Good Morning. In this newsletter, we'll delve into several key economic developments and financial concepts. First, we'll examine the latest Canadian economic update, focusing on recent job market trends and their implications for the country's economic outlook. Next, we'll explore the ongoing Canada Post strike and the increasing use of AI in clinical trials. Shifting gears, we'll analyze Bell's strategic expansion into the U.S. fiber market through its acquisition of Ziply Fiber, a move that significantly broadens its North American footprint. Finally, we'll conclude with a finance concept spotlight on operating leverage, explaining its importance in business operations and investment decisions, complete with real-world examples and practical calculations.

ECONOMIC UPDATE

CANADIAN ECONOMIC UPDATE

Canada added 14,500 jobs last month, falling short of the anticipated 25,000, further straining the labor market and keeping the unemployment rate steady at 6.5%, a near 34-month high. This weaker-than-expected job growth reflects the ongoing challenges of a high-interest rate environment and persistent inflation, which have led businesses to scale back investments in hiring and recruitment. Despite this, the labor market showed some resilience, as average hourly wages for full-time employees rose 4.9% year-over-year. To stimulate economic growth, the Bank of Canada has implemented several rate cuts, bringing its key policy rate down to 3.75%. However, confidence in additional rate cuts this December has diminished in light of the latest jobs report.

Overview of the Canada Post Strike

On November 15, 2024, Canada Post, a leading postal service providing mailing services to over 17 million addresses and over 8.4 billion delivered items to households across Canada, went on strike following a year-long negotiation with the Canadian Union of Postal Workers (CUPW). The CUPW represents approximately 55,000 Canada Post workers, which is around 85% of the total employee count at Canada Post. This strike commenced after workers demanded better pay, safer working conditions, and other contract improvements.

Implications for the Canadian Economy

The strike has far-reaching repercussions for both businesses and consumers across Canada. With mail and parcel processing suspended, many businesses face significant supply chain disruptions, particularly those dependent on timely deliveries to maintain operations and fulfill customer orders. For example, customers purchasing from Canadian small businesses are likely to experience delays as merchants pivot away from Canada Post to alternative couriers or private delivery services, which are typically more expensive. These higher delivery costs place additional pressure on businesses, especially smaller ones, making it harder to meet revenue targets. To offset the impact on their bottom line, businesses are forced to absorb these costs internally or pass them on to customers through higher prices. In most cases, these increased costs are passed on to customers, deterring consumer spending, especially in discretionary categories and further straining the economy.

Current Status and Next Steps

In response to the strike, the Canadian government has appointed a special mediator to facilitate negotiations between Canada Post and CUPW, underscoring the urgency of reaching an agreement due to the significant short- and long-term impacts on the Canadian economy. The situation draws parallels to the recent railway strikes, where the government intervened with a back-to-work order to mitigate economic disruption. A similar measure could be considered here if a labor agreement is not reached swiftly. This is particularly critical with the holiday season fast approaching, as failing to resolve the strike in time could lead to widespread logistical chaos during one of the busiest periods of the year.

MARKET TREND

INCREASING USE OF AI IN CLINICAL TRIALS

Current Landscape

The conversation surrounding AI has continued to grow but now there’s a wave of new innovation entering the healthcare space. Pharmaceutical stocks have seen growth close to 16% year over year and are expected to continue to grow. With clinical testing needed to drive continued innovation, the use of AI has been integrated in patient recruitment, trial design and data analysis. While it’s in the early adopter stage, this trend fuels the closing in the gap in the infrastructure needed for clinical trials.

Early Adopters

Dandelion Health

As one of the first players in the clinical trial tech-space, they have leveraged an AI-driven marketplace and GLP-1 data library that has identified clinical data for over 10 million patients. A proof-of-concept study, conducted on 4 million patients in six weeks, demonstrated AI's potential to match clinical trial results, such as those from Novo Nordisk’s cardiovascular risk research on GLP-1s. Their successful results have led to unmatched results and optimism surrounding broader industry transformation

Atropos Health

Atropos Health is another use case of AI-success in the private markets. Their ChatRWD has enabled a data network of over 300 million anonymous patient records that produce observational studies in minutes. They have achieved a score of 79.8 on the Real World Fitness Score recognized globally by physicians. Their push towards evidence-based healthcare has already closed 18% of the knowledge gap.

Evidence shows that there has been a lot of innovation among private companies that have influence the large cap players. Its traction has started to widespread as Pfizer (NYSE:PFE) announced research partnership with AI-focused firms while Novartis (NYSE: NVS) has built an AI tool-kit to optimize design.

Implications

AI in healthcare is transforming the industry on a global scale, with large implications for the healthcare industry as a whole. AI is bridging gaps and improving access to care by making tools services like diagnostics and telemedicine (providing medical care remotely) available in underserved areas. Economically, AI is also boosting efficiency in healthcare systems as it can handle repetitive tasks, make diagnoses more accurate, and help lower costs. In the long term, AI can significantly reduce the financial burden on healthcare systems by preventing diseases through early detection and optimizing resource allocation. However, the use of AI can also raise challenges, like disrupting jobs in healthcare, and creating a need for retraining programs. At the same time, industries like biotech and pharmaceuticals stand to benefit, fostering AI-driven growth and innovation. AI will undeniably reshape the healthcare industry, but its full impact will depend on how we navigate the challenges and opportunities it presents.

MERGER AND ACQUISITION

BELL SEEKING TO EXPAND ITS FIBER FOOTPRINT IN THE U.S

Deal Value and Structure

BCE the parent company of Bell Canada, has announced the acquisition of U.S.-based Ziply Fiber for an enterprise value of approximately C$7 billion. The transaction is fully funded with cash of CAD $5.0 billion and the assumption of Ziply's net debt of CAD $2.0 billion. Through this acquisition, Bell receives a strategic entry into the U.S. telecommunications market, serving to expand its fiber footprint across North America.

Company Backgrounds

Bell Canada operates within a diversified field in Canada's telecommunication sector, offering a range of services such as internet, television, and other wireless technological services. Recently, it has been expanding its fiber networks within its vision to be number one in North America in the fiber market.

Ziply Fiber, headquartered in Kirkland, Washington, provides fiber internet services in the Pacific Northwest, serving markets in Washington, Oregon, Idaho, and Montana. Its state-of-the-art fiber internet infrastructure has established the company as a leader in suburban and rural markets relatively that underserved by competitors.

Deal Financing

To fund the transaction, BCE plans to use proceeds from the recent sale of its 37.5% interest in MLSE to Rogers Communications, which netted CAD $4.2 billion. The rest of the funding will be generated through a discount to the DRP treasury. Along with the financing transaction, BCE will freeze dividend growth to ensure that its dividend payout and net debt leverage targets remain aligned. It is important to note that the deal is also immediately accretive to Bell’s operating cash flow considering the recent sale of its majority interest in MLSE.

Strategic Rationale

The main rationale for Bell is to create a natural expansion opportunity beyond the current operating market of Canada. As of November, Bell serves multi-gigabit speed fiber internet services to 7.7 million households across Canada, however the Ziply acquisition immediately unlocks 1.3 million American households, with plans to expand to 3 million additional households in the next 4 years. This results in a ~50% expansion to Bell’s current fiber internet customer base and would solidify their position as the third largest fiber network in North America. Drawing conclusions on this movement, Bell is further accelerating their transition from a sports-media targeted customer base, to prioritizing their fiber-optics service base.

This growth comes at minimal risk compared to other geographies or strategies due to the attractive competitive dynamics. According to Bell calculations, over 93% of Ziply’s network is underpenetrated, with one or fewer gigabit-capable broadband competitors. Furthermore, there is a strong customer conversion opportunity, with only 51% of households in the US powered by fiber internet, in contrast to 75% of households in Canada. Given that this industry faces large barriers to entry, with expensive setup and regulatory costs, it’s possible that Bell can convert this lack of competition into an area of efficient scale to block future competitors and secure a long-term source of profitability. Finally, given that the US has an underpenetrated fiber internet market, the ARPU (Average Revenue Per Unit) growth in the country is far stronger than regions within Canada, making the rapid expansion far more attractive for future profitability.

Conclusion

Overall, by expanding into a new, underserved market, with rapid expansion plans to secure customers for the long run, Bell is generating a significant source of profits to continue their rapid growth.

QUFN FINANCE CONCEPT SPOTLIGHT

OPERATING LEVERAGE

What is Operating Leverage?

Operating leverage is a measure of the degree to which a company’s operating income increases relative to increases in revenue. You can think of it as companies with a higher percentage of their fixed costs having high operating leverage. In contrast, companies with a lower rate of fixed costs and higher variable costs have lower operating leverage. Since fixed costs do not change following changes in revenue, high operating leverage amplifies the impact of changes in revenue. The formula for calculating operating leverage is as follows:

Degree of Operating Leverage = (Q * CM) / (Q * CM - F)

Where:

Q = Unit quantity

CM = Contribution Margin (price – variable cost per unit)

F = Fixed operating costs

Why Does It Matter?

Operating leverage is an important metric for a company to understand. It allows them to determine their break-even point and, therefore, set their selling prices to generate a profit. Firms can examine operating leverage compared to industry standards to determine points of optimization within their operations. If, for example, a company’s operating leverage is lower than the industry standard, they may want to invest more into fixed costs to increase the impact of revenue growth.

It is important to understand that higher operating leverage is not always a positive metric for companies. Firms with high operating leverage are particularly susceptible to the business cycle and recessionary periods. If a significant portion of a company’s costs are fixed, those costs will not fall in sync with decreases in revenue, meaning the company’s bottom line could be significantly impacted during periods of faltering sales, often generating significant fluctuations in quarterly reports. This contrasts with a company showing lower operating leverage where the higher percentage of variable costs means overall costs are more significantly correlated with decreases in revenue, therefore relieving pressure on the bottom line during a period of difficulty.

High operating leverage can also have an impact on an investors viewpoint when attempting to value a company. More operating leverage means that assumptions about revenue growth become extremely critical. Small forecasting errors could result in significant impacts on free cash flows projections and therefore intrinsic valuation. Investors should keep this in mind and account for it within their margin of safety when it comes to making and investment decision. Along with this, as mentioned earlier, high degrees of operating leverage make cash flow streams riskier as they are more susceptible to the cyclical nature of a company. Investors should also take this into account before making an investment decision.

Real World Examples

Some industries that are typically characterized by higher operating leverage:

Airlines

Fixed costs include Aircraft leases, aircraft maintenance, airport fees
Variable costs include fuel and wages

Manufacturing

Fixed costs include Factories, R&D and machinery
Variable costs include labour and raw materials

Pharmaceuticals

Fixed costs include R&D and clinical trial expenses
Variable costs include drug production costs

Lower operating leverage industries:

Retail

Fixed costs include Rent, wages, utilities
Variable costs include inventory and some variable wages

Restaurants

Fixed costs include rent and utilities
Variable costs include Food ingredients and wages tied to service levels

Consulting

Fixed costs include Rent, IT infrastructure, some wages
Variable costs include wages tied to consultants staffed to projects

Degrees of operating leverage are extremely industry specific. When determining if operating leverage is high or low, absolute values are irrelevant, and the industry standard is what should be used as a comparison tool.

RECRUITING QUESTIONS

BASIC UNDERSTANDING

1. Walk me through the three financial statements.

Income Statement: Shows a company’s revenue, expenses, and net income over a period.
Balance Sheet: Shows a company’s assets, liabilities, and equity at a specific point in time.
Cash Flow Statement: Reconciles the income statement and balance sheet by showing cash inflows and outflows from operating, investing, and financing activities.

2. How do the three statements link together?

Net income from the income statement flows into retained earnings on the balance sheet and the top line of the cash flow statement.
Changes in working capital on the cash flow statement are reflected in current assets and liabilities on the balance sheet.
Depreciation, capital expenditures, and financing activities affect cash flow statements and link to the corresponding balance sheet items.

Scenario Based

1. How would a $10 depreciation expense affect the financial statements?

Income Statement: Operating income decreases by $10, assuming a 30% tax rate, net income falls by $7.
Cash Flow Statement: Add back $10 (non-cash expense) in operating activities, so cash increases by $3.
Balance Sheet: Net PP&E decreases by $10, cash increases by $3, and retained earnings decrease by $7.

2. How does an increase of $10 in inventory, purchased with cash, affect the three financial statements?

Income Statement: There is no immediate impact on the income statement because purchasing inventory does not affect revenue or expenses until the inventory is sold.
Cash Flows Statement: The $10 increase in inventory is recorded as an outflow in operating activities. This decreases cash flow from operations by $10.
Balance Sheet: Inventory increases by $10, Cash decreases by $10. These are both assets which balances out, and Assets = Liabilities

3. Operating Leverage

Company XYZ has fixed costs of $100,000, variable costs of $20 per unit, and sells its product for $50 per unit. In its most recent quarter, the company sold 5,000 units.

a) Calculate the contribution margin per unit.

Contribution Margin per Unit = Selling Price per Unit – Variable Cost per Unit

$50 - $20 = $30.00

b) Calculate the degree of operating leverage (DOL) at the current sales level.

Degree of Operating Leverage (DOL) = Contribution Margin / Operating Income (EBIT)

$150,000 / [(50*5000)- (100,000+(20*5000))] = 3.00