The Toronto Stock Exchange building on Bay Street in Toronto on Jan. 23, 2019.Chris Helgren/Reuters
Investors already struggling with threats from high interest rates and a slowdown in economic activity are facing another source of worry right now: government interference.
There’s something about politicians trying to appeal to voters that can push a good stock into a steep descent, leaving investors blathering helplessly over whether political winds will perhaps shift again – one day.
First Quantum Minerals Ltd. FM-T offers the most gruesome example – and poses a big dilemma for investors.
The Vancouver-based company operates a copper mine in Panama that had received support from the government there. But as a new 20-year contract – underpinned by a substantially higher tax rate – meandered through the country’s legislature, widespread public opposition from environmentalists, Indigenous groups and labour activists spilled into the streets.
Now, Panama’s President is saying that the final approval of the new contract for the Cobre Panama mine – which accounts for about 60 per cent of First Quantum’s net asset value (essentially the discounted value of future cash flow) – will face a binding referendum in December.
Investors expect the worst: First Quantum’s share price slumped 47 per cent over the first three trading days this week. It closed Thursday at $15.72.
Bryce Adams, an analyst at CIBC Capital Markets, said the best-case scenario for investors would be a landslide vote in Panama in favour of approving the contract. The worst-case scenario: expropriation of the mine, which would reduce his estimate of the net asset value of First Quantum to $9.24 per share from $27.42.
“Worse still, in that scenario we estimate that debt servicing would be insurmountable,” Mr. Adams said in a note.
Sure, this is Panama, which isn’t exactly a large base of operations for many Canadian companies. Yet there are examples closer to home where politicians are tapping into popular outrage and adding significant risk to shareholders.
Grocers, including Loblaw Cos. Ltd. L-T, Metro Inc. MRU-T and Sobeys parent Empire Co. Ltd. EMP-A-T, have come under fire from Prime Minister Justin Trudeau this year. Mr. Trudeau has made these companies central to the federal government’s battle against inflation – and rising food prices – and has even threatened the sector with punitive taxes.
Picking a villain might make good politics when many Canadians are struggling to pay their bills, but it is unclear exactly how grocers are to blame for inflation when producers are also raising prices.
Investors are in a tough spot. There is a lot affecting grocers’ share prices besides political manoeuvring, including concerns about declining economic activity and weaker consumer confidence. But it’s worth noting that stock valuations are down.
In the case of Loblaw, the stock traded at a recent low of just 14.5 times estimated earnings last week. That’s well below its five-year average price-to-earnings ratio of 16 and down from a recent high of 18.6 in December, according to Bloomberg.
Canada’s biggest banks have also become political targets. The Trudeau government has imposed new taxes, including the Canada Recovery Dividend, on financial institutions to help offset government debt incurred during the worst of the pandemic.
In September, the interference prompted a rare public pushback from the Canadian Bankers Association, the industry lobby group, which argued that taxing banks could stunt lending activities.
The targeting of banks goes beyond taxes. The federal Conservatives are demanding the government block Royal Bank of Canada’s deal to acquire HSBC Bank Canada, arguing that the takeover would hurt competition within Canada.
Bank stocks, already reeling from a stalled Canadian economy and a worsening credit environment, may now be reflecting political risk as well.
How should investors respond? The good news is that buying into politically driven uncertainty can deliver bargains – that is, if you’re willing to bet that the risk will blow over.
Hydro One Ltd. H-T offers a great example of how this sort of bet can pay off. Doug Ford, now Ontario’s Premier, redirected public anger over rising electricity rates to the utility during the 2018 provincial election, vowing to turf the chief executive officer if he won.
He did. And by late July, 2018, weeks after Mr. Ford became Premier, the political interference had clearly contributed to Hydro One’s share price hitting a record low. But as investors guessed – correctly – that the utility’s days as a political football were over, the share price rallied 24 per cent over the next 12 months.
There is no guarantee that Canadian banks will also escape political attention one day, and what transpires next month at First Quantum is anyone’s guess.
That leaves the beaten-up stocks looking like tempting opportunities. But the political risks can’t be ignored.