10 gems for the value investor

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Two years after the market meltdown and the punishing recession that followed, investors are still rattled. Canadian stock markets remain about 20% below their pre-meltdown highs, and U.S. markets are still roughly 30% below their peaks. Worse, some of the biggest traditional blue chips proved to be flabby 800-pound weaklings during the crisis. Remember, folks, we live in a world where General Motors went bankrupt.

Are there any companies left that investors can still have faith in? You know, businesses that keep delivering profits and returns to shareholders year in, year out, in recession and recovery, through panic and euphoria in the markets? Has any company's share price climbed back beyond pre-crisis highs? And if these gems exist, do you now have to pay exorbitant share price multiples to buy their stock?

The short answer is: There aren't many, but there are some. You have to look beyond the biggest publicly traded Canadian companies atop rankings such as Report on Business magazine's Top 1000. And it turns out that some of these smaller gems are still bargains, priced well below the traditional value investor's price/earnings (P/E) ratio threshold of 20.

And a few of them look almost unbelievably cheap. Say that to Réjean Robitaille, CEO of Montreal-based Laurentian Bank, and he chuckles. Laurentian's profit has climbed more than 20% annually over the past three years, and it was the only major Canadian bank to raise its dividend in 2009. Yet the bank's shares still trade at a lowly nine times forecast earnings. "They look like a bargain to me, too," Robitaille says.

There is no foolproof method for finding these companies, but many of them share some traits. First, they aren't in hot sectors like mobile computing or green power, but in traditional Canadian businesses such as coal, oil, agriculture and fish. To discover how the managers of these firms have improved on traditional strategies, you have to look beyond a company's financial statements, to find out what it actually does. That's what we did, and here's what we found out.

ALLIANCE GRAIN TRADERS
Top 1000 Rank 230 Revenue $389 million Profit $29.9 million Three-year share price gain 328% (all ranking, revenue and profit numbers are from the 2010 Top 1000, which is based on results in 2009. All share price gains are from August, 2007, to August, 2010)

Alliance Grain Traders founder and CEO Murad Al-Katib, 37, and his brother Omer, 39, the head of investor relations, aren't the most likely Prairie agricultural magnates. Yes, they grew up in Davidson, Saskatchewan, but not on the farm. Their parents were Turkish immigrants-dad a physician and mom a community activist who was elected mayor. Every summer, the family travelled overseas. "They wanted us to know there was a world outside Canada," says Murad.

In 1995, Murad completed an MBA. Next stop, he figured, was Wall Street. But he also sent a three-page letter-not an e-mail-to Roy Romanow, then-premier of Saskatchewan, arguing that the province needed to develop new markets abroad for its commodities. The government quickly hired Murad to head up its trade promotion and financing efforts in emerging markets.

After six years in government, Murad decided to found his own business in 2001, starting with just "a piece of paper in my basement in Regina." The big idea: lentils. As tends to happen with Canadian staples, Saskatchewan was producing a lot of them but not capturing the value added in processing.

In 2003, Murad finished building a plant in Regina and shipped his first $10,000 order of lentils. Four years later, he raised $14 million from investors in a private placement to fund a reverse takeover of a Canadian Venture Exchange company. Annual revenue has exploded from $79 million in 2007 to $389 million in 2009, and Alliance is now the largest lentil and pea splitting company in the world, with 21 plants in Canada, the U.S., Turkey and Australia.

Alliance adds value with a liberal application of technology. Each humble lentil is split, cleaned and polished with canola oil; Murad is also proud of the company's techniques for destoning and sorting batches of the little legumes.

Last year, Alliance completed its biggest acquisition to date, spending $104 million for Turkey's Arbel Group, a pulse specialist that also sells its pasta in 52 countries. But thanks to several successful share issues, Alliance hasn't had to borrow much to grow. Its long-term debt is just $23.5 million.

"I've said we want to be a $1.5-billion company in five years," says Murad. Yet despite the rapid growth and a run-up in Alliance's share price from $8 in early 2009 to around $30 lately, it's trading at just nine times forward earnings.

BONTERRA ENERGY CORP. Top 1000 Rank 151 Revenue $138 million Profit $68.6 million Three-year share price gain 52%

Why spend a gazillion dollars and cause massive environmental dislocation to extract oil from the oil sands in Northern Alberta when there are still plenty of conventional deposits left further south in the Western Canadian Sedimentary Basin?

Why, indeed. The trouble is that producers have been sucking oil out of the basin for more than half a century, and much of the stuff that remains is in hard-to-reach pools underground. Many old wells are pumping out as little as 10 barrels a day, and Alberta drillers and producers have been squeezed as oil prices have slid from a peak of more than $140 (U.S.) a barrel in mid-2008 to around $75 (U.S.) recently.

But over the past year or so, Calgary-based Bonterra and a handful of other mid-level players have created a flurry of excitement by deploying a new technology-multi-stage fracturing-in the venerable Pembina oilfield southwest of Edmonton. They've been tapping into a geological formation called Cardium using horizontal drilling, then pumping huge amounts of sand and liquid hydrocarbon underground to push out the oil-a complex process, but less environmentally brutal than the oil sands. Many of Bonterra's wells yield more than 250 barrels a day.

For savvy oil investors, that technology creates an almost ideal scenario: Although Bonterra is drilling into a mature field, both current output and proven oil reserves that the company carries on its books are increasing. "Even though it's mature, we still have a long life of production," says Bonterra CEO George Fink.

The technology also lowers production costs per barrel. Despite the sharp decline in oil prices in 2009, Bonterra's revenue climbed from $125 million in 2008 to $138 million last year, and its earnings increased from $55 million to $69 million. The company's share price has soared, too, from $14 at the depths of the stock market meltdown in early 2009 to about $37 recently. But the forward P/E is still only about 11.

LAURENTIAN BANK OF CANADA Top 1000 Rank 109 Revenue $1.2 billion Profit $113.1 million Three-year share price gain 25%

Is it a big advantage for a major Canadian financial institution to be headquartered in Quebec and do the lion's share of its business there? In recent years, oui. Compared to other provinces, the impact of the recession has been less severe in Quebec, where Montreal-based Laurentian generates about 60% of its business. As a result, the earnings of Canada's No. 8 bank have been stronger and far more consistent than those of the Big Six.

Laurentian is often labelled a "regional bank" by analysts, but CEO Réjean Robitaille says that "doesn't mean we're a small bank. We're a regional bank with a Canadian scope." Laurentian has $23 billion in assets, making it the 60th largest bank in North America.

Robitaille, who joined the bank in 1988 and became CEO in 2006, says Laurentian's strong earnings are the result of much more than its location. It also avoided the big mistakes that many of its competitors made in the early 2000s. It chose not to aggressively expand into foreign markets, nor to dive into complex and dangerous products such as asset-backed commercial paper.

Instead, Laurentian stuck with what Robitaille calls its three "growth engines." The first is wealth management for individuals and small and medium-sized businesses in Quebec. The latter two engines are national in scope: business-to-business trust services; and commercial loans to medium-sized companies, construction loans in particular. "I think we could double the size of the bank," Robitaille says. Laurentian's share price performance has also been strong, climbing back from $25 in early 2009 to $45 recently. Yet the P/E ratio of about nine is still much lower than most of the Big Six. (Robitaille figures this is a lingering hangover from problems Laurentian experienced in the late 1990s.) Moreover, after last year's dividend increase, the yield is an attractively hefty 3.2%, and Robitaille would like to keep raising payouts. "It's a way to thank our shareholders," he says.

EXCHANGE INCOME CORP. Top 1000 Rank 315 Revenue $212 million Profit $13 million Three-year share price gain 22%

Canada's income trust boom exhibited a distinct pattern as it was heating up back in 2002. Financiers would find a publicly traded company that generated a healthy regular cash flow. Then they'd persuade management and shareholders to convert it to a trust-which could avoid tax by paying out almost all of its operating profits to investors as distributions.

To veteran Winnipeg merchant banker Mike Pyle, that approach was risky. When you invest in a single company, rather than several in different industries, you're fully exposed to the cycles in one sector. Also, investors at the time were paying high prices to get in on trust conversions-often six or seven times a company's annual operating profits, as measured by earnings before interest, tax, depreciation and amortization (EBITDA).

Pyle's solution: Raise money from investors first, then buy several companies in a variety of sectors. Pyle also figured it was best to search for "old, boring, cash-generating businesses." Family-owned companies with succession issues, in particular, are often good bets to take out because owners will often sell at a reasonable price-say, four to five times EBITDA. So, in 2004, Pyle formed one of Canada's first diversified income trusts.

The goal, originally, was to buy manufacturers with $2 million to $5 million in earnings. But Exchange's first acquisition was a surprise: In 2004, it paid $18 million to buy Perimeter Aviation, a regional airline serving Manitoba, Northern Ontario, Minnesota and North Dakota. Yes, major airlines are notoriously boom-and-bust. Little ones, not so much. Pyle points out that in many northern communities, particularly native ones, passenger and cargo demand "doesn't vary with the economy-it's an essential service."

Exchange has since bought two other northern airlines, Keewatin Air and Calm Air. The diversification goal notwithstanding, air transport accounts for 78% of Exchange's revenues. It also has holdings in specialized manufacturing, including makers of storage tanks for fuel, water and sewage, and another that makes industrial and commercial washing equipment. Last year, Exchange converted back from a trust to a corporation to comply with changes in tax rules for trusts that take effect in 2011. Its goal is still to generate steady income for investors, now as dividends rather than trust distributions. Looking ahead, Pyle, 46, says he'd like to add "a third leg to the stool"-another sector.

So far, the narrow mix has worked. Exchange's share price, which had been $12 in late 2007, dipped in 2008, but has climbed to around $15 lately, still only about 11 times forecast earnings for 2010.

HIGH LINER FOODS Top 1000 Rank 266 Revenue $627 million Profit $19.8 million Three-year share price gain 18%

If you want to make money in the seafood business in Atlantic Canada, here's a hint from High Liner Foods chief financial officer Kelly Nelson: Don't buy or hire boats to catch fish yourself. There's no money in it. That became painfully clear to a lot of East Coast fishery executives in the 1980s and 1990s. "We had to reinvent the company," says Nelson, "and it took us until 2006 to get rid of the last fishing assets."

High Liner was formed in 1899, and is still based in historic and picturesque Lunenburg, Nova Scotia. But the reality of the seafood business today is that the raw products are global commodities that can be sourced anywhere. High Liner still buys scallops from Nova Scotia fishers, and cold-water shrimp from Newfoundland, but it also purchases ocean shrimp and groundfish from as far away as Central America and Asia.

The profits are in processing and expanding into new markets abroad. High Liner currently generates about half its sales in Canada, and half in the United States and Mexico. But it would like to boost the U.S. portion significantly. "We're already the leader in Canada in every channel," says Nelson. But in the U.S., High Liner still has room to grow in all markets-supermarkets, restaurants and institutions such as universities and hospitals. In 2007, when Newfoundland's FPI Ltd. sold off all of its assets, High Liner bought its North American food service and frozen seafood business for $146.5 million.

That acquisition doubled High Liner's revenues from just under $300 million in 2007 to $627 million last year, and tripled its profit to about $20 million. The share price has climbed, too, although not a lot-from about $10 before the acquisition to more than $11 lately. Many investors still apparently don't fully comprehend how High Liner has reinvented itself, so that share price is a modest eight times forward earnings.

GRANDE CACHE COAL Top 1000 Rank 121 Revenue $262 million Profit $106.2 million Three-year share price gain 445%

There's very little about Calgary-based Grande Cache, or its coal deposits northwest of Jasper National Park, near Alberta's border with British Columbia, that's startlingly new or dramatic. Mines have been in operation in the area since 1969, and 56-year-old Grande Cache CEO Robert Stan has been in the coal business since 1979.

Yet many investors apparently view Grande Cache as a risky junior producer in a volatile sector. Both assumptions are mistaken, says Stan. True, he and a group of veteran Calgary resource executives formed Grande Cache in 2000 after the previous owner of the deposits was forced into receivership during a punishing slump in world coal prices. But the new owners knew the property very well, and were certain the long-term prospects were excellent.

Grande Cache produces coking coal (it's baked to yield coke, which is used in steelmaking). Although North America's steel industry was in a slump in the early 2000s, Stan and his colleagues could see huge surges in demand looming in China, India, Brazil and Russia. "People aren't building things out of fibreglass and bamboo over there," he says. "They're building out of concrete and steel." And from the coking coal buyer's point of view, Canada is more politically stable, hence a more reliable source, than other potential suppliers such as Mozambique and Mongolia.

In 2004, Grande Cache raised $57 million in an IPO on the TSX and began production. Annual output has grown from 400,000 tonnes to 1.8 million for the latest fiscal year ended March 31, 2010. Sales have more than doubled over the past three years, half of that business in 2009 going to China, which now has about half the world's steelmaking capacity.

Is Grande Cache vulnerable if there's a slump in Asia? Stan says a downturn is unlikely, but certainly possible. "Just remind me of the last time the good times lasted forever," he quips. That's why the company is trying to fund its expansion mostly though its own cash flow, rather than debt, and contains its costs by doing things like leasing equipment, rather than buying it.

Despite management's cautious strategy, Grande Cache's share price has had some wild ups and downs over the years, rocketing from $3 to $16 in 2004, plunging to below $2 for most of 2006 and 2007, surging briefly in 2008, and climbing to close to $6 over the past year. At that price, it's trading at just four times its forecast earnings.

LASSONDE INDUSTRIES Top 1000 Rank 225 Revenue $524 million Profit $30.6 million Three-year share price gain 45%

Lassonde isn't a familiar name in English Canada, but the fruit juices and drinks it makes are, including Allen's, Everfresh, Fairlee and Oasis. These brands, plus private labels that Lassonde produces for supermarket chains, compete head-to-head with Coca-Cola's Minute Maid and PepsiCo's Tropicana, as well as British Columbia-based Sun-Rype. Lassonde also recently beefed up two divisions focusing on specialty packaged foods (mostly sauces) and wine distribution.

The company was founded by Aristide Lassonde as a vegetable cannery in Rougement, Quebec, southeast of Montreal, in 1918. In the 1950s, Aristide's son, Willie, shifted the focus to making juice from the region's renowned apples. But the push into English Canada didn't start until 1999, when Lassonde bought the rights to the Allen's trademark. In 2004, the company added Toronto-based Alfresh Beverages. "We've been good at buying brands that were declining and reviving them," says Lassonde vice-president and CFO Guy Blanchette.

That cautious expansion reflects the long-term outlook of chairman and CEO Pierre-Paul Lassonde, who represents the third generation to run the company. As with many family-managed Canadian companies, he maintains control through a split share structure-he owns all 3.8 million class B multiple-voting shares, while the 2.8 million class As trade on stock exchanges.

Institutional investors usually don't like dual-class share structures on principle, but it's hard to argue with Lassonde's returns. Apart from a dip during the 2008-'09 stock market slide, the share price has increased steadily over the past decade from below $15 to more than $50 lately. "After what has been happening with private equity buying a lot of companies and not necessarily doing well with them, I think people now appreciate it when good operators want to stay," says Blanchette. "It may be good for the other shareholders that are tagging along."

Indeed, the hardest part for prospective buyers can be finding shares to purchase. A handful of Quebec institutional investors have large holdings in Lassonde, and much of the rest of the public float is held by patient individuals. Trading volume is usually just a few hundred shares a day, at what looks like a bargain price of less than 12 times trailing earnings.

HOME CAPITAL GROUP Top 1000 Rank 91 Revenue $489 million Profit $144.5 million Three-year share price gain 24%

Probably the scariest phrase in the business lexicon stateside is "alternative mortgage lender." The great collapse of 2008 was caused by dubious lenders loaning to dubious buyers, and institutions then packaging those loans into dubious securities.

Yet here in Canada, one of the most stable and stellar performers during the upheavals of the past three years has been Toronto-based Home Capital Group, whose Home Trust Co. specializes in lending to homebuyers who have trouble getting mortgages from the banks-owners of small businesses, recent immigrants with no credit history and borrowers with past credit problems.

For the second quarter ended June 30, Home's profit climbed by 26.3% to $43.3 million-the company's 16th consecutive quarterly profit increase. "We think our business model works," says Home president Martin Reid, sounding about as boisterous as he gets.

That model is determinedly old-fashioned. Canadian banks rely heavily on computer processing of mortgage applications. At Home, says Reid, "real humans" make all final decisions to accept or reject. And they do that within 24 hours, whereas banks often take days, despite the technology.

Yet the company is still small enough to be choosy about its borrowers. There are roughly $1 trillion in mortgage loans outstanding in Canada. Home has about $12 billion of those loans, or 1% of the total market.

Home is also steadfastly old school about how it finances its loans. During the U.S. real estate bubble, many lenders relied on short-term commercial paper for financing. They would then sell the mortgages as quickly as possible for cash. The institutions that bought the loans would then package them into often bewildering mortgage-backed securities, and shovel those off to investors. But when short-term commercial paper markets froze up, the house of cards collapsed.

Home keeps about 52% of its loans on its own balance sheet. To support them, especially during the liquidity crisis of 2008, it's kept a large proportion of its assets in safe and highly liquid government and bank bonds. Prudent market timing has helped, too. In the third quarter of 2009, when executives could see a turnaround gathering steam in the housing market, the company started lending more aggressively again.

On average, Home has been doubling in size every five years, and Reid sees no reason why that can't continue. The company's share price sank below $20 in early 2009, during the darkest days of the mortgage crisis, but it's motored back above $40 recently. Yet that's still only about eight times forecast earnings for the current year. "We'll focus on our part, which is generating the earnings, and eventually the market will see the value," says Reid.

BMTC GROUP Top 1000 Rank 154 Revenue $825 million Profit $67 million Three-year share price gain 106%

In a brief but, uh, lively phone conversation, BMTC chairman and CEO Yves Des Groseillers explains that he never grants interviews to analysts or reporters because he thinks that all investors should have access to the same information at the same time. So he prefers to let the financial statements and news releases of his furniture and appliance retailing business do the talking. Besides, he says cheerily, journalists and analysts "are all b.s. anyway."

All the best to you too, sir. But, to be fair, BMTC's numbers tell an impressive story. The family-run holding company owns two Quebec chains, Brault & Martineau Inc. and Ameublements Tanguay Inc., that have an aggressive discount marketing approach similar to that of Leon's or the Brick. If you'd bought a washer-dryer set during a recent Brault & Martineau "truckload sale," you could pay in 36 interest-free monthly instalments.

True, BMTC's total revenue dipped to $825 million in recession-plagued 2009, after climbing from $820 million to $860 million over the previous three years. But net income remained virtually level at $67 million.

The share price performance has been even more encouraging. Given those solid earnings and still-strong home sales in Quebec-which bode well for furniture and appliance sales-BMTC's share price has more than doubled from less than $10 in 2009 to around $22 recently (this reflects a 2-for-1 share split in April). Virtually the only caveat is that BMTC's public float is small and its shares are thinly traded. That's partly why the forward P/E is still an attractively low, low 12 or so. And that's no b.s.

PACIFIC NORTHERN GAS Top 1000 Rank 378 Revenue $104 million Profit $6.5 million Three-year share price gain 42%

Pacific Northern Gas was formed in the mid-1960s, when it built and opened a natural gas pipeline in British Columbia from Summit Lake, just north of Prince George, to Prince Rupert and Kitimat on the Pacific coast. The company was stable and profitable for decades; but in 2000, there was a crisis when PNG's biggest customer, Methanex, closed its methanol plant in Kitimat for a year. PNG began a long and complex financial reorganization that it finally completed in 2005. That year, however, Methanex shut down the Kitimat plant permanently.

Companies that lose domestic customers often try to find new ones abroad, but that's not easy for a gas pipeline company in a remote area. Yet that's what PNG has done. In 2006, it entered into a 50-50 joint venture agreement to build a pipeline to Kitimat, where gas will be converted to liquid natural gas and loaded onto tankers for export.

At first, investors didn't seem to believe that PNG could pull off a project that big. The company's share price drifted around $17 until 2008, and then was hammered down to $12 by the stock market crisis. The Kitimat project, scheduled for completion in 2015, does face some hurdles: The pipeline will require about $1.2 billion in financing, and the project must satisfy both regulators and First Nations whose lands are affected.

But PNG has made steady progress with governments and native bands, and the project got two shots in the arm this year when Texas giants Apache Corp. and EOG Resources Inc. agreed to buy the other 50% of the joint venture. PNG's shares have popped up to about $26 lately. "We weren't given a lot of credit for a while," says CEO Roy G. Dyce, "until Apache and EOG stepped up."

You also have to be impressed by PNG's solid operating track record, even through the upheavals in the early 2000s. The company has paid a dividend every year since 1978 (payments were suspended from 2000 to 2003, but PNG then covered all the missed payouts in one shot). Dyce has been CEO since 1994. "I've been through the ups and downs," he says. "I've got the grey hair to prove it."

And the share price still seems to be right. Despite the surge in the first half of this year, PNG is trading at a modest forward P/E of just over 12.