Motley Fool Canada's Iain Butler and Jim Gillies join the podcast for a special Canada Day edition of Industry Focus: Energy. We give an overview of the Canadian stock market, share a few Canadian stocks to watch, and more!
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This video was recorded on June 14, 2021.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. Today, I'm excited to welcome on the Motley Fool Canada's Iain Butler and Jim Gillies for a special Canada Day edition of the Industry Focus podcasts. Guys, welcome to the show.
Iain Butler: Fantastic to be here.
Jim Gillies: Thanks for having us.
Sciple: It's great to have you here. We're pre-recording this on June 14. If you're listening to this, it is July 1, 2021, which is Canada Day 2021, as you're listening to this, my friends, Iain and Jim are taking the day off today. Why do you have the day off today, Jim, what is Canada Day?
Gillies: Canada Day, to put in American terms, it is our version of July 4. It was the day in 1867 when the country was officially handed over by Queen Victoria, became its own nation, and we like to celebrate with basically the red and white bunting instead of red, white and blue. We steal all the good fireworks three days in advance, probably overpay for them frankly. Basically, it's yet another excuse during our oh-too-short summers to hang around the pool and the barbecue and drink a few bottles of beer.
Sciple: Is it still hotdogs or hamburgers, or is there a Canadian hotdog? Is there a Canadian bacon version of a hot dog?
Gillies: We are equal opportunity meat eaters up here. We have no problem with hotdogs, hamburgers, throwing a hot dog on a hamburger, it's all good.
Sciple: Awesome. We're excited to have you all here today in honor of Canada Day. We are an investing show. We will talk a little bit about the Canadian stock markets, what makes them special. Iain, why don't you just run us down. What's the size of the Canadian economy? How does the Canadian stock market compare to the U.S. stock market?
Butler: The size of the Canadian economy is throwing me for a loop because I don't know off-hand I must say. I think the rule of one-tenth is always a good one to go with. That's generally how the population washes out. Canada is about the population of California, obviously one of the biggest states population wise, but we've got about 33-35 million Canadians. Yeah, I think the economy here is considered a tenth the size of the U.S. From a stock record perspective, though, I believe there's over 5,000 listings between the Nasdaq and the New York Stock Exchange, is that about correct?
Gillies: That's the ballpark.
Butler: Yeah. I think there's about 1,500 to 2,000 on the primary Canadian Stock Exchange, which is the TSX index, Toronto Stock Exchange. We do not have near the breadth or selection that we find in the American markets, which is why we've spent a lot of time over the years telling Canadians that they need to be looking south of the border for ideas to complement their Canadian stock ideas.
Sciple: Yeah. When you look at the components of that market, you see a lot more oil and gas, a lot more resources, I think, as they're referred to as the north of the border. How does that aspect of the economy flash out in the stock market and the way people invest in the country?
Gillies: Quite often poorly, if I can put it bluntly. The problem with the resource side of the market is you're always beholden to essentially what is the price of the resource. You might be the absolute best lowest-cost operator in the oil and gas space, but if 2015 comes along or oil goes from $100 a barrel to sub $30 a barrel, it's not going to matter. As with everything I think given investing, people get very excited when they are working, but it's very hard to forecast the cycle for commodities or for resources. Hope I'm not speaking out of turn for Iain, but the time that we tend to get most excited for them is when things aren't working, because that's when you're paying a comparatively lesser price. The last decade, we've really only seen energy poking its head up in recent months, which is good. It's a good sign. But we've seen this kind of head popping up a couple of times since about 2015 and it's always been slapped back down. We have some hopes that right now it's going, but it can be a little bit more challenging. We lack a lot of the U.S. exposure to certain sectors, mainly the tech sector. But as Iain says, the equity markets in Canada are about 3% of the world's total, and we feel that investing only within that 3% is doing your portfolio a disservice, which is why the Canadian services focus on equal recommendations in Canada as well as in the U.S. because you guys, I think have got about 50% of the world equity market. We think it behooves Canadian investors to step outside our borders metaphorically. If we're not allowed to right now physically.
Butler: I think it's an important point to emphasize there that indeed we are severely lacking technology and healthcare and those have been two, especially technology over the past five, 10 years even. Technology has really driven the U.S. market, it's become the biggest weight that it's ever been in the S&P 500. If not, it's got to be close. Meanwhile, energy has done the opposite of the S&P 500. What's it, low single-digits sector-wise? Canada energy is still about a 12% allocation in the S&P TSX composite, financials are a big allocation there, and then the materials sector rounds it out. Those three sectors really make up more than 50%, I believe, of the Canadian market. It's a real dichotomy, which is why our two markets have diverged significantly in performance since about 2012. You can draw a line dating back quite a ways to 2012, and there were divergences, but it's amazing how close the Canadian and the U.S. market were up until that point. But since that point, the U.S. has just rocketed past and is well ahead now in terms of long-term performance.
Sciple: Certainly, it's been a tough decade for the energy space and some of these materials over the past year so far, and 2020 has been pretty strong for commodities. We'll see whether that cycle turns around, whether the TSX closes some of that gap we've seen over the past eight years or so that you laid out there, Iain. You mentioned several times this relationship between the U.S. and Canada and wanted to talk about that a little bit when it comes to companies in Canada. Naturally, you mentioned Canada is about one-tenth the size of the U.S. economy. But also, the No. 1 trading partner is the U.S. If you're a company in Canada and you're looking to expand pretty soon, one of the natural markets to expand to is South down into the United States. When you think about Canadian companies, how much of those companies are companies operating in Canada versus how much should we think about these companies as more North American businesses more broadly?
Gillies: There is certainly an aspect of, if you are a Canadian company, you want to succeed in the U.S. for the simple reason, as Iain out, that you guys are ten times our size, it's already an almost equal market in terms of the customer makeup down there, it's just, you're much larger. We want to see our success stories translated like, I'll throw one out, Lululemon. Lululemon is a Canadian company. It was founded in Vancouver and for the longest time it was traded on both the Toronto Stock Exchange and the U.S. exchanges. I think they dropped their Canadian listing four or five years ago now, because their products are appreciated and desired by practically everyone in North America. They almost established their own new niche, where companies like Gap and Under Armour started putting out other competitive offerings but still the Lululemon brand is so strong. But this is a company that was born and raised in Canada, outgrew Canada, and left Canada for a lack of a better term. Canadians who want to invest in this Canadian success story have to do so in U.S. dollars on, I think it's on the Nasdaq, I'm not sure. What tends to happen with Canada is, the small success stories, they either get bought or they outgrow or, in some cases, they skip the Toronto listing entirely and just go to the U.S.
Butler: From a business standpoint, I can't think of very many growth-oriented companies that purely have a Canadian strategy. I think every growth-oriented company has its eyes on the U.S, whether they get their start in Canada and grow to a point here and then expand or if they're always set on the U.S. The exceptions are in the telecom industry where there's essentially an oligopoly between three big companies, Rogers, BCE, and Telus. Telus does have an international strategy. The other two not so much or at all even. Same as the utility industry. They keep these big telecom companies, two of them, BCE and Rogers, I would say, are more like utilities in anything where it's regulated, they're promised a certain amount of growth, essentially, by the government regulations, and that's the game. But if you want a truly growth-oriented company, I can't think of a great example where it's purely a Canadian strategy.
Sciple: Naturally, you're seeking out these new markets and the U.S. is one of those. Another example where you think about companies starting in Canada and then growing up in the U.S, you see a lot of these with smaller businesses. The Canadian Venture Exchange, I know Jim has some opinions, maybe pro and con, of what goes on on that platform. But you see a lot of smaller businesses before they get their big boy listing. One of the popular places to do that is the Venture Exchange. Can you talk about the role that plays in markets and for businesses?
Gillies: Actually, I'm going to quote Iain Butler here on the Venture Exchange. I love this quote. Toronto Venture Exchange, home of the world's worst companies. There's a lot of drops on the Venture Exchange, frankly. There's a lot of things that don't -- certainly, there are some that grow and get their big boy listing and go up to the TSX. MTY Food Group would be one that pops up. AcuityAds is one that has popped up or moved up. Viamed, I think, is another one. Iain's probably got another 20 to think of. There's a bunch of others too that list there and are quite happy just sitting there. They don't really care too much about their public. I mean, Topicus.com is a recent spin-off from [...] and they've been there. Those are good companies, but they're just like, "Oh, well, we're happy here." You want to be really careful with what's on the Venture Exchange. I'll put it that way.
Butler: A lot of it, I won't say half, and it might even be more than half, but let's call it half, of the junior resource variety where there's a plot of land in some far-flung locale and promises of riches are mere weeks away if they just receive external money and then are able to --
Gillies: And have been for the last decade.
Butler: That story abounds on the Venture Exchange. I think, though, in its purest sense, if we want to take the least crappiest companies in the world, Canada hasn't had a very developed venture capital market. The whole private equity venture capital, Silicon Valley scene, hasn't really been overly developed here in Canada. I think it's improved a lot and actually, I think Canadian companies have increasingly been getting access to the U.S. venture capital market. It is evolving, but historically, that Venture Exchange has provided at least external financing for the gems that do come along. That would be the genesis of the exchange, but as Jim said, trade carefully. I think pink sheets in the U.S. are similar. There's just plenty of scuzz in Pink Sheet land.
Sciple: It's got that history, going back to funding these junior miners, for folks that aren't familiar with that term, industry term for, its miners that don't have a mine. They aren't pulling anything out of the ground yet. I don't know why that makes you a junior, but it means [...] producing anything. Historically with the resource nature of Canada, there's been a need for funding there. But today, as you mentioned, because of the nature of that market, if you're looking for micro-caps, that can tend to be a place where there are some hidden gem-type micro-cap companies. But again, buyer beware, all those things that you find in micro-cap land. There's some good stuff, there's some hidden gems, but there are some non-diamonds also down there in the rough.
Butler: It'd be the true venture capital approach where you throw, collect the basket and some are going to go away and ideally some are going to do fantastically well, but it's very much a venture capital mind set required.
Sciple: Another topic we can talk about is the peculiarities of Canada. I know Mr. Gillies likes to talk about this regularly, this phenomenon of where you often have this one star child of the Canadian market that rockets up to prominence and then historically has not ended super well. Jim, can you tell us the back story there and why this is something that is peculiar to Canada or maybe potential reasons why?
Gillies: Well, I mean, it's the curse of the largest company in Canada that's not a bank. Most of the time, the natural ruling order is the largest company by market capitalization in Canada is a bank, usually Royal Bank of Canada. Although I think TD, Iain, may have once or twice.
Butler: It's further up there. I wonder if Scotia got there at one point, but yeah, I think Royal Bank generally carries the day.
Gillies: Royal is the flag bearer. But every once in a while a new challenger takes the field and, as you say, rockets ahead, gains tremendous market share. Some of the names that have held the mantle over the past two decades include Nortel Networks, which is a zero today. Research In Motion, which is now BlackBerry and considerably smaller than it was at its height as Research In Motion. Potash Corporation of Saskatchewan, which is probably the silliest name we'll probably talk about. But that was a commodity supercycle that went stupid, frankly, and people bought all the way up. It's still a perfectly acceptable company, it amalgamated with their largest competitor.
Gillies: Agrium, and now is a company called Nutrien. Valeant Pharmaceutical, everyone's favorite leveraged recap. McKinsey, an interesting company that imploded for reasons that, well, don't try to financially engineer and screw your customers, I suppose. All those companies are significantly smaller today than they were. As I mentioned, Nortel. Nortel at its height in 2000 was one-third of the index. So if you were a passive investor in the Toronto Stock Exchange, you were unknowingly putting one-third of your money into an index where the largest company went to zero for various reasons. But today the largest company in Canada is not a bank, it was passed about a year-and-a-half ago by some little company called Shopify. I think Shopify has a pretty good chance of remaining the largest company in Canada and breaking this curse simply because the other names mentioned, Nortel did some questionable things and went a little stupid from valuation perspective and ran aground because they've done some dumb things in the tech crash. Research in Motion ignored the development of some little thing called an iPhone.
As I mentioned, Potash was a commodities thing that went a little silly and once the euphoria wore off, it went away. Valeant was financial engineering and fraud. None of what I've just described applies to Shopify. Shopify is a real business with a real growth story with, in theory, how many small and medium-sized businesses can we have around the world? It's not even a small business anymore. I mean, I was looking at the Globe and Mail, they are Canada's national newspaper. I was looking at their website to subscribe a couple of weeks ago and I see at the very bottom of the order page, powered by Shopify. They got Globe and Mail, that's pretty good. Iain, you knew another one.
Butler: Netflix is new online. Its merchandise store is also powered by Shopify. It's almost like Shopify is an American company, I must say. It's got that rare secular growth trajectory behind it that is so hard to find in the Canadian market, or I find it hard to find anyway.
Gillies: We think maybe the streak has been broken neck, but we're still going to knock on wood a little bit.
Sciple: What do you think makes Shopify special? Do you think maybe if Shopify breaks this trend of what we've seen historically with the sad ending to the biggest company in Canada, do they create a model that you see other companies maybe following in the future? I mean, because you see that happened in the past when you see success in Silicon Valley, other people come to Silicon Valley and things build up. With Shopify having success in Canada, do you think that could be a model for other businesses to follow?
Gillies: That's a real tough one.
Butler: It is, yeah. I almost thought for a second that maybe there's a different dynamic there because it's founder-led, but BlackBerry was founder-led, so that's out the window. Nothing obvious jumps out.
Gillies: I think Shopify, they came upon an opportunity that's almost perfect to what they were offering. They've seized it, and the founder-led aspect of it is essentially they are not content to rest on their laurels. I mean, I give Research In Motion a hard time justifiably, and Nortel as well because I think both of those companies, especially Research In Motion, they openly mocked the iPhone. It might be a good toy for some of the retail folks, but serious businesses and security things would continue to use the BlackBerry. They got it precisely wrong, but they were very overweeningly confident, I'll put it that way. I look at Tobi Lütke at Shopify and just the way they do things there, even though they are the largest company in Canada and they've had tremendous success, they feel hungry. They feel like they do not want to rest on our laurels. I think that more than anything gives me hope that they can continue to maintain the lead they have now on Royal Bank and TD Bank.
Butler: I might highlight, too, Shopify, it's biggest by market cap, but it certainly isn't biggest by other financial metrics. I'm just looking at the list here, and I mean Royal Bank of Canada is No. 2, it's got $47 billion worth of revenue, Shopify at $3.4 billion worth of revenue. Shopify has definitely benefited from the general tech environment and the willingness of the market to pay big multiples for these growth stories. That's really padded its market cap. But back to the company level, though, there's no doubt there's some magic there.
Sciple: We'll see Amazon, well, they're on pace, I think, to pass Walmart as the biggest employer in the U.S. Shopify has a long way to go to become the biggest employer in Canada, we'll see what happens there. Moving to another topic. We've talked about the broader Canadian market, the biggest company phenomenon, maybe some things that make Canada special. Then talked a little bit about Shopify and maybe what makes them special as the largest company in Canada. What are some companies that for U.S. investors or Canadian investors that you think are special that folks should have on their radar? Jim?
Gillies: Do you want a dual listing or do you want just the Canadian listing? I'll have to go find the pink sheets.
Sciple: I want companies that you think are special that do business in Canada that folks have on their radar.
Gillies: O.K. I Feel we've talked about this before, but again, we don't know the listenership of Industry Focus here and how many times. So you're going to have to go find this on the Pink Sheet, Fools. But I hope that the best company in Canada run by the greatest CEO slash capital allocator in Canada, there's a little company called Constellation Software. Constellation Software is run by Mark Leonard, who is the CEO. He's been there forever. I think he might be a founder actually. If it wasn't, certainly it doesn't matter because he's been the guy driving it the entirety of its public history. It's just been public just over 15 years, I believe, or roughly 15 years. In that period of time, I think it generated about 40% annualized returns, so mildly outperforming every market out there. Mark Leonard is notoriously reclusive, doesn't give interviews, doesn't do quarterly conference calls, used to write letters a couple of times a year, kind of stopped that or severely cut back. But they are basically a software acquirer, an integrator, and they are masters at going and acquiring small software companies in various different verticals and integrating into their own operations and just producing a ton of cash flow, which turns around and facilitates the next generation of acquisitions, and it becomes this virtuous circle. It's ticker is CSU on the Toronto Stock Exchange. There is a pink sheet listing somewhere which I will have to go look for you.
Sciple: Yeah. We'll throw it into a description of the podcast. Jim, you talked about the really strong history that Constellation Software has had and incredibly strong returns, and as you look into the future, the company has talked about maybe doing some larger acquisitions going forward. Do you think the company, the opportunity before them is just as bright as things have been in the past? What are you looking at with the company today?
Gillies: Well, part of me, I was speculating that, but yes, I think they have to do larger acquisitions because this is now a $32, $33 billion company, I believe. You can't go out and buy the $5 million revenue company anymore and expect to really move the needle. Plus, the $5 million revenue company is like two guys in a garage somewhere, so you're not going to move the needle much. We've actually talked of a couple of potential candidates that we could see Constellation targeting that are larger that would fit this bill. One of which is called Computer Modeling Group, which is out of Calgary. They basically do reservoir modeling for oil and gas players. Constellation, I don't know if this is deliberate or not, but Constellation has managed to get a couple of their executives-slash-directors onto the board of directors for Computer Modeling Group. Computer Modeling Group has had a history of lots of cash generation, not a lot of stock price appreciation in the last few years. There's another company called Enghouse or Enghouse depending on how you want to pronounce it. It's ENGH on the Toronto Stock Exchange. It's about $3 billion. It looks very similar to Constellation except it's one tenth the size. They've been struggling a little bit to get some growth. It wouldn't shock me to see Constellation maybe take a run at them because it's really been built on the same model as Constellation. I think they're going to have to start doing larger, you could put up the argument or you can put up the concern that while they have historically been really good at buying the $50 million company, they've done phenomenally at that, they don't have a great track record of buying the $500 million company or the $3 billion company.
So, it could be interesting, but then again, they also just spun off a company called Topicus, which trades on the Venture Exchange, but its operations are over in Europe. I believe the original Topicus acquisition. I'm looking to Iain to confirm my suspicions. I believe it was actually at least a couple of billion dollars in size, the original one was [...]. Am I making stuff up?
Butler: It's cloudy. That whole deal is cloudy, so I don't know. I'd be surprised actually, if it was that big. I don't have a definitive answer.
Sciple: All right. We'll trim that part out. Constellation Software, I think that's a great pick, like a Berkshire Hathaway of software at a significantly smaller scale, but with the opportunity to keep growing and growing and growing into the future. Iain, what's a company that fits the bill for you of a special Canadian company that folks should have on their radar?
Butler: I do, and I'm going to actually quickly change gears though from what I shared earlier. Because Jim said it was the greatest company in Canada. The company that came to mind on that front in the same echeclon is Brookfield Asset Management. I just want to maybe highlight that Brookfield Asset Management is indeed rooted in Canada. Even though its operations are international, it's the mother ship of four separate tentacles; Brookfield Infrastructure, Brookfield Renewable Energy, Property Partners, which is now brought in-house and is a private equity arm. I think similar to Constellation actually, Brookfield's done a fantastic job of recycling capital through these various tentacles, it harvests the cash flows that it's portfolio of hard assets bring in. Those cash flows go up to the mothership and the mothership directs them where to go next for the highest returning opportunities. All the while, I just like the space ship analogy when it comes to Brookfield. All the while, they've really stepped up their game on bringing external capital in as well, so their capital's flowing from the tentacles, and capital is also coming in from external sources that they're charging a fee on. It's become an absolutely wonderful business and one that I think all Canadians and American investors should own, a pretty good allocation, too.
The situation that Nick referred to however is a company called AbCellera Biologics, ticker there is ABCL, and it only trades on the Nasdaq. It's a Canadian company. It was born out of a Canadian university in Vancouver, the University of British Columbia in about 2012. It remains founder-led; the founder is still the CEO. It just IPO'ed back late last year, and it only IPO'ed in the U.S. on the Nasdaq, didn't even bother with the TSX. Again, that speaks to just the lack of coverage and lack of interest in anything Canadian healthcare-oriented in our market. AbCellera, it has an AI powered drug discovery platform, we'll call it. I think the way I visualize this one is that they can take from our humans bodies because we're producing immunity. I'm going to get it all.
Sciple: White blood cells is all.
Butler: Get ready to cut that. Humans are producing immunities. We're immune to many things. AbCellera takes from the human, puts it into their platform, spins it around and is able to then ship their findings to a drug company who they then partner with. And the drug company then goes on to make a treatment out of human originated antibodies. AbCellera really hit its stride last year because they came up with a treatment for COVID. They partnered with Eli Lilly again, that's their model. They partner with Lilly, Lilly then takes over the production of the treatment and marketing and so on and AbCellera collects a royalty upon that treatment. They had a blockbuster year last year, a huge windfall, very similar to Fulgent Genetics, if people are familiar with Fulgent Genetics, they also had a huge COVID windfall. But I think what's been lost on the market is that AbCellera is not a COVID story. It's been wonderful to pat its bank accounts with these COVID proceeds from this treatment that they come up with. But this platform is good to go on any number of fronts and they've got over 100 different partnerships in place. It's just a matter of these treatments being born from this platform and then AbCellera collecting a royalty from that point forward. I think it's a really interesting situation, certainly higher on the risk reward scale. But it's a $7 billion company that you could easily see become worth far more than that as they build their portfolio of royalty producing treatments.
Sciple: Can you spell that company?
Butler: AbCellera, and again, the ticker on the Nasdaq was A-B-C-L.
Sciple: Excellent. I had one follow-up on Brookfield for Iain, because you mentioned all the different tentacles of the business. I actually got a question on Twitter about this. They're growing another one. It's like the hydra where they keep growing the other one out there and moving into the end of the reinsurance business, do you have any thoughts on that and what's going on there with Brookfield?
Butler: Yeah, I think that's going to be really interesting to watch because they've gotten us in another direction in the past. They had a little internal specialty insurance company called Trisura. They actually punted that out from out of the mothership. This is a cool thing about Brookfield is that you'll just hear them announce that they own some entity that you didn't even know was in there. Trisura Specialty Insurance Company, they punted that out from the mothership and it's become a stand-alone company. I guess similarly, they're going to bring this reinsurance business out of the mother ship into the public world and allow it to live on its own. If I understand the deal, Jim is squinting so I might not have it completely right.
Gillies: No. It's alright. The Trisura story is just a wonderful example of the species of the spin-outs. It was spun out at $21 a share in July, literally four years ago, in July 2017. For every 150 shares of Brookfield you own, you got one share of this tiny little specialty insurer. So of course, what happened? Anyone who got just threw it over the side without a second thought. But if you were buying it and we were fans of it and remain fans of it today, but we were buyers there. It's gone from $21 and span out to $150 today. It's just this tremendous growth story of an industry where you didn't expect to see it so [...]
Butler: [...] insurance has performed like that. I think that hits the point too with this reinsurance business, it's going to be a similar situation Brookfield owners are going to get a share. I don't know what the ratio is.
Gillies: I think it's 1 for 140 shares or 150. Now, Brookfield has split three for two, since Trisura came out, so it's a slightly bigger deal than that. But the same thing is going to happen. People are just going to puke it and be done with it.
Butler: I think one to pay attention to. That's right.
Sciple: All right. We'll add that one to the watch list. You've got a bonus stock to keep on your radar here as Brookfield gets ready to spin off their reinsurance business. Y'all thanks so much for spending this time with me to run down Canada and celebrate Canada Day. I cannot wait to have you all back on again in the future.
Gillies: Thank you.
Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks and Anne Franks for their help mixing the show. For Iain Butler and Jim Gillies; I'm Nick Sciple. Thanks for listening and Fool on.