 we expect global consumer demand for toys to remain strong, and valuations to repair as the company works through the year. E-commerce Adoption Changes The Game
Shift Online Has Been Accelerated And Consumers Won’t Look Back The single most impactful – and lasting – change in consumer behaviour driven by the pandemic has been the accelerated shift to online shopping. Of course, this trend was already well under way pre-pandemic, but the forced adoption – both by new consumers and by existing customers but in new categories – has led to new behaviours that pushed online adoption well above what would have otherwise been expected. The exhibit below highlights the spike in online retail sales in Q2 and Q3 of 2020 and how, based on Q3, both Canada and the U.S. appear to have settled into an e-commerce penetration rate about 200 bps higher than what otherwise would have been expected.
14 2021 Equity Outlook - December 8, 2020
Exhibit 17: E-commerce Penetration, U.S. And Canada
25.0%
20.0%
15.0%
10.0%
5.0%
0.0% 6 6 6 6 7 7 7 7 8 8 8 8 9 9 9 9 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 / / / / / / / / / / / / / / / / / / / 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q
Canada US
*Retail sales excludes autos, auto parts, and gas stations.
Source: StatsCan, US Census and CIBC World Markets Inc.
The grocery industry has long been a laggard in e-commerce penetration as consumers have stubbornly clung to old habits. This was particularly true in Canada, where online penetration has lagged global leaders. However, just like every other country, adoption spiked in March and April as consumers sought to avoid stores and were pushed to other options. According to a study from BCG, grocery is the only major category in which online transactions (as a % of total) have continued to climb throughout the pandemic. As shown in the exhibit below, website traffic data from Similarweb does show a reversion, but with a new – elevated – baseline set. Either way, the net takeaway is that online adoption in the grocery channel was boosted in 2020 and, in our view, will very likely continue to rise from here.
Exhibit 18: Weekly Web Traffic And Y/Y Growth
7,000,000 350% 6,000,000 300% 5,000,000 250% 200% 4,000,000 150% 3,000,000 100% 2,000,000 50% 1,000,000 0% 0 -50% 9 0 9 0 9 9 0 0 9 0 9 0 8 8 9 9 0 9 9 0 0 9 9 0 0 1 1 2 2 1 2 1 2 1 1 2 2 1 2 1 2 1 1 1 1 2 1 1 2 2 ------l l r t r t r r y y v c v c v g p g p b b n n n n c c u u p p a a a a o e o e o u e u e e e a u a u J J A O A O J J J J M M F F N D N D N A S A S M M
Y/Y Growth Total Visits
*Includes all Loblaws, Metro, and Sobeys related websites, as well as Save-On Foods, Instacart, and Inabuggy; does not include app usage.
Source: Similarweb and CIBC World Markets Inc.
15 2021 Equity Outlook - December 8, 2020
The implications for retailers are wide-ranging. Higher demand in certain categories through the pandemic has somewhat obscured cannibalization, but, ultimately, more online sales will mean less at brick & mortar sites. Based on that premise, physical store space will look excessive when total consumption rates fall back to more typical patterns, and we expect this will appear in all categories, including grocery. However, we expect this will be another situation where we see bifurcation, and low-quality stores that entered the pandemic with below-average productivity and profitability will be the victims. And though the publicly traded companies we follow will likely have a handful of locations that fit this description, we expect that most of the pain will be felt by independents and weaker, or poorly capitalized, chains. Indeed, we have already seen a number of filings from such companies in 2020 and early 2021 will likely bring another round.
The shift online also accelerates another related trend: brands selling direct to consumers (DTC). The accelerated growth in platforms to support small business web presence (such as Shopify) is the best evidence of how brands are seizing greater control, and the gatekeepers (retailers) must adapt or be cut out of the equation. Beyond reinforcing their value proposition and gaining deeper insights into consumer needs, there are two key steps. The first is well established but still playing out, and that is building a differentiated private-label program. The second – launching online marketplaces – is still emerging; several large-scale retailers are making this leap, and we expect this trend to accelerate in 2021 and beyond.
We expect the winners of these trends to be companies that start with a differentiated brand position, and then have the scale to invest and deliver a great online experience, particularly one that supports smooth fulfillment and returns. Winners will also be able to leverage digital platforms to reach new customers and deliver the incrementality that is crucial in maintaining a positive financial equation. Canada Goose and Aritzia are the two companies in our coverage universe that most clearly fit this description, though Sleep Country, AutoCanada and even Gildan and BRP also benefit.
Companies in the most difficult position are those that compete with the scale giants like Amazon and Walmart where it is nearly impossible to win on price or convenience. While Canadian Tire may appear to fall into this category, its leading loyalty program and data analytics capabilities, high – and growing – private-label penetration, and ability to use stores as curbside pick-up centres will help offset.
16 2021 Equity Outlook - December 8, 2020 S&P/TSX Energy – Underweight Robert Catellier, CFA Energy Infrastructure 2020 At A Glance +1 416-956-6197 The year was extraordinarily difficult for the energy sector and we would take the golf [email protected] equivalent of a mulligan on our original expectations for 2020. The year shaped up to be anything but what was originally anticipated, and energy was hit exceptionally hard on the Dennis Fong, P.Eng. back of pandemic-related demand destruction and a brief OPEC+ price war. If it is any Senior Oil & Gas consolation, the Canadian index outperformed its U.S. peers, although we frame the +1 403-216-3400 [email protected] outperformance as being the difference between a double or triple bogey. Exhibit 19: Global Energy Performance By Equity Index, 2020 YTD Jamie Kubik, CPA, CA Intermediate Oil & Gas Total Return Performance 2020 Total Return +1 403-216-3405 Country GICS Level 1 Index Local Terms USD Terms [email protected] Korea MSCI Korea Energy -0.3% 4.7% France MSCI France Energy -19.5% -13.3% Dave Popowich Australia MSCI Australia Energy -28.1% -24.2% Intermediate Oil & Gas Canada S&P/TSX Energy -25.6% -25.3% +1 403-216-3401 Italy MSCI Italy Energy -34.3% -29.1% [email protected] Japan MSCI Japan Energy -32.3% -29.4% Russia MSCI Russia Energy -14.6% -29.5% USA S&P 500 Energy -34.2% -34.2% UK MSCI UK Energy -37.9% -37.5%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
If oil was a double or triple bogey on the year, natural gas came in better than par. ARX and TOU were two positive contributors to index performance as natural gas had better fundamental support through its use as a potential transition fuel, and given reduced associated gas production from shale oil. It is of little surprise that the bulk of the negative contributions to 2020 index performance was led by some of the largest oil-weighted businesses in Canada, such as ENB and SU. Along with TRP, these stocks initially followed the energy market downturn, and were further impacted by renewed ESG considerations, and related investor concerns on terminal values in a globe awash with oil.
Exhibit 20: S&P/TSX Energy Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
0% 2% 0.4% 0.3% Top 3 Negative Contributors S y t C i
I -5% -9.9% r 0% G u - c
b -0.1% e u S
S
-10% y
y -2% Top 3 Positive Contributors b
b
n n o
i -2.4% o t i t u
u -15%
-10.8% b -4% i b r i t r -3.9% t t t A
A
y y -20% g -6% r g r e e n n
-4.4% E
E
X
X -25% -8% S S T T -0.5% -25.6% -8.5% -30% -10% Energy Midstream Integrated E&Ps Other TOU CCO ARX TRP ENB SU (Level 1)
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
17 2021 Equity Outlook - December 8, 2020 A Structural Shift In Capital-allocation Priorities While capital allocation has always been important, it came into sharp focus in 2020. For energy infrastructure companies, it was due to a couple of reasons. First, the pandemic deferred a number of sizeable projects, leaving the market to wonder how energy infrastructure companies will allocate higher free cash flow. Second, renewed concerns about the pace of the energy transition in light of the Democratic presidential campaign raised questions about terminal values and long-term asset mix. For E&P and integrated entities, survival became the clear priority, with the downdraft in oil pricing since mid-March requiring companies to shore up liquidity and reduce cash costs. Debt reduction came to the forefront for most companies as discretionary calls on capital (growth, dividends and buybacks) were largely cut or suspended across the space. There will be a lasting impact from price volatility this year, but 2021 should offer a more stable footing to gauge how durable the shift in capital-allocation priorities will be.
Debt Reduction Will Be The First Call On Free Cash Energy infrastructure could shift capital towards buybacks or debt repayment: Despite manageable payout ratios, high dividend yields have prompted us to moderate our 2021 dividend growth expectations in favor of eventual share buybacks (which may not start until 2022). We see more benefit to lowering debt or buying back stock rather than adding to an already attractive dividend yield. Of course, resuming contractually supported growth projects is still the preferred use of capital for infrastructure companies.
We expect producers to continue to focus on lowering leverage while maintaining flat production: SMID-cap E&Ps have largely tabled stay-flat capital programs for 2021, with free cash flow being first allocated towards debt reduction. Of the larger names, those with stronger balance sheets have shifted their focus towards at least offering a balanced view of returning value to shareholders and reducing leverage. Some of the synergies engendered by consolidation are likely to also result in reduced overall capital programs from the sector, which should further enhance free cash flow generation available for debt reduction. Outside of the largest entities, we expect access to capital (debt or equity) will likely be very restricted, further enforcing self-sufficiency as a necessity for survival.
As Commodity Prices Strengthen, The Allocation Towards Growth Vs. Returning Cash To Shareholders Will Be A Litmus Test Of Industry Discipline Capital spending prudency and cash returns will be important for investors: A strengthening oil tape should lead to improving industry (free) cash flow generation. We expect balance sheets to continue to be restored to more comfortable levels; as such, returning cash to shareholders will represent the next strongest call on cash in 2021. Although operators have messaged that buybacks and dividends will compete for free cash flow, 2021 will likely represent a litmus test for true capital discipline from the energy industry. With history as a guide, times of excess cash flow generation have typically resulted in E&Ps reinvesting the bulk of this cash flow into growth-related projects that carry an enticing rate-of-return potential. For this reason, we think investors remain highly skeptical that free cash flow will actually accrue to equity holders. We are not as skeptical, however. We believe 2020 represented a year of reckoning for producers given that the significant pain inflicted on businesses is likely to drive a lasting shift in operator behavior and spending habits for many years into the future. Exhibit 21 illustrates that free cash flow yields in 2021 are likely to be at levels beyond what we have seen over the last number of years. Allocating a healthy portion of this free cash to shareholders represents a meaningful opportunity for the sector to demonstrate times have truly changed.
18 2021 Equity Outlook - December 8, 2020
Exhibit 21: Industry Production And Free Cash Flow Yield Estimates
Production (Mboe/d) Free Cash Flow Yield (%) 30,000 16% $10Bn 14% 25,000 $7Bn 12% $17Bn $82Bn $6Bn $13Bn 20,000 10% $69Bn 15,000 8% $74Bn $3Bn 6% $2Bn 10,000 $27Bn 4% $1Bn 5,000 2%
- 0% Super Major US Independents & Shale CIBC Coverage Super Major US Independents & Shale CIBC Coverage 2019A 2020E 2021E 2022E 2019A 2020E 2021E 2022E
Note: Numbers above the bar chart on the right represent total free cash flow generated by the group. Consensus estimates used for non-covered companies derived from FactSet. Companies in Super Major category include BP, ExxonMobil, Chevron, ConocoPhillips, ENI, Occidental, Shell, Equinor, TOTAL, and EOG. US Independents and Shale include Continental, QEP, Cabot, EQT, Range, Southwestern, Apache, Callon, Devon, Diamondback, Laredo, Marathon, Matador, Pioneer/Parsley and Hess. Source: FactSet; Company reports and CIBC World Markets Inc.
Transition-related Project Spending Likely To Remain Minimal For Now Concerns about terminal value risk are likely exaggerated: For the oil sands producers, we believe the current oil price, pipeline egress, and demand are of greater importance in any decision to allocate capital towards new greenfield projects than concerns about an eventual energy transition. In the interim, we expect growth will come from brownfield debottlenecking initiatives, which help dilute fixed costs over a larger throughput of barrels (improving supply costs). We believe the low capital cost of sustaining oil sands production and long reserve life provide resiliency for these assets, and reinforce the notion that a meaningful alteration of the underlying asset mix is something that will take many years to properly execute. This is not dissimilar to the situation in which energy infrastructure companies find themselves, and we expect the energy infrastructure industry will wait until public policy is supported by legislation and regulatory certainty before undertaking significant investments in emerging technologies (hydrogen, carbon capture, utilization and storage). Given the length of time needed to transition the energy infrastructure asset mix, we view the risk to terminal values from a rapid acceleration of the transition to be exaggerated. Further, we expect existing infrastructure to play a role in the transition.
We believe Canadian companies have taken a more practical approach towards improving environmental sustainability. We expect the industry is keenly aware of the desirability of reducing emissions in existing operations and will likely continue to do so within core competencies and where the returns are justified. Companies are seeking to lower carbon intensity, but also introduce net zero emission targets. Numerous companies, large and small, have put forth targets that aim to reduce greenhouse gas (GHG) emission intensity, which ultimately demonstrates a growing commitment towards sustainable development. ARX and ERF, in particular, included in recent sustainability disclosure GHG reduction targets within the next five to 10 years. The other oil sands companies have set similar GHG intensity reduction targets, and they are progressing despite the oil price volatility. Companies that have introduced net zero targets include CNQ and ENB. Further, ENB has an interim target to reduce GHG emission intensity by 35% by 2030. We expect others, including TRP, to follow suit with a plan to achieve similar goals.
19 2021 Equity Outlook - December 8, 2020 Clarity Around Market Access Initiatives Could Improve In 2021 Market access challenges have haunted the Canadian energy sector for multiple years running, and while little has changed through 2020, our expectation is 2021 will feature meaningful announcements for two significant projects: the Line 3 Replacement (L3R) and Keystone XL (KXL). Both projects should have additional, and perhaps final, clarity in 2021.
We are more optimistic that a Line 3 Replacement is successfully instituted based on progress on the regulatory front, and may finally be placed into service in 2021, or at least have greater visibility towards an in-service date (Exhibit 22). The Certificate of Need and Route Permit court cases remain the biggest risk factors, and should the courts grant a stay while they are under way, it could lead to delays. One thing we are sure of is that opponents of the project are likely to request stays to prevent the project from advancing.
The Keystone XL project could face some form of political turbulence in the U.S. during 2021, based on President-elect Biden’s campaign promise to revoke the Presidential Permit. Although on the surface, a Democratic House could be seen as a death blow for this project, we do not see this as necessarily being the case, as Republican control of the Senate may prompt Biden to compromise in favor of other issues.
While lifting Alberta curtailments may help sentiment, we are also keeping an eye on U.S. refinery utilization, a key demand driver for Canadian oil exports that has not fully recovered since the onset of the pandemic. Should both of these projects move forward, we foresee the potential for Canada to finally shift into a position of net long liquids egress within a relatively short time frame. This would stand to benefit oil sands producers in particular, although improved market access would likely be regarded as a positive development for most Canadian E&Ps.
Exhibit 22: WCSB Crude Oil Takeaway
7,000 6,500 6,000
d 5,500 / l b B 5,000 M 4,500 4,000 3,500 8 8 8 8 9 9 9 9 0 0 0 0 1 1 1 1 2 2 2 2 3 4 5 2 2 2 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / / / / / / / / / / 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 Y Y Y F F F Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q KXL TMX Line 3 Replacement Existing Pipeline Optimizations Refining Existing Pipeline WCSB Crude Supply (CIBC) WCSB Crude Supply (CER 2020) WCSB Crude Supply (CAPP 2019)
Note: Optimizations include: ENB Mainline, ENB Express, TC Keystone, PMC Rangeland. Source: AER, CAPP, CER, Company reports and CIBC World Markets Inc.
20 2021 Equity Outlook - December 8, 2020 S&P/TSX Financials – Overweight
Paul Holden, CFA 2020 At A Glance Banks and Insurers Global Financials largely underperformed across every major equity index, with Canadian +1 416-594-8417 Financials registering only marginally positive returns. Nonetheless, that was still enough to [email protected] render the sector the best relative to its global peers in local currency terms. After adjusting Nik Priebe, CFA for currency, only German Financials registered better performance but that is largely due to Non-Bank Financials the devaluation of the euro this year. The notable comp, the S&P 500 Financials, was down +1 647-449-2855 about 5%. [email protected] Exhibit 23: Global Financials Performance By Equity Index, 2020 YTD Dean Wilkinson, CFA Total Return Performance 2020 YTD Total Return Diversified Financials Country GICS Level 1 Index Local Terms USD Terms +1 416-594-7194 Germany MSCI German Financials 0.0% 7.9% [email protected] Canada S&P/TSX Financials 1.3% 1.7% Australia MSCI Australia Financials -3.6% 1.5% Korea MSCI Korea Financials -8.9% -4.4% USA S&P 500 Financials -5.1% -5.1% Japan MSCI Japan Financials -10.9% -7.1% Italy MSCI Italy Financials -19.8% -13.5% France MSCI France Financials -20.6% -14.4% UK MSCI UK Financials -19.0% -18.5%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
A late rally by the Canadian Banks since late October has lifted Financials into the positives, after spending most of the pandemic period in negative territory (see Exhibit 24). As such, it should not be surprising that the three largest positive contributors on the year have been RY, CM, and TD, respectively. The sector’s other large sub-industry, the Insurers, have had a tougher time this year, which has scaled back overall Financials performance. MFC and FFH were the two largest negative contributors this year, along with BNS.
Exhibit 24: S&P/TSX Financials Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
4% 3% y S t i C r I u G c - e b 3% 0.2% 2% 1.80% S u
S y
b y
b n
o n i t o i u t b u i
r 1% b 2% t i t r
t 0.56% A 0.55% t
A s
1.3% l s a
l Top 3 Negative Contributors i a c i 2.6% n c a n -1.5% n
a 0% 1% i n F i
F X
S X T
S Top 3 Positive Contributors T -0.61% -0.64% -0.69% 0% -1% Financials (Level 1) Banks Diversified Insurers RY CM TD BNS MFC FFH
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
21 2021 Equity Outlook - December 8, 2020 Looking Past The Pandemic
Potential For Positive Earnings Revisions The pandemic-induced roller-coaster ride is not yet over, but fiscal stimulus should prevent North American economies from going off the rails, and vaccine developments put the exit gate within our sights. Financials are already well on their way to pricing-in post-pandemic earnings potential (i.e., 2022E), which leads to the question of whether 2022 consensus estimates appear appropriate or not. Our view is that 2022 estimates still imbed a fair amount of pessimism related to the roller-coaster ride we have endured over the course of 2020. Once we find ourselves standing on firm ground again those reasons for pessimism are likely to fall away, leading to positive earnings revisions.
A comparison of 2022 adjusted EPS consensus estimates across our full coverage of Canadian financials shows that those estimates are 6% lower today than they were pre-pandemic. Banks have taken the largest hit, with earnings expectations down 14%, on average, which is aligned with the fact that bank earnings tend to be more macroeconomic sensitive. The life insurers by way of comparison have actually seen 2022 estimates revised higher, which is partly a function of acquisition activity and the associated EPS accretion. The potential for positive earnings revisions mostly rests with the banks and that relates to economic-sensitive earnings drivers, namely loan loss provisions, loan growth, and fee income. For lifecos there remains the possibility of positive earnings revisions and that mostly relates to market-driven earnings, such as fee income on AUM and earnings on surplus. Across the diversified financials landscape, we consider the most macro-sensitive names to be the private equity companies (i.e., ONEX and BBU). These names are more likely to experience an acceleration of NAV growth as opposed to earnings revisions per se.
Exhibit 25: The Banks Have Been Hit Hard By Negative Earnings Revisions
20% 15% e g
n 10% a h C 5% e t a m i
t 0% s E
s -5% u s n
e -10% s n o C
-15% E 2 2
0 -20% 2 -25% -30% SLF* GWO* X IAG* EFN NA RY CM BMO MFC CWB TD BNS LB
2022 Δ Average
*SLF, GWO and IAG 2022 consensus estimates only available starting April.
Source: Bloomberg and CIBC World Markets Inc.
Conclusion: We foresee a high probability of positive earnings revisions over the course of 2021, supporting an argument for continued upside in Financials. This could be a particularly powerful force for companies that were most affected by the economic impacts of COVID-19. Companies that we like on this theme include TD, BMO and MFC. We also believe that ONEX and BBU may have torque to the upside if the momentum in equity markets continues and concerns around the pandemic abate.
22 2021 Equity Outlook - December 8, 2020 Capital Allocation Following A Period Of Disruption
Unlocking Excess Capital Should Be A Catalyst We have already started to see transaction activity in the financial space gain steam in the second half of 2020. The pandemic has impacted some businesses more than others, creating valuation opportunities and encouraging capital (re)deployment in response to those impacts that are expected to be more enduring. A number of companies within our coverage universe completed material transactions in 2020, including GWO, IAG and SLF.
The other reason that capital deployment is a major theme heading into 2021 is the capital constraints that OSFI introduced in response to COVID-19. Banks and insurers are currently prohibited from increasing dividends and repurchasing stock. That ban continues while both sectors continue to produce earnings in excess of current dividends. While OSFI may not lift the restriction in early 2021, we believe it is likely to be lifted in the latter half of the year, providing even more time for regulatory capital to build. We expect a broad wave of dividend increases to wash across Canadian financials in the second half of 2021.
The average CET1 ratio for the banks stands at 11.5% versus 11.0% a year ago. TD and RY stand out in terms of having the most excess capital. As we already highlighted, a number of the lifecos already used excess capital to complete acquisitions in 2020, which means capital ratios overall have not increased over the last year. However, MFC and SLF have maintained a good amount of excess capital, providing these names with capital optionality heading into 2021.
Exhibit 26: Regulatory Capital Ratios Already High, And Will Continue To Build For Several Quarters
Canadian Banks' CET1 Ratio Canadian Lifecos' Regulatory Capital Levels
14% 160% 155% 13% 150% 12% 145% 140% 11% 135% 10% 130%
9% 125% 120% 8% 115% 7% 110% TD RY CM BMO NA BNS LB CWB MFC SLF GWO IAG
CET1 Average Capital Ratio Average
Source: Company reports and CIBC World Markets Inc.
Outside of the banks and lifecos, we expect capital deployment to be less of a prominent theme. Arguably, ONEX is best positioned in this group from an excess capital perspective, with 26% of its proprietary investing capital in cash. We expect the company to remain highly active on its normal course issuer bid (NCIB) given the deep discount to net asset value (NAV).
Conclusion: We see capital allocation as a potential catalyst for banks and insurers as the majority, if not all, should be in a position to introduce healthy dividend increases. NCIB programs should also return and execution on such will depend on valuations and capital priorities at the time. We believe there are several companies where M&A is a strong possibility in the not-too-distant future, including TD, BMO and MFC. We expect ONEX to continue buying back stock, which is accretive to NAV/share when the stock trades at a discount.
23 2021 Equity Outlook - December 8, 2020 S&P/TSX Health Care – Underweight
2020 At A Glance
John Zamparo, CFA, CA As was the case in 2019, Health Care underperformed the broader market, posting a decline Cannabis of 15.5%. In addition, the sub-sector underperformed global health care benchmarks, owing +1 416-956-6108 to Canada’s relatively undiversified universe of only 10 constituents, with ~50% of the index [email protected] tied to cannabis. The fortunes of the index can generally be linked to the performance of two names: Canopy Growth Corporation and Bausch Health Companies Inc., which together Chris Couprie, CFA account for nearly 50% of the index weight. Health Care Facilities +1 416-594-8179 Exhibit 27: Global Health Care Performance By Equity Index, 2020 YTD [email protected] Total Return Performance 2020 YTD Total Return Country GICS Level 1 Index Local Terms USD Terms Korea MSCI Korea Health Care 72.5% 81.1% Japan MSCI Japan Health Care 18.2% 23.2% Italy MSCI Italy Health Care 8.7% 17.3% France MSCI France Health Care 3.9% 11.9% USA S&P 500 Health Care 10.9% 10.9% Switzerland MSCI Switzerland Health Care -0.2% 7.8% Germany MSCI German Health Care -9.5% -2.4% UK MSCI UK Health Care -6.2% -5.5% Canada S&P/TSX Health Care -15.8% -15.5%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
After steep declines in 2019, the cannabis sector staged a comeback late in 2020 to be the lone positive contributor to the sector YTD, with Canopy Growth providing the largest source of positive sector returns as election euphoria and movement from U.S. Congress towards a possible outcome of federal legalization lifted sentiment. Health Care Facilities were weak, owing to the impact of COVID-19 on occupancy and costs, though well off the worst levels of the year as investors began to look past the short-term impact of the pandemic and toward the demographic tailwinds.
Exhibit 28: S&P/TSX Health Care Attribution By Sub-Index (Left) And By Most Impactful Security (Right) S
0% y 15% t C i I r u G - c 9.0% b e 10% u -5% S
S y
y b
4.7% b
n 5% n o Top 3 Negative Contributors i o -10% t
i 1.0% t u u b i b r
i 0% t r
7.5% t t t A
-15% A e
r e -2.5% a r -15.8% -5% Top 3 Positive Contributors a C
C
h
-20% t h -18.6% l -6.3% t a l -10% e a e H
H
X X -25% -4.7% S
T -15% S T -17.0% -30% -20% Health Care Pharma- Health Care Cannabis WEED APHA CRON CSH-U ACB BHC (Level 1) ceuticals Facilities
Note: Exhibit priced as of December 2, 2020 close. Pharmaceuticals as shown above excludes Cannabis. Source: Bloomberg and CIBC World Markets Inc.
24 2021 Equity Outlook - December 8, 2020 Seniors Housing – Vaccine Beneficiary We expect that 2021 may mark the recovery for the seniors housing sector from a painful 2020 – both in private-pay retirement housing and in long-term care (LTC). In general, both areas of seniors housing have faced pandemic-driven declines in occupancies and increases in operating costs; we expect these trends to reverse course throughout next year, but most likely not until the latter half. Clearly, this outlook is predicated on a moderation in the COVID-19 case count throughout 2021, which is reliant on recently enacted lockdown measures stemming from the recent rise and, ultimately, vaccine distribution.
Long-term Care – Government-backed Essential Service: In publicly funded long-term care, we believe that occupancy protection funding (i.e., full reimbursement despite actual occupancy levels) will likely continue until the environment stabilizes, and believe that, as the pandemic subsides, occupancy will be restored to the high 90% range as demand for this essential service has not gone away. With the passing of Bill 218, the spectre of broad class action lawsuits against LTC operators has been removed, and only “bad actors” would be expected to potentially face COVID-19-related legislative action. The Ontario government announced a $1.75B LTC construction funding program aimed at stimulating the development of new LTC beds, and the redevelopment of older Class B and C beds to modern standards. The new economics are more favorable than the prior program, as evidenced by announcements from various players that they will be restarting previously shelved LTC redevelopments. A key concern for LTC has been pandemic expenses running ahead of reimbursements from the government. While we do not expect all costs to be covered, we believe that the extraordinary items being incurred to combat the pandemic are also being borne by not-for-profit and municipal homes, and these models would not be sustainable without increased funding from the government. As such, we believe there is mostly a timing mismatch between expenses and recoveries. When comparing the valuations of seniors housing companies, it appears as though investors are more concerned about the prospects for LTC given the larger NAV discounts for Sienna and Extendicare, which have larger exposure to this segment of seniors housing. As the pandemic ebbs, we believe LTC organic growth should return to the historical levels of 1%+, which should restore confidence in the business and narrow the valuation gap.
Retirement Housing – Post-pandemic Fundamentals Poised To Improve: We expect occupancy pressures in private-pay retirement housing to continue through the early part of 2021 as the second COVID-19 wave runs its course. As touring activity re-opens, we expect occupancy to build as we think demand has been deferred, not destroyed. One of the consequences of the pandemic has been some postponement of development projects. As an illustration, according to an October survey by Senior Housing News, in the U.S. 65% of respondents reported postponing projects owing to the pandemic while 40% have cancelled them altogether. At the same time, demographics are such that the growth rate in the addressable market is poised to grow at a higher clip. As previously discussed, we believe that conditions may be setting up for an undersupplied market in 2022. With ~90% of net operating income (NOI) tied to retirement housing, we believe Chartwell is best positioned for this dynamic, followed by Sienna.
Exhibit 29: Canadian Retirement Home Market Could Be Undersupplied By 2022
Capture Rate 0.0 # 8.9% 9.0% 9.1% 9.2% 9.3% Supply Required By 2022E To Maintain Occupancy 15,844 18,970 22,096 25,221 28,347 Supply Growth To 2022E (Long-Term Rate) 15,684 15,684 15,684 15,684 15,684 Oversupply / (Undersupply) (161) (3,286) (6,412) (9,538) (12,663)
Occupancy in 2022E at Average Supply Growth 92.1% 93.2% 94.2% 95.2% 96.3% Occupancy Change vs. 2020 0.1% 1.1% 2.1% 3.2% 4.2%
Source: CMHC, Statistics Canada and CIBC World Markets Inc.
25 2021 Equity Outlook - December 8, 2020
Valuation – Still Room To Improve: Being ground zero for the pandemic, the three Canadian seniors housing stocks have seen their valuations slide and are trading below longer-term averages, especially, as discussed, those with higher LTC exposure. While stocks have recovered ground with the positive news of a vaccine, there is still room for multiple expansion as 2021E operating results improve, the impact of COVID-19 is lapped, and demographic tailwinds emerge.
Exhibit 30: Historical Consensus P/NAV CSH.UN EXE SIA 140% 120% 150% 130% 110% 140% 120% 130% 100% 110% 120% 100% 90% 110% 90% 80% 100% 80% 70% 90% 70% 80% 60% 60% 50% 70% 50% 40% 60% 40% 30% 50% 20% 30% 40% 6 1 8 1 8 2 4 7 9 4 6 7 9 4 6 0 5 7 4 7 4 7 6 0 7 0 2 7 9 2 9 4 1 7 8 6 2 3 9 0 2 3 9 0 9 6 9 9 2 9 3 0 8 5 8 5 1 1 1 1 1 1 1 0 0 1 1 0 0 1 1 1 1 1 1 0 1 0 1 1 1 1 1 1 1 1 1 1 1 1 1 0 1 1 1 2 1 1 1 2 0 1 0 1 1 1 1 2 0 1 0 1 ------l l l l l l t t t r r r r r r r r y y y y y v c v c v c v c v c p g p p g g p g p b b b n n n n n n n n n n n n c c c u u u u u u a a a a a p p p a a a a a o e o e o e o e o e e u e e u u e u e e e e u a u u a u a u a u a u J J J J J J A A A O O O J J J J J J J J J J J J M M M M M F F F N D N D N D N D N D S A S S A A S A S M M M M M
CSH Last: 93% Avg: 100% EXE Last: 76% Avg: 86% SIA Last: 90% Avg: 103%
Source: S&P Global Market Intelligence, Bloomberg, FactSet, company reports and CIBC World Markets Inc. Cannabis: Fundamentals Matter, But Politics Rule The Day Although we expect cannabis operators to continue to progress and largely become more profitable, we have absolutely no doubt that the story of cannabis in 2021 will be shaped by expectations for transformative regulatory change, in particular U.S. legalization.
Perhaps unlike any other industry, the prospects for cannabis stocks generally depend on political headlines, and the preferences of retail investors. The price action in cannabis stocks in the fourth quarter of 2020 has clearly reinforced this notion, as the largest moves involve political developments, even ones that seem to have been previously expected, whether it be further confirmation of a Biden presidency or a vote on legislation such as the MORE Act. In our opinion, 2021’s key themes will mimic those of 2020: regulatory catalysts south of the border, the countdown towards interest or opportunity from more institutional investors, and The most critical catalyst for the likely ongoing shift of capital allocation towards more profitable American names. cannabis in 2021 will likely occur just five days into the Georgia On Our Minds year as U.S. Senate control is determined. With the presidential election now in the rearview mirror, and largely positive for cannabis, the critical regulatory catalyst in 2021 will occur just five days into the year. The Georgia run-off elections that will determine control of the U.S. Senate will also be arguably the most important event for cannabis in some time. We assess potential implications below.
Exhibit 31: Georgia Senate Run-off – Decision Tree
Federal Senate legalization in SAFE Banking Act and outcome 2021? decriminalization in 2021? Commentary Favours Democrat Likely, via MORE n/a Transformational positive. Investors and capital would likely flock to Among our coverage, best-positioned are largest, Act the sector. Both Canadian and U.S.-based stocks would very likely most liquid names with strong balance sheets: surge further ahead. APHA, CRON, WEED.
Republican Very unlikely Possible Ability to decriminalize through executive action is disputed. U.S. multi-state operators would likely benefit the Republican-led Senate may pass SAFE Banking Act, which would most, as we suspect Canadian-based operators reduce cost of capital and possibly taxation burden, and may allow could not enter U.S. market. U.S. firms to list on national exchanges.
Source: CIBC World Markets Inc.
26 2021 Equity Outlook - December 8, 2020
As it relates to the beneficiaries of each outcome, we note one key caveat to our assessment above, which is that accessibility may be the most important driver of positive returns. It has been remarkably evident in 2020 that as the probability of positive regulatory events increases, stocks with U.S. listings outperform, which is true irrespective of whether those companies would actually benefit from the proposed regulatory change. We note that Canadian operators with dual U.S. listings have returned ~75%, on average, since November’s election, versus 25% for U.S. multi-state operators and ~15% for Canadian operators with domestic-only listings. Therefore, while Canadian producers require cannabis to be removed from the Controlled Substances Act in order to operate in the U.S. (which likely occurs only in the event of Democrats winning both GA seats), we expect movement towards any sort of reform, even modest in nature, will favour stocks with U.S. listings and meaningful liquidity. Among our coverage universe, this includes ACB, APHA, CRON, HEXO, OGI, SNDL and WEED.
Institutions Still On The Sidelines
Two factors may lead to To this point, the wave of buying in cannabis stocks has largely come from retail investors. increased involvement from Our discussions with some institutional investors reveal that sector exposure frequently institutional investors: the occurs to align with index composition. Many traditional long-only asset managers continue to ability for U.S.-based firms avoid this sector entirely. We believe two potential factors may change this in 2021. First is to list on large exchanges, the option for U.S. operators to list on exchanges like the NYSE or NASDAQ. This may occur or increased profitability of if the SAFE Banking Act passes. Second, if Canadian firms become more profitable, Canadian firms. investors may begin to add exposure to this sector. We expect the phenomenon of increasing interest from institutions could become a focus in late 2021, but could slip into 2022.
Canada Inches Forward, U.S. Surges Ahead The fact that potential U.S. legalization is the greatest catalyst for Canadian cannabis stocks in 2021 speaks to the current performance of the domestic market. Two years into legalization, Canadian retail sales have reached a run-rate of just $3.1B, roughly half of what market participants (ourselves included) expected before legalization. We believe there is little prospect for any Canadian regulatory reform that would significantly move the needle in 2021, and arguably the same is true for 2022. However, a sharp increase in retail stores – especially in ON, QC and BC – will likely facilitate sales of $4.1B in 2021E, and we introduce our 2022 forecast of $5.2B. A growing industry should support increased profitability, and we Canadian stocks’ main expect most Canadian producers to become EBITDA-positive by Q3/21. advantage is their ability to list on the largest However, it is worth noting the stark contrast to U.S. operators, almost all of whom already exchanges, but we expect generate materially positive EBITDA. It is for this reason that we believe investors will investors who are able to continue to favour U.S. names if accessible. Below we present estimates for Canadian access U.S. stocks will do licensed producers and U.S. cannabis peers, and note the incredibly wide divergence in so due to superior valuation. profitability and valuation. Exhibit 32: Valuation – Canadian And U.S. Peers ($MM, unless noted)
Enterprise Sales EBITDA Valuation (C2021E) Peer Group Value C2019 C2020E C2021E C2019 C2020E C2021E EV / Sales EV / EBITDA Canadian LPs 27,986 2,016 2,417 3,614 (1,098) (791) 107 7.7x nmf U.S. Operators 35,496 2,695 4,949 8,397 (224) 779 2,405 4.2x 14.8x
Source: FactSet, company reports and CIBC World Markets Inc.
27 2021 Equity Outlook - December 8, 2020 S&P/TSX Industrials – Marketweight
Kevin Chiang, CFA 2020 At A Glance Transport, Capital Goods, The Canadian Industrials sector has been the best performer relative to its developed world Commercial Services peers in local currency terms and bested only by Germany after adjusting for currency. Most +1 416-594-7198 [email protected] notably, the Canadian names strongly outperformed their U.S. peers within the S&P 500 (Exhibit 33). Jacob Bout, CFA Capital Goods and Exhibit 33: Global Industrials Performance By Equity Index, 2020 YTD Commercial Services Total Return Performance 2020 YTD Total Return +1 416-956-6766 Country GICS Level 1 Index Local Terms USD Terms [email protected] Germany MSCI German Industrials 9.1% 17.7% Canada S&P/TSX Industrials 13.4% 13.8% Scott Fromson, CFA USA S&P 500 Industrials 9.7% 9.7% Commercial Services +1 416-956-6728 Japan MSCI Japan Industrials 5.3% 9.7% [email protected] France MSCI France Industrials -5.4% 1.9% Korea MSCI Korea Industrials -6.6% -1.9% Stephanie Price, CFA UK MSCI UK Industrials -3.3% -2.7% Capital Goods and Australia MSCI Australia Industrials -8.8% -3.9% Commercial Services Italy MSCI Italy Industrials -12.9% -6.0% +1 416-594-7047 Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc. [email protected]
The overwhelming majority of returns came from Transportation, as to be expected, as bellwethers CN Rail and CP Rail constitute over half of the Industrials sector weighting. The names are up 19% and 26%, respectively, on the year and are the two most meaningful contributors to overall sector performance, as seen in Exhibit 34. The Transportation returns were somewhat offset by negative aviation performance, driven predominantly by Air Canada, which was the largest negative contributor to Industrials performance on the year. The remainder of strong positive performance largely lies within the Commercial and Professional Services, namely RBA, WCN and TRI.
Exhibit 34: S&P/TSX Industrials Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
20% 10% y t S i r C I u 8% c G 7.0% - e b S
u
15% y
S 13.4%
b 6% 5.1% y n b
o i
n -0.8% 3.9% t o u i 4% t b i u r t b 10% t i r A t 1.5%
t Top 3 Negative Contributors
s 2% l A
a i s l r t a i s r t u 0% s 5% 10.4% d u n I d
n -0.7% X I
-2% Top 3 Positive Contributors
S -1.3% X T
S -2.7% T 0% -4% Industrials Transport Commercial Capital CNR CP RBA CAE BBD/B AC (Level 1) Services Goods
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
28 2021 Equity Outlook - December 8, 2020 Time For Value Cyclicals To Shine We would argue that the growing optimism around a COVID-19 vaccine favours the value cyclicals. Looking into 2021, we see those companies/sectors that have been especially hard hit this year as positioned more favourably. While we are not expecting a linear recovery, we foresee a more solid foundation for economic recovery as the vaccine provides a path that allows a return to some sense of normalcy. From a macro perspective, we expect GDP to continue to rise, unemployment to fall, consumer spending to remain healthy, and industrial production to climb. We also expect governments to provide fiscal support to assist in this recovery.
We highlight in the exhibit below the YTD performance of the Canadian industrial landscape. Unsurprisingly, companies that have exhibited a higher degree of resiliency during this pandemic (i.e., rails, waste, engineers) have outperformed. This outperformance was also driven by multiple expansion as funds flowed into these safety trades. Further, we would point out that heavy equipment-related names have already posted a strong recovery in share price performance, driven by an improving infrastructure outlook and a recovery of underlying commodities (particularly copper).
Exhibit 35: Share Price Performance Relative To TSX YTD And YTD Multiple Expansion 0
150% n 8.0 2
o i 1 s 6.1 c n e 106% a 6.0 p D
x f 100% 85% E O
e l s p
A 4.0
60% i
t
53% l
D 50% 2.5 u T 39%
Y 1.8 50% M 1.7 1.7
29% 2.0
e 26% A 0.9 c 17% TSX YTD Performance 1.4% 14% D 0.5 n 0.3 0.4 0.4 0.4 7% 8% 8% T 0.1 a 1% 5% I B m
r 0.0 E
0% / o f V r -0.3 E e -8% -8%
P -12% -2.0 e r -31%-27% a -50% -34% h
S -47% -48% -4.0 -74% -4.0 -100% -6.0 I I L I B I T P T T P E V E E H R R N N C D N C G M F L I P T T P I V . H R N D N J G F F M T I T A F D T S A C R J R F H N S F N N C T N T D T S C R N S W T N C F C T G A B S E C A W T S A C F C C R W G W S E B W A C R W W C B C
Source: FactSet and CIBC World Markets Inc.
As we look into 2021, the names that have underperformed are now positioned to post stronger earnings growth next year as they lap easier comps. We believe this provides additional support for these recovery names.
29 2021 Equity Outlook - December 8, 2020
Exhibit 36: Earnings Metrics Y/Y Growth In 2021 ) 50% ) 300% E E 0 0 2 2
/ 40% /
E E 250% 1 1 2 2
( 30% (
% %
200%
Y 20% Y / / Y Y
e A
t 10% D a 150% T m I i t
0% B s E
E . 100% j e
-10% d u A n e
v -20% 50% e R -30% 0% -40% -50% -50% I I I I Z L I T P T T P E V E E R R I N N D C N C T T Z L G P V E B M E E F P C R R N N N C D M G F J F . F T R J T F A F T F D S C A T T R R H N S S T F N N C R R A C A C R N N N N H S N D W T C F W T T G C F S A B E T G C A S A A S A C C C R E S A W C C R W W W W B W C C B )
) 300% 200% E E 0 0 2 2
/ /
250% E E 1 1 2 2 ( 150% (
% %
200% Y Y / / Y Y
e e t 100% t
150% a a m m i i t t s s E E 100%
S T 50% I P B E E 50% 0% 0%
-50% -50% I I I Z L I I B T P T T P E V E E R R N D C N C G M Z L F I B T P T T P E V . E E R R N N D N C G J F F M F T . R T A T D S C A R J R F H N S F N N C T R N T D A T F D S C A R R H N S N W T C C F N D T G S B E C A W T A S C F C C R W T G W S A B E B A C W A C C R W W B W C B C B
Source: Company reports and CIBC World Markets Inc. More Stimulus Spending Expected While the economic outlook for North America shows an improving trend in 2021, we could be two years away before the economy is back to pre-pandemic levels.
As such, we expect governments to continue to maintain an accommodative fiscal policy to aid in the economic recovery. In Canada, we have seen the announcement of $70B-$100B in short-term stimulus spending in an effort to restart the economy. In the U.S., with the presidential election now behind us, we see a clearer path towards a second stimulus bill, with both Democrats and Republicans calling for more federal economic assistance. While the size of the stimulus bill is up for debate in the U.S. – although President-elect Biden is pushing for both sides to reach a compromise – we continue to see bi-partisan support for public infrastructure spending.
Recent evidence of such includes: 1) the one-year extension of the FAST Act after its expiration on September 30 (US$47.1B for highway programs and US$12.3B for transit programs though F2021) to allow for more time to put forth a long-term funding bill; 2) US$464MM in nationwide grants for bus infrastructure; and, 3) the passing during the recent U.S. election of 15 of 18 transit-related ballot measures (which adds to the 32 public transit measures already passed by voters in 2020, bringing the total to 47 wins out of 52 for public transit). These ballot measures total US$38B in new funding for U.S. public transit. Further, a recent survey by Heart+Mind Strategies found that 77% of American voters want to see emergency funding for public transportation while 74% approve of the new Administration and Congress taking action to address the public infrastructure crisis in the U.S.
30 2021 Equity Outlook - December 8, 2020
Another avenue for stimulus spending will likely come from Biden’s Climate/Infrastructure Plan. During his campaign, Biden released a US$2T climate/infrastructure plan that would come at a crucial time as it is needed to help offset much of the negative impact of COVID-19 on state and local budgets. Surface transportation (highways, roads, bridges, rail, etc.), and, to a lesser extent, water and waste sectors, will likely be a core focus in terms of dollars spent. We see the E&C names and NFI as best positioned to benefit from possible large infrastructure-related stimulus. Improving Operating Leverage While COVID-19 has been a black swan, it did force companies to re-evaluate their cost structures. We’ve heard often this year that the pandemic has resulted in companies finding permanent efficiencies within their operating structures. As such, costs are not expected to return on a one-for-one basis as revenue returns, which signals improving operating leverage. Therefore, earnings are positioned to return to pre-pandemic levels faster than revenue.
Exhibit 37: Cost-cutting Initiatives
Company Cost-cutting Initiatives
AC AC has achiev ed $1.5B of cost reductions and deferrals for 2020, and has reduced projected capital ex penditures from 2020-2023 by ~$3B.
Though not a cost-cutting initiativ e, ARE continues to negotiate compensation for ex tra costs / lost rev enues due to COVID-19 for multiple projects, ARE including Eglinton and Site C. If successful, these measures, in addition to the ramp of Nuclear w ork, w ould help the 2021 margin profile.
BBD Re-aligning of corporate cost structure to support a business jet pure-play business.
BDT $25MM of cost sy nergies from the SOX acquisition ($10MM in EBITDA, $10MM in interest and $5MM in D&A).
CAE Restructuring program, w hich ex pects to create ~$50MM in annualized sav ings beginning in F2022 (C2021).
Restructuring program to deliv er ov er $100MM in annualized cost sav ings, w ith about tw o-thirds permanent. Target to reduce SG&A/net rev enue FTT to 17% mid-cy cle (v s. 19% in F2019 and 22% YTD2020). During the quarter, SG&A costs decreased by 13% or $43MM v s. Q3/19, and by 5% or $16MM v s. Q2/20.
NFI: NFI Forw ard is ex pected to generate more than $65MM in annualized cost sav ings, plus an additional $10MM sav ings in FCF by the end of 2020. NFI As of Q3, the NFI Forw ard Initiativ e has achiev ed ~$13.5MM in sav ings, including a reduction in manufacturing ov erhead and direct material costs, and SG&A.
YTD, the Resources Serv ices business ov erhead cost has fallen by 40% v s. a 75% target reduction by the end of 2021. Headcount w as reduced SNC to 10,100 employ ees v s. 15,000 at the end of 2019. SNC remains on track to w inding dow n most of the Resources LSTK backlog by the end of 2020. There w ere also restructuring actions taken in the Middle East and UK regions of the EDPM segment.
Global staff reduced by ~2,800 (or 6%) v s. Q4/19 due to restructuring in Canada and the U.K. WSP’s Q3/20 adjusted EBITDA margin of 17.6% WSP w as 59 bps higher than a y ear ago (or 24 bps low er after backing out subsidies). Arguably , if WSP had not receiv ed the gov ernment subsidies, it w ould hav e likely undertaken further cost restructuring to maintain margins.
Source: Company reports and CIBC World Markets Inc.
31 2021 Equity Outlook - December 8, 2020 S&P/TSX Information Technology – Marketweight
2020 At A Glance Todd Coupland, CFA Technology Strategist The Canadian technology sector outperformed global peers (in USD terms) by a wide margin, +1 416-956-6025 being about 24 percentage points above its closest trailing peer (China), as seen in [email protected] Exhibit 38. These 2020 results follow two consecutive years in which Canada outperformed all global peers. This year’s performance was driven by a small cohort that benefitted from Stephanie Price, CFA growth which was accelerated by the COVID-19 pandemic. Relative to the rest of the Software & Tech Services S&P/TSX GICS, technology was the top-performing sector, earning a 76.5% return in USD +1 416-594-7047 [email protected] terms. Exhibit 38: Global Information Technology Performance By Equity Index, 2020 YTD Total Return Performance 2020 YTD Total Return Country GICS Level 1 Index Local Terms USD Terms Canada S&P/TSX Technology 75.9% 76.5% China MSCI China Technology 51.8% 52.5% Australia MSCI Australia Technology 35.2% 42.4% USA S&P 500 Technology 37.7% 37.7% Korea MSCI Korea Technology 29.6% 36.0% France MSCI France Technology 15.3% 24.1% Japan MSCI Japan Technology 18.9% 23.9% Germany MSCI German Technology -12.5% -5.6% UK MSCI UK Technology -17.4% -16.9%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
Exhibit 39 highlights the equities that contributed most meaningfully to the technology sector’s total return performance in 2020. Of the 10 names in the Index, eight posted positive total returns. The companies that produced the strongest total returns were those that enabled the economy to continue in a more digital setting during the pandemic, such as Shopify, Lightspeed, Kinaxis, and Enghouse. Shopify posted the strongest total return as SMBs and enterprises rushed to set up online stores. CGI was the largest negative contributor as the pandemic raised concerns regarding enterprise customers’ willingness to spend on digital transformations.
Exhibit 39: S&P/TSX Information Technology Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
100% 100% S y C t I i r G - 75.9% u 80% c b 70.7%
80% e u S S
y y 9.5% -0.2% b b
60% n n o o i i
60% t t u u b b i i r
r 40% t t t t A A
40% y y g g o o
66.7% l 20% l o o Top 3 Negative Contributors n
n 5.0%
h 1.8% h c
c 20% e e
T 0% T
X X -0.1% -0.2% S
S Top 3 Positive Contributors -4.1% T T 0% -20% Technology Services Software IT Hardware SHOP CSU KXS OTEX CLS GIB/A (Level 1)
Note: Exhibit priced as of December 2, 2020 close. Securities with marginally positive returns can still have negative contribution given index rebalancing. Source: Bloomberg and CIBC World Markets Inc.
32 2021 Equity Outlook - December 8, 2020 COVID-19 Drives An Acceleration In Tech Spending Much of the narrative driving technology stocks after the initial pandemic shock in March focused on the near-term acceleration of digital transformations. Enterprises with more advanced digital capabilities, or those that were further along in the transformation process, were better equipped to pivot to a remote working environment and able to quickly develop their responses to the pandemic. Organizations whose technological weak spots were exposed by the pandemic were forced to rapidly invest, with many of those companies accelerating their digital transformations and increasing software spending.
Gartner expects enterprise software spending to be the fastest-growing category of IT spending in 2021, projected to grow 7.2% versus an overall IT spend environment expected to grow at 4%. A Gartner survey of boards of directors found that 69% of companies have accelerated digital transformation efforts in light of the pandemic and that 60% of organizations have noted an increased focus on improving “operational excellence” through digital business.
The anticipated resilience of the enterprise software market is a positive for many of the Canadian technology companies which operate with a focus on enterprise end-users. We believe that there is a distinction between the group of companies that have benefitted specifically from remote work and those that are experiencing permanent shifts in demand due to digital acceleration. While positive news about vaccine developments has negatively impacted technology stocks, we recommend taking advantage of pullbacks in stocks that are well positioned to benefit from longer-term demand shifts.
Exhibit 40: Enterprise IT Spending Expected To Lead IT Growth In 2021
$4.5
4.0% $4.0 2.8% 5.1% -5.4% 3.9% -4.7% -0.3% $3.5
$3.0
$2.5
$2.0
$1.5
$1.0
$0.5
$0.0 n o
i 2014 2015 2016 2017 2018 2019 2020E 2021E l l i r t
$ Communications Services IT Services Devices Software Data Center Systems
All statements in this report attributable to Gartner represent CIBC Capital Markets’ interpretation of data, research opinion or viewpoints published as part of a syndicated subscription service by Gartner, Inc., and have not been reviewed by Gartner. Each Gartner publication speaks as of its original publication date (and not as of the date of this report). The opinions expressed in Gartner publications are not representations of fact and are subject to change without notice. Source: Gartner Inc.
33 2021 Equity Outlook - December 8, 2020 Leading Software Stocks To Outperform The technology sector’s relevance during a year in which the COVID-19 pandemic kept large portions of the world’s population at home helped propel it to index-leading returns. While some portion of the sector’s strong performance was the result of rising forward estimates, valuation expansion played a major factor in driving excess returns. Valuations in the technology sector hit all-time highs in September as investors built or added to positions in tech companies that had become more relevant during the pandemic or were able to maintain uninterrupted service to their customers. We have since seen valuations pull back from record highs as progress is made towards the approval and distribution of COVID-19 vaccines. The S&P 500 Software and Services Index is trading, at the time of writing, at 7.4x EV/S versus a high of 8.1x in September.
Exhibit 41: Software & Services Valuations Above Two-year Average
S&P 500 Software & Services S&P 500 Software & Services EV/NTM EBITDA (2 Year History) EV/NTM Sales (2 Year History) 25 9
+2 σ 8 +2 σ 20 +1 σ 7 +1 σ Av erage 6 Av erage 15 -1 σ 5 -1 σ -2 σ -2 σ 4 10 3
5 2 1 Premium To S&P 500 Premium To S&P 500 0 0 9 0 9 0 8 9 0 9 0 9 0 9 0 9 0 9 0 8 9 0 9 0 9 0 9 0 1 1 2 1 2 1 2 1 2 1 2 1 2 1 1 2 1 2 1 2 1 2 1 2 1 2 ------l l r r l l r r v v v y y v v v p p y y n n p p n n u u u u a a a a o o o e e a a a a o o o e e a a a a J J J J J J J J M M N N N S S M M N N N S S M M M M
Source: Company reports, FactSet and CIBC World Markets Inc.
As investors look to a post-COVID-19 future, we believe there is the potential for technology valuations and stock prices to either: 1) pull back as investors rotate out of the high-momentum sector into harder-hit sectors with depressed valuations; or 2) pause as market leaders grow into their valuations. We foresee the highest risk to a few of the technology names that saw a “COVID-19 bump” in sales during the pandemic and favour stocks that will benefit from accelerated growth as companies move forward their technology digitization plans over the next several years.
Throughout 2020, we have been tracking valuations in both the mature software and software-as-a-service (SaaS) sectors to better understand which sub-set of stocks has benefitted most. Unsurprisingly, the group of higher-growth, predominantly cloud-based SaaS stocks have been embraced during the pandemic, with stock prices and valuations climbing to record levels. Mature software names have also outperformed the broader indices, but the extent of that outperformance is less pronounced and valuations remain more in line with historical levels.
34 2021 Equity Outlook - December 8, 2020 Diverging Outlooks For Stocks With E-commerce Exposure The rush to online shopping during the pandemic resulted in massive transaction volume growth for companies with exposure to e-commerce. As an example, Shopify’s Q2 and Q3 gross merchandise volume grew 119% and 109% Y/Y, respectively (vs. an average of 48% Y/Y growth in the previous four quarters), while Lightspeed’s gross transaction value during its FQ2 grew 57% Q/Q (vs. previous four-quarter Q/Q average growth of 5%). This e-commerce growth spilled over into the payments industry as well, and consumers now increasingly rely on, and expect, a plethora of alternative payment methods to be available. Payments processor Nuvei’s merchant payments volume grew by ~36% in Q3 and the company indicated that it expected the trend to continue. Compare that to our annual volume growth forecast for Nuvei of ~17% from 2020-2023.
In 2021, with the prospect of a widely available vaccine and re-opened economies, we expect stocks that experienced this pull-forward to fall into two categories.
First, we don’t expect those companies that experienced outsized pandemic-induced growth this year to continue that trajectory into 2021. With growth likely to moderate, their share prices could also pause from their dramatic rise. While Shopify materially advanced its competitive position in 2020, our view is that it falls within this first category of companies. FactSet expectations call for the company’s revenue to grow 80% Y/Y in 2020, and we do not believe this growth will be replicated in 2021. Meanwhile, FactSet’s 2021 revenue growth estimate for Shopify is ~30%. Its growth will likely slow off the higher base, creating difficult comparables starting in Q2/21.
We expect the second group of companies to continue to benefit from higher growth, and anticipate their share prices outperforming in 2021. We believe Lightspeed and Nuvei belong in this category, and expect the adoption of their services to continue as countries and economies re-open. Demand for Lightspeed’s products is a function of the modernization of an industry that will outlast the pandemic. Restaurants and complex retailers benefit from access to a cloud-based POS platform with modules (such as Loyalty, Payments, and Delivery) largely regardless of whether stores are physically open or not. Growth during the pandemic was not temporary, but, instead, an acceleration of a longer-term trend of digital modernization that will extend into 2021.
We view Nuvei’s exposure to e-commerce and mobile transactions to also position the company for elevated growth in 2021. Recall that 75% of the transactions processed on its platform originate from e-commerce and mobile transactions, and specifically within verticals which are largely expected to grow at double-digit rates in the coming years. As verticals such as U.S. online regulated gaming, online marketplaces and social gaming follow their forecasted growth trajectories, Nuvei’s share price should follow.
2021 will mark a year in which the dust settles after an extraordinary upheaval across all sectors in 2020. In the technology industry, companies whose growth is being driven by the modernization of an industry that extends beyond the pandemic should continue to see rising share prices in 2021, albeit not necessarily at the same rate. Lightspeed and Nuvei are, in our view, two such companies. On the other hand are those companies, such as Shopify, whose growth must catch up with their elevated valuations. As the industry moves on in the aftermath of the pandemic, we look forward to following it and its constituents.
35 2021 Equity Outlook - December 8, 2020 S&P/TSX Materials – Overweight
Anita Soni, CFA 2020 At A Glance Precious Metals While we had an Overweight rating on this sector heading into 2020, and outperform it did, +1 416-594-7296 we could have never predicted a global pandemic nor the pace and size of the fiscal stimulus Cosmos Chiu, CFA that was injected into the markets. Unsurprisingly, the precious metals sector reacted Precious Metals positively to these events, lifting the returns of the Canadian Materials sector significantly, as +1 416-594-7106 both gold and silver climbed.
Bryce Adams The more meaningful weighting of precious metals equities in the S&P/TSX Materials Index Precious Metals relative to global peers also contributed to this Canadian GIC securing the #2 spot globally for +1 416-594-7293 the second year in a row.
Alex Hunchak Exhibit 42: Global Materials Performance By Equity Index, 2020 YTD Precious Metals Total Return Performance 2020 YTD Total Return +1 416-594-7457 Country GICS Level 1 Index Local Terms USD Terms Raphael de Souza, CFA Korea MSCI Korea Materials 65.8% 74.0% Base Metals Canada S&P/TSX Materials 20.6% 21.1% +1 416-594-8613 Japan MSCI Japan Materials 13.8% 18.6% France MSCI France Materials 9.1% 17.5% Jacob Bout, CFA USA S&P 500 Materials 17.4% 17.4% Chemicals & Fertilizers Australia MSCI Australia Materials 8.8% 14.5% +1 416-956-6766 UK MSCI UK Materials 12.5% 13.3% Germany MSCI German Materials -2.2% 5.5% Hamir Patel
Paper & Forest Products Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc. +1 604-331-3047 As for the other components of the TSX Materials Index, the Chemicals/Fertilizers group was Scott Fromson, CFA hit harder than the others, although all of these sectors have potential for outperformance Containers & Packaging over the year ahead. +1 416-956-6728
Exhibit 43: S&P/TSX Materials Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
Index/Commodity Precious Gold Base/Bulk Copper Forestry/ Lumber Chem/ Potash Polypropelene Tot Rtrn Performance Metals US$/oz Metals US$/lb Paper US$/Mbf Ferts US$/MT Packaging CNY/MT 2020 YTD Total Return 27.7% 19.6% 20.9% 23.1% 35.5% 56.7% 4.9% -1.8% 9.7% 16.2%
30% 10% S y t i C 8% r I 25% u 6.7% G - c e
b 0.8%
u 0.0% 20.6% S 0.7% 6% S y
b y 20% b n -0.8% o n
i 3.6% t o 4% i u t 3.0% b u 15% i r b i t r t
t Top 3 Negative Contributors A t 2%
A s
l s a l 10% 19.9% i r a i e r 0% t e a t a M -0.3% -0.3% -0.7% M X 5% Top 3 Positive Contributors X
S -2% T S T 0% -4% Materials Precious Forestry Packaging Base/Bulk Chem/ ABX FNV WPM NTR MX TECK/B (Level 1) Metals Metals Ferts
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
36 2021 Equity Outlook - December 8, 2020
As we look into 2021, we believe COVID-19 and global growth uncertainty will remain near-term headwinds, although somewhat offset by additional fiscal stimulus. CIBC Economics also continues to call for the Fed and Bank of Canada to remain on hold in 2021, and likely in 2022 as well. While headline inflation may pop above 2%, it is hard to see real rates posting a significant recovery. As such, we believe that investors seeking both a hedge to global economic uncertainty and yield will lead to overall outperformance of this sector in the year ahead. Déjà Vu – Another Year Of Outperformance For Some Macro concerns continue to dominate the backdrop for the market as we head into 2021, with the world still firmly in the grips of a second wave of COVID-19 and a vaccine not expected to be widely distributed until mid-next year. Despite lofty government debt loads, it is clear that more fiscal stimulus will be required, as well as further Central Bank support. As such, we do not believe that yield curves will steepen materially beyond current levels, and, in fact, fiscal stimulus may fall short of expectations given how much has already been deployed.
Precious Metals equities led the charge in outperformance within the Materials sector over Preferred names for the past year and, given our ongoing bullish outlook for both gold and silver, we believe that leverage to higher precious 2021 could see a repeat of that outperformance. Real rates, the primary driver for gold, in our metals include Agnico view, are expected to stay well under the key 2% level, and global macro uncertainty and Eagle, Barrick Gold, SSR investor demand for currency diversification will likely remain core drivers for ETF and Mining, Pan American physical demand for gold and silver. Silver, and Wheaton Precious Metals. Our gold price forecast stands at US$2,300/US$2,200/US$2,100/US$2,000 per oz for 2021/2022/2023/2024. We also recently substantially increased our silver price forecast to US$32/US$31/US$30/US$28 per oz for 2021/2022/2023/2024. We note that, even though the commodity has already performed well year to date, this metal has potential to provide Nutrien should deliver a investors with even more torque given the relatively smaller market for silver vs. gold. step-up in earnings and FCF in 2021 driven by retail COVID-19 and trade wars had a detrimental effect on demand for Chemicals/Fertilizers, with organic growth and margin many of the stocks in this sub-sector only recently recovering to their pre-pandemic levels. expansion. The 2021 expectations for this sector have improved given the inflection point in global ag, seven-year-high U.S. farm income, multi-year-low stock:use ratios for corn and soybean, and a tighter potash market. U.S. corn/soybean prices are up ~30%-40% since May, U.S. potash prices are up 20%-25% in the past three months, and we expect higher Chinese contract prices in the new year (at present, Canpotex is not shipping to China as it is fully booked until early 2021).
As for Paper & Forest Products, we continue to favour wood products equities such as West Our top pick in wood Fraser, Interfor, and Canfor Corp. given the attractive supply/demand fundamentals for U.S. products is West Fraser. housing, especially in light of a low interest rate environment and expectations for a Biden stimulus plan in 2021. While we acknowledge the potential for some further near-term volatility for wood product shares, as pricing for lumber/OSB moderate from record highs, we believe low channel inventories will lead to prices stabilizing well above cash costs.
In packaging, the essential nature of CCL Industries’ and Winpak’s products has stabilized Intertape Polymer is our top demand, while Intertape Polymer has been a large beneficiary of e-commerce. We believe pick within packaging. that these trends will continue into 2021. As for direct exposure to the pandemic, one small-cap name that stands out within Materials is AirBoss of America due to its exposure to U.S. government contracts for respiration PPE.
37 2021 Equity Outlook - December 8, 2020 Yield, Yield, And More Yield A combination of fiscal discipline already well under way to start the year and stronger balance sheets put many within the Materials sector on good footing to weather the pandemic storm, and in an even better position to end 2020. Given the outlook for rates to stay lower-for-longer, investors will continue to seek yield in less traditional spaces and this sector definitely fits the bill and should attract interest.
In the precious metals sector, most of the larger-cap names within our coverage universe could almost fund a 25%-50% increase in dividends from free cash flow (FCF), even at a conservative gold price of US$1,550/oz.
On the fertilizer side, we forecast Nutrien to deliver an 8.0% FCF yield excluding growth capex, and easily support its current 3.6% dividend per year.
Within forestry, very strong free cash flow generation in H2/20 is putting most lumber/OSB companies under coverage on a path to a net cash position over the next few quarters (even sooner if we give the companies credit for their share of lumber duties on deposit with the U.S. government). We forecast an 11% FCF yield for wood products names in 2021.
Exhibit 44: 2021 FCF Yield Forecasts For Materials Sector Top Picks
18.0%
16.0%
14.0%
12.0% d l e i Y
w 10.0% o l F
h s
a 8.0% C
e e r
F 6.0%
4.0%
2.0%
0.0% NTR WFT* ITP GOLD AEM WPM SSRM PAAS SPTSX S&P500 DJII NASDAQ Top Picks
Spot Spot +10%
*Calculated at the CIBC price deck and CIBC price deck +10%.
Source: FactSet, Bloomberg, Company reports and CIBC World Markets Inc.
As can be seen in the FCF yield forecasts in the exhibit above, we expect all our top picks for exposure to this GIC to deliver FCF yields in excess of consensus estimates for the major North American indices. Further, our top picks within the Materials sector all possess some of our standard preferred attributes in terms of quality of assets, strong management, and ability to generate and grow free cash flow over the next several years.
38 2021 Equity Outlook - December 8, 2020 S&P/TSX Real Estate – Underweight Dean Wilkinson, CFA Real Estate 2020 At A Glance – When The Unthinkable Happens +1 416-594-7194 2020 started on an optimistic note with valuations roughly in line with long-term averages and [email protected] earnings growth projected to be in the low-single-digit range, with yields at a slightly Chris Couprie, CFA below-average ~5.5%. All in all, it looked to be another year of largely income-driven returns Real Estate for the sector. Then the unthinkable happened, and on March 11 the World Health +1 416-594-8179 Organization (WHO) declared COVID-19 a pandemic. For us, we were advised that we would [email protected] be sent home for 14 days while the situation was being monitored. The publication of this report falls almost nine months later and the situation is still being monitored and back to the office is now a 2021 event (though what that ultimately looks like is still largely unknown). Given an unprecedented set of circumstances, the Real Estate sector reacted predictably in a ready, fire, aim kind of way, with a precipitous and across-the-board drubbing, the likes of which not seen since the global financial crisis (GFC) (the lows of both turning out to be generational buying opportunities for the steeliest of investors).
Exhibit 45: Global Real Estate Performance By Equity Index, 2020 YTD Total Return Performance 2020 YTD Total Return Country GICS Level 1 Index Local Terms USD Terms Germany MSCI German Real Estate 8.9% 17.6% Australia MSCI Australia Real Estate -5.5% -0.2% USA S&P 500 Real Estate -3.5% -3.5% Canada S&P/TSX Real Estate -7.0% -6.7% Japan MSCI Japan Real Estate -13.9% -10.5% Hong Kong MSCI Hong Kong Real Estate -11.1% -10.6% UK MSCI UK Real Estate -12.7% -12.0% France MSCI France Real Estate -37.8% -32.8%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc. Exhibit 46 highlights the equities that most meaningfully contributed to the Canadian Real Estate sector’s total return performance in 2020. The majority of the positive returns emanated from non-traditional real estate plays (i.e., not rent collectors) and Industrial REITs, which are largely viewed as a beneficiary of the current environment.
Exhibit 46: S&P/TSX Real Estate Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
4% 0% y t i S r 2.9% C u I c G e - S b -5.2%
y 2% u 1.2% b S
n
y 0.7% o
b Top 3 Negative Contributors i
-5% t n u o i b i
t 0%
+1.7% r u t t b
i -1.0% A r
t -7.0% Top 3 Positive Contributors e t
+5.1% t A a
t
e -5.2%
s -2% t E a -1.8%
t -10% l s a E e -2.5%
l R
a e X -4% -3.5% R S
-2.3% T X S T -15% -6% Real Estate Diversified Apt/HlthC Retail Office Real Estate Industrial FSV GRT-U CIGI AP-U HR-U REI-U (Level 1) REIT REIT REIT REIT Mgmt REIT
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
39 2021 Equity Outlook - December 8, 2020 2021: Vaccine, Vaccine, Vaccine Looking forward to 2021 the health and recovery of the real estate sector appear to be largely contingent on the broad dissemination of an effective vaccine and a return to normal (or perhaps more correctly a “new normal”) of people’s everyday lives, while the long-term effects of the short-term disruption will no doubt be felt for years (maybe generations) to come. We believe that real estate will remain an attractive long-term asset, particularly in what may ultimately be a longer-than-anticipated low interest rate environment. The impact of the global pandemic has prompted the real estate complex to sell off to a magnitude that we suggest is perhaps disproportionate to the long-term value of the underlying assets and certainly the current operational metrics. While this circumstance likely represents an opportunity not seen since the 2008 global financial crisis, we are also pragmatic enough to recognize that the “unknown unknowns” will dominate the tape for the foreseeable future (read elevated volatility). Unlike the 2008 period, however, which was a banking crisis that permeated the economy, this is a pandemic that has entered the financial system. We would note that debt is the de facto lifeblood to real estate, and a widespread freezing of credit could have a lasting impact on not just real estate but also on the broader economy at large (but it’s not something we are seeing at this point). Needless to say, we don’t have much clarity (yet) on what the ultimate impact from the COVID-19 outbreak will be on the direct commercial property environment. From what we have seen to date, there have been some temporary dislocations, but it is not clear to what extent such dislocations might cause a longer-term (permanent) impact. Once the economy restarts, and the majority of us are no longer at home, most of the fundamental market forces that were under way in the various asset classes should resume, albeit potentially at a more measured pace, i.e., that which was working will in all likelihood continue to do so. In an optimistic scenario, whereby the current recovery continues, we would generally expect a strong “reversion trade” (i.e., those REITs that have seen the largest price declines are likely to deliver the highest torque on the upside). On the other hand, if sentiment towards the sector were to sour, we would suggest that trough COVID-19 prices provide a reasonable proxy for downside risk, with a few caveats: 1) A number of early investor fears have generally proven to have been overblown (occupancy, for example, has remained resilient across most asset classes). Implicit in this notion is that pandemic trough prices may have been overly punitive. 2) REITs that are at one extreme – trading near pandemic lows – do not necessarily carry less downside risk. Indeed, in certain situations there is warranted concern that the pandemic will have a longer-term impact on said REITs. Downside risk may actually be above average in these cases. 3) REITs at the other extreme – trading well above the pandemic lows – do not necessarily carry higher downside risk. For example, certain asset classes have proven more resilient than one might have otherwise thought (single-family rental, for example). Downside risk may actually be below average in these cases. How one approaches 2021 can simply (ok, things are never that simple) be distilled into a view on pandemic recovery. A bullish view (which we are slightly but not overtly biased towards) favours an allocation tilted towards the pro-cyclical (and most oversold) segments of the space, such as retail and office, and favours names such as REI, FCR, SRU and AP. Such a view would also be positive for the “yield trade” that likely benefits the broadly diversified REITs such as BPY and HR. Conversely, a more conservative stance towards recovery would favour the REITs that have been deemed more defensive, such as the industrial REITs (GRT and WIR) and grocery-anchored/single-tenant-dominated retail REITs (CHP, CRR and CRT). Residential has been quite resilient during the pandemic and likely works well in either scenario, with a bias towards discounted domestic names like KMP and MI, and internationally TCN, ERE and HOM.
40 2021 Equity Outlook - December 8, 2020 Interest Rates: Lower For (Much, Much) Longer? Given the unprecedented economic stimulus that has been directed to combat the pandemic around the world and the ensuing debt that ostensibly comes along with it, we believe that the current rate environment may ultimately be more pervasive than even the most pessimistic of projections, particularly if concepts such as Modern Monetary Theory (MMT) gain momentum, with a view that as long as interest rates stay low, governments can borrow more – it becomes somewhat of a circular low rate trap. While a significant upward move in the long end of the yield curve (the basis on which REITs are generally believed to be valued) does not appear to be on the horizon, the possibility of such remains a key risk to REIT prices. Indeed, it is the perception of future rate movements that is of importance. As we have highlighted in the past, a flat to declining yield curve has generally lined up with positive relative returns from the sector.
While the prevailing interest rate environment is always a key consideration in evaluating valuation levels within the REIT complex, we believe rate levels will likely take a back seat to the market’s broader sentiment in regards to the COVID-19 pandemic for the foreseeable future.
To this end, we are of the view that within an increasingly benign interest rate environment, valuation levels across all yield-oriented investments are likely to find support at levels that are higher than they have been historically (all things equal, of course):
Once the COVID-19 situation is in the rear-view mirror, if interest rates remain at such low levels, a rebound to pre-COVID-19 valuation levels is plausible (i.e., the yield trade). The entire complex should continue to demonstrate a heightened volatility to any sharp (i.e., unexpected) moves in interest rates (the natural convexity embedded in low rates). Should long-term interest rates increase, or should the yield curve steepen, valuation levels are more likely to eventually revert closer to historical levels (i.e., not the elevated pre-COVID-19 levels). Taking a step back, we would note that while much attention is given to the directionality of long-term interest rates, the flattening/steepening of the yield curve has proven to be a more accurate harbinger of REIT performance (with REITs delivering higher returns when the yield curve flattens, and vice versa). We demonstrate the high correlation between REIT performance and the structure of the yield curve in the exhibit below.
Exhibit 47: The Term Structure Of The Yield Curve Drives REIT Performance
Relationship Between Canadian REITs and Interest Rates S&P/TSX REIT Returns Vs. The Yield Curve 350 60% 150 3.50 ) 0
0 300
1 140
= 3.00 250 40% 1
3 130 n s
r e c i 200 u r t e 2.50 e
120 u D d (
s 20%
R a
a
x 150 e x e r e 110 e r d 2.00 p d T
n S 100 n
I r
I r
100 a 0% T T Y e I I
0 50 Y E
1.50 E 1 -
90 0 R R
r
1
d Y 0 X e D 2 -20%
80 S
p 1.00 A T
p -50 C P a 70 & C
0.50 -100 S
X -40%
S 60 T -150 P 50 0.00 S 3 4 5 6 7 8 9 4 5 6 7 8 9 0 4 5 6 7 8 9 0 -200 -60% 1 1 1 1 1 1 2 1 1 1 1 1 1 1 1 1 1 1 1 1 2 ------2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 r r r r r r r c c c c c c c g g g g g g g 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 2 p p p p p p p ------e e e e e e e u u u u u u u A A A A A A A n n n n n n n n n n n n n n n n n n n D D D D D D D A A A A A A A a a a a a a a a a a a a a a a a a a a J J J J J J J J J J J J J J J J J J J S&P/TSX Capped Reit Index CAD 10 YR S&P TSX Reit Index US CAD LTA US LTA CAD
Source: FactSet and CIBC World Markets Inc.
41 2021 Equity Outlook - December 8, 2020 Getting Back To Normal Canadian REITs are trading at valuations (overall) that are below long-term historical measures. However, the COVID-19 pandemic is a unique situation, and valuation levels need to be evaluated within this context. To this end, we would note the following:
Most REITs continue to trade well below their historical P/NAV valuation levels, with large-cap retail REITs SRU, FCR, and REI still trading below 2010-2019 trough valuations (all REITs are trading above GFC trough levels). At the same time, we acknowledge that sentiment is likely to trump fundamentals and valuation levels in the near term. Looking further out, we would expect the prevailing interest rate environment at that time to lay the foundation for valuations (a lower-for-longer rate environment is generally positive for the sector). To that end, the average distribution yield spread vs. the 10-year of ~470 bps remains wider than the 2010-2019 historical average of 437 bps. The S&P/TSX Canadian REIT Index serving as a proxy reflects an average NTM FFO multiple of 15.0x, slightly above the five-year average of 14.5x and post-GFC (2010 onwards) average of 14.2x. However, we believe that forward FFO estimates are a poor indicator of the longer-term cash flow potential of the underlying real estate of most REITs given the presumably short-term impact of COVID-19 on cash flows, and, as a result, we prefer P/NAV over P/FFO multiples at this time. REITs with below-average multiples that have experienced significant multiple contraction may carry an overall lower valuation risk profile, such as certain REITs within the diversified, retail, and retirement sub-sectors (which are generally trading at below-average multiples) vs. the apartment and industrial sub-sectors, which are trading near (and even above) historical multiple averages. We expect large deviations from historical averages to revert to said averages over time, barring any material change that could impact the long-term fundamentals of the underlying asset.
Exhibit 48: Historical REIT Sector Valuations P/NAV Distribution Yield Less 10 Year Price To FFO 10% 21x 30% 9% 19x 20% 8% 17x 10% 7% 6% 15x 0% 5% 13x -10% 4% 11x 3% -20% 9x 2% -30% 7x 1% -40% 0% 5x 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 ------0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 ------c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c c e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e e D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D D
Source: S&P Global Market Intelligence, Bloomberg, FactSet, company reports and CIBC World Markets Inc.
42 2021 Equity Outlook - December 8, 2020 S&P/TSX Utilities – Overweight
2020 At A Glance
Mark Jarvi, CFA The TSX Utilities Index has posted a 13.0% total return year to date 2020. On a constant Power and Utilities currency basis (priced in USD) the Canadian Utilities Index performed relatively well versus +1 416-956-6429 its global peers and delivered a return that vastly outperformed the S&P 500 Utilities Index. [email protected] Some European Utilities indices saw stronger performance – likely due to a flight to safety during the COIVD-19 pandemic and a more attractive alternative to negative-yielding Robert Catellier, CFA European sovereign debt. Energy Infra, Utilities +1 416-956-6197 Exhibit 49: Global Utilities Performance By Equity Index, 2020 YTD [email protected] Total Return Performance 2020 YTD Total Return Country GICS Level 1 Index Local Terms USD Terms Spain MSCI Spain Utilities 21.1% 30.4% Italy MSCI Italy Utilities 18.2% 27.5% Germany MSCI German Utilities 12.4% 21.2% Canada S&P/TSX Utilities 12.5% 12.9% France MSCI France Utilities -3.2% 4.3% USA S&P 500 Utilities 1.2% 1.2% UK MSCI UK Utilities -6.4% -5.7% Australia MSCI Australia Utilities -12.6% -7.9% Japan MSCI Japan Utilities -13.7% -10.1%
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
Within the sector, the renewable energy companies all posted positive total returns and were key contributors to the TSX Utilities Index’s positive return. Resilient results, progress on growth, favourable long-term trends, and strong demand for ESG-friendly investments were key drivers for the renewable energy stocks. Brookfield Renewable had the highest total return (~67%) and the greatest contribution to the Index’s positive performance. Northland Power had the second-highest total return (~66%), but a lower impact on the Index given a smaller weighting. Brookfield Infrastructure (lower return, but higher weighting) also had a significant positive contribution. Firms with a greater exposure to Alberta and the energy sector (direct or indirect) generally had a negative impact on the TSX Utilities Index performance. Namely, ATCO Ltd., Canadian Utilities and TransAlta all posted negative total returns.
Exhibit 50: S&P/TSX Utilities Attribution By Sub-Index (Left) And By Most Impactful Security (Right)
15% 6% S
12.5% y C t I i r
G 4.09% u - 1.2% 0.0% c b e
u 4% S S
2.0% y y 10% 2.81% b
b
n n o o i 2.11% i t t u u 2% b b i i r r t t t t A A
Top 3 Negative Contributors s s
5% e e i
i 9.3% t t i i l l i i
t 0% t U U
X -0.14% X S
S Top 3 Positive Contributors
T -0.63% T -0.75% 0% -2% Utilities Renewables Multi Utilities Electric Gas BEP-U NPI BIP-U ALA CU ACO/X (Level 1) and Other Utilities Utilities
Note: Exhibit priced as of December 2, 2020 close. Source: Bloomberg and CIBC World Markets Inc.
43 2021 Equity Outlook - December 8, 2020 Can Renewable Energy Stocks Continue To Outperform Or Did The ESG Pendulum Overswing? As we highlighted in a report earlier this year (link), the TSX-listed renewable energy stocks have clearly outperformed more regulated utility-based firms. In fact, they outperformed in four of the last five years and the outperformance over the last two years has been a remarkable ~80%. We believe there are some fundamental reasons for this outperformance. First, these firms performed better through the COVID-19 pandemic, particularly the highly contracted firms that showed very resilient cash flows. Further, the pace of growth has been more robust, with an average trailing three-year FFO/share CAGR of 18% vs. 2% for the regulated utility firms. That being said, a majority of the returns have come from multiple expansion through lower discount rates for the current cash flows (given low bond yields) and/or increased long-term growth rates or terminal values given secular growth trends and the strong investor appetite for these ESG-friendly stocks. Some of the expansion is justified in our view. And we would note that the TSX-listed renewable stocks have actually mirrored the performance of global renewable peers, and trading multiples are comparable (global names have largely caught up to TSX-listed renewable companies in the last five years). So, arguably not over-extended vs. global peers.
Exhibit 51: Historical Relative Price Performance 220 100
200 ) 80 % ( )
e 180 % c (
n 60 d a a e m
160 r r o p
f 40 S r
e 140 e P v
i t e a v 20 l i t 120 e a l R e
R 100 0
80 -20 9 0 9 0 9 0 9 0 9 0 9 0 1 2 1 2 1 2 1 2 1 2 1 2 ------l l r r y y v v p p n n u u a a a a o o e e a a J J J J M M N N S S M M Cdn Renewables vs TSX Capped Utilities (RHS) Cdn Renewables vs Global Renewables (RHS) Cdn Renewables (LHS) Global Renewables (LHS) TSX Capped Utilities (LHS)
Source: FactSet and CIBC World Markets Inc.
Exhibit 52: Historical EV/EBITDA Multiples
30x 25.3 25x 22.3 23.3 )
2 18.8 Y 20x F (
A 15.6 15.2 14.5 16.7 D 14.1 T 15x 15.1 15.3 I 14.8 14.5 14.1 B 12.2 12.0
E 12.2 13.2 10.4 12.4 / 8.9 12.1 11.9 V 10x 10.5 12.6 10.4 E 9.7 9.9 8.2 10.2 10.6 9.3 7.4 8.4 7.5 5x 6.8 6.5 7.2 5.8 5.6 0x I s s P X E N X A W P e e L l l T D E P N Q l I N N b b B A B C a A R a a b C
w w o . l e e g G n n v
5-Yr Range 5-Yr Average Current 5-Yr High 5-Yr Low e e A R R
Notes: 1) Average CAD Renewables is the simple average of AQN, BLX, BEP, INE, NPI and RNW. Source: Bloomberg and CIBC World Markets Inc.
44 2021 Equity Outlook - December 8, 2020
Looking forward, we don’t foresee risk that growth will slow for the renewable energy stocks. Rather, the strong policy support around the globe could enhance or extend the growth prospects. We would also note that the healthy equity valuations for the public renewable energy firms should allow them to continue with accretive M&A to support robust organic growth outlooks. As such, arguably the greatest risk to these names is fund flows and potential multiple compression if the sentiment changes. We do see some risk from a rotation into value or laggards, and also believe investors should be mindful the ESG pendulum might have swung too far with too much pessimism around firms with meaningful fossil fuel exposure. We would also note these stocks generally offer a lower dividend yield than regulated utility peers. While we could see some profit taking in the renewable stocks in the short term, we believe longer-term focused investors can remain long quality names. We would be positioned in stocks with proven growth strategies, potential catalysts, ability to unlock new growth through organic and M&A efforts, and more reasonable valuations. Northland Power would be our preferred name at this point. Regulated Utility Stocks Didn’t Work In 2020, So Why Would They Provide Alpha In 2021? Given bond yields hitting all-time lows earlier this year and substantial economic uncertainty with the ongoing COVID-19 pandemic, we believed the regulated utility stocks would have fared better in 2020, but they did not. The “yield trade” did not really materialize in 2020 and the rise in beta for the utilities meant they were not viewed as defensive nor as providing the low volatility characteristics many investors covet in these companies. That being said, the beta for the sector has started to moderate—utilities currently are the third-lowest beta of the 11 GICS classifications.
With bond yields likely continuing to rise off their lows and a potential economic recovery taking hold through 2021 (assuming vaccines are successfully deployed), it seems likely to us that more regulated utility firms will not provide alpha in 2021. If the “yield trade” were to recover, other sectors like the REITs, Telcos, and Midstreamers (and even the Banks) offer a higher relative dividend yield and more exposure to an economic recovery.
Overall, we are not bearish on the regulated utilities and generally think EPS growth will be better in 2021 than in 2020 given a recovery in load/volumes and rate case settlements, but we do believe utilities may be lower down on a yield investor’s shopping list. While there might be a mean reversion trade in some laggards, we would rather investors be positioned in more diversified firms with clear growth strategies, like Fortis and Brookfield Infrastructure.
Exhibit 53: Dividend Yield And Beta Analysis
Dividend Yield Beta2 Current Current 10 Yr. Avg. 10 Yr. Avg. Current Current GICS 10 Yr. Avg. 10 Yr. Avg. Yield Spread1 Yield Spread1 Beta Rank3 Beta GICS Rank3 Financials 4.08% 3.38% 3.92% 2.07% 1.31 9 0.93 7 Midstream4 6.03% 5.11% 3.73% 1.88% 1.38 10 0.96 9 Real Estate 5.00% 4.29% 5.46% 3.61% 1.00 7 0.61 4 Telcos 4.88% 4.17% 4.57% 2.72% 0.90 5 0.46 1 Utilities 4.36% 3.63% 4.47% 2.62% 0.83 3 0.55 3 Notes: 1) Spread is based relative to the Canadian 10-year bond yield; 2) Beta is the six-month trailing Beta; 3) For GICS Ranking, 1 is the lowest Beta, 11 is the highest Beta, Midstream Ranking is based on the Oil, Gas & Consumables sub-sector Beta relative ranking to the GICS industry rankings; 4) Midstream Dividend Yields and Betas are based on the simple average of the individual constituents of the Oil, Gas & Consumables sub-sector (ENB, GEI, IPL, KEY, PPL, TRP). Source: Bloomberg and CIBC World Markets Inc.
45 2021 Equity Outlook - December 8, 2020
Important Disclosures
Analyst Certification: Each CIBC World Markets Inc. research analyst named on the front page of this research report, or at the beginning of any subsection hereof, hereby certifies that (i) the recommendations and opinions expressed herein accurately reflect such research analyst's personal views about the company and securities that are the subject of this report and all other companies and securities mentioned in this report that are covered by such research analyst and (ii) no part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by such research analyst in this report.
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Rating Abbreviation Description Stock Ratings Outperformer OP Stock is expected to outperform similar stocks in the coverage universe during the next 12-18 months. Neutral NT Stock is expected to perform in line with similar stocks in the coverage universe during the next 12-18 months. Underperformer UN Stock is expected to underperform similar stocks in the coverage universe during the next 12-18 months. Not Rated NR CIBC World Markets does not maintain an investment recommendation on the stock. Restricted R CIBC World Markets is restricted (due to potential conflict of interest) from rating the stock.
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46 2021 Equity Outlook - December 8, 2020
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47 2021 Equity Outlook - December 8, 2020
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Ratings Distribution*: CIBC World Markets Inc. Coverage Universe (as of 08 Dec 2020) Count Percent Inv. Banking Relationships Count Percent Outperformer 166 55.1% Outperformer 166 100.0% Neutral 121 40.2% Neutral 120 99.2% Underperformer 7 2.3% Underperformer 7 100.0% Restricted 7 2.3% Restricted 7 100.0% Important disclosures required by applicable rules can be obtained by visiting CIBC World Markets on the web at https://researchcentral.cibcwm.com/rcportal/legaldisclaimer. Important disclosures for each issuer can be found on Research Central Website by navigating through the following path: Company & Industry Research < Companies Listing < Ticker < Company page. Access to the system for our dissemination policy can be found at the bottom of each page on the Research Central website. These important disclosures can also be obtained by writing to CIBC World Markets Inc., 161 Bay Street, 4th Floor, Toronto, ON M5H 2S8, Attention: Research Disclosures Request.
48 2021 Equity Outlook - December 8, 2020
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49 2021 Equity Outlook - December 8, 2020
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