Investoid

Despite my tech background, I currently don’t have any tech stocks or index funds in my portfolio. I think part of the reason for that is that Canada’s tech index is so heavily weighted on RIM, but also because there is a dearth of up and coming public tech companies, relative to the U.S. I plan on looking at more Nasdaq-based companies in the future, but in the meantime I have been looking at Systems Xcellence (SXC – TSX / SXCI – Nasdaq), which is a company that has a dual listing.

Company Analysis

• SXC is a pharmaceutical software provider. Their business focuses on managing the prescription drug supply chain.
• Two primary market customers:
• Payor customers such as Blue Cross/Blue Shield and Governments
• Provider customers such as chain and independent pharmacies
• Currently the payor market represents approximately 70% of revenue, providers the remainder.
• Revenue is concentrated in the U.S. (over 95%).
• The company had a U.S. IPO on Nasdaq in the past six months, which has raised its profile in the U.S.

Market Analysis

• Total market size for payors and providers: $4.5B.
• Growth potential:
• The number of prescriptions being filled is increasing as North American population ages.
• In addition, number of prescriptions per individual is increasing.
• Payor customers are looking to increase operational efficiencies to reduce administration costs.
• Pharmacies require effective solutions to manage increasing volume.

Financial Analysis

Stock Analysis

• Since dropping to $12 (Canadian) in June, the company’s stock has increased dramatically. It reached a high of over $25, but has since pulled back to the $21.50 range.
• The stock is more volatile than the Canadian IT index (as represented by XIT), but is strongly correlated to it.
• According to the company, 12 analysts cover the stock on both sides of the border. According to GlobeInvestor, the consensus recommendation on the stock is a strong buy.

Opinion

Overall, I think this company is in a solid growth sector and has demonstrated strong organic growth over the years. I like the space they’re in and the fact that they are part of the solution to manage overall costs in the health care system, rather than being a cost driver.

Using my valuation models, I have arrived at fair value prices pretty close to SXC’s current price. I think that the stock is fairly valued at this point given future expectations, but if the stock continues to fall to $19 or so I think it becomes a good value and I will be looking to accumulate some for my portfolio.

I am currently overweight financials in my retirement portfolio and will likely remain that way over the long term. I get my exposure to financials two ways currently:

1. Via the approximate 35% weighting financials have in the TSX/S&P Index, which I replicate using the TSX/S&P Index Capped iShares (XIC)
2. Via the TSX/S&P Financials iShares (XFN)

I like the Canadian financial stocks for several reasons:

1. Barriers to entry: the banks in Canada enjoy some level of barriers for their core services in Canada, from retail banking to investment banking and corporate services. While some small progress has been made by multinationals (such as ING) on the low end of financial services, their limited success only highlights how tough it is to break into this country.
2. Willingness to accept fees: as is currently being highlighted by the NDP, Canadians accept a lot of fees with little resistance. Whether it’s ATM fees, regular account fees or high mutual fund MERs, we seem to accept them all in stride, even when they increase (insert whatever cliché you wish about Canadians and our ‘nice’/passive personalities; it seems to apply here). This factor pads the profit margins of financial firms and is quite stable regardless of the economic cycle (less so for the mutual fund companies though).
3. Yield: in today’s low yield environment, it’s nice to get an extra 2-3% annually in a stable dividend. When government long term bonds are currently yielding only about 4%, you can really see the advantage to owning financials.
4. Currently, there is little to indicate that interest rates will be increasing in this country. Inflation (ex-housing) is pretty stable and low, while the economy is not growing that strongly. If anything, I see a rate decrease if the US housing collapse ends up affecting enough resource suppliers in Canada and depressing our GDP figures further.
5. Outperformance: since January 1, 2002 the financials have outperformed the capped iShares by 3% annually in terms of total return (all figures calculated based on figures available at Yahoo Finance Canada). Note that this does not provide any diversification away from the market risk associated with the TSX. The correlation between the XFN and XIC over this time period is 0.989, meaning you are not reducing your market risk in any meaningful way.

In the past 5 years financial stocks as a whole have risen steadily with only a few brief pauses or drops. In my opinion, you can’t go wrong buying XFN at nearly any time. But, if you’re already invested in XFN and are looking to get some additional return, here are a couple of tips.

1. Wait until there’s a slight pullback (4% or more) to purchase more. You may get a chance in the near future if Finance Minister Flaherty acts along the lines of his current comments and does something to restrict ATM fees or some other bank profit machine.
2. Pick the specific stocks which have consistently outperformed the financials index. Of the large banks, the two that pop up in terms of 5 year historical performance in Bank of Nova Scotia (BNS) and National Bank (NA). Both have outperformed XFN by at least 2.5% annually since January 1, 2002 on a total return basis. Of the two, BNS is less volatile, while NA has outperformed BNS by about 0.8% annually since 2002. Both offer solid yields in the 3.3% range.

I’ll update these to outright long-term buys if there’s a pullback on any of these three stocks in the near term without material news which affects their long outlook.