This weekend, I had a few “free” hours between spreading mulch and carrying moving boxes to the basement, to catch up on some research and a handful of recently published annual reports. Time flies when you’re having fun, so Saturday and Sunday must have been quite the party, as it is already Monday morning.  I am in the office two days this week, before leaving for Canada on Wednesday, so this will likely be our only note of the week, which will highlight my favorite new acronym along with a contrarian stock idea from a recent annual letter.

But before diving in, I’d like to ask any of our Canadian readers if they have contacts in the Toronto area that would be open to meeting with me.  I can make time in my schedule on Wednesday and Friday and would be very interested in speaking with folks connected to the banking industry and real estate market in Canada.

It would seem that our neighbors to the north have more than a few things in common with our friends Down Under.  Like Australia, which has been suffering from Dutch Disease, the Canadian Dollar has remained quite strong over the past decade making Canadian exports more expensive on a relative basis at the same time Mexico has been gaining share of US imports.  Both Canadian and Australian households are now more levered than those of Americans, with growing private sector debt driving these housing markets to frothy levels. No other developed country has levered up to the extent Canadians have since 2007.  A recent report from the OECD notes that Canadian house prices are among the most stretched in the world based on price-to-rent and price-to-income ratios.  Home prices in Canada have continued their ascent even as US housing expenditures collapsed, leaving residential investment in Canada far higher than the peak reached at the height of the American Housing Bubble.


Of course, it’s all fun and games until the bubble begins to deflate and someone gets hurt.  Consequently, it looks like someone is about to get hurt.  Our friends at Variant Perception point to decisive signs of weakness and a gradual unwind of excess froth in the Canadian housing market. “The aggregate house price index in Canada is still showing a positive trend, but underlying data is starting to roll over in earnest. Building permit growth has resumed negative prints after only increasing slightly from the nadir of the crisis.”

Source: Variant Perception

The Canadian economy, like Australia, has appeared artificially strong as aggregate demand has been driven by a surge in credit.  But importantly, we are now seeing decisive weakness in mortgage credit growth.  It’s also worth noting that Moody’s downgraded the long-term ratings of the six Canadian banks earlier this year, stating that, “Today’s downgrade of the Canadian banks reflects our ongoing concerns that Canadian banks’ exposure to the increasingly indebted Canadian consumer and elevated housing prices leaves them more vulnerable to unpredictable downside risks facing the Canadian economy than in the past.”

Source: Variant Perception

We don’t think it is a coincidence that the flaws in Canada’s banking system are being exposed at the same time China’s appetite for natural resources is being suppressed by a glass ceiling on capital misallocation.  In fact, while traveling through China last year, we learned that many of Chinese refer to one particularly popular Canadian city as “Hongcouver” – hence, our strong interest in Canada and in meeting new friends up north. Today, the world’s “healthiest” economies are closely tied to the insatiable Chinese demand for resources.  This is the part of the world that is supposed to be healthy.  These are the countries the rest of us are counting on for growth.  Yet, as noted in a recent report outlining the short thesis for iron ore, “The transmission mechanism that will take this disease that started quietly in the summer of 2011 and spread it globally are CRABS.  The CRABS are the commodity rich countries that are riding China’s spending spree.  They are Canada, Russia, Australia, Brazil and South Africa.”  This is absolutely perfect.  We think the CRABS will ultimately be a much bigger problem than the PIGS.  If for no other reason, we understand that CRABS are highly contagious.

The good news, for value investors, is that CRABS isn’t the end of the world.  And even in Canada, smart investors are still finding opportunities far away from bubbles in housing and commodities.  In his most recent letter to shareholders, available here, Prem Watsa offers up the following analysis we thought was worth sharing:

Markets fluctuate – and very often in extreme directions. Remember the tech boom, when companies with no sales were valued at tens of billions of dollars? In 2000, Northern Telecom accounted for 36.5% of the Toronto Stock Exchange index and was worth almost Cdn$400 billion; by 2009, it was bankrupt! Well, last year the opposite happened to Research in Motion (now known as BlackBerry). At its low of approximately $6 1/2 per share, it sold at 1/3 of book value per share and a little above cash per share (it has no debt). The stock price had declined 95% from its high! The company produces the BlackBerry which for years was synonymous with the smart phone.  The BlackBerry brand name is perhaps one of the more recognizable brand names in the world and the company has 79 million subscribers worldwide. Revenues went from essentially zero to $20 billion in about 15 years – and then it hit an air pocket! The company got complacent, perhaps overconfident, and did not respond quickly enough to Apple and Android. Mike Lazaridis, the founder and a technological genius – and a good friend – asked me to join the Board, which I did after meeting Thorsten Heins, whom Mike recommended as the next CEO of the firm. Thorsten’s 27 years of experience in all types of leadership jobs in small and large divisions at Siemens, combined with his five years at BlackBerry, were exactly what was needed. Thorsten hired a very capable management team and then focused on producing a high quality BB10 – the next generation of BlackBerries. The brand name, a security system second to none, a distribution network across 650 telecom carriers worldwide, a 79 million subscriber base, enterprise customers accounting for 90% of the Fortune 500, almost exclusive usage by governments in Canada, the U.S. and the U.K., a huge original patent portfolio, an outstanding new operating system developed by QNX and $2.9 billion in cash with no debt, are all formidable strengths as BlackBerry makes its comeback! The stock price recently moved as high as $18 per share, a far cry from the $140 per share it sold at a few years ago. And please note, 1.8 billion cell phones are sold worldwide annually, and of the 6 billion cell phones in the world, only 1 billion are smart phones. Lots of opportunity for Canada’s greatest technology company! What is striking, even for a person like me who has seen many bull and bear markets, is that at $6 1/2 per share, all the Wall Street and Bay Street analysts were uniformly negative – just as they were uniformly positive only a few years ago at prices north of $100 per share. John Templeton’s advice to us: “Buy at the point of maximum pessimism”, still rings in our ears!! We own approximately 10% of the company at an average cost of $17 per share and we are excited about its prospects under Thorsten’s leadership and Mike’s technical genius.

We don’t own Blackberry today – this one is too tough for us to call – but we do still get quite a kick out of recent headlines.  Have a good week!!

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