Why we think this is the perfect contrarian stock pick for your TFSA

Benj Gallander, Ben Stadelmann, and Philip MacKellar
October 25, 2021

Our readers know that when it comes to stocks, we are very picky. We comb through hundreds of candidates for every company we eventually add to our portfolios. But when it comes to his TFSA, Ben goes beyond selective, he gets exceedingly fastidious.

Tax-free savings accounts are, in a word, awesome. It is said that there are only two certainties in life: death and taxes. While TFSAs won’t grant anyone immortality, they neatly glide by the government’s cut. The TFSA was implemented in 2009; any Canadian who was at least 18 at the time now has accumulated total contribution room of $75,500. There is no lifetime limit. Tack on some growth and we’re talking about enough capital to move the needle on personal net worth.

For older folks who are unlikely to need the money, these accounts also make an ideal legacy compared with registered retirement savings plans, registered retirement income funds and non-registered accounts. The tax-free status allows heirs to harvest your capital gains without paying tax. How sweet is that?

The only hitch with TFSAs is that losses cannot be deducted from other gains. If you blow it, there is an associated opportunity cost, the contribution room is gone forever. Fair enough. So, we want companies with high upside and income potential to maximize tax-free gains, yet with limited downside risk, especially permanent damage to capital. Sounds like a rare beast. What would it look like?

Such enterprises should have a long track record showing resilience to different economic conditions. Geographic and customer diversification is key. They ought to generate steady cash flows, which can be reinvested in the business. Low debt and a cash buffer are essential.

The company’s product or service should be specialized. Ben’s view is this is not the place for cyclical commodities or manufacturing that can be outsourced to low-cost jurisdictions. The highly prized “moat” fits the brief.

A dividend is on point, but there is a wrinkle here. RRSPs and RRIFs allow for US dividends with no withholding tax. Not so for TFSAs, where American dividends entail a 15-per-cent headwind. So home-team Canada is ideal.

A steady share count is desirable, as it shows management isn’t getting larded with options and restricted stock units. With the ability to internally generate cash, the firm doesn’t need to raise equity. A share consolidation is not something you want to see in your TFSA.

Lastly, for us, it should fit the contrarian mould because that’s just the way we roll — that buy low, sell high thing.

Computer Modelling Group appeared to meet all of the above criteria when Ben added it to his TFSA in late August at $3.95. The software provider was founded in 1978 and has traded since 1997. It now has 617 oil and gas clients and consulting firms, scattered over 61 countries.

CMG has generated positive cash flow every single year since 2000, and plows 20 percent of revenue into research and development. Half of its employees have a master’s degree or higher. There are competitors, but not many. CMG is a recognized leader in reservoir modelling, key to estimating oil and gas reserves, knowing where to drill and forecasting production. The company says its clients include the top 20 Canadian heavy oil producers.

The most recent quarter closed with $54.4 million cash, zero debt and no significant concerns over accounts receivable collectability. The share count is 80.3 million, up modestly from 74.6 million in 2012.

Low risk does not mean without possible hazard. All that brain power can be poached by other tech companies. Service providers in the petroleum ecosystem are dependent on the level of spending in the industry. That has been much lower in the past couple of years, which is why CMG could be purchased at a bargain level.

The bet here is that oil and gas corporations must invest in order to produce. Perhaps not today or tomorrow, but soon, and for a long time after that. As fields are depleted, the ability to model reservoirs accurately becomes progressively more important. Eventually, petroleum production will lean toward petrochemicals and associated products as we move toward net zero emissions. CMG’s software can be used for enhanced oil recovery and carbon sequestration, as well as alternatives such as hydrogen and geothermal.

The annual dividend of 16 cents gives a yield on capital of 4.1 percent. It is expected that this will increase as the share price moves in the direction of the $12 sell target. If it works out, it’s all tax-free. Awesome.