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Craig Jerusalim, senior portfolio manager at CIBC Asset Management.
The rotation between growth and value is not one I pay much attention to. I would frame the rotation we’ve seen over the past few quarters as a rotation between cyclicals, like financials, materials, and energy, that benefit from economic reopening, with the secular growth, like technology industrials and consumer discretionary, that benefit from earnings growth and low interest rates that support multiple expansion.
So given the relative positive, fundamental backdrop of strong GDP growth, rapidly improving employment trends and demand outstripping supply — that’s just a need to keep an eye on inflation. Because rising inflation leads to rising interest rates, which can hurt those high multiples that I just talked about.
Now, I would argue that stocks are one of the best ways to protect portfolios against inflation, specifically companies that can offer inflation protection. So three top picks that I’ve been talking about are Telus, Brookfield and the Canadian banks, and all three of these companies or groups of companies offer inflation protection in different ways.
Telus offers inflation protection by being able to increase pricing that they sell their services for over time because of the strong demand for their services. Brookfield Asset Management, as the owner of real assets, has built-in inflation escalation in their pricing, which benefits them over time. And the Canadian banks have a strong oligopoly, which benefit from rising rates through higher net interest margin.
Let me drill down into each one of these companies a little further. Telus does have high corporate leverage post the 3,500 megahertz spectrum auction, but they also have lots of potential offset to quickly pay down that debt, including partnering in Telus Health or Telus Agriculture, as well as selling down some of their real estate assets. And finally forcing some of their customers to migrate from the copper networks to fiber networks, which result in big savings for the Telco.
As for their key areas of business, wireless is probably the biggest driver where they have a best-in-class turn. And moving forward, some of those Covid-related headwinds quickly turned to tailwinds as migration increases, and we see a recovery in roaming and overage charges. And then on Wireline, their biggest competitor, is slightly distracted from the massive acquisition that they’re undertaking with Rogers purchasing Shaw. Plus, if the acquisition does go through, there’ll be yet another year of integration that Rogers has to deal with, giving a competitive advantage to Telus during that period. So with Telus, you get it all, you get growth, stability and the yield.
The second company was Brookfield Asset Management. There’s lots of moving pieces with them and they have a lot going on right now with the Brookfield reinsurance business, if it was just spun out as well as their purchase of American National for $5 billion. But all of the moving parts around Brookfield have a similar theme, alternatives and real asset valuations benefit from low interest rates and improving economic growth. And as their four public subsidiaries grow, infrastructure, renewables, private equity and insurance, and the fundraising continues to accelerate, the fees accrued by the parents begin to snowball. And that’s exactly what we’re seeing for Brookfield Asset Management right now. And then finally, what sets Brookfield Asset Management apart is their global reach, ability to operate assets, and the propensity to invest in regions where capital is scarce and others don’t see the valuation that they see.
And then finally turning to the Canadian banks. The whole group took a very conservative view on reserves at the onset of Covid and now are benefiting from the release of those reserves. The banks are very well capitalized with excess capital level well above regulatory minimum levels, as well as any self-imposed buffers. And once OSFI, who imposed a dividend moratorium, lifts that moratorium, we expect that the dividends could be increased anywhere from five to 25% on average, to get back to their 50% tip payout target.
So with mortgage growth that fuelled 2021 results, we are expecting a pickup in commercial loan growth, which should help 2022 results. Now the group is still trading at about 11 times next year’s EPS estimates with three to 4% dividend yield and leverage to the economic growth moving forward — a very attractive risk reward profile in our opinion.