Growing Pains and Growing Gains
Population growth (mostly through immigration) has been and will continue to be the most important driver of Canadian economic growth. Canada’s major cities still maintain a vast amount of developable space and all of the country’s political parties recognize immigration both as the singular most important economic growth driver for the country and as a fundamental bedrock of Canadian identity.
That does not mean the country is immune to growing pains, in particular the current acute shortage of housing (due to a number of factors… demographics; interest rates that have stalled both downsizing and construction; the stupidity of local politicians, “environmentalists”, and zoning rules; and the sheer scale of growth).
However investing behind this continued growth in population gives investors a material edge across a diverse set of investing opportunities. We’ve collected a few ideas below,
Housing (obviously)
Apartment REITs:
Ontario-focused REITs will go through a period of stall-speed as Canada’s cap on student immigration reduces the overall number of students coming to Canada from 500,000 to 350,000 for two years AND allocates this by province. This will reduce Ontario’s student intake by 50% thereby reducing rental demand pressure in the Greater Toronto area (and to a lesser extent in Vancover, BC), the major market for many Canadian apartment REITs. This will stall, for a time, gains from pushing rents higher. On the other side this will benefit most provinces other than Quebec (limited English programs), most notably Alberta which has the greatest ability to accomodate additional foreign students (and a world class education system) and the strongest and most diversified employment base of any other province. The standout amongst the large cap multifamily REITs is clearly Western-Canada focused Boardwalk REIT but we think the easy money has already been made here.
Very few trade multi-family REITs trade at large discounts but there are a few at out there that for idiosyncratic reasons remain undiscovered by the market. We will be publishing privately on one soon.
Land Development:
Genesis (GDC) a small land developer in Alberta transitioning into building more houses themselves.
Dream Unlimited (DRM) has a massive land bank in Western Canada but also has holdings in many other Dream entities (office, industrial, etc.) which drive valuation much more than its exposure to land.
Melcor Developments (MRD) remains one of our Top Ideas - the company has an enormous land bank in Alberta and to a lesser extent BC and the USA as well as a sizeable real estate portfolio although it is primarily a residential lot developer. MRD trades at 30% of tangible book value, with the best capital allocation (repurchasing the maximum number of shares, sizeable regular dividend), and is the best managed of the lot. The US comparable Forestar (FOR) doubled in the past year and trades at a premium to book value. We’ve published on MRD many times on the subscription service and would note that the shares tend to follow fundamentals with a lag, a reflection of it’s slower retail investor base.
Telecom
Canadian telecom has been a natural and major beneficiary from population growth given it is a high fixed cost oligopoly. Currently however the dynamics are fraught - Quebecor’s purchase of Freedom, historically a discounter that focused on the GTA, has resulted in a new player that is under increasing pressure to find growth and a new go-to-market strategy. In a market that had hundreds of thousands of easy subs there was plenty to go around - now that there are hundreds of thousands less in Freedom’s main market the likelihood of a price war are increasing. Quebecor’s Freedom needs to grow - and the only way it can do so is by taking someone else’s piece of a pie that is growing a lot more slowly than it was just a few months ago.
Cogeco also stands out as particularly vulnerable and a victim of epic self-destruction - spurning a premium takeover offer at $>100/share from Rogers at literally peak cable valuations on a business staring at years of massive new competition from both Fiber and FWA. The best case scenario of teaming up with Quebecor’s Freedom to launch an MVNO to shore up their subpar cable product risks the incumbents launching FWA in Canada (to the benefit of Canadians, and to the loss of every telco shareholder) which would be bad for Rogers, BCE, and Telus but downright awful for Cogeco and Quebecor.
Construction & Engineering
A growing population requires more infrastructure and as the country densifies the nature of infrastructure spending will increasingly shift from low engineering content (roads, suburbs, etc.) to complex / higher engineering content (ultra-dense/tall buildings, subways, etc). Engineering firms like Stantec and WSP trade at premium multiples for this reason and because they are less capital intensive, deliver more reliable earnings, and are generally immune from cost overruns / inflation. The former SNC-Lavalin (now Atkins-Realis) learned this lesson painfully and is now transitioning into an engineering services firm and is the one to watch.
Construction Spending Proxies: Black Diamond (BDI) remains one of our Top Ideas even after returning ~150% from when we first published the idea on the subscription service - a reflection of how well the business has executed and how truly ludicrously cheap the company was. The thesis has transitioned from one that somehow needed to prove to the market that there was value to now proving to the market that they can compound value. BDI continues to trade at a substantial discount to comps which will continue to narrow as they prove that they are a long term compounder. A pullback in rates; continued execution, scaling, and diversification; and a narrowing of the punitive discount to comps should see another doubling in the shares over just a few years from here.
Manufactured and Affordable Housing: A key pillar to solving the acute shortage of housing in Canada is the cost to build a home and the government now sees factory-built homes or modular home construction as a key to ameliorating what is likely to be a decade long shortage of housing. This leads us to our main idea for this blog post, an already undervalued equity that ascribes practically zero value to one of it’s major divisions - one of the largest modular or pre-fabricated structures manufacturers in Canada. If any serious effort is made by industry and/or government to boost modular home construction this company stands to benefit tremendously. We think the shares are already worth 50% more ascribing zero value to the modular manufacturing division, with the value created by helping solve the affordable housing crisis in Canada making the shares worth more than double.
The company?
Keep reading with a 7-day free trial
Subscribe to LF Research to keep reading this post and get 7 days of free access to the full post archives.