FidelityConnects: Inside the Canadian consumer: What earnings are telling us now

[00:04:52] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. Well, we've seen this week Canada's latest CPI print being a little bit of a balm to the overall story for economics. We saw inflation increasing to 2.3%. This is for recent months, below expectations, while grocery inflation showed signs of cooling. We're going to talk about that today. Even though consumers remain focused on essentials and markets are taking note are consumer staples becoming the market's new safe haven as disruption risks appear elsewhere. Might utilities ultimately be quietly benefiting from steady demand? Joining us here today for a look at the health of the consumer is equity research analyst Andrew Hall. Warm welcome to you, Andrew. How are you today?

[00:05:39] Andrew Hall: Very well. Great to see you, Pamela.

[00:05:39] Pamela Ritchie: Great to have you here. We'll invite everyone to send questions in for Andrew over the next half hour or so. We're going to put this to you now because it just came across the headlines, the IEEPA ruling from the Supreme Court in the US. This is essentially against the tariff policy that the Trump administration has put out. It affects Canada. I guess your initial reaction one way or the other. It's hard to know when this was going to break but here it is. It's here today.

[00:06:04] Andrew Hall: Exactly. I think there are a few things to unpack when we think about this. Number one, it's a big deal. The tariffs were a central plank of Trump's agenda since he got into office last year and the IEEPA tariffs were kind of the broadest implementation of that. Obviously, he's done it a few different ways and there are still some tariffs in place but it's pretty big deal. You're seeing a relatively market reaction so far. I think that reflects...

[00:06:30] Pamela Ritchie: Why is that?

[00:06:30] Andrew Hall: This was widely expected. If you go back to oral arguments in the Supreme Court late last year there was a lot of skepticism from the Justices. Obviously, all of the lower court rulings that brought it up to the Supreme Court were against the tariffs so I think people were just kind of waiting, when is this finally going to happen. We had a few false starts through the year where people were expecting it maybe a little bit earlier in the docket. I think the second component is if we knew that it was likely to be struck down so did Trump and his administration and they're likely going to try to find a way to salvage much of the agenda through other means of tariffs. It remains to be seen how quickly those get back in place, whether they'll be an air pocket. But like I said, I think they were ready for this and so it will be relatively quick. Then we'll probably have to go through another litigation process of are those tariffs legal. Whatever the new regime is are those legal?

[00:07:27] Pamela Ritchie: Broadly does this affect consumer staples as you look at it, this industry, and I'll ask more broadly Canada, a lot has been pushed under CUSMA to a certain extent, except for various very important sectors. We've been protected from some of those tariffs, certainly. What is sort of the net impact to Canada, would you say, of this ruling?

[00:07:48] Andrew Hall: As it relates to my companies, they were typically relatively insulated from the tariffs that we've seen since last year. The retailers', grocery, they buy products and they sell them in Canada so they're not doing a whole lot cross-border. They were importing products under the reciprocal tariffs but Canada pulled them off last year on food items so there was a relatively small share of their products that were kind of tariff-impacted. That's already kind of gone through the system. It's more of a relative change. I do think there is an element of this is one fewer arrow in Trump's quiver for the upcoming CUSMA or USMCA negotiations. Maybe it gives him a little bit less leverage to make changes to things like supply management in dairy that he's been really focused on or other industries. Of course, as we know, Trump's unpredictable and he tries to get what he wants through means regardless of how much precedent there is for that so it would be, I think, a mistake to get too complacent but this is a benefit.

[00:08:48] Pamela Ritchie: Ultimately, and as you say, to the sectors that you're looking at it's not a meaningful story for the way you're looking and analyzing your companies.

[00:08:57] Andrew Hall: Exactly.

[00:08:59] Pamela Ritchie: Let's go into how your companies, and any company, really, that has been a place to hide out while there's been some market action. We've seen a lot of button pressing and sort of running for the hills for basically hard assets or staples. How, again, some of that market action, this is the AI disruptive waves that are going through the markets right now, how have staples sort of benefited ultimately?

[00:09:26] Andrew Hall: I think it's a pretty unique time in the market for a couple of reasons. Number one, while we've seen a ton of volatility the actual indices have been pretty stable. TSX, S&P are close to or at all-time highs despite a ton of carnage in certain areas of the market.

[00:09:42] Pamela Ritchie: And intraday.

[00:09:43] Andrew Hall: And intraday, and a lot of volatility on the high end and the low end going down. I think what's really happened here is this is a unique risk. Typically we think about staples and utilities as when economic risk is high people want to buy them because the certainty on their earnings is high and the certainty in earnings elsewhere in more cyclical parts of the economy is low. But we're not necessarily seeing that. We're seeing energy work, a more cyclical sector, alongside consumer staples and utilities which have all essentially been working for the last three weeks because, as you say, it's the unique risk that's going on which is that a lot of the technology companies in the market or maybe consulting services, anything kind of white collar, people are concerned about how transformative AI can be to them. The reality is in twelve months you're going to see very little impact, I think, on the majority of companies in the next twelve months from their growth rates.

[00:10:37] But because these companies started with such high valuations people aren't worried about the next six or 12 months. They're worried about, I was paying for cash flow 10, 20 years out on this trajectory of growth and what's going to change there. Inherently, there's less of a floor to the stocks than there would have been, say, low valuation starting sectors because people were looking out for growth previously. If you want stability in your portfolio and you're looking for that, of course, staples and utilities have been a place to hide because the risk of AI disruption in places like that, it's much lower.

[00:11:11] On the staple side, grocery, your shopping list, you've got to eat your food. Maybe it can change how the grocers approach promotions or how, you know, we talk about agentic commerce, there are things on the margin but fundamentally you're still going to buy food from your retailer so it's not likely to be high disruption. On the utility side, of course, AI superpower-intensive. We all see that. These data centres require enormous amounts of power. In Alberta, for example, the requests into the grid for data centre connections are in excess of the entire size of the grid today.

[00:11:48] Pamela Ritchie: So just the demand story regardless if anyone short term, long term, is looking for somewhere to hide, that is just a long term demand. A good problem to have, basically. That's really interesting. On the staple side of things has something been brought forward on the evaluation side of things because people have dumped themselves into these stocks, essentially? Is there anything to be aware of on the valuation side of things, short term, long term? Is it a long term transition, I guess, to some of those more defensive names?

[00:12:19] Andrew Hall: I think for sure these names have seen their valuations increase over the last two or three weeks but what we tend to do is try to look at the historical precedents and see where are we sitting relative to them and then in our fundamental forecast have our earnings estimates kind of change. I think on the former point, valuations have come up relative to the market but valuations across the market are still relatively healthy. On a relative basis, if you compare it to Liberation Day last year when there was a lot of economic fear, or the Silicon Valley banking crisis going back to 2023, or the economic concerns around rates rising in 2022, we're below all of those levels in terms of kind of relative valuation indicators. It does give us a sense for we're not at a scary point where it's probably all priced in but it remains to be seen exactly how the pace of AI adoption will go through. No one has a crystal ball on exactly how that's going to play out.

[00:13:13] Pamela Ritchie: Is a piece of the relative stability that you're talking about compared to some of those others, does it have to do with a ballast from the economy? We've gotten some data out over the last several days on the inflation front, on sort of overall growth front, things look okay. There's the discussion that we've skipped the recession and there's a bit of a footing on the economics. That doesn't mean there isn't a K-shaped economy, it appears there is, does that account a little bit for an underpinning?

[00:13:44] Andrew Hall: I think that's a good point. Coming into the year there was a lot of enthusiasm around the growth outlook is getting better for Canada and for the US, stimulus in the US, Canada, we've got these kind of major projects and after years of sort of anemic growth, pressured by the change in rates, rates have come down. That's typically not the best setup for kind of more defensive companies. You want to be in other areas of the market. But as we've seen this is a unique type of disruption. Like I said, it's not about a recession coming down the pipe for the next 12 months that might disrupt earnings or fundamentals, it's about the long term potential structural change.

[00:14:19] The challenge is, of course, up front it's hard to know ... certainly there's going to be areas of the market that were hit very hard that are going to ultimately not be impacted nearly as negatively, or going to be winners. There's going to be other areas of market that were hit harder. I think unlike a recession it's harder to necessarily have short term indicators that can disprove this sort of long term structural argument versus sort of saying, okay, well, employment data is getting better or rates have come down. Tou do have a bit of a difference in the narrative between the economic underlying story which is, I think, a story of kind of muddling through. It's not gangbusters but we think we've skipped the recession. It's about the long term uncertainty on some of these high valuation companies that are drawing questions and putting that more into the staples.

[00:15:07] Pamela Ritchie: Within the staples, let's go into the grocers for a second here just because it's often what we all do every day. Food prices are high, this has not changed. The inflation that was brought in basically during the pandemic has not really come off in a way that people feel it. There's still complaints and frustrations and so on. What do you do with that within the staple story? It's just going to stay there until we earn more? Will prices come down? Tell us a little bit about what grocers, food retailers are navigating through on that front.

[00:15:39] Andrew Hall: What I would say is first off food inflation in Canada today looks really high, it's close to 5%. There's a bit of an artifact from, if you recall last year the GST, HST sort of rebate piece and that's artificially elevating that. We think on an underlying basis it'd be more than a point below sort of those headline figures but that's still relatively high versus the overall CPI number or historical food inflation which kind of tends to run in the mid-2s. What you're seeing there is it's concentrated in a lot of protein and produce categories which tend to be more volatile. It's harder to say it's here to stay with us but there are some structural things, beef, in particular, has been a huge driver of inflation, coffee, those are sort of a bit more structural in terms of sort of the agricultural dynamics of the countries that produce a lot of that, what they've been challenged.

[00:16:27] Pamela Ritchie: Because no one's going to give up coffee. I mean, you might think about giving up beef but coffee's a staple.

[00:16:32] Andrew Hall: It's true that beef, I think, is more substitutable. You've seen that benefit to other types of protein. Maybe people buy more chicken, they buy more pork, which have also seen inflation just not to the same magnitude. That's why I think when you speak to the grocers they're generally saying that their basket inflation, the way they calculate it, is lower than the CPI you see from Stats Canada. That's because Stats Canada is a fixed basket so it doesn't account for the fact that you're buying pork instead of beef, whereas the grocers would say that's a protein occasion and you've made a different decision and so the net inflation.

[00:17:01] In terms of your question around do we see deflation anywhere and is that a likely reality? I don't think so. I think it's very unlikely. There's very little precedent over 50 plus years of data in Canada for food deflation. Typically, it's around kind of competitive entrance, trying to make a name for themselves maybe when...

[00:17:20] Pamela Ritchie: Or a recession.

[00:17:22] Andrew Hall: Even in recessions, in 2009 food inflation actually was still positive. It's really more so about competitive intensity. I think most of the competitors are already here and they're already doing what they're doing so it's unlikely you're going to see sort of any kind of sustained negative inflation.

[00:17:36] Pamela Ritchie: Tell us a little bit about that. There have been players that moved into groceries. This is X years ago when home delivery came onto it. Some players were better at that. There was an expansion. Pretty stable competitive ... we talk a lot about moats in this area but there's nothing there sort of on the horizon where you see that shifting different players and so on.

[00:17:55] Andrew Hall: I think that's a great point in terms of when we're thinking about the AI disruption risk and how to size it for grocery. E-commerce, 10 years ago, I think, when Whole Foods was bought by Amazon 10 plus years ago, or close to 10 years ago, I think it was in 2017, it was, oh my gosh moment for a lot of the retailers. Here's a big behemoth that's made a lot of inroads in a lot of places, what are they going to do to the category?

[00:18:20] Pamela Ritchie: And knows how to deliver.

[00:18:21] Andrew Hall: Exactly. What we've seen in Canada is penetration rates for grocery delivery almost 10 years later, it's running in the mid-single digit, low single digit across the country.

[00:18:32] Pamela Ritchie: Why is that?

[00:18:32] Andrew Hall: I think it's hard to replicate the shopping experience in store in terms of maximizing your promos, seeing what's on special, picking the right produce. I think that the e-commerce solutions have gotten better but people still like to just go to their grocery store. For most people it is relatively convenient to get there. The relative advantage of going to your weekly grocery shop versus getting it delivered to you is smaller than it might be for other industries.

[00:18:59] Pamela Ritchie: So then layer on top ... this is part of the reason why it's an interesting place to hide from the AI disruption, it sounds like ... so layer on the AI destruction. How disruptable is that? I mean, because you're going to things like logistics, the services side of things. It sounds like we already did that with basically the internet boom, is that fair?

[00:19:18] Andrew Hall: I think that what people are mostly focused on from an AI standpoint today is this notion of agentic commerce, which is really AI shopping on your behalf, making more of the decisions in order to free up some of your own time. We saw the biggest grocer in the US make a partnership with OpenAI late last year. We saw a partnership with the largest grocer in Canada this year with OpenAI and Google over the recent months. What the biggest grocery in the US has said right now is that we're talking a tiny fraction of an infinitesimal part of their sales today are related to agentic commerce so it's more of a question of how big. I do think that the e-commerce and the delivery story is a good benchmark for saying having an AI agent pick my grocery list, my grocery list is 80% the same every week anyways so it's less beneficial that an AI agent is kind of relieving that from you versus, let's say, planning a two-week trip across multiple countries, trying to organize itineraries, pick the best tours. That could actually be hours of work that maybe they can at least point you in the right direction on a lot of things so it's likely to be a more disruptive element for something like that. Just as an example, not calling that one as the number one use case. I think in grocery, other than maybe, hey, I want to try this new recipe and then you ask the AI for a recipe and it gives it to you and then it says just buy me those ingredients. There are occasions where it could be beneficial but it's probably on the margin.

[00:20:50] Pamela Ritchie: But New York Times Cooking does that for you already. You could just go into the app for your restaurant and say print me a list, it does that, or send it somewhere. Let's go into the utility story. This is so fascinating of whether certain utilities and how they're going to be disruptive and how the grid that they are providing and overseeing and regulating and making sure it happens is going to change because of data centres, basically. It can change in a few different ways. This is an area of stability, it's a defensive play, but it's also kind of a growth play as well. How do you see the shifts in that industry?

[00:21:29] Andrew Hall: It's a really interesting kind of intersection of that sort of old economy notion versus new economy. The mantra of Silicon Valley is move fast and break things. The mantra of utilities is be reliable and definitely don't break things. Trying to marry the unique capital intensity of the AI boom with these data centres with grid realities around we were planning for kind of zero demand growth and most of the investment was around kind of storm resiliency related to climate change or maybe transition to lower the carbon intensity of generation and then kind of truing up ageing infrastructure on the transmission side. Now all of that has this data centre piece which is substantial to demand.

[00:22:15] On one hand it's for sure a positive because it's accelerating the growth potential but it is also inviting a lot of political scrutiny. We're seeing that with the Trump administration talking about a special auction in PJM, one of the largest grid operators in the US. The governor of Pennsylvania, which is part of PJM, also putting caps on rates. Typically, political uncertainty is bad for utilities because you buy them for certainty so there's this sort of trade-off of we want to capture this potential growth avenue but do it in a very measured way to not draw the ire of the regulator or the politicians. Affordability, as we know, is the number one political issue right now and peoples' power bills going up is top of mind for them, just like it is in grocery, so it's a compromise.

[00:23:01] Pamela Ritchie: One of the questions is can it be ring-fenced? Can the grid be shared in that sense? Can it be a ring-fenced to protect the rate payers who need to turn their lights on at home and do their dishwasher and all that kind of stuff and have the portion that needs to go to everything from resource development to building the actual data centres themselves. How can it be shared physically, or will it be at some point? Is this the goal?

[00:23:27] Andrew Hall: I think that's the idealized version which is these tech companies are huge, they have a lot of cash and so they'll pay through the nose to get it done and then we'll be able to figure it out. But there are physical constraints on infrastructure and the pace and how many skilled people are available. It is not easy work to build the transmission line for potentially hundreds of kilometres or tens of kilometres long, as we saw with the Ontario line or the Eglinton line. Big infrastructure projects, even if you have a big blank cheque, take time. I think there are those physical constraints that are slowing the pace and that's why you've seen the tech companies try to go into whatever market they see there's a little bit of excess today that they can then kind of latch onto for speed reasons. I think as we kind of move 18 to 24 months ahead, a lot of those areas are going to be tapped out and then it's how fast can we actually build the new stuff, and that is still a challenge.

[00:24:20] Pamela Ritchie: What sort of power is going to be going into the grids over the course of the next 10 years?  Where's it going to come from?

[00:24:27] Andrew Hall: I think nuclear has done a 180, from no new nuclear, we're going to retire it, whether that's Japan, Germany, France was talking about it, to nuclear is the biggest piece. We want it to be a really long term piece because it's stable, it's reliable, and it's clean. The challenge for nuclear is it costs a lot of money and it takes forever.

[00:24:52] Pamela Ritchie: So you just build little ones. Just build the little ones and then they're faster.

[00:24:54] Andrew Hall: That is a possibility, it's still a science project. It's a possibility but it's still a science product. I think we're talking about early 2030s by the earliest for the SMRs to really be commercially available and will remain to be seen how well they perform. You're even seeing some of the SMRS, the small modular reactors, getting kind of upsized because they're realizing that it doesn't make sense to do 100 megawatts or 300 megawatts, just doesn't change the game as much as a traditional nuclear facility that would be probably three one-gigawatt reactors, so three gigawatts of power in totality. That's still probably more of a mid-2030s story.

[00:25:34] I think gas is clearly a bigger part of the story, natural gas. We've gone from are we ever going to build new gas turbines again to certain companies are basically sold out for three to five years on the turbine side. Renewables are still there as the cheapest, fastest way to get power but not reliable power. It's intermittent, whether the sun's shining or the wind's blowing. I think it is an all of the above solution. Renewables are going to have a place in that growth, gas is going to have a place and nuclear is, hopefully, going to take us home further out. For today, to change the facts on the ground today, it's mostly renewables and a bit of gas.

[00:26:13] Pamela Ritchie: Really, really interesting. What do you want investors to know probably about the utility space going forward? There's a story today. There's the piece of the running for the hills going into something that's kind of low vol, essentially, and then there's the other story. There's a great question coming in on the consumer side so we'll go back to staples in a second. What do you think you'd like to leave investors with to think about for utilities because there's real change happening there.

[00:26:38] Andrew Hall: There's real change but I think you should always think of utilities as incremental. Because of the regulated nature, because of way the organizations are set up you can't go from 6% growth to 15% growth. What we are talking about is an acceleration of that growth from kind of that mid-single digit to maybe creeping into the high single digit, depending on the utility. That's meaningful on a base of 5 or 6% going to 8% but it's not going to break out ... even if the rate of investment grows out into the double digits for very specific utilities they're going to need to fund that with equity because these are 9% type ROE businesses so as a result your kind of ability to grow your EPS is still going to be constrained by sort of that financing structure and the regulated returns that the governments have these constructs. It's helpful but I think it's not going to become like a leading growth sector in general.

[00:27:34] Pamela Ritchie: The utilities that exist today, the companies, the ones that are private and public, is it likely that if you put the ability of management to execute aside just for a second, they are all sure things?

[00:27:52] Andrew Hall: I would say no specifically because we go back to the affordability question. The political scrutiny is always there and that's one of the number one things that I do when I'm stock picking within the group is where do I see political risk as higher or lower? Like you say, people typically buy utilities for certainty and safety and if there's an elevated risk of, when I say political risk what does that mean, it means they could go to the regulator and give you a really bad outcome so your 9% ROE becomes ... sure, it's still 9% allowed but your ability to actually earn that return is severely constrained so you're earning 7% which is pretty meaningful change. I think there's always going to be that sort of undercurrent. This, to your point about execution, increases the stress on management teams to be able to manage all these stakeholders. We want to grow faster, we want to support the data centres, we want to support AI but we want to do it in a way that doesn't undercut our consumers, people who vote, and draw the ire of politicians and kill all the growth because then you'd see a moratorium on data centres or something like that.

[00:28:52] Pamela Ritchie: So interesting. The regional story of how that will be managed, ultimately, across the country. Back to the consumer. Are higher consumers making up for potential spending curtailment at the lower end? Really interesting in the K-shaped economy, just the health overall, what do you see there?

[00:29:08] Andrew Hall: That's for sure been the case. We've seen the lower income consumer, they spend more of their paycheque so they are less resilient when there's changes to inflation or changes on sentiment. We've also had a rising stock market, higher income people participate in that, lower income people don't participate nearly to the same degree. That's, no doubt, the story. I would say that there are some green shoots on the lower income side that we haven't seen in the last sort of 12 to 18 months that we're starting to see.

[00:29:36] Pamela Ritchie: Are they all fiscally related?

[00:29:38] Andrew Hall: I think that you're seeing some of it ... inflation is coming down, wages are catching up on the low end and then you do have this, the hope, I think, we are already seeing some of that in kind of Q4 into Q1 on things like restaurants which skew lower income or convenience stores or dollar stores in the US late last year. There's some signs of improvement. The hope is that's going to be carried forward by sort of higher tax refunds, no tax on tips, no tax on overtime for certain types of workers, as an additional stimulus to the lower income consumer. I think that piece of it is still kind of the hope remains to be seen. Even ex that  think things have gotten a little bit better, albeit from a low base.

[00:30:20] Pamela Ritchie: Really interesting. Final thoughts just on those two sectors. You also take a look at telecom which we'll go into another time. Tell us a little bit about what you want to leave with investors sort of this moment, literally, of people running through the hills and looking at these two particular sectors that you follow on a more incremental basis.

[00:30:39] Andrew Hall: I think that, like I said at the outset, these are relatively insulated sectors so the disruption risk from AI is pretty low. What's unique about this disruption risk relative to economy or recession risk is that it impacts things that are traditionally recession resistant as well. That's narrowed the list of companies that might be of interest. In one sense, like in terms of quality companies, but it also has widened it in terms of why are sort of resource companies doing well in a time where people are selling off sort of other things. I think that's because people generally feel like the economy is okay. It's not an economic risk issue, it is a disruption risk issue. Where are we in valuation? Again, we're not at the levels, despite the moves we've seen in the last couple weeks, that we've seen in previous kind of times of stress so it's not necessarily all priced in but remains to be seen exactly how the disruption risk will come. What's the pace of AI adoption? That's still a big question. Nobody truly knows the answer to that. I think, as we said on utilities, these are incremental stories. From an earnings standpoint, I think you're going to see relatively consistent earnings growth with history, probably a bit of an acceleration on the utility side and more similar for the staples.

[00:31:53] Pamela Ritchie: Really, really interesting, of course, both at the heart of sort of the hard asset story right now.

[00:31:57] Andrew Hall: Exactly.

[00:31:59] Pamela Ritchie: Andrew, thank you very much for joining us. Have a great weekend and we'll see you next time.

[00:32:03] Andrew Hall: Thank you very much.

[00:32:05] Pamela Ritchie: Coming up on Fidelity Connects over the next few days, we shoot to the next week, to Monday, Fidelity Director of Global Macro, Jurrien Timmer, is back with the macro themes on his radar to set you up for the trading week ahead. There's some big earnings next week that could certainly affect the marketplace.

[00:32:22] On Tuesday of next week portfolio manager Reetu Kumra, she shares the alternative investing themes that she is tracking and what they could mean for diversified portfolios in the current environment, very much focused on Canada because the fund that she manages is absolutely focused on Canada. The webcast will be presented in English and have live French audio interpretation.

[00:32:43] Next Wednesday, first at 10:30 Eastern time, join Philippe Poulin, he is District Vice President of Sales, for a French language webcast. Phil's going to be discussing how Fidelity Preferred Program can elevate your client offering and how automatic fee rebates and pricing protection from negative market action work together to deliver meaningful long term value for investors. Then at 11:30 in English District Vice Presidents of Sales, John Hollingshead and George Novachis, are going to be sharing stories from the road, drawing on real conversations with advisors from across this country. They are going be exploring common themes emerging in client discussions including how cost, performance, and expectations are showing up in client meetings, and how different advisor models are approaching some of those conversations. You'll want to tune into those. Thanks for joining us here today. Have a great weekend. I'm Pamela Ritchie.