Canada is known for maple syrup, ice hockey and its natural scenery. However, what investors may not know is that the country is also ranked number nine on the list of the world’s largest economies.
Its economy is generally driven by its booming real estate sector, followed by manufacturing and mining for natural resources. Its location with only one neighbor, the U.S., as well as its avoidance of getting involved in other countries' politics, means it has minimal geopolitical risk. Whereas in parts of Europe, economic and military crises are much more common.
Many investors have a “home bias” in that they are overweight in their own country's assets. However, for foreign investors, I believe Canada offers a great way to expand one's portfolio reach without adding undue risk. Thus, in this article, I will reveal my top two favorite Canadian stocks; let’s dive in.
Canadian Pacific Railway
Warren Buffett (Trades, Portfolio) has been a major fan of railroads, and Berkshire Hathway (BRK.A, Financial)(BRK.B, Financial) owns ~17.5% of Burlington Northern Santa Fe (BNSF). That's how I discovered Canadian Pacific Railway (CP, Financial). Railways tend to be great investments for a couple of reasons. Firstly, these assets tend to have high barriers to entry as it is extremely expensive to build a competing railway. In addition, achieving the necessary regulations and permitting is getting harder each year. Railways also provide consistent cash flow as they are used to carry goods in an extremely cost-effective way. Paraphrasing Buffett, many railways act as the arteries of industry.
In this case, Canadian Pacific operates a vast rail network that stems from Vancouver to Monteral. In addition, it serves major cities across the U.S. such as New York City and Chicago. The total length of the railway is ~14,000 miles, or 22,500 kilometers.
The railway is used to transport a variety of goods and resources. Coal is the most popular item transported on the Canadian Pacific Railway, which moves resources from the Elk Valley coal district in British Columbia. A portion of this coal is then exported to Asia through Canada’s various ports. In addition, Canadian Pacific Railway also transports agricultural products such as grains and livestock as well as lumber and even consumer goods from automobiles to retail merchandise.
Solid financials
Canadian Pacific makes its revenue by charging fees for the use of its rail network. Paraphrasing Buffett again, this basically acts as a “toll road” style cash generator. In addition, the company makes revenue through intermodal services which include the movement of containers between ships, trucks and trains. It also leases railcars and runs a passenger rail service called The Canadian, which is a luxury-focused transcontinental train.
Note: The below financials for Canadian Pacific are in Canadian dollars (CAD $).
Canadian Pacific reported strong financial results for the third quarter of 2022. This included revenue of C$2.30 billion ($1.72 billion), which increased by 19% year-over-year.
The company also reported solid earnings per share of C$0.96, which increased by a rapid 37% year-over-year.
Canadian Pacific Railway pays a solid 0.76% dividend yield, which has grown consistently over the past five years. The company has a strong balance sheet with cash and cash equivalents equal to C$138 million vs. total debt of C$20 billion, of which the vast majority is long-term debt. High debt levels are expected for a railway and thus this is manageable.
Valuation and guru investors
Canadian Pacific trades at a price-earnings ratio of 32, which is 35% more expensive than its five-year average. The positive is the company trades at a price-book ratio of 2.63, which is 63% cheaper than its five-year average.
Activist investor Bill Ackman (Trades, Portfolio) loaded up on shares of Canadian Pacific in the third quarter of 2022 according to his firm's 13F report. During the quarter, shares traded at an average share price of $75, which is ~4.77% cheaper than where the stock trades at the time of writing. Growth stock investing firm Baillie Gifford (Trades, Portfolio) also previously invested in the stock.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
2. Canadian Solar
Canadian Solar (CSIQ, Financial) is a leading photovoltaic cell manufacturing and project management company. Global warming is becoming a major topic and regulatory tailwinds are favoring companies in this industry. Regulatory tailwinds include the Paris Agreement, which aims to increase solar capacity from 5,200 GW in 2030 to 14,000 GW by 2050. In addition, the Biden administration has enacted the Inflation Reduction Act, which plans to increase renewable energy investments to a substantial $369 billion.
The cost of producing solar panels has also declined from ~$6/Watt in 2010 to less than $1.50/Watt by the end of 2021 according to SEIA data.
Canadian Solar is poised to benefit from these trends, and the company plans to increase its solar module manufacturing capacity from 27.9 GW in the third quarter of 2022 to 50 GW by the end of 2023.
Canadian Solar has also built out an energy storage segment, which uses service agreements with its customer to “lock in” recurring revenue. In addition, the company manages over 3.1 GW of operating projects and has bold plans to manage over 20 GW of solar projects by 2026, which would mean extensive growth.
Mixed financials
Canadian Solar reported mixed financial results for the third quarter of 2022.
Note: The Financials for Canadian Solar are in USD.
Revenue was $1.93 billion, which missed analyst expectations by $141.11 million, despite increasing by a rapid over 57% year-over-year.
The company also reported solid earnings per share of $1.12, which beat analyst estimates by $0.53. This was an increase of over 116% year-over-year, which was outstanding.
This huge growth was partially driven by the recent sale of 70% of its stake in a 738 MWp solar project in Marangatu and Panati-Sitia in Brazil. These assets were sold to SPIC Brazil and helped Brazil get closer to reaching 23% of its energy from renewable energy sources by 2030.
In addition, Canadian Solar sold two of its solar and battery energy storage projects in the UK to Gresham House, a UK-based alternative asset manager.
Canadian Solar has a solid balance sheet with $1.082 billion in cash and short-term investments vs. total debt of $2.6 billion.
Valuation
Canadian Solar trades at a non-GAAP price-earnings ratio of 17.2, which is 21% cheaper than its five-year average.
In addition, the GF Value chart indicates a fair value of $45.87 per share, making the stock “fairly valued” at the time of writing.
Guru investors Paul Tudor Jones (Trades, Portfolio), John Hussman (Trades, Portfolio) and Jim Simons (Trades, Portfolio) purchased shares in the third quarter of 2022. During the quarter, Canadian Solar traded at an average price of $38 per share, which is ~12% cheaper than where the stock trades at the time of writing.
Final thoughts
Both Canadian Pacific Railway and Canadian Solar are two very different but fantastic companies. Canadian Pacific Railway offers stable cash offers and strong barriers to entry, whereas Canadian Solar offers huge potential for growth given the momentum behind the renewable energy sector. Both stocks are great ways to diversify, in my view.
