From energy to retail to banking, invest in companies enjoying the Alberta Advantage

Stocks with big exposure to the province are poised to grow faster

Construction site in Calgary

There’s money to be made in Alberta, and not just in the energy sector. (Jason Franson)

Alberta’s business community was no doubt patting itself on the back this past June. Three reports came out in the space of a week trupompeting the same message: The province is outperforming the rest of Canada and will continue to do so in the foreseeable future. While Canada’s economy as a whole struggles to move forward—GDP growth is expected to hit around 2.3% this year—the country’s fourth most populous province will grow at about 3.7%, according to the Royal Bank of Canada. As the title of a June 10 Bank of Montreal paper explains, “There’s Alberta, then there’s everyone else.”

As you might expect, it’s the oil and gas sector that’s driving this growth. But the ripples touch nearly every sector operating in the province, from real estate to restaurants. For instance, retail sales rose 6.9% last year in Alberta, compared with 2.5% for the rest of the country. Domestic airline passenger traffic increased by 9% in the province in 2012 compared with just 5.5% for Canada as a whole. Bank loans in Alberta are expanding at about twice the nationwide pace. Plus, the absence of a provincial sales tax may leave more room for retailers’ margins.

Investors typically categorize stocks by sector or investing style, but there’s a strong case to be made for geographical targeting within Canada. The stocks of retailers, banks, railroads and other companies with big exposure to Alberta will enjoy better growth prospects than their peers. “Sometimes people forget that there are opportunities in the region beyond the oilsands,” says Dave McColl, senior equity analyst with Morningstar.

As impressive as Alberta’s GDP growth has been, a stickier reason to invest there is its expanding population. In the 12 months leading up to June 2013, Alberta saw a net influx of 52,000 people, far more than any other province. Albertans’ incomes are also higher and growing at a faster rate than those of other Canadians. Between 2007 and 2011, their incomes grew 9.5%, compared with 8.5% Canada-wide.

It’s these two numbers—population and income growth—that savvy investors are beginning to watch. “It’s the strongest migration we’ve seen in three decades,” says Ian Cooke, the lead manager of IA Clarington’s Canadian Small Cap Fund. “Wages are higher and taxes are lower, so it’s a good place to live and start a family. That ripples through all levels of the Alberta economy.”

While most of the people who come to the province don’t directly work in the energy industry, Alberta’s growth still depends on the oilpatch. Fortunately, its long-term prospects look good. Between now and 2035, the International Energy Agency estimates US$1.6 trillion will be invested in the Canadian energy sector, with more than half of that going into the oilsands. McColl points out that the large-scale oilsands projects have 30-year reserves. Jerry Koonar, a Calgary-based portfolio manager with Leith Wheeler Investment Counsel, adds that new technology will allow companies to extract even more out of those reserves. The question is less about how long the resources will last and more about how long we will continue to use them in a carbon-constrained future.

READ: Oilsands in Canada: no apologies »

For now, the province’s economic momentum is hard to ignore. Take a drive along Highway 2 between Calgary and Edmonton, and you’ll see new car dealerships, gas stations and malls, says Koonar. Calgary’s skyline is dotted with cranes. The provincial government is spending $19 billion on infrastructure such as roads and schools over the next three years. Companies big and small are spending money in the region. Telus, for instance, announced in May that it was sinking $2.6 billion into the province between now and 2016 to upgrade its phone and Internet infrastructure. Empire Co., parent of Sobeys, rationalized its $5.8-billion acquisition of Canada Safeway last year in part for making it the No. 1 grocer in Alberta.

For these and other companies, Alberta continues to offer an island of pre-2008 growth in a world overshadowed by secular stagnation. Compare the performance of Edmonton-based Canadian Western Bank, which has nearly half of its business in Alberta, with the Big Five national banks. In the quarter ended April 30, its revenue was up 13.7% over the previous year, a growth rate the Big Five can’t touch.

READ: Stock pick: Canadian Western Bank (CWB) is small but mighty »

Industries that benefit from increased spending, such as construction, real estate, banking and retail, are the most likely to enjoy the Alberta Advantage, says Cooke. Investors with a higher risk tolerance should also consider small-cap stocks, adds McColl. While there are larger, more geographically diversified operations making a push into the province, the more weighted a business is to Alberta, the more exposed it will be to the province’s growth. That higher return potential naturally comes with higher risks. While most analysts don’t think the price of oil will plummet anytime soon, any downward movement will ultimately cascade to other sectors of the Alberta economy as investment in the sector slows, McColl cautions.

Also make sure that a company isn’t growing just for the sake of growing. That’s a huge danger in an environment like this, says Koonar. Companies can become less discriminating about how they allocate capital. If the boom falters, the business will suffer. When Koonar searches for opportunities, he zeros in on whether the company’s expansion decisions are prudent and whether it’s taking on too much debt. He wants to see how a company is reinvesting its capital and what the return on capital is relative to the cost of capital over time.

READ: Secrets of Calgary’s Fastest-Growing Companies »

Investors should also pay attention to past performance. Look for how the company performed in previous downturns—not just during recessions, but in energy boom-and-bust cycles as well. See if the company has been able to stay profitable, grow its book value and stay afloat without loading up on debt, Cooke says. “We look at companies in periods of contraction,” he says. “It’s those times that count.”

Don’t forget to layer on the usual metrics, such as price-to-earnings and enterprise value–to–EBITDA (earnings before interest, taxes, depreciation and amortization), depending on your investing style. Koonar’s looking for undervalued companies; McColl likes businesses that can grow their free cash flow; Cooke wants to own operations that have low debt-to-equity ratios. When you do find a company that meets your criteria, count on holding it for years. As long as Alberta grows as fast as the experts say it will, then you should see better-than-average returns.