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A value stock is like a good quality product available for a low price. Good quality stocks with strong fundamentals — dividends, earnings, sales — and growth potential become value stocks when investors sell them due to short-term fears. An economic downturn is a great buy opportunity for long-term investors as it creates many value stocks.
In the current COVID-19 pandemic-driven downturn, the most valued real estate, utilities, and natural resources stocks have declined to more than five-year lows. This decline has created a significant buy opportunity as these stocks have the potential to grow when the economy revives. We have listed below the top four value stocks with strong growth potential.
Four Best Canadian Value Stocks for 2020
Two REIT stocks too attractive to ignore
REITs (Real Estate Investment Trust) suffer in an economic downturn and prosper in economic growth. The current pandemic has created a scenario of lockdown, where most physical shops and business spaces are temporarily closed. Many commercial REITs are suffering from rent collection, thereby impacting their revenue in the short-term.
However, time and again, real estate has proved to be resilient as their assets remain unchanged, and the need for property remains intact. REITs with strong fundamentals will recover when the economy reopens, and the business normalizes. In the COVID-19 pandemic, retail REITs like SmartCentres (SRU-UN-T) and RioCan (REI-UN-T) could derive significant value in the long-term.
SmartCentres REIT portfolio comprises 157 Canadian properties worth $9.9 billion. Around 60% of its tenants are creditworthy essential businesses like Walmart, Loblaws, Canadian Tire, and Scotiabank. SmartCenters collected 70% of the rent in April as essential stores are running even during the lockdown. Its biggest client is Walmart accounting for 25% of REIT’s income.
SmartCentres has 34 million square feet of retail space and plans to add another 30 million square feet over the next five years under the $12 billion intensification program. The program will broaden its portfolio to include rental apartments, condos, senior residences, hotels, offices, and storage facilities.
RioCan’s portfolio comprises 38.4 million square feet of space spread across 220 properties, including retail, office, and residential. It earns over 40% of its revenue from grocery-anchored centers. In April, it collected 66% of its expected rent.
SmartCentres and RioCan stocks go back 11 years
Both SmartCentres and RioCan have a strong balance sheet with a debt to asset ratio of 43%. They have ample liquidity and unencumbered assets to withstand the crisis. Their diversified asset portfolio positions them to benefit during an economic boom. The two REIT stocks fell more than 50% in the March sell-off to their lowest level since the 2008 crisis.
SmartCentres is trading at $19.5, which is 9.3 times its earnings per share. In the 2008 crisis, the stock fell below $10 and grew more than 300% in the next 10 years. RioCan is trading at its 2008-level of $14, or 6.5 times its earnings per share. The stock rose more than 100% in the last decade. Both stocks have a history of paying regular dividends even during the crisis. This is an excellent opportunity to buy SmartCentres and RioCan at such a low price and earn a dividend yield of 9.4% and 9.94%, respectively. In the long-term, these stocks will also give returns through capital appreciation.
Canadian Utilities – A must-have value stock
Utilities are an essential business that are open during the COVID-19-driven lockdown. However, the falling oil prices and the temporary shutdown of many companies have negatively impacted Canadian Utilities’ revenue. Like real estate, utilities with strong fundamentals have been resilient even in an economic downturn. Utilities’ revenue increases when the economy grows, but its decline is capped during a downturn.
Among utility stocks, Canadian Utilities (CU) is a value stock that has an attractive history of 48 years of consecutive dividend growth. Over the last 10 years, the stock rose 125%, and it has increased dividends at an average annual rate of 9.5%. Over the previous eight years, the stock fell below $35 in two instances in 2015 and 2018 but recovered to its regular trading price of $40 and above. The stock has once again declined to its 2018 low of $30. It is trading at 10 times its earnings, below its peers Emera and Fortis price-to-earnings ratio of 19x and 13.5x. Canadian Utilities is offering a dividend yield of 5.6%, which is higher than Emera’s 4.74% and Fortis’s 3.8%.
Scotiabank – A preferred value stock among bank stocks
Canada is known for its big five banks, which continued to pay dividends even during the 2008-2009 financial crisis. These five banks have grown over the years and deliver a dividend yield of over 5%. But the COVID-19 pandemic spells troubled times for banks as well. The pandemic-driven economic downturn is seeing many clients going back on agreements, which could even lead to a default on loans. Investors have priced in the economic downturn, sending all five bank stocks down more than 30% in the March sell-off.
Among the top five banks, Scotiabank (BNS) is a preferred value stock because of its foreign market exposure and dividends. The bank is expanding its exposure outside Canada into the emerging Latin American trade bloc comprising of Chile, Colombia, Mexico, and Peru.
Scotiabank ranks third among the top five banks in terms of market capitalization. However, it ranks second in terms of dividend yield and price to earnings ratio, as seen in the above table. The stock is trading at 7 times its earnings, which is lower than its ten-year average price-to-earnings ratio of 11.8x.
In the 2008 crisis, Scotiabank did not cut its dividend but paused it in 2010. Since then, it has increased the dividend at an average annual rate of 6%. At $51 stock price, it is offering a dividend yield of 6.96%. The bank could continue to pay dividends in the current recession. When the economy recovers, the stock could return to its regular trading price of over $75, representing a 50% upside potential.
Trading on value stocks
Real estate, utilities, and banks are traditional industries that grow along with the economy. Major players have strengthened their balance sheet during economic growth to make themselves resilient to a downturn.
Despite strong fundamentals, SmartCentres, RioCan, Canadian Utilities, and Scotiabank are trading at multi-year lows as economic uncertainty has created short-term challenges. However, their long-term growth remains unaffected, creating attractive buy opportunities for value investors.