Which stocks have piqued the interest of Canada’s top portfolio managers? CFA Society Toronto brought them together at the 2014 Equity Investment Symposium to share their big picks. What stocks do they like and why?

WHO: Matt Skipp, founder and CIO SW8 Asset Management Inc.
PICK: Indigo Books & Music (TSX symbol: IDG)
TARGET: Price target of over $12.50 per share
UPSIDE: We believe shares of Indigo, currently trading at $9.50 a share, are materially undervalued based on both asset value and growth potential. The stock has no debt and substantial cash on the balance sheet—about $7.23 in cash per share.

The company operates stores in prime locations across the country, and we believe that their portfolio of lease holdings could potentially be monetized for a significant sum. Recently, Indigo has been a neglected retail name due to fears of a continuous decline in physical book sales. That said, physical book revenues saw a 1 percent uptick last quarter and have remained fairly stable for a number of quarters now.

The company should further benefit from its investment in its non-book retail segment, which is growing nicely at a rate of over 15 percent and with gross profit margins of close to 50 percent. As an example of retail growth initials, the company is rolling out the American Girl doll brand in Canada (debuting May 2014). This upcoming launch should be a boon to both store traffic and revenues.

In terms of valuation, Indigo is materially undervalued. We believe revenues will grow next year by 2.5 percent to $890 million. And, using a 3.1 percent EBITDA margin, the company should see 2015 EBITDA of $27million. Based on its current market capitalization and estimated 2015 cash balance, Indigo is trading at an EV/EBITDA multiple of 2.2 times. Typically, a five times EV/EBITDA multiple can be ascribed to steady, low growth businesses. In Indigo’s instance, a five times multiple results in a share price of over $12.50.

POSSIBLE DOWNSIDE: The largest risks are a significant weakening of the Canadian economy and/or a downturn in Canadian book sales.

WHO: John Stephenson, Senior Vice President and Portfolio Manager, First Asset Investment Management Inc.
PICK: Citigroup Inc. (NYSE symbol: C) (among other U.S. financial stocks)
TARGET: 12-month price target of $65 per share
UPSIDE: Money centre banks in the United States are the most unloved sector of the S&P 500, as investors see them as slow growers that are fraught with regulatory risk, and their valuation reflects that skeptical view. However, a much derisked U.S. banking sector, with the powerful tailwinds of an improving U.S. economy, housing market, and rising interest rate environment and trough multiples, make this a massive buying opportunity.

Citigroup trades at 8.3 times forward P/E ratio versus a 50-year average multiple of 15.5 times. The company is on a steady path to a fully normalized earnings recovery, and with this improving financial health, Citigroup is to release billions in loan loss reserves that will be returned to shareholders in the form of dividends, share buybacks, and special dividends.

The company is greatly derisked and now boasts more than 50 percent of its revenue from outside of North America, making it a play on a recovering global economy.

The company is well capitalized, with its Basel III Tier 1 common capital ratio recently clocking in at 10.5 percent. The company is being effectively restructured and derisked, led by an experienced turnaround management team of Chairman Michael O’Neill and CEO Michael Corbat.

POSSIBLE DOWNSIDE: The biggest risk to Citigroup and the U.S. money centre banks is litigation risk stemming from the 2008–2009 financial collapse. But this risk is increasingly in the rear-view mirror, which will lead to the release of provisions for pending litigation over the next several years. This will help underpin a healthy return-of-capital story for investors.

WHO: Robert Spafford, MBA, CFA, Partner & Portfolio Manager, Toron AMI International Asset Management.
PICK: Keppel Corporation (Bloomberg symbol: KEP SP, Reuters symbol: KPLM.SI)
TARGET: S$13.00
UPSIDE: Keppel Corporation is a Singaporean conglomerate with major interests in offshore oil rig construction (including jack-ups, floating production storage and offloading vessels [FPSOs], drill ships, and semi-submersibles), property investments and development throughout Asia, and infrastructure development activities.

Following S$7.0 billion in new contracts in 2013, Keppel Offshore & Marine’s net order book stood at S$14.2 billion at the end of 2013. So far in 2014, the company has signed contracts totalling more than S$1.8 billion, and with yard slots in 2014 and 2015 already filled, the group is now focusing on its remaining slots in 2016.

We believe that the market requirements for younger, more sophisticated equipment will continue to drive demand for new jack-up rigs. Further supporting this demand is an ongoing replacement cycle, as roughly half of the existing global jack-up fleet is more than 30 years old.

Longer-term, Mexican energy reforms should be positive for Keppel, as the company has signed a memorandum of understanding with Pemex to build an offshore yard in Mexico, giving it a first mover advantage. Keppel’s recent agreement to manage a new Chinese yard opens the door to China’s large but protected offshore market, without large capital requirements.

While government measures to cool the property markets in both China and Singapore are likely to weigh on Keppel Land Limited’s results in 2014, the company’s land bank can support nearly 80,000 residential units, providing growth for many years to come. Keppel Land’s joint venture with China Vanke will allow the company to grow its portfolio of high-quality commercial assets in China. Relaxation of the one-child policy in China could create further demand for residential homes and could be a medium-term positive.

At S$10.93, the shares trade at an attractive discount to our intrinsic value estimate of S$12.00, and they pay an attractive dividend of 3.7 percent. Group net leverage stands at just 11 percent. Finally, Temasek, the sovereign wealth fund of Singapore, maintains a 21 percent equity interest, which we believe is an understated value to Keppel Corporation.

POSSIBLE DOWNSIDE: Sustained low world oil prices could result in global exploration and production companies reducing their capital expenditure budgets. Alternatively, financing constraints (either lack of available financing or higher funding rates) could impact future order activity. In these scenarios, the stock could trade down to $9.50.

WHO: Brian Huen, Managing Partner, Red Sky Capital Management
PICK: Hudson’s Bay Company (TSX symbol: HBC)
TARGET: 12-month target of $22 to $25
UPSIDE: Unrealized real estate value from both Hudson’s Bay Company and Saks presents an attractive upside. Restructuring and growth opportunities within the newly combined entity create a solid-base business. At the same time, the U.S. listing of the real estate investment trust and/or the retailer will provide support for further investor interest and multiple expansion.

Strong and value-oriented shareholder base will push for value maximization strategies. It also represents a unique way for Canadians to get exposure to the U.S. dollar.

Upside risks would be significantly higher value in real estate versus the current estimate of $3 billion, improved operating performance from retailing segments, and a restructuring of underperforming businesses (Lord & Taylor).

POSSIBLE DOWNSIDE: For this stock, downside risks include lower expectations in the monetization of real estate or failure to monetize, a weaker retailing environment in Canada and the U.S., or inability to execute on expansion plans for Saks in Canada.