May 9, 2017

Jennifer Radman's Top Picks: May 9, 2017

BNN Bloomberg

Jennifer Radman , BNN

Jennifer Radman, Vice President and Senior Portfolio Manager, Caldwell Investment Management

FOCUS: U.S. Large Caps

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MARKET OUTLOOK:

We believe the most pressing issue for Canadian investors is the amount of closet index product in this country. A recent study showed that 37 per cent of all mutual funds in Canada are closet indexers. Applying this percentage to the amount of assets in Canadian equity mandates, we estimate there is a minimum of $275 billion of Canadians’ hard-earned assets invested in strategies that are structurally positioned to underperform (we say minimum because there is likely a lot more in separately managed account programs and institutional mandates). Closet indexers take minimal bets relative to the market index — if a manager studies company XYZ and believes the stock will not perform well going forward, but company XYZ is the largest component of the index at five per cent, for example, a closet index manager might buy only a three per cent weight. While from that manager’s perspective the portfolio is underweight the market in company XYZ, our question would be: Why own any at all?

Top Picks:

Apogee (APOG.O)

About: Apogee designs, manufactures, and installs architectural glass solutions and aluminum framing for non-residential buildings, with a particular focus on office buildings. Apogee has strong market share positioning in each of their segments and generally operates in fragmented markets. Their products are highly customized and used in many state-of-the-art non-residential buildings.

Thesis: There are strong industry and company-specific drivers for Apogee that we believe will bode well for the company.

Industry specific - Strong commercial construction growth (mid-single digit growth) expected for next 2-3 years supported by macroeconomic data (tight U.S. office vacancy rates; consistently solid Architectural Billings Index). The importance of architectural glass continues to grow as it is visually appealing, cost/energy-efficient, and utilizes natural daylight.
Company specific - expected to grow above the market on several growth initiatives: a) penetration of mid-sized buildings (had historically targeted high rises); b) geographic expansion of underpenetrated areas; c) retrofit initiative where they restore existing buildings for visual appeal and energy efficiency (had historically targeted new buildings only); d) expansion through M&A. This continued growth is enabled by strong competitive advantages, namely product expertise, execution and scale. They are also undervalued considering we are at a sweet spot in the cycle.

Steris (STE.N)

About: Steris’ growth is primarily tied to surgical procedure volumes. The company sells equipment to hospitals (tables, lights, trays in the O/R), and provides services to hospitals, medical device and pharma companies (surgical instrument cleaning, sterilization and repair and medical device sterilization). The company acquired Synergy in late 2015, a UK firm that is a leading provider of outsourced sterilization services to US hospitals.

Thesis: We like Steris for the following reasons:

Steris guides to mid-high single digit long-term revenue growth driven by increasing surgical procedures (aging demographic), market share gains and acquisitions. The bottom line will grow even faster given that management’s ability to improve operations and divest low margin businesses.
Steris has been largely misunderstood by investors after their large and complex acquisition of Synergy in late 2015, which has resulted in muted stock price performance. However, this is a very strategic acquisition which positions Steris well for the coming trend of sterilization outsourcing by hospitals.
Steris trades at a relatively attractive multiple versus other medical device peers that offer a similar growth trajectory.

Cognizant Technology Solutions (CTSH.O)

About: Cognizant is a leading provider of IT outsourcing and consulting services.

Thesis: The Board put out a new strategy around expanding its digital capabilities, growing margins and returning capital to shareholders. Revenue growth should also re-accelerate as headwinds in its Financial Services and Health business, which make up around 70 per cent of revenue, subside. The stock generates a healthy cash flow and we expect these catalysts to continue to drive shares higher.