In January, I had the pleasure of attending CFA Society Toronto’s 11th Annual Equity Symposium, and it exceeded my expectations. The 2024 symposium offered a rich variety of discussions, ranging from broad macroeconomic trends to the nitty-gritty of individual stock selection, and even delving into the intricacies of quantitative investing strategies. 

This article focuses on the presentation from Joanna Wolff, CFA, Associate Portfolio Manager at Sionna Investment Managers, a premier value shop in Toronto. Wolff discussed her outlook for Canada and value investing and shared an investment recommendation. What stood out to me was her presentation approach—she wouldn’t divulge her stock until later in the presentation, and I take the same approach in this article to be consistent. 

Why Canada? 

Wolff began her presentation by making a case for Canada. She believes there could be a flood of money coming into Canada, in particular to value stocks. Canada tends to outperform the U.S. when inflation exceeds 4 percent, with Canadian names outperforming by about 8 percent annually. While inflation has been falling, it doesn’t just disappear. One study suggested that since the 1980s, it has taken an average of ten years for inflation to decline to 2 percent once it surpasses 5 percent. 

Why value? 

Most investors are under allocated to the value investing style. Wolff highlighted a chart provided by Professor George Athanassakos from Western University that shows that value stocks tend to outperform when inflation surpasses 2.5 percent (see Figure 1). Additionally, she presented a Fama and French chart for 1936 to 2020, illustrating periods of value outperforming growth. Notably, growth outperformed value only during two specific periods: the mid-1930s to early 1940s and the 2010 to 2020 period. Subsequently, value stocks regained favour. After both of those periods, we saw a regime change, and the team at Sionna thinks we could be in a new regime that favours inflation because of structural changes, namely: demographics, decarbonization, deglobalization, digitization, and increased debt. This observation underscores that growth tends to thrive in disinflationary periods while value tends to shine during inflationary phases. Given the current shift toward higher inflation, there’s an anticipation that value stocks could attract more investment capital. 

Figure 1: 
Annualized three-year average monthly U.S. value premia to P/B ratio based value and growth strategies: 1966-2019

Source: Athanassakos, George. Value Investing: From Theory to Practice. Center for the Advancement of Value Investing Education, 2022, page 48. 

The stock pick 

Wolff had laid the groundwork for why Canada could witness a surge in investment capital and why value stocks tend to excel, yet the specific stock name remained elusive. What was clear, however, was that the company fit the profile of being in an underappreciated market, belonging to a struggling sector, and being heavily discounted—a true “triple threat.” Presently, it trades at a discount compared to its peers based on valuation metrics like price-to-earnings (P/E) and price-to-book (P/B) ratios, while also boasting lower debt-to-equity (D/E) ratios and higher return on equity (ROE). Essentially, it stands out as a high-quality company with reduced financial risk, trading significantly below its usual price levels. This company is Linamar, a diversified manufacturing enterprise operating in two primary segments: auto and industrial. 

Operating in the auto sector presents significant challenges, particularly with the persistent downward pressure of 1 to 2 percent annually on product prices sought by customers. Despite this formidable hurdle, Linamar’s auto segment has demonstrated remarkable resilience, achieving an impressive 8 percent annual revenue growth over the past decade. Furthermore, gross profit in the segment grew 7 percent per annum during the same period, even amid the challenges posed by the pandemic. Management’s adept handling of these adversities underscores their competence and effectiveness. 

Using a strategic approach, Linamar has leveraged acquisitions to forge a synergistic business model. By harnessing the cash flow generated from its high-margin industrial segment (Skyjack/MacDon), the company strategically invests in the larger automotive segment to fuel growth. In turn, the automotive segment capitalizes on its purchasing power and manufacturing proficiency to bolster the industrial segment, fostering mutual growth and profitability. 

This has resulted in: 

• Sustainable, consistent growth in sales and earnings over the past fourteen years, or in at least ten of the past fourteen years 

• Double-digit return on invested capital in thirteen of past fourteen years 

• Positive free cash flow in eleven out of fourteen years 

• Strong, stable balance sheet that allows for opportunistic acquisitions 

There are, of course, challenges weighing on Linamar. It is in a cyclical sector, but it is not broken. The company has been investing in electric parts and propulsion-agnostic parts, pressuring margins. Margins will improve as these new programs ramp up. Cars in North America are older than they have ever been and need replacing. Electric vehicle adoption may be choppy, and Linamar can also mine profitable parts for combustion engines using its flexible manufacturing process. But these short-term fears can create good opportunities for people looking for value. Wolff expects Linamar to achieve a normal cyclical recovery as Linamar’s new programs ramp up on the auto side and its industrial businesses improve along with its peers. Together, this could result in at least a 30-percent return and, potentially, a much higher 50-percent return for patient, long-term investors. 

The author has referenced information in this article which was provided by Sionna Investment Managers Inc. (Sionna) and includes the following disclaimer in that regard: Sionna has taken reasonable steps to provide accurate and current data. The data has been gathered from sources believed to be reliable, however Sionna is not responsible for any errors or omissions contained herein. This material has been provided by Sionna and is for informational purposes only. It should not be construed as a recommendation to buy or sell. The foregoing reflects the thoughts, opinions and/or investment strategies of Sionna and are subject to change at their discretion and without prior notice, based on changing market dynamics or other considerations.