Top Canadian Picks: Positive Residual Income, Attractive Valuation

We have conducted an analysis on Canadian stocks and found the 10 most attractive stocks (see table below). It might come as a surprise that no mining company made it on the list - despite their heavy presence on the Canadian stock market.

Return spread drives performance and valuation
Essentially, we were looking for companies that have a positive residual income, that is income after subtracting cost of capital. The next important criteria was that these quality companies should trade at attractive valuations relative to the return spread. This we measure by the enterprise value / total invested capital ratio, an approximation for the total value of the company (equity + net debt) relative to the capital invested (replacement cost).

One of the top picks is Westshore Terminals, which operates North America's largest coal-export facility in Vancouver. Performance has been strong over the past five years and as the return spread suggests, the company boasts a large residual income. A EV/TIC ratio of 1.32 is quite low, given the true earnings power of this terminal operator. In addition, the nature of the business gives it a solid moat that adds further value to its operation. However, not all is rosy. The company actually lowered its dividend in February, as Westshore is investing CAD 210 million in its coal terminal south of Vancouver. The company is also expected to see output drop as a ship recently collided in one of the terminals, damaging some equipment.

Another pick is Metro, a regional food retailer that also sells pharmaceutical products from its chain of drug stores. The company operates primarily in Québec and Ontario and has a total of 564 retail stores (both supermarkets and discount stores). The retailer is printing a phenomenal ROIC of 35.4 percent and a return spread of 5.1. These strong numbers have been consistent and as a result, the stock performance has been very strong and is trading far above the highs before the financial crisis. With EV/TIC at 1.55, the valuation looks attractive for this steady growing Canadian retailer.