Canada, the US and the Great Muddle

By David Dittman • October 11, 2011 • Canadian Edge Weekly

Statistics Canada reported last Friday that Canadian employers hired 60,900 new full-time workers in August, nearly six times the consensus estimate. Canada’s unemployment rate is now down to 7.1 percent, from 7.3 percent in August. The unemployment rate hasn’t been this low in Canada since December 2008.

In the 12 months ended Aug. 31 employment grew by 1.7 percent, or 294,000 jobs, concentrated in Ontario and Alberta. Full-time employment rose by 2.5 percent, or 344,000 jobs, while part-time work declined by 1.5 percent, or 50,000 positions. Total actual hours worked increased 2 percent.

The September 2011 Labour Force Survey is yet another sign of Canada’s strength relative to other developed economies. For example, the Organization for Economic Cooperation and Development (OECD) unemployment rate for August was 8.2 percent. And it set up an easy comparison with the US, where the unemployment rate still stands at 9.1 percent.

The US Economy: Still Growing…

It was a midsummer’s nightmare for stocks after Jul. 7, when the S&P 500 closed at 1,353.22, within striking distance of the 2011 closing high of 1,363.61 established Apr. 29. From there until Oct. 3’s 1,099.23 the most widely followed index in the world shed nearly 19 percent. The S&P/Toronto Stock Exchange Composite Index, meanwhile, gave back more than 23 percent.

Much of this wealth destruction was the result of an unseemly debt-ceiling debate in Washington, DC, and an obtuse, ill-timed credit downgrade of Uncle Sam by Standard & Poor’s. But there are legitimate issues in play the maladroit handling of which could result in chains of events that tip vulnerable economies into recession.

Fears of a European sovereign debt contagion persist, and there’s no assurance a deal will be reached that adequately recapitalizes vulnerable institutions, prevents the spread of debt contagion and staves off the onset of another global financial crisis, particularly in a political system where a libertarian faction in Slovakia can hold 17 other EU members hostage.

The kind of financial shock that spreads to and takes out Italy and Spain and threatens to undermine the flow of credit in the US could result in a recession. But at this point the market isn’t pricing this risk; there doesn’t appear to be the kind of stress in the financial system that suggests a crisis is imminent.

The HSBC Financial Clog Index measures the aggregate level of stress in the financial system based on four factors: interbank stress, measured by the TED Spread and the LIBOR-OIS Spread; financial institution default risk, measured by US financial credit-default swap spreads; mortgage agency credit spreads, measured by credit spreads for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE); and equity volatility, measured by the Chicago Board Options Exchange Volatility Index, or VIX.

Source: Bloomberg

Although clearly elevated, the Clog Index is nowhere near the levels we saw at the height of the financial crisis during the winter of 2008-09. A precipitating event–failure of negotiations with Slovakia and over the extension of commitments first made in July 2011 that are now insufficient to deal with Greece’s rapidly accumulating shortfalls could qualify–could push it there.

But even in that event, there can be no crisis where credit isn’t absolutely necessary. We buy businesses, and the businesses we cover–particularly those we recommend in the Canadian Edge Portfolio-have taken steps to protect themselves from the potential impact of a 2008-style crisis by paying down debt and refinancing at historically low rates over the last three years.

There is also concern about China and a “hard landing” and what this would do to global growth. It’s important to note that the emerging market industrial production slowdown is policy enforced, due to concerns about inflation. Emerging market growth on average is still strong, forecast to be around 7 percent in 2012. And if things slow to an uncomfortable level policymakers can reverse prior decisions and get less restrictive, particularly in China.

The concern with legs is that of a slowing US economy, particularly to the extent that this concerns Canada, with which it still forms the biggest bilateral trade relationship on the planet. But evidence that the world’s biggest economy is still expanding–albeit at a sluggish pace insufficient to absorb long-term unemployed, for example–continues to mount.

The Federal Reserve Bank of Chicago National Activity Index (CFNAI) is a weighted average of 85 previously reported monthly economic indicators; these indicators are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories.

The index has an average value of zero and a standard deviation of one. Because economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend. Through August the three-month average stood at -0.28.

…But Not Quite Chooglin

Usually readings like this on the CFNAI indicate an economy already in a recession. But contributing numbers for September–data for jobs created, in particular–have been better than August and suggest recession fears are overblown.

The Institute for Supply Management’s manufacturing Purchasing Managers Index was 51.6 in September, up from 50.6 in August. A value above 50 indicates that more responders reported improvements than reported deteriorations, so we’re still on the positive side. But the average historical value for manufacturing PMI is 52.7, so we’re continuing with the jagged, slow and inadequate theme. September was better than a poor August, but it was still suboptimal.

Source: Bloomberg

Non-manufacturing PMI for September, meanwhile, was 53, 0.3 percentage point lower than the 53.3 percent registered in August but still showing growth for the 22nd consecutive month. Light vehicle sales, among the 85 CFNAI indicators, increased 9.8 percent over September 2010 but were down slightly from August. Sales of domestically manufactured light trucks were up 16.9 percent over September 2010 and even up slightly over August 2011.

The key number, however, is employment. The more people get back to where, the more they can service their mortgages and start consuming again. But combined with the upward revision to August’s jobs created number from zero to 57,000, the September data establish a trend that isn’t consistent with a rise in unemployment back to 10 percent.

That’s not to say great progress will be made getting 14 million long-term unemployed back to work; the rate of job growth is still insufficient to accommodate new labor force entrants as well as those who’ve lost jobs since 2007. And job creation will likely remain below the critical 150,000 per month level well into 2012.

But we’re simply not seeing the job losses that would define a new US recession. Because the unemployment rate will remain stubbornly high, it’ll be difficult to distinguish–as has been the case throughout this recovery–between a stalling economy and one that’s just gathering momentum.

The Roundup

By 1930, innovations in the form, including the introduction of sound and music, evolution of editing techniques, and the use of film to dramatize and romanticize outlaws, was drawing 65 percent of the US population–about 80 million people–to the cinema on a weekly basis. Studio moguls had levered up during the ’20s, leaving themselves overextended and exposed when the brutal early years of the Great Depression saw unemployment soar above 20 percent and movie attendance fall by about 40 percent.

It was only after about five years of suffering along with every other industry that movie-making turned a corner during the 1930s. A combination of savvy marketing moves–including a drastic reduction in ticket prices–and an era of creative brilliance drove box office totals to new records, and American movies reached a peak once more, drawing nearly 60 million viewers per week between 1942 and 1946.

Ever since the movies has enjoyed a reputation as a recession-resistant business.

Movie attendance–at least in North America–has been in slow, steady decline ever since that golden age, challenged first and most formidably by television. In 2000 27 million people–9.7 percent of the US population–had attended the cinema on a weekly basis.

As it seems with everything these days, the action is overseas. Worldwide box office for all films released in each country around the world reached USD31.8 billion in 2010, up 8 percent over 2009’s total, boosted by box office increases in markets outside the US and Canada. International box office (USD21.2 billion) made up 67 percent of the worldwide total, a slightly higher proportion than in previous years. International box office in US dollars is up more than 30 percent over five years ago.

But in 2009, amid the Great Recession, North American box office increased 6 percent to 1.42 billion admissions, the best year-over-year increase since 2002. And the category of “frequent moviegoers” increased to 11 percent of the population in 2010, or 35 million people, up from 32 million in 2009. “Frequent moviegoers” drive the industry, accounting for more than 50 percent of ticket sales.

It would be easy to lump these statistics in with general arguments about how working people can afford stuff like movie tickets versus undefined but presumably more expensive forms of entertainment during economic downturns. The fact is, however, that there is no data to support the proposition that the competition for the entertainment dollar is a zero-sum game, in good times or bad.

It’s important to return to another reason we remember the 1930s: It was a golden age for film-making, featuring form-defining popular classics such as Public Enemy, Top Hat and Gone with the Wind. In addition to making cinema accessible to cash-strapped working people, studio heads also served up high-quality entertainment to put and keep people in theater seats. Working people have discerning tastes, too.

It’s likely that North American movie theater attendance would have declined even further since its recent 2002 peak at 1.57 billion admissions but for the era of the epic series’ defined by the Harry Potter films. These films, and others, such as the Lord of the Rings trilogy and the recent spate of superhero updates, incorporate new technologies that make the big-screen experience a critical part of the story. The star power–Fred Astaire and Ginger Rogers–that carried Top Hat, in other words, has given way to technical prowess, represented best by a film that isn’t part of a series but is as definitive of the era, 2009’s Avatar.

Data suggest the 2009 attendance bump had more to do with James Cameron’s latest epic than with the relative affordability of a movie ticket in tough times. Generally speaking, making money in movies is still all about a quality entertainment experience.

That’s what Conservative Holding Cineplex Inc (TSX: CGX, OTC: CGXPF), the largest motion picture exhibitor in Canada, has done consistently over the past decade. Cineplex operates theatres from British Columbia to Quebec and is the exclusive provider of UltraAVX and the largest exhibitor of digital 3D and IMAX projection technologies in the country.

The company has managed to reduce the influence of the critical variable–film quality–on its overall business by finding new things to show on its screens, including live rock concerts and broadcasts of the Metropolitan Opera Company from Lincoln Center. It’s a leader in providing up-to-date technology in its core business, having allocated significant capital to provide IMAX and 3D capabilities across its cinemas. Cineplex recently closed the acquisition of video-game making company, giving it ownership of another cash-generating vehicle in its complexes.

The company reported a second-quarter revenue increase of 6.6 percent on a 17 percent increase in “value added revenue” and a 3.8 percent jump in attendance. The box-office increase was encouraging given a generally lackluster spring movie lineup. Cash flow margin rose to 17.2 percent from 17.1 percent a year ago. Free cash flow per unit was off slightly, but dividend coverage was still strong with a 64 percent payout ratio.

Management continues to have success controlling costs and reducing dependence on Hollywood’s ups and downs with ancillary sales. Combined with conservative financial policies, that should ensure the safety of the dividend, even as the theater owner expands its presence in Canada’s fastest-growing markets.

Overall North American box office revenue for the summer of 2011 was up, but growth was less than 1 percent. About 543 million tickets were sold this summer, the lowest number since 1997. Its diverse revenue mix and ability to generate higher revenue per customer should allow Cineplex to post solid if unspectacular third-quarter numbers when it reports in mid-November.

Management last announced a dividend increase in May 2011 for payment in June, from CAD0.105 per share per month to CAD0.1075. That’s an annualized dividend of CAD1.29 per share; the stock is yielding about 5 percent at current levels. Cineplex–unique because of its market dominance and its innovative expansion of cash flows–is a buy under USD25.

Here are links to analyses of second-quarter earnings for all Portfolio Holdings, followed by reporting dates for the third quarter.

Conservative Holdings

Aggressive Holdings

Stock Talk

Comments Guidelines

Add New Comments

You must be logged in to post to Stock Talk OR create an account