Sprott results could surprise on the upside

Date: Wednesday, July 30, 2008
Author: Shirley Won, Funds Reporter, The Globe and Mail

Veteran fund manager Eric Sprott has enjoyed a reputation as an astute stock picker.

While shares of Sprott Inc., which he founded, have yet to emulate the upside of some of his winners, some market watchers remain upbeat on the asset manager.

Since going public in May on the Toronto Stock Exchange - not the most welcoming environment for an initial public offering - its stock has fallen 22 per cent. It closed off 13 cents yesterday at $7.85.

As Sprott gets ready to report its second-quarter results tomorrow, its stock appears to be getting whacked on jitters over its high exposure to commodities stocks that have come under selling pressure.

"Sprott has a big, bullish bet on commodities and a bearish bet on financials," said Marc-André Robitaille, founder of Montreal-based Robitaille Asset Management Inc.

"I think the rebound that we saw in the financial sector and the negative performance of oil and gas and materials in the past week and a half could explain the reason that we saw the stock of Sprott go down."

But that is just "short-term volatility," said Mr. Robitaille, who holds 936,900 shares of Sprott in his $750.7-million AGF Dividend Income Fund.

"I think over the long term that the stock will show decent results, and ... trade at a premium to its peers," he said. "They have a business mix that is showing more potential growth than a traditional retail fund management business."

Unlike such publicly traded fund companies as IGM Financial Inc. and CI Financial Income Fund, Toronto-based Sprott runs mutual, hedge and offshore funds, and charges performance fees on top of management fees.

Gluskin Sheff + Associates Inc. may be a closer comparison because it also earns performance fees, but it doesn't run mutual funds.

"Sprott, for me, is a good way to play [the wealth management business] because they have historically focused on higher net worth or 'sticky' clients," Mr. Robitaille said. "Performance is a big driver of their asset growth and I think this will continue."

Sprott went public at $10 a share in an IPO led by Cormark Securities Inc. and TD Securities Inc. Cormark once had ownership links to the asset manager, but they became separate entities in 2002.

"Sprott probably has the best growth profile of any mutual fund company in Canada," said Cormark Securities analyst Jeff Fenwick, who rates its stock a "buy" with a one-year target of $11.75.

"I am looking for their total assets to have grown to approximately $7.4-billion at the end of June," he said. "That would be a combination of market appreciation in their funds and about $550-million in net sales for the first half of the year."

Because the IPO process helped to highlight the strong performance of many Sprott funds - particularly the 30-per-cent average annual return for Sprott Canadian Equity over 10 years - that likely will have attracted a fairly significant amount of new money, Mr. Fenwick said.

Despite the turmoil in July, Sprott Hedge Fund LP and Sprott Hedge Fund LP II were both up 28 per cent so far this year as of yesterday, he noted.

Sprott's overall net sales for the first six months, whose numbers will be released tomorrow, could "surprise on the upside," he said.

They will certainly contrast with the mutual fund industry, whose long-term funds (which exclude money market investments), were in net redemptions, he added.

Sprott generates performance fees, but these won't be calculated until the end of the calendar year, and will translate into a special annual dividend in addition to its quarterly payout. Mr. Fenwick is projecting a special dividend per share of 35 cents.

Unlike Gluskin Sheff + Associates, whose performance fees focus on absolute returns, Sprott earns these fees by outperforming such benchmarks as the S&P/TSX composite index.

"It's an opportunity to generate some very good performance fees even if the markets don't perform all that well," Mr. Fenwick said. "Their ability to outperform their [fund company] peers comes from being able to generate performance fees."

RBC Dominion Securities analyst Geoffrey Kwan echoed that Sprott is "an attractive growth story in the near term," adding that it also has potential to boost sales through increased marketing.

"Historically, Sprott did not spend much time marketing its funds, instead opting for a strategy that used delivering outstanding returns to drive net sales growth," Mr. Kwan wrote in a note to clients.

But Mr. Kwan, who has a "sector perform" rating on Sprott with a target of $10, cautioned that its investment strategy focusing on the resource sectors - while successful so far - also presents a "significant source of risk to valuation and net sales momentum" if they stumble.

By the numbers

percentage stake of Eric Sprott, biggest shareholder

$6.8-billion

assets under management at March 31

$10.10

highest stock price since IPO

$7.81

lowest stock price since IPO

10¢

annual dividend per share

$1.2-billion

market capitalization

Source: Bloomberg, Sprott IPO prospectus