Canada's economy is on a roll and its underlying strength is primarily a commodities story. The main protagonists are uranium and oil, says Jody Clarke in a two-part series from our U.K. affiliate, MoneyWeek Magazine. Those commodities and more are causing investors to see green in the Great White North.
[Editors Note: The First of Two Parts. To Read Part One, Please Click Here. It is Free of Charge.]
The slang term for the Canadian dollar is the "Loonie." But there's nothing crazy about what's been happening north of the border, where the Canadian dollar is trading at a 50-year high, while Canada's unemployment rate is at a 33-year low.
The key factor behind both pieces of good news is one and the same: Soaring commodity prices.
In searching for profit opportunities stemming from the strong Canadian dollar and from Canada's commodities boom, it's important to understand that it's not just about oil.
That diversity is part of Canada's investing allure. Indeed, the country is a veritable Aladdin's cave of commodities. It is home to the largest oil reserves outside the Middle East, and boasts the second-biggest natural gas deposits. Its miners are world leaders, conducting 40% of mining operations worldwide, and it is one of the world's largest producers of zinc, lead and copper.
Of course, when you buy your nickel or potash from Canadian mines, or your wheat and beef from that country's Midwest prairie region, you have to pay for the purchase in Canadian dollars. That means you must first sell your U.S. dollars, or British pounds Sterling, or Chinese Yuan, and then buy Loonies - an oft-repeated process that pushes up the currency's relative value. And with oil, gold and most other commodities carrying stratospheric prices, the rest of the world has to pay top dollar for the minerals and energy it buys from Canada.
With all those things considered, it's no wonder that a currency that was languishing down around $0.62 to the U.S. dollar back in January 2002 finally reached par in mid-September, and right now is trading at about $1.07. That now means it's cheaper for Canadians to order goods online from the United States and have them shipped over the border than it is to buy them locally.
Needless to say, U.S. imports have soared. And so have job opportunities. The jobless rate in Canada for October was 5.8%, a 33-year low.
Canadians are clearly enjoying an improved lifestyle. And savvy investors have much better profit opportunities. We'll organize those opportunities by commodity classes.
Uranium
The rocketing price of oil, combined with fears about greenhouse gases, has refueled interest in nuclear power. In June, the price of uranium - the main nuclear fuel - hit an all-time-high of $138 a pound. That's stunning when you consider that the average price per pound back in 2000 was just $7.
But no bull market goes up unchecked and, by September, the price had slipped back to around $75. News of some production shortfalls has fueled a bit of a rebound, to about $90 a pound, and it should go further, says Blackmont Capital Inc. analyst George Topping.
"We believe the uranium price has bottomed, as witnessed by the modest price increases on higher volume reported in October," Topping told clients in a recent research note.
Speculators such as hedge funds - which bailed out in July - also are now making a return.
"Renewed buying interest on the part of speculators and hedge funds is contributing to the upward price pressure," says research group TradeTech.
This new uranium rally is partly down to more bad news from the Cigar Lake mine, the world's second-largest uranium depository. Discovered in 1983, it is located about 400 miles north of Saskatoon, Saskatchewan. It had been expected to supply 18 million tons of uranium a year, or 17% of world production, by 2008. However, severe flooding in 2006 put those plans on the back burner, affecting other companies with operations at the mine, including French giant Areva.
The mine is operated by Cameco Corp. (CCJ). Cameco's share price has understandably suffered from the delays, and is currently trading about 22% below its record high. But anyone buying into the uranium rebound should also buy into Cameco - in modest amounts. Despite its problems at the Cigar Lake site, Cameco remains the world's largest - and most-liquid - uranium minder, and is vital to the global supply.
Cameco already operates the world's largest uranium mine, McArthur River, and third-quarter results underscore the company is still growing at a healthy pace. Even with the summer price drop in uranium, Cameco still earned $94.3 million for the three months ended Sept. 30, up 25% from earnings of $75.6 million for the comparable quarter in 2006.
And the fundamentals remain strong. According to the International Atomic Energy Agency, China has four reactors, but this is expected to grow fivefold by 2020. India has similar expansion plans. Japan wants to increase nuclear power's contribution to its overall electricity supply from 30% now to 40% by 2016.
"Between now and 2011 we have to come up with 100 million pounds of uranium inventory, and it's not clear we have 100 million pounds," Raymond Goldie of Toronto-based Salman Partners told MoneyWeek in August.
Cameco Chief Executive Officer Gerald W. Grandey predicts that that uranium will hit the century mark anew sometime this month. He also believes that uranium production should grow by 80% over the next nine years, noting that if prices don't firm up, Cameco will make up the shortfall through acquisitions.
In an address to investors in New York earlier this month, Grandey said the company's mined uranium should reach 36 million pounds of uranium by 2016, just through organic growth.
"That doesn't count on any new discoveries, potential joint ventures, or any equity investments or acquisitions," Grandey said. "Over time we expect that there will emerge opportunities and then Cameco will ... begin to identify better opportunities, the ones that have long term significance, then we'll become active in the acquisition sphere."
Topping, the Blackmont Capital analyst, expects production in 2015 to hit 32 million pounds, up 46% on this year. He also has a buy rating on the stock and a C$62.50 price target on the Canadian-listed shares [$64.77 in U.S. dollars]. The Canadian shares closed yesterday (Tuesday) at $41.81. The U.S.-listed shares closed at $43.59, down 74 cents each, or 1.73%.
Soft Commodities
Canada's not just big in the areas of energy and base metals - it also has enviable position in the agricultural sector, a market that will grow significantly as such overseas markets as mainland China continue to make the shift from emerging economy to capitalist powerhouse.
Times were that the prices paid for such grains as wheat and corn were reasonably stable. One year there'd be a bumper crop, and then the next year there would be a ruinous drought. But farmers try to prepare for the worst by storing the excess from the good years. Unfortunately, that theory has been blown apart by the China factor and the demand for 'eco-friendly' fuels.
Three years ago, it cost $23 a ton to ship canola, an edible oil, from Vancouver to Shanghai. Now it costs $103. Demand for grains has jumped, in large part because of the expanding appetites of the Asian middle class - with a big assist from the biofuels craze. Unable to keep pace with demand, commodity prices have soared worldwide. Wheat prices are up 59% in the past year, hitting a record $9.61 a bushel in September. Global stockpiles are expected to fall to 107 million tons - their lowest level since 1976 - by the end of next May, the United States Department of Agriculture reports. That would be a year-over-year decline of 13%.
But Canadians aren't in any danger of going hungry. Canada is the world's second-largest wheat exporter, and is expected to harvest 20.64 million metric tons this year, 1.6% more than the 20.32 million metric tons estimated in July, a survey of farmers by Statistics Canada recently showed.
That's good news for the Canadian-listed Saskatchewan Wheat Pool (VT). It's now the biggest grain handler in the Canadian West, with a 42% market share after the purchase of Agricore United in June.
Saskatchewan Wheat's business stretches across the country, from a livestock business in Manitoba to retail outlets in British Columbia. The valuation has become a bit frothy of late, with a forward P/E ratio of 19. But if the Canadian Wheat Board monopoly is dismantled, as is currently being discussed in Ottawa, the grain-handling volumes of Saskatchewan Wheat could jump as a consequence.
Saskatchewan Wheat also has an agri-products arm, selling fertilizer, feed and other products to more than 50,000 farmers. With the boom in soft commodities leaving farmers flush with the cash to invest in their farms, that side of the business is performing well right now, analysts say. And while the ethanol story might only be sustainable for as long as the U.S. government feels like propping it up with subsidies, Asian consumers won't be excusing themselves from the global dining-room table anytime soon, meaning that boom likely has quite a ways to run, yet.
Railways
It's easy to forget that someone has to move all these commodities from Point A to Destination B. Two of the main carriers are Canadian National Railway (CNI) and Canadian Pacific Railway Ltd. (CP). We'd avoid Canadian National Railway - for now - because it has a large forestry products business, which exposes it to the ailing U.S. housing market.
Timber is big business in Canada. But Canadian Pacific Railway has of a timber-sector exposure than its rivals, meaning it has a smaller entanglement with the U.S. housing malaise. And right now, that's a huge plus. What's more, earnings are expected to advance nicely. On Monday, Canadian Pacific Railway reported that third-quarter profits were $219 million, up 34% from the $164 million reported for the comparable quarter in 2006. Earnings per share were $1.41 for this year's third quarter, up 36% from the $1.04 per share recorded for the third quarter of 2006, as the railway transported extra grain, coal and industrial products.
At yesterday's closing price of $64.91 a share, Canadian Pacific Railway is trading at a forward P/E of 17.47. Fadi Chamuon of UBS [Canada] AG (UBS), has a price target of $83 on the stock.
From yesterday's close, that would represent a gain of 28%. The stock has a modest dividend yield of 1.5%.
The Three Best Ways to Play Canada's Oil Reserves
For McMurray was once a sleepy backwater town. Home to just 1,000 or so residents, there wasn't even a road into town until the 1960s - just a railway. And yet today it's home to 70,000 people and the population is expected to hit 100,000 by the end of the decade. Property is more expensive than it is in the suburbs of Canada's major cities.
And it's all because of one thing - oil.
It's long been known that Alberta was home to the largest oil deposits outside the Middle East. The oil is located in the "Peace River" and "Cold Lake" deposits. But it's mostly found in Alberta, where the Athabasca Region is home to approximately 30,000 square miles of the stuff - an odd mix of sand, water and clay that's known as "tar sands."
Black and sticky, it only takes you a moment to realize that extraction is the real problem.
When the price of crude oil was low - as it was throughout the 1990s - there wasn't much point in spending the money on getting the oil out of the sands.
But with oil becoming much more expensive in recent years - and with prices expected to continue their upward climb - the tar sands, or oil sands oil sands have become economically relevant. sands have become a more attractive prospect. In fact, back in 2004, Morgan Stanley (MS) calculated that oil sands returned an average of 18% on capital employed, verses only 15% for conventional North American crude oil. Why is that the case? Well, for one thing, although the oil is harder to refine, it is easy to locate.
So exploration costs are low. The Athabascan sands lie close to the surface, meaning they can be extracted quite easily - moved by enormous trucks to a facility where the sands are converted into synthetic crude oil, which is then shipped to a refinery. And while the price of crude oil is unlikely to keep rising in a straight line, it is expected to keep rising, and it won't likely fall back to a point where tar sands become uneconomical again. Emerging economies now account for just 15% of global oil demand, but at current growth rates that share will rise to 40% in the next five years.
This demand has made Albertans very wealthy. Oil sands development returned $1.87 billion to the provincial government in the last three fiscal years, from 2003-04 to 2005-06. Output reached 966,000 barrels per day in 2005, a figure that is expected to grow to 3 million barrels per day by 2020 if forecasts are correct. Now the government wants a bigger share of the pie.
A recent report recommended a boost in royalties by 20%, or about $2.08 billion a year. That's led to some short-term weakness in tar sands stocks. But this is a good buying opportunity, says one Calgary-based analyst, who declined to be named. "I don't think it's going to be that onerous on the companies," the analyst said. "What I think we will see is some short-term weakness. All these companies are still attractively valued."
Firms to look at include Suncor Energy Inc. (SU), which was the first company to commercially develop the oil sands back in 1967. In 2006, production at the oil-sands facility averaged 260,000 barrels per day, but the company expects production of 500,000 to 550,000 barrels per day by 2012. That makes the forward P/E of 19 seem much more reasonable.
Syncrude Canada Ltd. is the world's biggest producer of crude oil from oil sands. A joint venture between several firms, including ConocoPhillips (COP) and Imperial Oil Ltd. (IMO), the largest shareholder is the Canadian-listed Canada Oil Sands Trust (COS), with a 36.74% stake.
You could invest in any of the three, although we favor the Canada Oil Sands Trust. The stock closed yesterday at $34.50, down 38 cents, or 1.09%.
Syncrude increased output by 40% in July to about 350,000 barrels per day. An upgrade will boost capacity by 50,000 bpd in five years, and a final planned expansion will bring production to 500,000 bpd in about 10 years, according to securities-researcher Seeking Alpha. The group's bitumen deposits are located close to the surface, meaning they can be mined rather than liquefied and then pumped up from the ground, a reality that slashes production costs.
Also interesting is Canadian-listed Husky Energy Inc. (HSE), Canada's No. 3 oil producer, which recently saw third-quarter profit rise 12.8% to $800 million. It has holdings in the Alberta oil sands, but also has offshore operations on the East Coast near Newfoundland, where it expects daily output to rise to from the current 110,000 barrels per day to 125,000 barrels per day.
That makes it more diversified than its peers. Husky Energy shares are currently trading at a forward P/E of 13.20.
To summarize, here are the six key profit plays we see, plus the two solid alternatives we identified for you in ConocoPhillips (COP) and Imperial Oil Ltd. (IMO). The six top picks are:
- Cameco Corp. (CCJ).
- Saskatchewan Wheat Pool (VT).
- Canadian Pacific Railway Ltd. (CP).
- Suncor Energy Inc. (SU).
- Canada Oil Sands Trust (COS).
- Husky Energy Inc. (HSE).
[Part One appeared in Money Morning yesterday (Tuesday). To read Part One, please click here. The article is available free of charge.]
News and Related Story Links:
- Money Morning Investment Research Report:
How to Profit from Canada's Commodity Boom [Part I]. - Reuters:
Cameco Sees 80 percent Production Rise by 2016. - Money Morning Investment Research Report:
Wheat's Forecasted Price Drop Highlights Profit Plays in Commodities. - Money Morning Investment Research Report:
Four Ways to Profit as China Ignites Global Milk and Dairy Prices. - Wikipedia:
Tar Sands. - Money Morning Investment Research Report:
Three Ways to Profit From the Mining Sector's Takeover Boom.