Interest rate cuts can encourage investments and boost consumer spending.ThongSam/iStockPhoto / Getty Images
Falling interest rates can be a tailwind for smaller-cap stocks.
Rate cuts can help lower debt burdens, encourage investment in growth and capital expenditures and boost consumer spending.
The Bank of Canada has cut its key rate nine times to 2.25 per cent from 5 per cent since June, 2024. The U.S. Federal Reserve Board recently reduced its rate by a quarter of a point to the 3.5-to-3.75 per cent range, and more cuts are expected next year.
We asked three portfolio managers for their top picks among smaller-cap names.
Aubrey Hearn, portfolio manager and lead for U.S. and small-cap equities, CI Global Asset Management in Toronto
His funds: CI Canadian Small/Mid Cap Equity Fund and CI U.S. Small/Mid Cap Equity Fund
His Canadian pick: Cargojet Inc. CJT-T
Cargojet, Canada’s largest airfreight carrier, is a compelling investment because it benefits from the e-commerce trend, and its stock valuation is “stunningly cheap,” Mr. Hearn says.
The Mississauga-based company has long-term contracts with customers, such as Amazon.com Inc. AMZN-Q (which has a minority stake in Cargojet), DHL Group DHL-NE and United Parcel Service Inc. UPS-N.
Cargojet’s stock took a hit this year because of softer global trade, falling consumer confidence and weakening demand for ACMI business, which involves leasing its aircraft with crews, maintenance and insurance to other companies for specific routes.
The fourth quarter should show improvement, while consumer spending could increase as rates decline, he says. Higher tariffs and weaker employment are potential risks.
His U.S. pick: QXO Inc. QXO-N
QXO, a building products distributor, is an attractive roll-up acquisition play led by entrepreneur Brad Jacobs, who has a successful track record building companies, Mr. Hearn says.
The Greenwich, Conn.-based firm, which acquired Beacon Roofing Supply Inc. in April for its first purchase, uses technology to drive efficiencies and is targeting US$50-billion in annual revenue.
Mr. Jacobs founded United Rentals Inc. URI-N, XPO and United Waste Systems Inc., which was sold to Waste Management Inc. WM-N.
He sees opportunities in the fragmented building products sector, while falling rates can help builders with financing as well as motivate potential homebuyers.
QXO’s stock is trading at fair value but is cheap “if you believe that Mr. Jacobs can execute,” Mr. Hearn says.
Jeff Mo, portfolio manager, Mawer Investment Management Ltd. in Calgary
His funds: Mawer New Canada Fund and Mawer U.S. Mid Cap Fund
His Canadian pick: Stella Jones Inc. SJ-T
Stella Jones, North America’s largest manufacturer of treated wood, is an appealing investment because of growing product demand and its relatively attractive stock valuation, Mr. Mo says.
The Montreal-based firm produces utility poles, railway ties and lumber for fencing and decking. Utility poles are in high demand because of rising electricity needs driven by artificial intelligence data centres and for replacing aging infrastructure, he says.
Falling interest rates help Stella Jones because it will be cheaper for customers, such as utilities, to invest in capital expenditures, and can encourage consumers to buy its residential lumber, he adds.
Its shares trade at around 13.5 times forward earnings and that’s attractive for a business that’s quite defensive because most utility poles and railways ties are purchased for replacement, he adds. An economic recession is a risk.
His U.S. pick: ITT Inc. ITT-N
Shares of ITT, an industrial conglomerate making parts and systems for the automotive and other markets, are compelling because of the company’s growth profile, Mr. Mo says. “Its gross margin is around 35 per cent.”
The Stamford, Conn.-based firm’s products include brake pads, pumps and connectors and the end markets for its products are often interest-rate sensitive, he says. For example, most brakes go into new vehicles, which can see rising demand when rates decline.
Luca Savi, its chief executive officer, is a strong operator, who’s growing the firm by acquisitions, Mr. Mo says. ITT recently inked a deal to buy SPX FLOW Inc. for US$4.8-billion in cash and equity.
ITT’s stock trades at around 22 times forward earnings, which is “fair for the value of the assets,” he says. Risks include a cyclical downturn and poor execution on its acquisition.
Greg Dean, chief executive officer and lead investor, Langdon Equity Partners in Toronto
His funds: Langdon Canadian Smaller Companies Portfolio and Langdon Global Smaller Companies Portfolio
His Canadian pick: A&W Food Services of Canada Inc. AW-T
Shares of this North Vancouver-based fast-food chain, known for its burgers and root beer, are compelling because its growth potential is still underappreciated, Mr. Dean says.
A&W Food Services of Canada, which acquired the remaining 70.6 per cent of A&W Revenue Royalties Income Fund last fall, is an operating business now, but that’s still under the radar, he says.
With its stock’s 5-per-cent dividend yield and expected earnings growth of 10 per cent, “that’s a 15-per-cent annual total return,” he says. And for a firm with a capital-light business model, its shares are trading attractively at about 15 times forward earnings, he adds.
Lower interest rates, he says, can encourage consumer spending, which can help same-store sales.
A&W just got the franchisor rights to the London-based Pret A Manger sandwich chain, but “we don’t think the market is paying anything for this opportunity,” he says. The risk stems from A&W’s illiquid stock, as only 40 per cent of A&W shares are publicly traded.
His U.S. pick: Yeti Holdings Inc. YETI-N
Yeti Holdings, a designer, retailer and distributor of premium outdoor products, is an attractive investment because of its growth opportunities, Mr. Dean says.
The Austin, Tex.-based firm, known for drinkware and coolers, has diversified its product line and is expanding internationally.
Drinkware doesn’t have a lot more growth, but the rest of Yeti’s portfolio should increase revenue and profits by 10 to 15 per cent, he says.
The company is expanding into the health and wellness market with the acquisition of Helimix’s blender-shaker bottle design and into cookware with the acquisition of Butter Pat Industries, he says.
Yeti, which has a capital-light business model, no debt and buys back its stock, trades at about 15 times free cash flow and earnings, Mr. Dean says. Consumer confidence, he adds, is a driver of sales, so falling rates help. Declining sales in the drinkware category is a risk.