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Canada: America Junior No More

Canada represents the best and safest way to invest in the long-term commodity bull market as well as growth in Asia.

Homer Simpson, the star of The Simpsons, the brilliant, animated satire of American life, perhaps best summed up most Americans' opinion of Canada in an episode from 2002. When his son Bart suggests they go to Toronto, Homer responds incredulously, “Canada? Why should we leave America to visit America Junior?”

Typical, eh? If you're Canadian, that pretty much epitomizes Americans' rather arrogant and condescending view of Canada. Perhaps Americans — particularly American investors — shouldn't be so smug. Canada has much to boast about and, in fact, represents an excellent investing opportunity. Consider these facts: Canada, the eighth-largest economy in the world, has an unemployment rate at a 30-year low, and for four straight years, the country has run a positive trade surplus and a budget surplus. The country is filled with every commodity that the world is craving, from oil and uranium to copper and gold. And — this is the best part for investors — Canada also offers companies that sell at substantial discounts to U.S. company valuations. In my opinion, Canada represents the best and safest way to invest in the long-term commodity bull market as well as growth in Asia.

Our long-ignored neighbor to the north offers enormous opportunities, from investing in the Canadian dollar to buying Canadian equities. You simply want to invest in Canada right now. (Note: My hedge fund, Sabre Value Fund, has long-term holdings in Canada, including the stocks mentioned in this article.)

The Loonie

I don't want to resort to hyperbole, but Canada is truly experiencing a modern-day gold rush. The description isn't perfectly apt — since it isn't limited to gold — it also includes tungsten, copper, natural gas, oil, nickel and others. Here is a fun fact to know and tell: Canada possesses the second-largest reserves of oil in the world behind Saudi Arabia (called Alberta's “oil sands”). And here is another: Starting next year, Canada will likely be the third-largest producer of diamonds in the world. Of course, this boon in its natural resource sector is why unemployment is so low, wages are soaring and real estate prices are jumping.

Investment is surging into the country to develop its natural resource base, which represents about 11 percent of its economy. And with the surge in prices for commodities, Canada's tax revenue has increased. So much so that the government of Canada is running a huge budget surplus and has been actively buying back debt. The province of Alberta has not only paid off all of its debt, it issued C$400 checks to every citizen earlier this year, because it did not know what to do with its money.

Comparing the economic fundamentals and health of Canada to the U.S. is quite dramatic. This is why I recommend that investors buy the Canadian dollar as a way to hedge against the depreciation in the greenback. It's interesting to note that in the last inflationary period, 1971 to 1976, the Canadian dollar traded for par to a premium to the dollar versus the current rate, in which US$0.88 will buy you a Canadian loonie, as its currency is nicknamed. Actually, it could be worse for the U.S. dollar in the future: In 1971 the U.S. was a creditor nation, not the debtor nation it is today, and Canada's oil reserves are far greater and much more developed today than they were in the 1970s.

To put it more plainly, I think the Canadian dollar may actually soar over US$1 in the next five years. With massive budget surpluses, the Canadian government can spend money on infrastructure and other public works projects that should pump lots of money into the economy.

Of course, some may gripe that the Canadian dollar has already enjoyed a phenomenal run, from US$0.65 in 2002 to its current level. But the charge of the loonie isn't over just because of four years of rallying. You can't undo 20 to 25 years of underinvestment in commodities in just four years. As long as oil doesn't return to $30 (now at $75), copper to $1(now at $3.50) and nickel to $3 (now $11), there is sure to be investment in the country for at least another decade. Further, as Asia's commodity appetite grows, I expect closer ties in the form of investment and cooperation between Asia and Canada. In fact, I view Canada as a low-risk way to invest in China and India. (For more on the secular bull market for commodities, see legendary hedge fund manager Jim Rogers' book, Hot Commodities published in 2004 by Random House.)

It's Not Just About the Raw Materials

These macro factors not only benefit the currency, they also benefit many Canadian companies as well, which makes investing in Canadian equities just as compelling. Yes, it's true that most energy company stocks worldwide have been exploited for nice capital appreciation, and Canadian energy companies are no different. So, I'm not going to focus on energy names. Instead, I'm going to focus on companies you have never heard of with compelling valuations and, in some cases, attractive yields, too.

Being a believer in the Canadian economy, I want to own Canadian retailers, which benefit from rising wages and low unemployment. There are three opportunities to benefit from strong Canadian retail sales: Canadian Tire, Golf Town Income Fund and North West Company Fund.

Canadian Tire Stores are a weird mix of automotive goods, sporting gear and home products. Canadians love these stores: One-third of the bicycles sold in Canada are bought at Canadian Tire, as are one-quarter of all barbeque grills. Another fun fact: One-fifth of all hockey sticks sold in the world are bought at a Canadian Tire — and Canada has a small population (around 32 million). In short, Canadian Tire is undergoing a substantial expansion to take advantage of the strong Canadian consumer. (See table on p. 88 for valuations.)

What makes Canadian Tire all the more intriguing is that it is buoyed by two substantial assets: its credit-card division and its real estate. With an extremely undervalued $2 billion book value in real estate and a credit-card business that could be worth $3 billion, investors are essentially getting Canadian Tire's retail business for free. And that retail business should be strong for several years, thanks to the combined tailwinds of a strong economy and a robust consumer.

Golf Town Income Fund is a Canadian income trust yielding 10 percent. An income trust is a company that pays out most or all of its income into a dividend, and then is not taxed on a corporate level, much like U.S. REITs. But, in Canada, almost any company can become an income trust. Golf Town is the largest retailer of golf equipment, apparel and assorted golf-related items.

When I say that valuations are lower in Canada than in the U.S., Golf Town typifies the valuation gap. Golf Town trades at a mere seven times this year's forecasted earnings. The closest comparable American company is Golf Galaxy, which trades at 22 times earnings. And while Golf Galaxy pays no dividend, Golf Town pays more than a 10 percent yield in monthly increments. Better yet, Golf Town has been slow to raise its distributions and pays out only 60 percent to 70 percent of its distributable income. I expect it to raise its distribution by year-end, to an indicated yield north of 11 percent.

The North West Company Fund is probably my favorite of the Canadian retailers. This company is a Canadian income trust, much like Golf Town. It is a descendant of the famous Hudson's Bay Trading Company and can trace its roots back to 1779. They operate stores in the northernmost parts of Canada and Alaska, and operate the only stores in many towns.

Three years ago this was a boring company with a boring business. But as a result of the explosion in prospecting for commodities of all kinds and a robust Canadian economy, sales have picked up and are growing briskly. North West has 40 percent higher margins than Wal-Mart and has a natural moat around its businesses, because it is very costly and expensive to open a store in the northernmost spots of Canada.

North West trades at 15 times my earnings estimate of C$3.15 this year, and 13 times next year's estimate of C$3.60 a share. North West also pays out a 5 percent yield and has indicated it will raise its distribution again later this year, due to strong earnings and cash-flow growth. I think this company can grow earnings at 10 percent to 15 percent annually for the next five years, and that in three to four years it will be trading at C$100 a share.

Beyond the retail sector, there are some interesting commodity-related speculative — and not for every investor — small-capitalization companies to consider, including Baffinland Iron Mines and Bioteq Environmental. (The latter trades on the successor to the Vancouver Stock Exchange, which used to have a pretty bad reputation as a wild, penny-stock marketplace, where you'd “play” at your own risk. But it has since merged with Alberta's stock exchange to form the Canadian Venture Exchange and there are now tighter regulatory controls.)

Baffinland Iron Mines, a raw-materials play, is sitting on the highest quality iron ore deposit in the world. With China and the rest of the world driving steel demand higher, iron ore prices have doubled in the last two years. Iron ore is the chief commodity used in making steel. Three companies control 80 percent of the world's iron ore supply: BHP Billiton, Companhia Vale do Rio Doce ADS and Rio Tinto.

While Baffinland is a speculative small-cap, don't tell that to insiders who have bought over C$5 million worth of stock in the past year. Or Mitsubishi, which invested C$5.5 million last year. I expect more strategic partners to come on board, including some steel companies who may want to lock down this project to protect themselves from the iron ore cartel.

Don't be fooled by Bioteq Environmental Technologies name. It's no pharma company; this company cleans the wastewater that comes off of a mine. While cleaning the water through a biotech process, it can extract whatever metal — copper, nickel, gold and more — that is remaining in the water. This undiscovered company is an environmentalist's dream, but it is also on the verge of making money due to sky-high metals prices.

Bioteq already has a plant processing copper out of water from a Phelps Dodge mine in Bisbee, Ariz., and will soon be up and running with a nickel plant for Inco in Canada. The company is so busy that it actually doesn't have enough engineers to keep up with current demand.

China also beckons as an opportunity. Bioteq signed an agreement with China's largest copper company, Jianxi Copper, and will be running one plant for the company by the middle of 2007. Bioteq should break into profitability in 2007, a catalyst, in my view, to push the stock higher.

Finally, there is an interesting turnaround situation that investors should consider, CSI Wireless. While its former empire-building CEO fueled dreams of fixed-wireless glory to shareholders, the GPS division fed the other cash-guzzling divisions until the board got fed up. Earlier this year, it ousted the CEO and sold or closed down the other divisions. What CSI Wireless is left with is an excellent GPS division focused on the growth industry of precision agriculture. Using GPS devices to plant, seed, spray and fertilize fields is a growth area in the agriculture business, allowing farmers to cut down on soaring costs for fuel and fertilizer.

CSI Wireless is now in the messy task of cleaning up its business and unleashing a slew of new GPS products on the market. Its new Crescent receiver chip, which the company claims is faster, smaller and cheaper than competitors, drove sales 59 percent higher in the first quarter of the year. With cost cutting — down due to its smaller size — on track for this year, next year promises to be a year of record profits.

Breaking down the numbers, CSI Wireless has C$0.50 a share in cash and shares in another company, to which CSI sold a business unit. That means that at current prices of C$1.60, it trades at less than one times sales and six times my earnings estimate of C$0.20 a share in 2007. This compares to three times sales and 20 times earnings for comparable companies, like Trimble Navigation or Novatel. CSI Wireless is a steal at current prices.

And these are just a few of the opportunities I have found in Canada. Better returns await you in equities, which offer better yields and lower valuations, and an economy that looks to keep steaming ahead for years, thanks to strong commodity prices.

Go north U.S. investors. Go north.

Canadian Picks
These companies from the Great White North are worth a look.
Company Name Ticker Price (CAD) 52-Week High/Low Market Cap Yield 2007 P/E
Canadian Tire CTC.A $65.46 $71.71/$56.34 $5.12 billion 1% 13
Golf Town Income Fund GLF.UN 11.50 13.09/8.92 126 million 10 7
North West Company Fund NWF.UN 46.75 47.89/26.65 758 million 4.60 13
Baffinland Iron Mines BIM 2.31 2.95/1.20 98 million NA NA
Bioteq Environmental Technologies BQE 1.77 2.00/0.90 85 million NA 18
CSI Wireless CSY 1.62 2.69/1.11 74 million NA 8
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