retail strategy

Volume 23, N°5, may 2012

eDIToRIal ed sollbach, CFAPortFolio StrAtegy And QuAntitAtive reSeArCh AnAlySt

F CuS

Please see The lasT Page of ThIs DocumeNT foR comPaNy sPecIfIc DIsclosuRes.

Continued on PAge 2

message fRom The geNeRal maNageRbruno desmaraisviCe-PreSident And generAl MAnAger Full ServiCe BrokerAge The global financial markets are characterized

by sharp regional differences—the US is

recovering steadily but slowly from the worst

recession in 70 years, Europe continues to

struggle with sovereign debt problems in

the PIIGS and China is slowing after two

years of tightening.

United StateSIn late April, the US Federal Reserve (Fed)

revised upward its forecasts for 2012,

increasing its GDP growth forecast to

2.4 – 2.9% (from 2.2 – 2.7%) and signifi-

cantly lowering its unemployment forecast

to 7.9 – 8% (from 8.2 – 8.5%); it also

increased its inflation forecast to 1.9 – 2%

(from 1.4 – 1.8%). However, the Fed is

stubbornly sticking to its belief that rates

will remain at zero until late 2014.

CanadaFollowing a few weak months, Canada had a

blockbuster jobs report in March with 82,000

jobs created—proportionately seven times

more than in the US—while unemployment

dropped to 7.2% (from 7.4%). The Bank

of Canada raised its forecast for Canadian

GDP growth to 2.4% in 2012, and expects

the Canadian economy to return to full

capacity by mid-2013. However, the Bank

of Canada warned of a “withdrawal” of

monetary stimulus—a statement that leads

us to believe it will likely raise rates modestly

in mid-2013, about a year ahead of the

Fed. We believe the Canadian dollar can

continue to appreciate toward US$1.05 as

Canadian short rates are now 100bps higher

(1% vs 0% in the US), with this spread likely

increasing in 2013 as Canada raises rates

ahead of the Fed.

GloballyGlobal GDP growth is expected to slow

to a near-average 3.5% in 2012, from

4% in 2011, as Europe is dragged into

a recession because of sovereign debt

problems in peripheral countries. Recent

worries centre on Spain and its banking

system—the downward spiral due to severe

austerity, job losses and a contracting

economy has resulted in a depression-like

record unemployment of 24.4%. In China,

which has been tightening its monetary

policy to combat inflation, growth slowed

to 8.1% in 1Q12 (from a high of 11.9%

in 2010); however, we note that spending

and lending data in China has been more

positive recently. Lastly, for the first time in

over a year, the International Monetary Fund

raised its global growth forecast in view of

stronger US growth, and now expects global

growth of 4.1% in 2013.

“ Our models suggest that relative valuations continue to favour stocks vs the

competing asset classes of government or corporate bonds.“

As investors, we are continually bombarded with all sorts of information: debt crisis in the euro zone, Barack Obama’s difficulties with the U.S. Congress or, closer to home, fluctuations in the price of gold and oil. All this data can influence our investment decisions, hence the importance of knowing your goals and having a plan.

In addition to clearly defining your situation, a well-structured financial plan gives a direction to your decisions. Your Investment Advisor can help you in this regard, because he or she can understand your situation and support you in achieving your financial goals. Your Advisor’s experience, knowledge and judgment are just some of the elements that make him or her a financial partner of choice, provided, however, that you enable your Advisor to correctly assess your situation. It is therefore essential that there be open lines of communication between you and your Advisor.

I encourage you to contact your Investment Advisor for any change that may have an impact on your situation. The more transparent you are in your discussions with your Advisor, the better your relationship will be with him or her, which could be very beneficial for you.

“The only route that offers any hope of a better future for all humanity is that of cooperation and partnership.”

— Kofi annan

EDITORIAL (continued) REcOmmEnDATIOns

PRIC

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Algonquin Power & utilities CorP

CAnAdiAn nAtionAl rAilwAy ComPAny

05

10154

5

6

7

Apr-11 Jul-11 Oct-11 Jan-12 Apr-12

RiSKSThe main risks to our positive outlook for

North America are the elections on May 6 in

Greece and France, which could jeopardize

the recent political consensus of more

austerity in Europe. Longer term, with rising

unemployment in the European peripheral

countries and uneven distribution of the

benefits of a common currency, we are

concerned that politics will tear apart the

fragile European consensus.

Oil prices have climbed to US$110/bbl this

year. Political unrest in Syria or growing

tensions concerning Iran’s nuclear program

could push oil prices higher, hurting the US

consumer.

StoCKSThe S&P  500 hit our original 2012 price

target of 1420 in early April and then had

a much needed correction after rallying

for 105 days—the longest run since 2007.

Similar to the seven previous corrections,

the US dollar and bonds rose, while investors

sold stocks and commodities. A fall in bond

yields and commodity prices is an important

reset for longer term economic recovery as

falling bond yields mean lower mortgage

rates for US homebuyers.

Our models suggest that relative valuations

continue to favour stocks over the

competing asset classes of government or

corporate bonds. As yields are at historically

low levels and below inflation, the price of

bonds in Canada and the US continues to be

high. With 2.7% inflation, bond investors

are losing 80bps per annum to inflation.

Currently, both the S&P 500 and the TSX

yield more than government bonds (currently

around 2%), a situation not seen in 54 years.

The TSX yields almost 3%, and its 100bps

premium over Canadian government bonds

is the highest since World War II. Moreover,

dividends are increasing rapidly while the

return on government bonds is, of course,

fixed. TSX dividends are up 8.9% over the

last year and have tripled over the last

10 years.

We continue to believe that investors are

best served by holding equities. Normally at

this time of the year, a good switch is to sell

low-yielding stocks and buy high-yielding

bonds. However, this May, for the first

time since 1958, stocks are yielding more

than bonds (+22bps); stocks yielded at least

140bps less than bonds the previous two

times when stocks corrected in May.

Our portfolio strategy has not changed

this year, as we continue to recommend a

core portfolio consisting of high-yielding

REITs, utilities, telecoms and pipelines, with

a riskier component comprised of growing

companies (preferably with yield protection)

in the financial, technology, industrial,

consumer discretionary, transportation,

gold, oil and oil services sectors. n0246

60

70

80

90

Apr-11 Jul-11 Oct-11 Jan-12 Apr-12

RATING TOP PICK–AVERAGE RISKTarget $7.75

Symbol AQN

Sector Utility & Power

Recent price $6.34 Total potential return 26.7%52-week range $4.90–6.59

Market cap $930m

Year-end Dec-31

EBITDA 2012E $140.8m

2013E $201.1m

CFPS 2012E $0.77

2013E $0.90

Adjusted debt/total capital 31.6%

Dividend yield* 4.4%

* Most recently announced dividend (annualized) Sources: Desjardins Securities, company reports, Bloomberg

RATING BUY–AVERAGE RISKTarget $88.00

Symbol CNR

Recent price $84.39

Total potential return 6%

52-week range 63.72–81.79

Market cap 37,216m

Year-end Dec-31

Revenue 2011A $9,028m

2012E $9,796m

2013E $10,477m

Adjusted EPS 2011A $4.59

2012E $5.49

2013E $6.19

Last quarter ROE 28.2%

Dividend yield 1.8%

Sources: Desjardins Securities, company reports, Bloomberg

3

Recommendations

Volume 23, n°5, may 2012 2-3

Sources: Desjardins Securities, company reports, Bloomberg

Algonquin Power & utilities CorP

CAnAdiAn nAtionAl rAilwAy ComPAny

n Stable earnings and cash flow from a diversified portfolio

of ~424MW of renewable and thermal power capacity in

Canada and the US, as well as regulated water, gas and

electricity distribution utilities in the US

n exceptional near-term growth from investments in

~$1b of power projects under construction and ~$550m

of utility acquisitions in progress

n attractive relative valuation and ~5% dividend yield

Algonquin Power & Utilities Corp. (AQN) is a diversified power and

utility infrastructure company, with ownership interests in a portfolio

of ~424MW of net installed hydro, wind and thermal capacity, as

well as regulated water, gas and electricity distribution utilities.

The company’s power portfolio is supported by long-term power

contracts for ~70% of installed capacity, while its utility operations

are underpinned by healthy regulated equity returns in the

8–10% range.

We expect strong near-term growth for AQN over the next five

years based on utility acquisitions in progress, including expansions

into the electricity and gas distribution sectors, as well as upcoming

investments totalling ~$1b in contracted power projects in Ontario,

Québec and the US.

Our Top Pick recommendation for AQN is primarily based on its:

• Very strong near-term growth outlook, which is expected to

generate five-year EBITDA and cash flow growth in excess of

~20% per year;

• Inexpensive relative valuation of only ~5x estimated 2012

EV/EBITDA and P/CF (vs ~9x average for its peers);

• Healthy ~5% dividend yield, ~40% forward cash payout ratio

and low ~33% debt-to-total capitalization ratio.

The risks to our recommendation include fluctuations in the

foreign exchange rate and commodity price risk associated with

the company’s current operations, as well as political, regulatory,

financing and execution risks associated with its growth projects.

n Cn reported solid 1Q results, driven by a record

operating ratio

n Several growth opportunities on the horizon should

boost future earnings

n Cn’s premium valuation is justified

CN recently reported solid 1Q12 results that handily beat our

expectations on the back of a record operating ratio (operating

expenses/revenues), of 66.2%, the lowest among North American

railroads. Following these results, the company raised its 2012

outlook, calling for EPS growth of “a full 10%” (previously “up to

10%”), which we view as conservative.

We expect CN to continue to increase its profitability as it generates

additional volumes at low incremental cost and sustains above-

inflation pricing gains. CN has several growth avenues:

• Markedly higher potash shipments through Canpotex;

• Stronger export coal and intermodal shipments out

of Prince Rupert, BC;

• Growth in frac sand shipments;

• Opportunities in Mexico with Kansas City Southern;

• Plan Nord;

• The Contrecoeur, Québec, intermodal expansion.

Trading at 15.4x our estimated 2012 EPS, in line with its historical

average of 15.6x (last-12-month basis), CN shares are still worth a

look despite their premium valuation vs US peers, which are trading

at an average (ex KCS) of 12.9x consensus 2012 EPS. In our view,

this premium valuation is justified given CN’s limited exposure

(~2% of revenue) to further expected declines in thermal coal

shipments, which are severely impacting US railroads.

Moreover, we prefer CN over CP in Canada (CP is trading at 17.1x

our estimated 2012 EPS) as we believe significant profitability

improvement has been largely factored into CP’s current price.

Our $88 target for CN is based on the average of three valuation

methods.

Jeremy rosenfield, CFA, ANALYST

Benoit Poirier, CFA, ANALYST

DesjarDins securities top 25

Volume 23, n°5, may 2012 4

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NOTE: All information (including prices and returns) as at April 27, 2012

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COMPANY TICKER RATING & RISK TARGET PRICE ($) MARKET CAP (M$)

Toronto-Dominion Bank (The) TD Top Pick–Average 95.00 75,150Bank of Nova Scotia (The) BNS Top Pick–Average 65.00 61,953Brookfield Asset Management Inc. BAM Top Pick–Average US$40.00 US$20,515TransForce Inc. TFI Top Pick–Average 22.00 1,721Algonquin Power & Utilities Corp. AQN Top Pick–Average 7.75 930Whitecap Resources Inc. WCP Top Pick–Average 15.00 797Royal Bank of Canada RY Buy–Average 66.50 82,241Canadian National Railway Company CNR Buy–Average 88.00 37,216Potash Corporation of Saskatchewan Inc. POT Buy–Average 58.00 35,946Enbridge Inc. ENB Buy–Average 42.00 31,685BCE Inc. BCE Buy–Average 43.20 30,969Manulife Financial Corporation MFC Buy–Average 18.00 24,567Teck Resources Limited TCK.B Buy–Average 64.40 21,615Agrium Inc. AGU Buy–Average 106.30 13,756Yamana Gold Inc. AUY Buy–Above-average US$22.25 US$11,033Tim Hortons Inc. THI Buy–Average 58.00 8,932Penn West Petroleum Ltd. PWT Buy–Average 30.50 8,068Bombardier Inc. BBD.B Buy–Above-average 7.00 7,175Baytex Energy Corp. BTE Buy–Average 68.00 6,191Metro Inc. MRU Buy–Average 59.00 5,341Finning International Inc. FTT Buy–Average 34.00 4,805Vermilion Energy Inc. VET Buy–Average 59.00 4,598Dollarama Inc. DOL Buy–Average 58.00 4,040Inmet Mining Corporation IMN Buy–Average 80.10 3,815Cogeco Cable Inc. CCA Buy–Above-average 55.00 2,361Source: Desjardins Securities Portfolio Advisory Group in collaboration with Research analysts.