Is Canada’s Housing Market About to Rebound?

By Ari Charney • July 2, 2013 • Canadian Edge Weekly

A number of investors remain concerned about the health of Canada’s housing market, and depending on how you slice and dice the data, there’s plenty for optimists and pessimists alike.

While the Canada Mortgage and Housing Corp (CMHC) expects full-year 2013 housing starts to drop 14.9 percent from a year ago, to 182,900 units (the midpoint of its projected range of 173,300 units to 192,500 units), the government agency forecasts a return to growth toward the end of the year.

And the midpoint of next-year’s projected range (166,500 units to 211,300 units) indicates year-over-year growth of 3.3 percent, though it should be noted that the low end of that range is nearly 4 percent below the low end of the 2013 range.

So what could spur this growth amid an otherwise anemic economy? The CMHC believes both the economy and employment will improve in time to support the real estate market.

It’s difficult to reconcile that rosy outlook with the Bank of Canada’s forecast for the economy to grow 1.5 percent in 2013 versus 1.8 percent last year. But Canada’s gross domestic product (GDP) surprised economists by growing at a 2.5 percent annualized pace during the first quarter.

And April GDP grew 0.1 percent month over month, for the fourth consecutive monthly increase. That included a 1 percent rise in output from real estate agents and brokers for the second month in a row, thanks to an increase in sales of existing homes.

Less reassuring is the fact that the resource sector appears to be contracting, with mining, quarrying, and oil and gas extraction down 1.5 percent from a month ago, the first decline in seven months. However, drilling drove a 3.2 percent rise in energy services, and that could bode well for future extraction.

Of course, the ratio of household debt to income is still near its record high. That ratio stood at 161.8 percent at the end of the first quarter, though it’s declined for two consecutive quarters from its all-time high of 162.8 percent at the end of the third quarter of 2012.

At the same time, housing prices are expected to continue heading higher, with an average listing price ranging between CAD359,400 to CAD380,000 in 2013 and CAD362,400 and CAD392,200 in 2014, with the average home price up 1.6 percent and 2.1 percent, respectively.

May sales rose in 24 of Canada’s 28 major markets compared to the prior month, while listings rose in 18 markets, four higher than a year ago. However, the sales-to-listings ratio fell in 23 markets, which suggests that price increases offset flagging demand. Indeed, only three markets suffered a drop in prices.

Higher prices despite excess supply are usually indicative of a market top, especially since regulators have made housing less affordable for first-time homebuyers. Last July, Finance Minister Jim Flaherty tightened the rules governing the types of mortgages that could be insured by the CMHC. The most significant change was the shortening of the amortization period to 25 years, down from 30 years.

Although that reduces the overall amount of interest borrowers would pay over the life of the loan, it also means that monthly mortgage payments rose an average of CAD200 to CAD300.

By making it more difficult for first-time homebuyers to afford a home, that dampens support from the one demographic that replenishes demand with each passing year. Now it’s just a matter of when prices finally succumb to reality. Of course, that doesn’t mean there won’t be a soft landing, however tempting it is to extrapolate the popping of the US real estate bubble to overheated housing markets elsewhere.

The Roundup

In May, Parkland Fuel Corp (TSX: PKI, OTC: PKIUF), Canada’s largest independent supplier and reseller of fuels and petroleum products, reported sales and earnings per share that exceeded analyst estimates by 11.3 percent and 37.3 percent, respectively.

Shares of the CAD1.2 billion company rose as much as 13.3 percent in the several trading sessions following its earnings announcement, but are currently down 6.3 percent from that near-time high. Meanwhile, Parkland’s shares presently trade 15.6 percent below the 52-week high set back in early February.

For the past eight quarters, sales results have been within 7.7 percent of analyst estimates, while earnings per share have been more volatile. For instance, second- and third-quarter 2012 results blew past estimates by 640 percent and 249.6 percent, respectively, while fourth-quarter results fell short of projections by 49.3 percent.

Drilling down into the actual numbers, Parkland reported CAD1.2 billion in revenue, up 14 percent from the prior-year period, while profits jumped 74 percent, to CAD30.5 million. Distributable cash flow (DCF) increased 73 percent to CAD44.9 million, causing the dividend-to-DCF payout ratio to improve to 39 percent versus 64 percent a year ago.

The company’s all-cash acquisition of Elbow River Marketing, which closed on Feb. 15 at a price of CAD95 million, including the assumption of CAD15 million in debt, helped boost first-quarter fuel volumes 29 percent year over year, to 1.4 billion liters. Absent Elbow River’s contribution, fuel volumes would have declined by 1 percent, largely due falling commercial fuel volumes (down 6.4 percent, to 433 million liters) as a result of a sharp drop in natural gas production.

Elbow River’s extensive network of relationships with refiners, fuel suppliers and customers, along with its fleet of 1,200 tank cars, should help Parkland ensure landlocked energy commodities in Western Canada reach key markets throughout North America.

On April 2, Parkland announced the acquisition of Sparling’s Propane. The price was not disclosed, but management says the purchase makes Parkland a major player in the Canadian propane market. Sparling’s Propane delivers 120 million liters of propane each year to around 25,000 customers. Management notes Sparling’s operations complement Elbow River’s efforts in this arena.

These were Parkland’s first two acquisitions since mid-2011. And it looks like M&A will be key to achieving the ambitious growth targets in the company’s Parkland Penny Plan, which aims to grow annual fuel volume sales to 7 billion liters by 2016, while achieving higher margins via economies of scale and other efficiencies.

Management hopes to double its 2011 normalized EBITDA (earnings before interest, taxation, depreciation and amortization) of CAD125 million by the end of 2016, with CAD55 million of this growth derived from acquisitions and CAD70 million from higher operating margins.

Among Bay Street analysts, Parkland currently has six “buys,” three “holds,” and no “sells.” There was no change in the ratings mix following earnings. Among the eight analysts for which we have data for price targets, the consensus 12-month target price is CAD19.28, which is 11.2 percent above the current share price.

Analysts forecast full-year 2013 sales to rise 24.4 percent, to CAD5.1 billion, while earnings per share are projected to rise a more modest 6.3 percent, to CAD1.36. Thereafter, sales growth is expected to slow to 3.9 percent in 2014, while earnings per share are forecast to fall 17.6 percent, to CAD1.12.

At the end of the first quarter, Parkland had CAD22.5 million in cash and cash equivalents on its balance sheet and CAD329.7 million in long-term borrowings. Total long-term liabilities stood at 33.5 percent of total assets.

Parkland has CAD97.8 million in convertible debt coming due in November 2014, and another CAD45 million coming due at the end of 2015. The company has CAD342.4 million available from its credit revolver, after accounting for the CAD107.6 million it’s already drawn.

After cutting its monthly dividend to CAD0.085 in Jan. 2011, when it converted from an income trust to a corporation, Parkland finally boosted its payout in March, by 2 percent to CAD0.0867.

With its shares yielding 6 percent, Parkland Fuel Corp remains a buy below 18 in the Aggressive Portfolio.

Here’s where to find our analyses for Portfolio Holdings that have reported earnings for the first quarter of 2013:

Conservative Holdings

Aggressive Holdings

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