Full episode: Market Call for Thursday, July 13, 2017
Jerome Hass, portfolio manager at Lightwater Partners
Focus: Canadian mid-caps and long-short strategies
At Lightwater we have a saying: “We don’t care what the markets do because we always have our fund structure in place.” What we mean is that our portfolio is always long and short equities at the same time in the form of pair trades. We are always hedged against the direction of the market. Markets have been very volatile for quite a while and are likely to remain so. While many investors feel like the markets have been going straight up, the TSX is down year to date. In the U.S., five tech stocks have accounted for 40 per cent of the S&P 500’s gains. Here in Canada, we have rising interest rates, falling oil prices, and a cooling housing market. So we don’t claim to know which way the markets are going, but we don’t need to know to be successful.
There are three types of major risks when investing in stocks: Market risk, industry-specific risks, and company-specific risks. We focus our research on company-specific risks by examining their valuation, management, business model or growth potential. We use pair trades to “go long” a company and “sell short” another company in the same sector. This technique allows us to largely eliminate two of the three major risks in stock investing, namely market risk and industry-specific risk. We think this is a far more precise way to invest as it isolates the company-specific risks of the long versus the short positions. We like to sleep well at night, and so do our investors.
ZCL COMPOSITES (ZCL.TO)
ZCL Composites is the largest supplier in North America of fibreglass storage tanks for gasoline stations, water and wastewater markets. Fibreglass tanks offer a number of advantages over steel tanks (previously the dominant choice): They’re corrosion-free, double-walled, and environmentally friendly. About 40 per cent to 50 per cent of installed tanks are still steel, so ZCL’s growth is primarily driven by replacements. There are 110,000 tanks in North America older than 30 years and 340,000 tanks older than 20 years. Given that ZCL currently sells only 7,500 tanks per year, based on its existing market share, that equates to eight years of demand for 30-plus-year-old tanks and 25 years for 20-plus-year old tanks. Hence, we like the long-term growth path of ZCL just relating to gasoline tank replacement. Recent initiatives into water storage will provide further growth. We like ZCL’s high barriers to entry, high margins, 60 per cent market share, as well as its stable business model: It has been profitable for 24 consecutive quarters. We added to ZCL only July 11, 2017 at $13.21.
SPIN MASTER (TOY.TO)
Spin Master is a Toronto-based toy company that is now the fifth largest by sales in the United States and in the top 10 globally with sales in over 60 countries. The company is expected to report on August 1, and investors will be focused on guidance for the upcoming holiday season. While Hatchimals continue to grab headlines, the company has a large portfolio of globally successful franchises and other toys. “Hatchimal Colleggtibles” are in high demand and are already hard for parents to get their hands on. “Paw Patrol” is one of the top-ranked preschool animated shows around the world; it is now in its fourth season and began a full rollout in China this month. We think the pipeline of shows, toys, and licences are large enough to maintain double-digit growth. The stock is up 17 per cent YTD and is now trading at 19x 2018 EPS estimates. Buying shares of Spin Master for the grandkids is also a great way to introduce them to the stock market through a company that kids can relate to. We last added to our position on January 30, 2016 at $32.
LONG: CINEMARK (CNK.N) / SHORT: CINEPLEX (CGX.TO)
The motivation for this pair trade lies mainly on the short side: We think Cineplex is overvalued relative to U.S. comparables and “over-owned” by Canadian long-only funds. When analyzing Cineplex, investors focus on the upcoming film slate. As a hedge fund, we mitigate as much risk as possible. In this instance, the risks on the short side are blockbuster movies. To offset this “industry-risk,” we are long Cinemark. Both companies show the same movies on both sides of the border, so the box office risk is eliminated. The pair trade allows us to focus on the mispricing of both securities. Cineplex is currently trading at about twice the valuation of Cinemark: CGX is at 27.5x 2017 P/E and 13.0x EV/EBITDA, while Cinemark is trading at around 15.3x 2017 P/E and 6.5x EV/EBITDA. We last added to our Cineplex short position on December 31, 2015 at $47.65. We last added to our Cinemark long position on October 16, 2015 at $33.84.
FUND PROFILE: LIGHTWATER LONG SHORT FUND
PERFORMANCE AS OF MAY 31, 2017:
- 1 month: Fund* 0.05%, Index** -1.52%
- 2 years: Fund* 4.16%, Index** 1.11%
- 3 years: Fund* 6.92%, Index** 1.67%
- 5 years: Fund* 12.20%, Index** 5.92%
** Index: S&P / TSX Composite Index
* Returns provided are net of all fees and expenses. Two-, three- and five-year figures are annualized returns.