In the previous iteration of the 5i Filter, we found the material sector to be a top performer with the volatile open of 2016, as investors sought the safe haven investment qualities. With this filter, we take a closer look at the sector and focus on the health of the balance sheet. We wanted to focus on balance sheet strength because while precious metals have had good performance this year, the commodities are still down significantly over the longer-term, with gold prices down roughly 12% over a five year period.

Below we show Canadian material sector companies with a market-cap above $200mm and that are within the top 30 percentile of YTD price performance. Resulting companies have been ranked by the D/E ratio from lowest to highest. 

Looking at the metrics it is easy to see why investors have rewarded top performers like SVM.TO. First and foremost, SVM is debt free. In times of market weakness, a company’s solvency may be threatened as it struggles to meet creditor commitments. To deleverage the balance sheet, the company may then in turn be required to sell assets. Taking the opposite perspective, those that are debt free have a higher ability to wait out a downturn and subsequent capacity to take on debt when the market strengthens, putting the capital to use to generate leveraged returns. This ties in nicely with a high cash balance. Some may view this as a negative, preferring to see cash put to use; however, in a falling market ‘cash is king’. It reassures investors the company remains liquid and can meet its commitments. As well, cash creates an opportunity to acquire cheap assets from competitors, forced to sell. If nothing else, a high cash balance can help put a floor value on the stock price in times of higher volatility. Finally, it does not hurt when a stocks pays a dividend to investors as compensation while waiting for a larger sector rebound.